We recently published an article in which we gave a preview on what to expect from the forthcoming first quarter earnings report of Synergy Pharmaceuticals (SGYP). While the May 10th report and conference call will be closely watched for signs of progress on the commercialization efforts for constipation drug Trulance, the real action is likely to come a month later when, on June 12th, the company is scheduled to hold its Annual Meeting of Stockholders.
The annual meeting looks set to produce fireworks, thanks to a series of worrisome resolutions proposed by management that would expand their pay and options pool, as well as authorize a substantial expansion of the maximum allowable share count. These proposals, coupled with an apparently stalled Trulance commercialization program, have tipped long-held shareholder dissatisfaction into a nascent revolt: a group of shareholders is now seeking to coalesce sufficient voting power to vote down management’s proposals and to force a change of strategic course.
In this article, we discuss management’s proposals, the budding shareholder uprising, and what ought to happen in June. We contend that the effort to stop the proposals, as well as to force management to look for a large company that could better manage commercialization efforts, is in the best interest of shareholders and the company’s future.
Management Leans into Self-Dealing Image
Synergy’s management has frequently shown a tin ear when it comes to messaging. The most egregious recent example of this came during the Q3 2017 earnings season. During the earnings call, CFO Gary Gemignani boasted of the company’s rude financial health thanks to its having inked a private loan agreement that would give it access to $300 million broken into a number of tranches. The first tranche of $100 million had already been tapped at the time of the call.
Then, just a day later, Synergy announced a dilutive share offering that crushed the share price and shattered all bonds of trust between management and shareholders. While the CEO, Gary Jacobs, was pushed to step down after that debacle, Gemignani kept his position and Jacobs shifted to the role of chairman of the board. That is far from a slate-cleaning, but new CEO Troy Hamilton subsequently made strong indications that the company’s direction would indeed change under his leadership, with management focused on protecting and increasing shareholder value.
Thus, it is unsurprising that the market has reacted negatively toward the resolutions proposed by management to be voted on at the June annual meeting. The resolutions appear to continue the pattern of self-dealing and dilutive financing that marked Jacobs’ tenure at the helm.
Two Bad Compensation Ideas
Two major resolutions going before the shareholders at the annual meeting deal with management compensation and incentives:
Advisory Vote on Compensation
While the specific compensation packages granted by Synergy are ultimately at the discretion of the company’s compensation committee, shareholders are entitled to an advisory vote. Given management’s tendency to act in its own interest first, a vote on this measure either way will have little meaning. Thus, the first resolution, the advisory vote on compensation, is not a matter of importance, though a negative vote would undoubtedly shake management to a degree.
Proposal to Expand Equity Compensation Pool
The second major proposal is one that could actually deliver a serious blow to management if voted down by rebellious shareholders. The proposal calls for the approved number of shares available for equity compensation to be expanded from 9 million shares to 19.4 million. Management offers the following justification:
“We believe we must continue to offer a competitive equity compensation plan in order to attract, retain and motivate the industry-leading talent imperative to our continued growth and success…As of April 18, 2018, we had 3,338,750 shares available for grant under the Plan. Based on historical usage, as discussed below, if we do not increase the share reserve during 2018, we estimate that we would need to make significant changes to our equity award practices in order to conserve the share reserve balance until the time of our 2019 annual meeting.”
In essence, management is asking that its equity compensation pool be more than doubled so that they can keep the best talent and motivate performance. The obvious problem with the proposal, of course, is that management has largely failed to live up to its performance goals while damaging shareholder value through poor commercial execution and dilutive share issuance. Until management can demonstrate that it can do more than oversee a deteriorating stock price and ongoing cash burn, there is little justification for handing them more shares to issue themselves at fire-sale prices.
Proposal to Increase Share Count Sparks Worries
The other major proposal on the docket for June 12th is a vote to “effect an increase in Synergy's authorized shares of Common Stock from 400,000,000 to 500,000,000. We currently have authorized 400,000,000 shares of common stock.” That represents a 25% increase in the approved number of shares the company can issue. Considering that it has already undertaken considerable dilution in recent months, the fear of more of the same is not unjustified.
But why would Synergy need to worry about increasing the number of approved shares? After all, it had $137 million at the beginning of 2018 and could tap a loan tranche worth $100 million in non-dilutive funding at will. That should be enough cash to easily pass mid-2019, even without the improvement to revenues and cost of sales that are expected throughout this year. Stranger still, there are only 246.7 million shares currently outstanding. Adding all outstanding options, senior convertible notes, and warrants to the share float still only brings us to 311.6 million shares. That leaves 88.4 million shared authorized but unissued. More than doubling that count seems like a rather bizarre move.
The answer to the conundrum is actually quite simple: management is moving to protect itself from a takeover attempt. Management couches its justification for the proposal in general language about how such shares might be used, but its focus on the possibility of a takeover is made quite explicit:
“The increase could have an anti-takeover effect, in that additional shares could be issued (within the limits imposed by applicable law) in one or more transactions that could make a change in control or takeover of us more difficult. For example, additional shares could be issued by us that may dilute the stock ownership or voting rights of persons seeking to obtain control of us, even if the persons seeking to obtain control of us offer an above-market premium that is favored by a majority of the independent stockholders. Similarly, the issuance of additional shares to certain persons allied with our management could have the effect of making it more difficult to remove the current management by diluting the stock ownership or voting rights of persons seeking to cause such removal. Our board of directors is not aware of any attempt, or contemplated attempt, to acquire control of us and this proposal is not being presented with the intent that it be utilized as a type of anti- takeover device.”
So Synergy’s management is happy to admit that it is more than willing to dilute the current shareholders severely in order to maintain their control. Such a “poison pill” used to be more common among publicly traded companies, but have fallen out of vogue due to widespread disgust at company managers acting in what is manifestly their own interest and at the expense of the shareholders.
Given Synergy’s poor management thus far, shading of the truth, and continued struggles to compete with Allergan’s (AGN) much large salesforce and resources, a takeover would likely be cheered by the vast majority of investors. No shareholder who cares about the long-term value of their investment would reasonably vote for such a measure.
Shareholder Revolt Starts Small
Synergy shareholders have largely taken their lumps in stride to date. But it seems the proposals put forward by its management team have finally tipped some into open rebellion. A campaign has started in grassroots fashion to coalesce sufficient voting power to deny management’s requests, and to get an activist player into the mix. According to the group’s sparse mission statement:
"We want the company to partner, to merge or to be sold. Going alone has caused our investments to collapse and put in question our future. In less than 72 hours we already have 6.8 million shares pledged. We are in the process of contacting several hedge funds and activists. Our first options are Bill Ackman and Carl Icahn. By joining you agree to support such effort and be contacted in case we do decide to take action. Also by joining you agree to have your voice represented at the annual meeting to address our concerns."
Trying to get Ackman or Icahn interested as a small class of shareholders is a bit unrealistic, but that is not to say the effort cannot bear fruit to some extent. Certainly, it will shine a greater spotlight on management’s bad proposals and likely galvanize a higher percentage of opposition.
It is difficult to know how the major shareholders will vote on the resolutions, but it seems likely that they will look askance at the compensation and share count expansion proposals. It is certainly in shareholders’ interest to prevent management from entrenching itself against a potential takeover effort. Indeed, such an occurrence could at last unlock the potential of Trulance that Synergy has thus far squandered to a fair degree.
Trulance is a valuable drug and, with projected peak sales of $500 million, it is worth considerably more than Synergy’s entire market cap. There is a clear opportunity in this stock. The current management might be able to deliver, but it looks increasingly like it cannot unlock Trulance’s full potential. The annual meeting will allow opposition to coalesce and apply pressure to change direction. Taking on a partner or putting itself up for sale is now in shareholders’ best interests.
Disclosure: I am/we are long SGYP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.