Description

This is a recommendation to go long both PIP and SIGAQ as a pair (or one of them, your choice!). Both of these stocks have previously appeared on VIC, so please reference those write-ups for the pre-bankruptcy background. The decade-long litigation between SIGAQ and PIP is finally at an end. PIP won. SIGAQ will exit bankruptcy this year and likely engage in a capital raise to pay off the PIP judgment. PIP currently trades for 50% of the SIGAQ judgment amount. Post-capital raise, SIGAQ can finally put PIP and bankruptcy behind it and pursue other commercial opportunities for its smallpox treatment.

As an owner of both stocks, if a SIGAQ capital raise happens, you will be shifting money from one pocket to another. Exercise your judgment to determine the appropriate ratio of SIGAQ and PIP to own.

Brief Background

PIP is currently a litigation shell. PIP originally sued SIGAQ in December 2006 on a breach of contract claim. The company wisely cut expenses to the bare minimum to be able to fund the SIGAQ litigation to final judgment. PIP has $17mm of cash and no debt. Cash burn is minimal at less than $500K/quarter. The company has some R&D contracts for its anthrax vaccine, but its main asset is a $200mm+ judgment against SIGAQ.

SIGAQ filed bankruptcy in September 2014 as a result of losing a $195mm judgment to PIP. SIGAQ has a $433mm contract to supply its ST-246 smallpox treatment to BARDA, the federal bio-defense agency. As of September 30, 2015, SIGAQ has received $249mm, which leaves $184mm remaining on the BARDA contract. Of that, $61mm is to be received from future deliveries of ST-246, $21mm upon filing of a NDA with the FDA, and $103mm upon FDA approval of ST-246. SIGAQ currently has $111mm of cash and no meaningful liabilities besides the PIP judgment.

Litigation

SIGAQ and PIP have been in litigation for nearly a decade now. The history is colorful and makes for fun reading while eating lunch, but I will keep to a brief synopsis here. SIGAQ agreed to agree to license ST-246 to PIP in 2006 (a Type II Agreement). SIGAQ then had a massive attack of seller’s remorse and reneged on its agreement. PIP sued SIGAQ in December 2006.

In 2011, the Delaware Chancery Court denied PIP’s requests for specific performance and expectation damages, but found for PIP under the doctrine of promissory estoppel. The Chancery Court awarded PIP 50% of the net profits on from the sale of ST-246 for 10 years after SIGAQ retains the first $40mm of profit. SIGAQ appealed this judgment to the Delaware Supreme Court.

In 2013, the Delaware Supreme Court upheld the Chancery Court determination that SIGAQ breached its contractual obligation to negotiate a license for ST-246, but reversed the conclusion that SIGAQ was liable under the doctrine of promissory estoppel and thus reversed the damages award. The Delaware Supreme Court held that a trial judge may award expectation damages for a breach of a Type II agreement if such damages are proven with reasonable certainty. The Supreme Court remanded the case back down to the Chancery Court to reconsider damages.

In August 2014, the Chancery Court did reconsider damages and subsequently awarded PIP $195mm of lump sum expectation damages. This judgment precipitated SIGAQ’s bankruptcy filing in September 2014. SIGAQ filed to prevent PIP from enforcing the judgment and to appeal the award to the Delaware Supreme Court without the need to post a bond. This was much like the Texaco bankruptcy post-Pennzoil judgment, except there has not been a Carl Icahn to knock heads and force a settlement between the parties.

On December 23, 2015, the Delaware Supreme Court affirmed the Chancery Court award of $195mm of lump sum expectation damages. Four justices formed the majority and there was one dissenting opinion. Aside from the extremely unlikely situation where the U.S. Supreme Court grants cert or the Delaware Supreme Court reconsiders its ruling, this is a final judgment for SIGAQ and PIP.

SIGAQ Chapter 11 Plan

SIGAQ and PIP reached a consensual reorganization plan that provides SIGAQ a few options to satisfy the PIP claim. The options are 1) capital raise; 2) hand over 100% of SIGAQ equity to PIP; or 3) some other negotiated solution.

Capital Raise: SIGAQ will have to raise roughly $225mm to satisfy the PIP claim. MacAndrews & Forbes owns 25% of SIGAQ, so any capital raise will likely require their participation. SIGAQ’s bankruptcy counsel, Weil Gotshal, billed some time for a tax partner to look into a potential rights offering (presumably for tax ramifications). If a rights offering backstopped by M&F is the construct SIGAQ pursues, the mechanics could be as follows.

The plan contemplates a reverse split and the first version of the plan had a 1:15 placeholder value. 15 is a good a number as any other, not that it matters, other for SIGAQ to get an exchange listing. SIGAQ has 51.12mm shares outstanding at $0.58/share, which divided by 15 is 3.61mm at $8.70/share. The subscription price discount to the market price will probably depend on how evil M&F wishes to be since a shareholder will have to come up with a 7.2x multiple of their investment or face massive dilution (to M&F’s benefit as the backstop).

Let’s set M&F’s evil at moderate and set the subscription price at $7 or a 20% discount to the current price. To raise $225mm at $7/share would require about 32mm new shares. The new SIGAQ would have 35.8mm shares outstanding and assuming the current price, a $311mm market cap. With $110mm of cash, the EV would be $200mm for a company that has $184mm of extremely high margin revenue still to come from the existing BARDA contact and other commercialization opportunities (more BARDA, CDC sales post-FDA approval, sales to other governments, etc… you can read all about this in the old SIGAQ write-ups).

As an owner of PIP, the SIGAQ capital raise will be reflected in the PIP stock price. PIP currently has a market cap of $104mm. With a $225mm check from SIGAQ, PIP will have $242mm of cash and no debt. I have no insight into what PIP plans to do with the money. It could range from dumb (a myriad of misadventures) or smart (special dividend). I’ll assume dumb and that PIP trades at a 10% discount to cash for a $218mm market cap.

Of course, this is simply one possible construct. SIGAQ may pursue a different plan, but to the extent a dilutive raise happens, all shareholders will be entitled to participate on the same terms as M&F. Section 6.16(d) of the plan provides:

“Notwithstanding any provision of the Plan to the contrary, any issuance and sale by the Reorganized Debtor, in connection with the treatment of the PharmAthene Allowed Claim, of common stock, preferred stock, or any other security convertible, exchangeable, or exercisable into common or preferred stock of the Reorganized Debtor to MacAndrews & Forbes Incorporated or any of its affiliates (“MacAndrews”)  so long as at the time of such issuance and sale MacAndrews is an affiliate (as defined for securities law purposes) of the Reorganized Debtor) shall provide each other holder of Existing Common Stock with the opportunity to purchase its pro rata share of any class of such securities issued to MacAndrews based on each holder’s percentage interest in the Existing Common Stock of the Reorganized Debtor on the same terms and conditions as MacAndrews.”

Hand Over Equity: If SIGAQ chooses not to or is unable to raise enough capital to pay the judgment, SIGAQ can essentially hand the keys over to PIP. Existing SIGAQ shareholders would be wiped out in this scenario. I think this is an unattractive outcome for both SIGAQ and PIP. SIGAQ shareholders would lose the residual value beyond the PIP judgment, which may be substantial. For PIP, how would the hand over even work? Do SIGAQ’s employees stick around? Does the transfer endanger the BARDA contract, which is the main source of current value? What happens with the ongoing FDA trial? I can’t imagine PIP would prefer this over a cash payment, even a reduced one.

The consensual Chapter 11 plan was the product of protracted negotiation between SIGAQ and PIP, and this option is the fail safe for PIP. In the worst case, PIP will wind up with ownership of SIGAQ. Again, this is an unlikely outcome because it is value destructive for both SIGAQ and PIP.

Negotiated Solution: The plan leaves open the possibility of a negotiated solution. I’m sure in warm glow of hindsight, both SIGAQ and PIP wished they had reached a negotiated settlement 10 years ago (or any time since then), but it’s never too late. SIGAQ does face the not insignificant task of raising 7x its current market cap, so before the nuclear option of the equity handover happens, there is room for a settlement. The fact that SIGAQ and PIP agreed on a consensual plan is some hope that both parties are not irrationally entrenched after a decade of litigation.

Risks & Other Issues

1)     Capital raise fails: The success of a capital raise is dependent on the participation of M&F, both as SIGAQ’s controlling shareholder and a deep pocket. M&F’s behavior throughout the bankruptcy suggests they see value in SIGAQ above and beyond the PIP judgment, and thus have acted to preserve it. If it was otherwise, why bother pursuing the Chapter 11 plan after the Delaware Supreme Court loss? Just hand over the keys to PIP. The remaining value of the BARDA contract and other commercial opportunities for ST-246 provide quantitative support to M&F’s view. FWIW, SIGAQ counsel stated the following in a February 15, 2016 filing:

“As the Court is aware, the Debtor’s Plan is the product of protracted negotiations with PharmAthene and provides the Debtor with up to seven months to raise the capital to satisfy PharmAthene’s claim. The Debtor views this as a major accomplishment for its shareholders and already has embarked on a process to pursue every reasonable avenue to generate the funds necessary to preserve the interests of its shareholders … Simply put, SIGA believes it is solvent and is optimistic that it has a

reasonable likelihood of raising the capital to satisfy PharmAthene’s claim during the time

period provided by the Plan.”

2)     M&F as controlling shareholder: There exists the potential for conflicts of interest between M&F and other SIGAQ shareholders. For example, M&F may use the capital raise to transfer value from SIGAQ and/or other shareholders to itself. Esopus Creek, a 2% holder of SIGAQ, has filed objections to the open-ended and “to be determined” nature of the plan. Esopus wants the capital raise decision to happen while SIGAQ is still under the supervision of the bankruptcy court to ensure fair treatment for all equity holders. From the February 16, 2016 hearing, the judge appears sympathetic to Esopus’s concerns and Esopus is educating the court on all the ways M&F may screw over other shareholders. I have run into Esopus many times in my bankruptcy travels – they are smart and provide a good counterbalance to M&F. That combined with the fact that M&F and other shareholders are mostly aligned provide on upper bound on M&F’s potential evil.

3)     FDA approval: The bulk of the remaining BARDA contract value and other future commercial opportunities depend on FDA approval of ST-246. SIGAQ began a Phase III human safety trial in June 2015 that is scheduled to complete in April 2016. SIGAQ recently announced that the FDA agreed on the clinical dose of ST-246 for the trial. This is important because one of the four key factors for approval under the Animal Efficacy Rule is “the data or information on the kinetics and pharmacodynamics of the product or other relevant data or information, in animals and humans, allows selection of an effective dose in humans.”

ST-246 has historically shown no ill effects and has been well-tolerated in a number of different animal species and in emergency human applications (http://www.ncbi.nlm.nih.gov/pmc/articles/PMC3151656/), as well as in a study of 38 human volunteers (http://aac.asm.org/content/52/5/1721.abstract). However, the possibility of an adverse event in the current Phase III trial is a risk.

4)     Chimerix competition: CMRX has a competing smallpox treatment, brincidofovir. The company previously protested the SIGAQ’s original $2.8b BARDA contract in 2011. Chimerix is in discussions with BARDA to provide brincidofovir to the Strategic National Stockpile in a contract that mirrors SIGAQ’s.

5)     As for taxes on any litigation award, PIP has $153mm of federal NOLs and a full $68.7mm valuation allowance against DTAs. PIP recently enacted a NOL protection plan. SIGAQ has $87.4mm of federal NOLs.

Summary 

Hopefully, both SIGAQ and PIP can soon put bankruptcy and litigation behind them and move on with their corporate lives. SIGAQ must raise a significant amount of capital to satisfy the PIP judgment, but the Chapter 11 plan affords them to the time to do so. The remaining value of the BARDA contract and future commercial opportunities for ST-246 suggest there is potentially a significant amount of value in SIGAQ beyond the PIP judgment. PIP currently trades for ~50% of the judgment awarded to it by the courts. Take your pick to go long SIGAQ or PIP, or both in an appropriate ratio.

Catalyst

Successful capital raise by SIGAQ

Bankruptcy exit by SIGAQ

Completion of Phase III by SIGAQ without any adverse events 

Receipt of judgment proceeds by PIP