A Retail Investor's Look At Prometic's Refinancing Plan

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About: Prometic Life Sciences Inc. (PFSCF)
by: C. C. Abbott
Summary

On April 15, Prometic announced their refinancing plan.

The stated purpose of the plan is to restructure the debts, to reduce interest and other payment obligations, and to raise sufficient cash to extend the runway.

The plan was described as the only option available to avoid liquidation while "providing our existing shareholders an opportunity to benefit from our future success”.

I take a closer look at the plan, and I conclude that not all Prometic shareholders will fare the same under the refinancing.

The non-SALP, non-Consonance, existing shareholders won't get a fair shake.

The Refinancing Plan

On Monday April 15, Prometic life Sciences (OTCQX:PFSCF) announced their refinancing plan. All the prices in this article are in Canadian dollars.

Here are the highlights:

  • an offering of common shares of Prometic (the “Common Shares”) on a private placement basis led by Consonance Capital Management (“Consonance”) at a per share price rounded to the nearest 5 decimals of $0.01521 (the “Transaction Price”) for aggregate gross proceeds to Prometic of $75 million (the “Private Placement”);
  • the conversion of approximately $229 million of the outstanding debt of Prometic owned by Structured Alpha LP (“SALP”) into Common Shares (the "Debt Conversion") at the Transaction Price, comprising all but $10 million of SALP’s outstanding debt;
  • the adjustment of the per warrant exercise price of certain outstanding Common Share purchase warrants of Prometic held by SALP to the Transaction Price (the "Warrant Repricing");
  • a rights offering to all shareholders of Prometic whereby each shareholder will receive one right for each Common Share held, with each right entitling the holder thereof to subscribe for 20 Common Shares at a price per share equal to the Transaction Price (i.e. a per share price of $0.01521), for aggregate proceeds to Prometic of up to $75 million, which will commence following the closing of the above-mentioned transactions (the "Rights Offering" and collectively with the Private Placement, Debt Conversion and the Warrant Repricing, the "Refinancing Transactions").

(Source: Prometic PR, April 15, 2019)

In summary:

1. An equity offering on a private placement led by Consonance, priced at $0.01521 (transaction price), for an aggregate gross proceeds of $75M.

2. The conversion of $229M (all but $10M) debt owned by SALP to equity, and repricing the exercise price of the warrants held by SALP to the transaction price.

3. A rights offering to all shareholders that entitles them to subscribe for 20 common shares per pre-refinancing share, at the transaction price, up to $75M.

The Common Shares Counts

In the same announcement, the company has presented more details in a table of the common shares count before and after the refinancing.

Table 1

Investors

SALP

Consonance

Current Common Shares registered and beneficially owned (non-diluted basis)

24,071,775

Nil

% of Common Shares prior to the Debt Conversion and Private Placement

3.26%

Nil

Common Shares issuable to Investor through the Debt Conversion

15,050,312,371(1)

Nil

Common Shares issuable to Investor through the Private Placement

1,643,851,555

3,287,703,109

% of Common Shares owned by Investor following completion of the Debt Conversion and the Private Placement (fully-diluted basis)

66.60%

12.97%

% of Common Shares owned by Investor following completion of the Debt Conversion and the Private Placement (non-diluted basis)

80.68%(2)

15.87%

(1) Based on debt being converted through the Debt Conversion in the aggregate amount of $228,887,948.

(2) Excludes Common Shares issuable upon the exercise of Warrant 10 in the aggregate amount of 168,735,308 Common Shares.

(Source: Prometic PR, April 15, 2019, emphasis mine)

For an easier read, I round up these big numbers and add the non-SALP existing shareholders to the table.

Table 2

Investors

NON-SALP

SALP

Consonance

Current Common Shares registered and beneficially owned (non-diluted basis)

736M

24M

Nil

% of Common Shares prior to the Debt Conversion and Private Placement

96.7%

3.3%

Nil

Common Shares issuable to Investor through the Debt Conversion

Nil

15B(1)

Nil

Common Shares issuable to Investor through the Private Placement

Nil

1.6B

3.3B

% of Common Shares owned by Investor following completion of the Debt Conversion and the Private Placement (fully-diluted basis)

20%

67%

13%

% of Common Shares owned by Investor following completion of the Debt Conversion and the Private Placement (non-diluted basis)

3%

81%(2)

16%

(1) Based on debt being converted through the Debt Conversion in the aggregate amount of $229M.

(2) Excludes Common Shares issuable upon the exercise of Warrant 10 in the aggregate amount of 169M Common Shares.

(Source: Prometic PR, April 15, 2019, emphasis mine. The numbers have been rounded up for simplicity).

I think that this second table shows very clearly, at least to me, that the resulting change in % of ownership is not the same for all Prometic share holders.

For Non-SALP shareholders, the % ownership drops by 76.7% (=96.7-20).

For SALP, the % ownership increases by 63.7% (=67-3.3)

For Consonance, the % ownership increases by 13% (=13-0)

The opportunity to 'benefit in future success'

In the announcement and the conference call, Prof Simon Best, the interim CEO and the chairman of the BOD, explained that this is the only option available to avoid liquidation of the company at this point.

It was also stated that 'the rights offer' provide the opportunity for the existing shareholders to 'benefit in the future success'.

However, this 'rights offer', comes with a cap of $75M.

I did some simple math to estimate how meaningful is this so called 'opportunity.'

I list my estimations below, in Table 3.

Table 3

1. How many new shares can be subscribed by the existing shareholders, with a cap of $75M?

The answer: 4.93B new shares=$75M/$0.01521

2. How far does the new shares go to cover all non-SALP shareholders, if all are interested in exercising the offer?

The answer: 6.7 new shares for every pre-refinancing share=4.93B/736M

4. A post-refinance, post-rights-offer average cost estimation for existing non-SALP shareholders (with the $75M cap)

For those with prior average cost of $3 per share,

their new average cost will be $0.40 (or 26 multiples of the transaction price)

$0.40=[$3+(6.7 x $0.01521)]/(1+6.7)

For those with prior average cost of $2 per share,

their new average cost will be $0.27 (or 18 multiples of the transaction price)

$0.27=[$2+(6.7 x $0.01521)]/(1+6.7)

For those with prior average cost of $1 per share,

their new average cost will be $0.14 (or 9 multiples of the transaction price)

$0.14=[$1+(6.7 x $0.01521)]/(1+6.7)

For those with prior average cost of $0.06* per share,

their new average cost will be $0.02 (or 1.4 multiples of the transaction price)

$0.02=[$0.06+(6.7 x $0.01521)]/(1+6.7)

For SALP (existing shareholder) and Consolence (new shareholder), their average cost is $0.01521 (the transaction price)

*Prometic close price on April 16, 2019

My estimation above is a simplistic one.

It imagines a scenario where

1. All the non SALP existing shareholders would like to 'benefit in the future success' of the company

2. They can afford so by subscribing the full amount of new, cheap shares available to them to buy at the transaction price.

It also estimates how successful the future success needs to be (i.e. multiples of the transaction price) in order for these shareholders to break-even.

Table 4 presents the same calculation, but this time without a cap of $75M.

In other words, I try to further imagine a scenario where the company welcomes all injections of new cash, regardless of where the cash comes from. Thus, all the non-SALP shareholders can buy 20 new, cheap shares if they choose to.

Table 4

4. A post-refinance, post-rights-offer average cost estimation for existing non-SALP shareholders (without the $75M cap)

For those with prior average cost of $3 per share,

their new average cost will be $0.16 (or 10 multiples of the transaction price)

$0.16=[$3+(20 x $0.01521)]/(1+ 20)

For those with prior average cost of $2,

their new average cost will be $0.11 (or 7 multiples of the transaction price)

$0.11=[$2+(20 x $0.01521)]/(1+20)

For those with prior average cost of $1,

their new average cost will be $0.06 (or 4 multiples of the transaction price)

$0.06=[$1+(20 x $0.01521)]/(1+20)

For those with prior average cost of $0.06*,

their new average cost will be $0.02 (or 1.1 multiples of the transaction price)

$0.02=[$0.06+(20 x $0.01521)]/(1+20)

For SALP (existing shareholder) and Consolence (new shareholder), their average cost is $0.01521 (the transaction price)

*Prometic close price on April 16, 2019

A summary table

Table 5 below summarizes the key data from table 3 and 4. I also include columns for those who do not want to participate in the rights offering.

Table 5

New cost av. for those not participating in the rights offering

Multiples needed to break even

New cost av.

With $75M Cap

Multiples needed to break even

With $75M Cap

New cost av.

Without $75M Cap

Multiples needed to break even

Without $75M Cap

$3 prior av. $3 197 $0.40 26 $0.16 10
$2 prior av. $2 131 $0.27 18 $0.11 7
$1 prior av. $1 65 $0.14 9 $0.06 4
$0.06 prior av. $0.06 4 $0.02 1.4 $0.02 1.1
SALP and Consonance $0.01521 all upside $0.01521 all upside $0.01521 all upside

A simple question from a simple retailer investor:

If the purpose of refinancing is to strengthen the cash position of the company, why is there a need to cap how much new cash can come from existing shareholders?

Prof Best stated in the PR that

To remain viable, it is necessary to substantially reduce our debt burden. We have found a way to achieve this while adding new high-quality investors and providing our existing shareholders an opportunity to benefit from our future success.”

(Source: Prometic PR, April 15, 2019, emphasis mine)

Is there a difference between the cash from the existing, non-SALP, investors and the cash from the 'new high-quality' investors & SALP, that has compelled the management to decide to put a limit on the former?

And by doing so, the chance of shareholders actually 'benefiting' from the future upside, is drastically different (worse), than if no cap was put in place.

The only reason I can see for limiting the existing shareholders' new cash is so that the ownership of SALP & Consonance do not go below 67% and 13% respectively; while the management does not seem to mind that the ownership of non-SALP investors drops from 96.7% to 20% under this plan.

Looking closely at Prometic's refinancing plan and its resulting impact, it would seem that not all cash is equal; not all ownership % changes are of equal concern; and certainly not all shareholders' chances of 'benefiting in the future success' are equal!

Exemption

In the announcement, the management is seeking exemption from the Canadian security authority with regards to shareholder approval and MI61-101. Here are the statements:

The Debt Conversion, and the Private Placement trigger the requirement for approval from the holders of a majority of the currently issued and outstanding Common Shares, excluding the votes attached to the Common Shares held by SALP, under sections 501(C), 604(A) and 607(G) of the TSX Company Manual, unless an exemption is applicable, because the Debt Conversion and the Private Placement represent transactions involving SALP, a related party of Prometic that (I) will materially affect control of Prometic, (II) for which the consideration to be received by SALP exceeds 10% of the market capitalization of Prometic, and (III) are for an aggregate number of Common Shares issuable greater than 25% of the number of Common Shares outstanding, on a non-diluted basis, and the Transaction Price is less than the market price. The Warrant Repricing also triggers the requirement for approval from the holders of a majority of the currently issued and outstanding Common Shares, excluding the votes attached to the Common Shares held by SALP, under section 608(A) of the TSX Company Manual, since it involves amendments to warrants held by SALP, a related party of Prometic, resulting in a new exercise price which is less than the market price.

In addition, these transactions will constitute “related party transactions” within the meaning of Multilateral Instrument 61-101 – Protections of Minority Security Holders in Special Transactions (“MI 61-101”). However, in light of the fact that the Board and the Special Committee have determined that Prometic is in serious financial difficulty, Prometic is relying on the exemption from the formal valuation and minority shareholder approval requirements of MI 61-101 contained in Section 5.5(G) and Section 5.7(1)(E) of MI 61-101, respectively, on the basis of the “financial hardship” exemption therein.

(Source: Prometic PR, April 15, 2019, emphasis mine)

I am not a lawyer and therefore this is entirely a layman's simplistic understanding of the legal oversight/protection provided by the Canadian security law and authority as mentioned in the announcement.

However, there seems to be a circular logic here.

The statements quoted above indicate that a plan of this magnitude must normally have the approval of the majority share holder, unless an exemption is applicable.

However, this particular plan, if approved and implemented, will cause a switch of the holder of majority of the currently issued and outstanding common shares, from non-SALP shareholders to SALP (shown in the Table 2 above), and thus constitute a possible reason for applying for an exemption.

That is to say, a plan that will cause a switch of the majority and minority shareholder, asks to be exempt from obtaining the majority approval, based on the fact that the plan will change who the majority is?

Using an example from daily life: A proposed new owner of a house, wants to take over the property without the approval of the current owner, based on the fact that they propose to own it in the future.

Secondly, the company also seeks to be exempted from the formal valuation and minority share holder approval, on the basis of 'financial hardship'.

Thus, no approval from the minority shareholder is required either.

Let me see if I understand this situation correctly.

According to Prometic's management/BOD, a materially-significant financial plan that will affect all parties, need approval from neither the majority nor the minority share holders?

Who then should approve such a plan? By-standers?

Are the investors supposed to simply sit back and trust the management/BOD?

The same management/BOD whose past performance, or lack of, has led to the current 'financial hardship'.

The same management/BOD whose 'no-need-to-be approved-by-anybody-but-themselves plan' seems to value 'cash' from different investors differently, resulting in different impacts on these shareholders, if ok-ed by the Security Authority, and then implemented.

If this is not a case that requires legal oversight to ensure the 'fair treatment' of all market participants, then what is!

I do not think that it's exemption that is needed in this case, but a complete compliance with the applicable laws: laws that are intended for such a time as this: to uphold the principle of fairness and to protect the rights accorded to all market participants by the laws.

Somewhere in my upbringing, I seem to have picked up an understanding: that NO one is above the law, or am I simply too old-fashioned for my own good?

Concluding Thoughts

As a biotech investor myself, I think that I understand the significant risks involved in investing in small cap, clinical stage biotech companies.

I think that most Prometic investors do too.

However, this situation is not about risk management or even about losses.

It's about how the proposed refinancing, in my opinion, acts in bad faith towards the non-SALP shareholders.

What I mean by acting in bad faith is that: non-SALP shareholders are to take all the downside of the 'financial hardship' that was, arguably, not of their making; and are to be given little to no chance to 'benefit in any future success.'

These are the very shareholders whose investments make any 'future success' at all possible.

I have closed my position in Prometic, as I have lost confidence in both the integrity and the competence of the management and the BOD.

Before I go, allow me to encourage fellow, former longs: our becoming wiser, more successful investors, is a reward that no company can rob us of.

Finally, I wish all who remain long, all the best for the future. I sincerely hope that you all will get to fairly share in the reward of your investment.

Thank you very much for reading.

Disclaimer: This articles is not an investment advice, and I am not an investment adviser. Small cap biotech stocks are highly volatile, speculative, and risky. Investing in these stocks may result in a partial or complete loss of investment. Conduct your own due diligence and/or consult a certified financial adviser before making any decision to buy, sell or hold any stock. You alone are responsible for your investment decisions, actions and results.

Disclosure: I am/we are long ATBPF, KRYS. 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.