Description

Aksys represents a compelling short opportunity given the recently announced news regarding the company and the most likely near term outcome that will stem from it.

Background:

On July 24th, Durus Capital, a $400mm to $500mm hedge fund run by Scott Sacane, announced that it had “inadvertently” acquired 21.8mm shares of Aksys (AKSY) along with 9.7mm shares of Esperion Therapeutics (ESPR). The position in Aksys represents 79% of total shares outstanding, while the position in Esperion represents 33% of total shares outstanding. The 13F filed by Durus on March 31st, 2003 showed that the hedge fund owned 5.28mm shares of Aksys. The 13D subsequently filed by Durus showed that the fund bought close to 9 million net new shares from March 31st to July 24th. Simple math suggests that the 13F filed by Durus was incorrect.

During the time that Durus acquired the 9 million net new shares, AKSY went from 7 on March 31st, 2003 to 15 on July 24th. For the month of June alone, Durus reported to L.P.’s that the fund was up over 20%, closing out a hard to believe 41% second quarter. But Durus wasn’t just buying stocks at this time, they were also selling. According to filings, from December 31, 2001 to July 24, 2003, Durus acquired 21.8mm shares and sold an aggregate of 659k shares. The average buying price was around 7.5 and the average selling price was 11.8. The fact that Durus was a 10% owner and was making short term profits from buying and selling the stock adds to the hedge fund’s oncoming legal troubles (AKSY just filed suit today).

Forced Selling:

Forced selling, or selling that is a disconnected from a company’s underlying business prospects, is usually one of the best times to buy rather than sell a security. Indeed, the fact that AKSY is now down 38% after the news broke, may suggest to some an opportune buying opportunity. I have a few points here. First, the buying that Durus was doing had more to do with stock manipulation than some underlying intrinsic value thesis the fund had on AKSY. The fund had marketed itself to investors by claiming that 65% of the funds profitability came from short-term “event driven” positions that had an average holding period of twelve weeks. What they forgot to mention to investors was that that the “event” was going to be their own buying (it certainly wasn’t going to be the two analyst downgrades that happened on June 13th and 16th). The stock, which has religiously stuck in a 4 to 15 dollar trading range for most of its existence, was brought up by “disconnected” buying and has now come down closer to where the stock was trading before the additional buying began. The second point here is that there is a whole lot more selling to come (the recent selling has mostly come from short sellers - not from Durus). A 79% shareholder who is forced to significantly reduce their position in the quickest manner possible will likely create a scenario where whatever is being sold trades below “intrinsic value”, at least temporarily.

I have several observations to make after having had conversations with several Durus L.P.’s and reviewing some filings:
• The fund has quarterly liquidity. This can be ascertained from a public filing by Excelsior Hedge Fund which holds Durus in its fund of funds. Any sort of lock up (initial one year lock up etc.) will likely be relaxed if investors (and the courts) have anything to say about it.
• L.P.’s want out and lawsuits are coming. Investors are livid now that they have found out that two positions represented more than 3/4 of the funds assets. Investors suggest that the funds marketing material states “maximum initial individual long position of 5%” and “30 to 40” long positions. Investors were not being sold on a concentrated style of investing and were clearly mislead. I don’t think the fact that the buying was “inadvertent” will make the L.P.’s any more understanding. Next redemptions would normally be in September but L.P.’s will argue for it sooner than that.
• Esperion’s board recently asked Durus for it to agree to a lockup provision for “optics.” Durus agreed to a 90-day lockup period, expiring Oct. 29, in addition to other 180-day lockups in effect. If this in fact holds up in the coming months, it means the Durus will have to sell more shares of AKSY to meet the coming redemption onslaught.

Aksys without the forced selling:

The intrinsic value of Aksys is hard to pinpoint given that it has spent the majority of its history as a development stage company with $298k of revenue in 2002 and an accumulated deficit of $111mm as of March 31st, 2003. The company’s sole product is an automated personal hemodialysis system, known as the Aksys Personal Hemodialysis System (the “PHD System”) which is designed for patients suffering from end-stage renal disease (“ESRD”), commonly known as chronic kidney failure. This device is targeted to wealthy individuals and large dialysis service providers (Renal Care Group, DaVita, Fresenius Medical Care). The dominant player in dialysis equipment is Fresenius Medical (Baxter and Gambro AB are other competitors). Fresenius, whose machine can service four people a day, sells its dialysis machines at an average price of 13k. Aksys’s machine today costs 65k to service one person a day and the company has said that they expect to bring the cost down to 25k by 2005. The big service providers that AKSY is targeting have all said that they have no intention of purchasing home hemo dialysis equipment until the cost of the machines is significantly below that of existing machines and will not move until that happens.

Net loss for the company in 2002 was $15.7mm. In the three months ending 3/31/03, AKSY generated $102k of revenue and showed an operating loss of $4.7mm with cash used from operation of $6.3mm. The company was authorized by the SEC on April 28th, 2003 to raise up to $60mm by issuing various securities in order to fund their current and expected cash burn. On June 30th, 2003, the company announced that they had raised $15mm as part of the $60mm (how is that for timing) bringing their total cash position to $31mm as of June 30, 2003. According to First Call, the company is expected to lose $0.74 this year and lose $0.56 next year. Finally, the company has 27.5mm shares outstanding and a market cap of $253mm as of the end of business today.

While I wouldn’t be surprised by a short term jump in price tomorrow as management tries to calm investors fears on the earnings call (the fact that they are suing leads me to believe that Durus has not agreed to the same lock-up provision with Aksys as Esperion who have not yet sued), I ultimately expect AKSY’s market cap will be cut in half before all is said and done.

Catalyst

L.P. redemptions
Competition
Cash burn