Melinta Therapeutics (MLNT) is a commercial stage antibiotics company with four approved drugs currently being marketed. Despite successfully navigating the FDA approval process for its lead drug, Baxdela, in June of 2017, the stock has traded down 95%. Many investors and traders are weary of shorting small cap biotech stocks despite their high failure rates because of the obviously asymmetric bet you’re placing. In the event your wrong, an unexpected drug approval or buyout from a larger player can rip a multi-bagger in your face. However, in the case of MLNT, there is no blockbuster drug around the corner; all four of their formulas have received FDA approval (and two EMA approval) and the only remaining catalysts are label expansion. The company’s lead product has been in the market for a few years now and failed commercially, like many antibiotics. Additionally, the company’s debt ought to provide a near term catalyst for shorts to cash out within 2-6 months. Although the stock price has been battered the last 4 years, over $66mm of market remains (EV of approximately $140mm) and we believe the stock will be trading for pennies shortly.

When MLNT began selling Baxdela in Q1 2018, it generated $11.9mm of revenue that quarter and has failed to gain material since. The product has averaged quarterly sales of $12.8mm in the last four quarters, we estimate the annual run rate to be $51.2mm - $55.3mm. With quarterly SG&A averaging $30.2mm per quarter and gross margins having stabilized around 37%, MLNT needs sales to rise 6-fold to break even on an operations basis (which roughly equates to EBITDA). Add on top of that $9.0mm - $10.0mm of quarterly interest expense and you get the picture…

This summer the market seemed to be sniffing out this situation, despite the stock making a retail-driven parabolic run on the announcement that the FDA had accepted their Baxdela sNDA for a new indication. The 8-K on July 1, 2019 disclosed that its creditors (Vatera and Deerfield) were reducing the company’s credit lines:

Given the current lack of clarity surrounding the Company’s ability to meet certain future minimum product sales and cash balance requirements under the Vatera Loan Agreement and the Deerfield Facility Agreement and its ability to deliver audited financial statements for the year ending December 31, 2019 that include an audit opinion that does not contain a going concern qualification, the Company determined that it would not be able to meet the conditions to draw additional funding under the Vatera Loan Agreement by June 30, 2019. On June 28, 2019, Vatera and the Company agreed to an amendment to the Vatera Loan Agreement (the “Vatera Loan Agreement Amendment”) to provide for: (i) an extension of the period to draw the remaining unfunded commitments under the Vatera Loan Agreement to October 31, 2019; (ii) a reduction of such commitments to $27 million (replacing the $60 million of unfunded commitments that were previously available for borrowing under the Vatera Loan Agreement as described above); (full document can be found here: https://www.sec.gov/Archives/edgar/data/1461993/000119312519187483/0001193125-19-187483-index.htm)

The stock fell from its parabolic high of ~$8.50 to mid-3s in the following two weeks. Confirmation of MLNT’s distress came on August 9th when the Q2 2019 10-Q was released and the stock fell approximately 40% to the mid-2s in a day. The 10-Q stated that “we believe there is substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should we be unable to continue as a going concern”. Also, a couple key covenants were highlighted in the 10-Q, we expect MLNT to breach both in the first quarter of 2020.

• Deerfield Facility requires product sales of $63.75mm for FY 2019 and Vatera $57.37mm. Through Q2 they’ve achieved $25.6mm, meaning they need to average $15.89mm in Q3 and Q4, which would represent 44% yoy growth for Q3 and 9% growth yoy for Q4 compared to the 2018 periods.

• Deerfield and Vatera also require minimum cash balances of $40.0mm and $36.0mm, respectively, through March 2020. MLNT had $90.3mm on hand as of 6/30/2019 and cash burn from operations has averaged $32.2mm the last four quarters, meaning they cannot maintain the cash balances they need without a sudden surge in product sales or by drawing more from their lines.

Even more bad news arrived with the 10-Q as the company’s CEO, John Johnson (not a typo), who was hired just 9 months earlier to lead the turnaround, quit, as well as the Chairman, Kevin Ferro. MLNT appointed Jennifer Sanfilippo as the company’s interm CEO in early September. She was previously the company’s general counsel (not a great sign). The company withdrew full-year guidance for 2019 as well.

So what changed since MLNT was hanging around death’s door in the $2s in August? The sNDA that was accepted by the FDA and set off the retail-frenzy of buying back in June is expected to receive a decision on October 24th (apologies for the last-minute idea but recent price action suggests being tardy was the play). As frequent traffickers in the “bioturd” arena, we expect the stock to have one last gasp of buying on the upcoming headline, before met with selling from remaining institutional longs who realize how immaterial it is.

The expected label expansion is for the use of community-acquired bacterial pneumonia (CABP) and he stock has ramped over 110% now into that catalyst. A quick assessment for the CABP antibiotics market shows how meaningless this will ultimately be for MLNT’s financials. Paratek (PRTK) had their drug, omadacycline, approved for CABP in October of 2018. The stock is down 70% since the headline spike and the product only generated $3.0mm of sales in the first 6 months of 2019. Then another small cap name, Nabriva Therapeutics (NBRV) had a drug approved to treat CABP just this August. It’s share price has languished since and their product, Xenleta, will provide MLNT more competition in a clearly crowded field. Those following biotechs the last few years know that in the antibiotics space payors have been shifting demand to generics, making the field highly unprofitable for smaller companies like MLNT, PRTK and NBRV. Clearly CABP cannot save MLNT from the $32mm quarterly cash hole that needs to be plugged, even if they had the capital to begin a marketing campaign for use in CABP cases.

We see MLNT as a gift in the $5s, as the stock has already more than priced in any bullish news around CABP label expansion, and the stock is likely to work it’s way back into the $2s shortly. The Q3 earnings release should cement fears that the company is likely to be taken over by its debtholders shortly, and we expect them to default in Q1 (although the stock will likely have retraced enough by then to move on from a short position). Although borrow is tight in the name, we still see availability for smaller funds and personal accounts, options are also tradeable.

The only realistic scenario we can envision in lieu of outright default, is a highly dilutive equity raise into a positive PR, leaving retail chasers holding the bag. The company filed an S-3 last year for $150mm that has not yet been utilized. We could also see more debt be converted to equity and dumped by Deerfield, who took 550,000 shares at a price of $5.15 this March to extinguish $2.83mm of debt.