Description

Probably only suitable for PA's and very small funds. Contingent value right on Swiss nanocap acquired by Swedish microcap. Potential for a 10x on invested capital. 

I think this opportunity exists because non-professional investors have difficulties understanding CVR's and aren't usually very fond of buying left for dead biotechs. The downside is scary because of the burn rate which limits position sizes people can take. Professional investors can face some difficulty administrating the CVRs.  

August 13 a bid was made by a Swedish company, Calliditas Therapeutics, to acquire a large block of Genkyotex shares and a full acquisition through a second step. The bid consists of a blocktrade for blockholders at € 2.80 per share and future payments based on milestones. When that closes, Calliditas will take out minority holders at €2.80 per share and a contingent value right. The shares trade at a premium to the cash component of the bid at €3.04.

Genkyotex is developing a pipeline of first-in-class product candidates targeting one or multiple NOX enzymes Genkyotex lead product candidate is setanaxib a NOX1 and NOX4 inhibitor. I understand this is a new therapeutic class. In March the stock went to 9+ setanaxib significantly improves immunotherapy including checkpoint inhibitors in multiple preclinical cancer models. This research was published in the journal of the American Association for Cancer Research. Subsequently, the stock went under 2 per share when Genkyotex revealed in April it had less than a year of burn left while in the middle of a Pandemic.

Genkyotex is farthest along demonstrating clinical evidence of anti-fibrotic activity in liver fibrosis patients in a Phase II trial in primary biliary cholangitis (PBC, a fibrotic orphan disease). The therapy is also entering phase 2 trials for pulmonary fibrosis and type 1 diabetes.

The interesting part of the story is that the contingent rights look very juicy, they are broad and flexible, based on approvals and have ten years to get hit. Before I get into the CVR’s let’s look at the deal.

Calliditas Therapeutics tender offer, announced August 13, is for € 2.80  per share which means contingent value rights cost at least 24 cents. The deal is supposed to close October 2020. Tender offers usually close fast. Calliditas is a $600 million market cap company and it has sufficient cash to close. Tenders are used more often when there could be other acquirers.

This is probably not relevant but the Johnson & Johnson jet recently visited Geneva on September 15, August 30 and August 25. Genkyotex seems like an unlikely target for JNJ because it is so small. In hundreds of its most recent deals, JNJ’s smallest target had a market cap of $400 million. Geneva is also an elite hub and a popular retreat destination which may be alternative explanations for the jet movements. I’m mentioning it because there aren’t any clear acquisition candidates headquartered in Geneva. The JNJ visited once in February and now three times in quick succession following shortly after the tender for Genkyotex. It’s a long shot but you never know.

Given the properties of this acquisition offer, it is highly likely to close successfully. If it doesn’t there is a lot of downside because the company's burn rate only gets it to February 2021. Probably a major reason they are selling out. Management owns around 3% of the shares. 

Pre-offer the shares trades at €2. But given that time has passed and financing is running out I could see that halved to €1 per share. My data leads me to believe a deal with these characteristics closes 91%+ of the time. Within a few months you either have a loss of 24 cents or 7% and a contingent value right OR a loss of up to 67% OR a 3% profit due to an overbid(an overbid would likely remove the CVR and offer cash instead but for simplicity sake, I’ll assume the CVR remains and the overbid only increases the offer marginally.

On average you are 28 cents down on the initial € 3.04 investment in the next few months.

I view that as the average cost to gain exposure to the upside which potentially materializes in the coming years.

on confirmation of following regulatory approvals or marketing authorization of setanaxib no later than within ten years of the closing of the tender offer:

• €30m on approval of setanaxib for a first indication by the US Food and Drug Administration (FDA);

• €15m on approval of setanaxib for a first indication by the European Commission; and

• €10m on approval of setanaxib by the FDA or the EC for either idiopathic pulmonary fibrosis or type 1 diabetes (unless such milestone has already been paid out for such indication by the FDA or the EC as per above).

This translates into

1. € 2.6 per share
2. € 1.3 per share
3. € 0.87 per share

I’ve used baseline data from academic research up to 2018 to estimate approval rates of the indications that are in trial. I’ve assumed the company will not seek additional indications that could be conservative.

There are many different paths to payouts. If one fails, there’s often another way to still get there. The least likely milestone to hit is the last one which would also take the most time. Combining the probabilities I get to the following odds to hit various milestones:

The total expected value adds up to €2.8

This is a very large expected value relative to the required investment. It is an 84% return on the initial investment laid out. Most of it I would expect to materialize within years. But the multi-year process of fishing for this payoff ties up very little capital (about 28 cents) except for the first few months.  

A bad result will materialize very quickly. And admittedly, to get the contingent value rights you have to risk quite a bit of capital for a short time. If the deal doesn’t fall through you have only 28 cents tied up and it doesn’t really matter whether it takes 1 or 5 years to determine whether you have an ok return. If the approval probabilities are ballpark correct the expected value for the 28 cents is a ten-bagger.

Besides the acquisition falling through one other obvious risk here is that the probabilities are not correct. It is possible they are very different from historical probabilities for this new therapeutic class. Or they will turn out to be low for this specific new therapeutic class. But approval rates for the new therapeutic class would need to be substantially different from existing classes to turn this into a mediocre investment idea. There are pros and cons to the orphan designation so I haven’t adjusted for it.

There's also the risk that the acquirer tries to dodge the milestones but because they are regulatory, broad, and have a 10-year limit that would seem to be a very suboptimal strategy.

Catalyst

Milestones 1, 2 and 3.