Fortress Biotech (NASDAQ:FBIO) continues to make strides since bottoming out in December. Up a hefty 134% since my last coverage on December 19, plenty of upside remains for the stock. This is because Fortress’s strong jump at the end of January had nothing at all to do with my thesis for buying the stock in the first place. That thesis still applies. Let’s begin with a mention of why Fortress exploded higher followed by a quick review of my previous bull case that still remains intact.
On January 31st, Fortress announced that one of the companies it owns, which it in fact founded, Caelum Biosciences, signed an agreement with Alexion (ALXN) to advance CAEL-101 for amyloidosis. An interesting side point here is that Caelum had already signed a preclinical research agreement with Columbia University on March 12th 2018 to advance this same product. See page 19 of its previous quarterly report for reference. By June the drug had already shown promising Phase I results, with 63% of patients showing organ response and no patients showed organ progression, meaning amyloid buildup in the organs had stopped for all patients. Unfortunately Phase I trials are often ignored because they are early stage, but this was enough to spur Alexion to make a move. So half a year later here we are, and Alexion stepped in and basically offered to buy all of Caelum if Phase II trials succeed. The initial upfront payment of $60M comes with potential milestone payments of $500M.
Judging by the market move since the announcement was made (in fact from 3 days before the announcement was made, as movement apparently started 2 days beforehand), the jump makes perfect mathematical sense. From January 28th until now, Fortress’ market cap has jumped by about $60M, the same amount that Caelum received upfront from Alexion. That means that if Phase II succeeds and CAEL-101 makes it to market, then we’re looking at another jump of up to $500M in market cap. That depends on whether Alexion exercises the option to buy the whole company.
A unique feature of this deal as it relates to Fortress shareholders is that if Alexion does acquire Caelum, the Fortress shares won’t be converted to Alexion shares. They would be the recipients of cash paid by Alexion and Fortress would continue developing its other assets.
Which brings me to the initial reasons I was bullish on Fortress in the first place. First of all, the sale of its National Holdings (NHLD) shares to B. Riley Financial (RILY) was certainly a wise decision given that the stake got Fortress mired in needless controversy that ultimately ended up severely hurting its stock price. Plus, its majority stake was a financial drain on Fortress besides, with a loss from National operations of over $100M in 2017 (see page 37). The final stage of the sale of National went through on February 12th. You can read about the details of this in my previous article on the topic. Suffice it to say here, that the controversy brought Fortress shares down way below market value, exacerbated by bad timing together with a broader bear market, especially in risk assets. The move since has helped corroborate that assessment.
Here’s why there is still plenty of room to run though. First of all, all the Alexion deal did was capitalize the upfront payment of $60M into Fortress’s market cap. It's just accounting for added cash. Aside from that, my initial reason for buying the company in the first place was as a more balanced play on IV tramadol and Avenue Therapeutics (ATXI). Avenue already has a deal to be acquired for $13.92 a share by Indian pharma Cipla if IV tramadol is approved, subject to conditions outlined in my previous piece on Fortress as well. This thesis has nothing to do with the recent 137% price rise. It is completely unrelated, and therefore not at all priced in at this point.
There have been further developments on this front. Earlier this month, Cipla took another step towards acquiring Avenue by purchasing a 33% stake in its capital stock at $6 a share. This had virtually no effect on its share price, which will be entirely dependent on approval for IV Tramadol. The final Phase III study is ongoing and will be completed by June, with a primary outcome measure simply of adverse events.
Further, going back to the Alexion development, this can be seen not just as adding value in a positive sense to Fortress, but also as a derisking element to the Avenue and IV Tramadol value proposition. Meaning, prior to Alexion’s deal with Caelum, much of Fortress’ value was dependent on a positive outcome for IV Tramadol. Now, even if IV Tramadol fails to gain approval, or more likely gains approval but only with a post-approval REMS requirement, which would negate Cipla’s deal to acquire Avenue for $13.92 a share even if IV Tramadol makes it to market, then the consequent fall in Fortress would now be much less severe with Alexion already in the picture and $500M in potential milestone payments supporting the share price.
All in all, my earlier thesis was that Fortress was the less risky way to play Avenue Therapeutics. Now, with the Alexion/Caelum development, Fortress is not only the less risky Avenue play with less downside on an IV Tramadol failure, but now has more potential upside overall than Avenue alone, on the success of CAEL-101 Phase II.
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Disclosure: I am/we are long FBIO. 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.