Giveaway sale signs

Few of the life science companies listed on the ASX are likely to mature into profit-generating sustainable businesses; a significant number will fail to generate acceptable investment returns. Some will fail because the product or technology in development fails to meet essential development or marketing criteria; some because the board and management can’t appropriately fund and position the company; and others for a combination of these reasons '” with some bad luck and incompetence thrown in.

Any single investor's time horizon varies, from short-term traders looking for returns over days or weeks, to other investors inclined to engage a biotech stock for a three to six-month period. Longer-term investors may hold a biotech stock for up to 10 years. What is worth noting about this more patient set of investors who invest over the long term is that even they have a limit on how long they will lock up capital in a stock. This limit is even more pronounced when a stock has underperformed relative to its IPO price, or to entry prices paid by investors at one or more of the various fundraising rounds conducted by the company.

The typical response by investors to sustained underperformance is to sell the stock. However, for those with sizeable holdings in underperforming stocks that have poor liquidity, the ability to sell or exit the stock is much more difficult. Selling large quantities of stock on-market, if at all achievable, is likely to substantially depress the share price and cause long-term damage to the share price, making future fundraising more difficult.

Exit scenarios

Exit scenarios for owners of significant blocks of stock include the off-market sale to a party looking to enter a stock quickly and cleanly and gain a significant holding. An example of this is the sale of holdings in Acrux by three of that company's founders to Orbis Mutual Funds in October 2005. In this way, Orbis obtained a 12% stake in Acrux.

Another exit scenario is through the sale of a company to another, preferably much larger firm. An example of this is the proposed acquisition by CSL (capitalisation: $10.6 billion) of Zenyth Therapeutics (capitalisation: $105 million), a transaction that was approved by Zenyth shareholders this week and is scheduled to be approved by the Federal Court tomorrow, October 31.

How can a biotech investor determine whether a company is being conditioned or made ready for sale? There are several events or signs that can signal this is happening.

Strategic reviews

An obvious signal is when a company commissions an external party to conduct a strategic review. Adelaide-based Gropep, which is in the process of being acquired by Novozymes, commissioned a review in February 2006 by Ernst & Young Corporate Finance. This review was a continuation of one commenced by the board of Gropep that had been "examining the appropriateness of the existing business model and alternative operating and corporate structures".

Company announcements

From time to time, companies may make statements regarding the ownership of the business and the viability of the business models they are adopting. For example, the Gropep board stated after the recent review of its business model and strategy that "after careful consideration, the Board has resolved that it is in the best interests of shareholders to modify the Company's existing business model and strategy. The Board is of the view that shareholder value is not being maximised at present through the existing business model, whereby profits and cash flow generated from GroPep's Biological Products division are invested in biopharmaceutical research and development."

Change in management

A sign that sometimes can indicate that a company is being readied for sale is when changes are made in management ranks. The board may appoint a chief executive who is more able to meet the tasks associated with the preparation a company for sale. This CEO is less likely to be noted for his or her fundraising skills or ability to design and set long-term strategy, but more for the ability to improve the operational performance of the firm (ie, hit milestones on time) and initiate and conclude sales and marketing agreements. On occasion, the CEO may have none of these skills, but simply be a senior executive drawn from the firm who has sufficient knowledge of the activities of the business to keep it well maintained and in good order until the sale is completed.

Sales of other assets

The purchase or disposal of assets, projects or businesses may also indicate a company is preparing itself for sale. For example, Vision Systems sold its Fire and Security business because it had, according to that company's CEO at its AGM in 2005, "become clear the Australian stockmarket is unable to discern the true value of the Fire and Security business when it is mixed in with our other activities". The business was sold for $253 million, and it can be argued that this event paved the way for the recent takeover battle for Vision Systems as a more focused life sciences instrumentation business to commence. Although, in our view, Vision was not being readied for sale, the act of divestment illustrates how it can improve the attractiveness of a company to potential acquirers.

Changes in board positions

There are many reasons for the membership of boards to change. However, when changes to boards occur at the same time as the sale of assets or strategic reviews are commissioned, then such board movements, considered in context, may be an important sign that a sale of the business is being considered.

Progress without share price recognition

Another sign for investors to consider is if a company has made what it perceives to be reasonable progress but has not seen a sustained and corresponding uplift in its share price over a reasonable period. This situation may stimulate investors with significant holdings to propose the sale of the firm as a means for value in the firm to be recognised.

With these considerations in mind, what listed biotechs may be up for sale? Five companies stand out as potential candidates as “businesses up for sale”. They are Acrux, Agenix, Cytopia, Prima BioMed and Starpharma Holdings.

Each of these companies is bearing one or more of the signs mentioned above. For example, the CEOs of all these companies have been replaced in the past 12 months, although in the case of Prima BioMed, their CEO will step down at the end of November, with the position to be taken up by the executive chairman.

With the exception of Agenix, all these stocks have generally recorded positive progress over the past 12 months, but have not benefited from increased and sustained investor interest in the stocks. Cytopia cemented a deal with Novartis for its JAK3 kinase and has a Phase I trial for its cancer drug candidate well under way. Acrux's partner Vivus completed a Phase III trial of Evamist (Estradiol MDTS) for menopause symptoms. Starpharma concluded two funding arrangements with US National Institutes of Health, one of which was worth $26 million, with the value of the second kept confidential. Prima BioMed is well on the way to completing a Phase II trial of its ovarian cancer immunotherapy, Cvac. In contrast, Agenix failed to conclude a licensing deal for its ThromboView clot imaging technology by the deadline it had set for the end of 2005.

None of these companies have commissioned external reviews. However, Agenix has undertaken an internal review. This review concluded the company needed to reconsider the timing for securing a deal on ThromboView, sell its animal health and human health diagnostic test businesses, expand its antibody focus to include therapeutics, and improve the company's financial position. To date, Agenix has sold its animal health business and concluded a sale and lease back on its properties, gaining $5.15 million. While the company has improved its cash position, gaining the necessary funds for the optimal development of it assets may be a great challenge for the company.

Starpharma has undertaken several repositioning activities, including buying out royalty entitlements owed to the Biomolecular Research Institute and recently proposing to acquire (now approved) the 70% of US based Dendritic Nanotechnologies it did not already own. Starpharma will, going forward, possess an impressive dendrimer chemistry patent portfolio that may be very attractive to a potential acquirer because of its domicile in a single corporate entity.

Prima BioMed has flagged that it will out-license or sell its non-core assets, and sell its equity holding in Trillium Therapeutics. However, the company has a challenge at hand, similar to Agenix, to fund the next stage (Phase III) of development of its Cvac therapy.

Cytopia has advised for some time that it would "actively seek value-adding merger or acquisition opportunities to take the company into the next phase or growth and this element of our plan remains unaltered". The company has made a small acquisition in the US but has been unsuccessful in consummating any other M&A opportunities either in Australia or elsewhere.

Over the past 12 months, the change in the share prices of these five stocks has been Acrux –3%, Agenix –48%, Cytopia 7%, Starpharma 2% and Prima BioMed –38%. Although Cytopia has performed positively on a 12-month basis, it is down 33% from a 12-month high. Starpharma is down 5% from its 12-month high.

While these five companies may not be explicitly be “up for sale”, each of offers enough signs to place them in a class of likely possibilities in the near to medium term.

Other companies up for sale

In addition to the above five, there are many other companies that have been configured for a “trade sale” almost from inception. Many, but not all, of these are device companies, and our list of possible trade sale candidates includes BrainZ Instruments, CathRx, Heartware, Sunshine Heart, Living Cell Technologies, Phylogica, Evogenix, Peplin and Mesoblast.

The conditions for sale of these companies hinge on their achieving a particular level of development (such as proof of concept) or even levels of sales that would satisfy an acquirer. However, the timing and eventuality of any sale is much further in the future than for the first five companies described above because of the extensive development of their products or technologies that most of these companies need to undertake.

Reproduced by permission from Bioshares 190 (October 28, 2006)