the upcoming merger between ThermoGenesis (KOOL) and TotiRx to create a new entity called Cesca Therapeutics has been covered recently by another SA author, and as the merger approaches I wanted to revisit the deal points and understand the value proposition for the new entity. Often, mergers offer attractive cost and portfolio synergies (particularly in biotech) and at the right price, can deliver significant value for shareholders. As this article will show, at the right price point, the KOOL merger can potentially deliver an attractive risk/reward proposition.
Background of the Deal
On July 16th, KOOL announced the merger with TotipotentRx, a private California company that develops cell-based therapies for regenerative medicine. The terms of the deal were that KOOL would issue stock equal to $18.6m (based on a price of $1.49) and that the new company would be called CESCA which stands for Clinical Excellence in Stem Cell Applications. While the merger was set to close before year end, the deal is now slated to close in Q1/14.
Thesis on the Combined Company
Some of the points below were outlined by KOOL in its proxy; my assessment of the most compelling merits are as follows:
the company will be one of the first to combine cell therapy devices, with patented technology, proprietary cell formulations, and treatment protocols.
KOOL now carries 8 clinical trials (from TotiRx) across various indications, including osteoarthritis, avascular necrosis, cardiac and critical limb ischemia. Specifically, TotiRx is the world's only clinical research organization (CRO) specializing solely in cellular therapeutic development services
KOOL can tap into the existing revenue stream of TotiRx's established cord blood banking business (and its partnership with Fortis Healthcare- a chain of hospitals across India and Asia). Recall that KOOL has its BioArchive System (an automated cryogenic device), which is already used by cord blood stem cell banks in 30 countries for cryopreservation and archiving of cord blood stem cell units for transplant. Further, KOOL's AXP, used for the processing of cord blood (preparing cell concentrates, including stem cells for bone marrow aspirates), should be synergistic with Toti's offering. Management has recently signed long term supply agreements, including one struck earlier in January for 5 years with the San Bruno based Cord Blood Registry.
Established footprint in emerging markets- due to KOOL's legacy US presence, and Toti's Asia core.
Risks to the Thesis
As with any deal particularly those involving development stage companies, there are a few notable risks that investors should watch out for, including:
Clinical Trial Risk- the completed data from the 10 pilot and Phase 1B clinical trials, while proven safe, is still very early and yields substantial risk to commercialize
Autologous cell therapy, in general, has many 'bodies littered on the road' even after safe & effective initial therapies
Cash burn will likely necessitate additional equity raises within the next 24 months, depending on how the cord blood business can ramp
Management execution across geographies (US and Asia) as well as oversight on the clinical programs will require coordination that heretofore had been done by 2 different entities
Why is this an interesting setup?
Today, KOOL trades at $2.20 a share, giving the company a market cap of $37mm, with average trading volume of 2.65m shares a day (or $5mm notional), a decent trading volume given its current market cap. The company currently exhibits low institutional ownership (only 9%), a high beta (1.5), and is still losing money.
Since the day the deal was announced (July 2013), the stock is up 46%, vs. the S&P up 7% over this period. Since mid-January, KOOL stock has risen from $1 to as high as $3, before settling on $2.20; this excitement has been driven by the January 27th announcement that the company has raised $6.67m in a private placement with investors at a price per share of $2, with another 1.66m shares available to purchase at a strike price of $2.81 per share.
This strength of the stock price on the secondary (that the deal was able to be struck at $2 with shares at $1 only a few weeks prior), coupled with the unusually strong liquidity and trading volume for a stock with this market cap indicates that there is a great deal of pent up enthusiasm for the merger profile.
On a risk/reward framework, I look at the shares outstanding (16.7m as per Google Finance) with $6.7m in the bank today, as $0.40 per share, plus the pipeline and patents at $1 per share, to yield $1.50 per share downside; relative to today's $2.20 stock price, this yields a downside risk of 31%. Realistically, it is likely that the shares have strong support at the $2 level, which is only 10% down from current levels.
On the upside, I look at a few factors: the strength of the supply agreements, revenue outlook for the cord blood business, which management disclosed to be $18m annually (in its deck presentation on the website), penetration into the potential $16b market for target therapies. Combined with capital efficiency ($29m in non dilutive clinical trial funding benefits to date) and a peer group selection based on current multiples, it is conceivable that a path to $6 target can be achieved, which would be on the low end of the peer group multiple.
Specifically, when looking at peers such as Cytori (CYTX), Aastrom (ASTM), Athersys (ATHX), Neostem (NBS), Cytomedix (OTCQX:CMXI), Mesoblast (MSB), BioTime (BTX), and Osiris (OSIR), one sees a median revenues of $12m, market cap of $112m, and revenue multiplier of 12x.
When applying this revenue multiplier to Cesca's pro forma run rate of $25m (2014), you arrive at a market cap of $300m, which is ~$6.00 per pro forma share.
Investors would likely gravitate towards the closest comp as Neostem given its dual path of revenue generating businesses (via its PCT) and upside via clinical trial driven product launches. NBS has a market cap of $200m currently vs. KOOL at $37m.
On a $6 target, this would represent a 3x return with ~10-30% downside at risk. I will await more indication as trial data comes in later this year to validate the execution pathway, but it's one that is worthwhile to keep on the radar.
MFG
Chali
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