January May Determine The Fate Of Synergy Pharmaceuticals
- January will be a critical month for Synergy.
- The FDA will vote on indication expansion for Trulance and the company will have to prove that it has sufficient cash to qualify for the second tranche of a debt.
- An expanded indication could prompt a buyout offer. Failure to set a clear course not involving further dilution could instigate a shareholder revolt.
- Management has a lot to prove in January. External actors may soon get the scent of blood.
As we reach the tail end of 2017, many investors may be eager to pause and reflect on the year just past – or perhaps to try and forget about it in the glow of holiday cheer. The holiday season does tend to focus one’s mind on the present. With the crush of familial obligations, gift-giving, parties, squabbles etc. it is easy to neglect consideration of the year ahead.
۲۰۱۷ was supposed to be a breakout year for Synergy Pharmaceuticals (SGYP). With Trulance, its drug for treating chronic idiopathic constipation, going on sale, Synergy was going to be pushing into a highly lucrative market. Yet sales growth has been slow and the cost of marketing high. Despite starting the year off very strong, 2017 has turned nasty for Synergy.
Disastrous Secondary Sets the Scene
The proximate cause of the negative turn came on November 13, when the company announced a secondary offering of its shares, a move that blindsided many investors who had been sure that any near-term funding needs would be covered by the $200 million still available from a $300 mill debt facility negotiated during the third quarter. Days earlier, during the Q3 2017 earnings call, the company’s CFO had stated, “We are confident in our ability to meet the conditions that will allow us to access to the additional capital if and when we need it.” After the announcement, I expressed confusion at the move given Synergy’s access to non-dilutive capital and significant cash in the bank at the end of the quarter.
It turns out that the extra cash was indeed required. According to the terms of the debt facility, Synergy needs to meet a cash requirement before it can access the second tranche worth $100 million. The only way to get the next piece of the loan was to raise more cash in advance. Unsurprisingly, the move has severely shaken confidence in Synergy and its management. The apparent dishonesty concerning financing needs, as well as concerns over the unsustainably high costs of bringing Trulance to market without a partner in competition with Allergan’s (AGN) Linzess, has put Synergy in the investor penalty box, with shares trading around $2 – a far cry from the $3.50 a share of October.
Synergy has back-to-back catalysts in the back half of January that will each have major impacts on the company’s future. First up, on January 24, the company faces an FDA PDUFA deadline for approval of an expanded indication for Trulance to treat irritable bowel syndrome with constipation, or IBS-C.
The second catalyst is a matter of corporate finance. In order to secure the second tranche of its debt facility in February, worth $100 million, Synergy must first demonstrate that it has $128 million in the bank on January 31. With $117.8 million in the bank at the end of September and a net loss of $48.9 million in Q3 2017, it is clear why the company needed to bring in the $56 million it raised in the secondary.
What Should Happen
Synergy ought to get the thumbs up on both counts. Markets seem to be treating the expanded indication as in the bag, and the share price is unlikely to get much of a bump from FDA confirmation. The company’s trials have proven out the efficacy and safety of Trulance for treating IBS-C. Further, the company has also demonstrated that attitudes among patients with IBS-C and their physicians are highly negative toward current offerings. The FDA should have no difficulty signing off on this one. As for the second tranche of the debt facility, some commenters and authors on Seeking Alpha and elsewhere have expressed concern that the numbers do not add up and that Synergy will still be short the necessary funds to unlock the second tranche. The cash burn rate is a blunt instrument we use to show financial sustainability over time, but we must remember that it is just that – blunt.
A company can pull all manner of levers, from radical measures such as laying off salespeople to simpler methods such as delaying payments. In other words, there is little chance Synergy will fail to get the second tranche if it wants it. Remember, the offering in November was underwritten. No investment bank would agree to underwrite an offering if it suspected it would be so ineffectual as to demand a follow-up a month or two later.
If Things Go Wrong
If Synergy loses on either front, it will be seriously bad news. With regard to the indication expansion, the $300 million IBS-C market opportunity is crucial to the long-term growth story of Trulance sales, and hence of Synergy as a whole. Without the expanded indication, Trulance will be restricted to the CIC market, limiting its value to Synergy – as well as to any potential partner or acquirer down the line.
With regard to the second loan tranche, the fallout from failing to meet the cash requirement could be severe – and endanger the viability of the company. Irrespective of the loan, the company will be able to make it through the first half of 2018 unscathed. But that may be cold comfort to shareholders if Synergy had to dilute them even further.
Outlook: Scenting Blood?
In the event of a failure to secure the debt facility, shareholders might revolt. With a depressed market capitalization of just under $500 million – sure to be pressed down further by the uncertainty of a failure to secure the second tranche – the company would certainly look like appetizing prey to a number of potential buyers or activist investors interested in changing out management.
If management fails to deliver significant sales improvements and a clear path to profitability in the early days of 2018, its days may be numbered. With little in the way of insider ownership, and a general attitude of shareholder disgruntlement, management would find any proxy fight difficult to win.
Indeed, there may already be potential predators waiting in the wings. With the expanded indication still up in the air, it makes sense that they would not make a move until the FDA has reached its final decision – as that will have an impact on the value of Synergy’s sole asset. Once Trulance is approved to treat IBS-C in addition to CIC, buyers could well come out of the woodwork. Sales growth for Trulance have been solid, a pattern evidently continued during Q4 2017, according to data excised from Bloomberg. Yet the cost of going it alone has been immense. A bigger, better managed buyer or partner would undoubtedly expand sales faster and at significantly lower cost. In such a scenario, the buyout price would likely show most of the potential that Trulance could have in the absence of poor management.
Unfortunately for shareholders, given the current depressed state of the company, any buyout offer would unlikely be priced much higher than $5 a share, if that. Yet, given the loss of faith in management to deliver, as well as the alternative of potentially more dilution, shareholders would likely get onboard in sufficient numbers.
While management has been insistent that it will market Trulance without help, in 2018 shareholders and external actors may not give it that choice.