Monday, January 30, 2017

Buying OvaScience at Negative Enterprise Value

OvaScience (OVAS) aims to improve chances of fertility. It has two products in early stage development, and one that’s already in the market outside of U.S.

I have some notes in the next section about what the company does, but the thesis is really quite simple - extreme cheapness presents attractive risk and reward.

At $1.6/share, this company has $56mm market cap, yet it has $130mm of cash and securities and no debt. There are no off-balance sheet arrangements either. Stock options are mostly way out of the money, so there’s minimal dilution risk. Taken together, the company has enterprise value of negative 70mm+.

Put another way, the market is pricing in 100% chance of OvaScience burning $70+mm of cash (more than the market cap!) and get nothing in return. Implicitly, the market judges the science behind OvaScience to be worse than worthless.

Now that’s harsh.

Let’s go through some hypothetical scenarios.

First, it goes without saying that this is a multi-bagger if the pipeline in development actually works out. Even if the pipeline doesn’t ultimately work in the long term, the stock can go higher with any positive results from clinical trials. Also, keep in mind we’re in a new era of deregulation – the FDA approval process can conceivably get easier.

But how if it does not work? What’s OvaScience without the science? Is it “game ova”?

No. On the contrary, the stock offers multiple options: a) as a target of acquisition and/or liquidation, 2) as an acquirer of another company.

The company is not majority controlled by insiders. So this is not a situation where management can destroy shareholder value with impunity. Various types of potential acquirers can take control and monetize the discount here.

Management did say they will burn cash in 2017, but not nearly as much as the stock price would imply. If clinical trials start showing bad results, an activist fund can step in, liquidate the company and realize the remaining cash hoard. A pharmaceutical/biotech company can likewise do the same. IVF clinic like Virtus Health could also be natural buyers.

OVAS can also act as an acquirer. This would remove the threat of management running cash down to 0, and thus a boon to valuation. The stock would be worth more even if management buys some snake oil with that $130mm of cash. If they buy anything worthwhile this could be a quick double.

Obviously, things have not gone well with the company thus far. But at this price the downside is minimal.

What the company does

Women are starting families later, which means their eggs are older and have lower chances of conceiving. OvaScience plans to improve fertility via operations on EggPC cells, defined as “immature egg cells found in the outer lining of the ovary, which have the potential to mature into new healthy eggs, thereby replenishing egg supply”. Here’s a picture from the company’s presentations.

Their 3 products in development represent 3 different ways of utilizing these immature egg cells.
  • AUGMENT - enhances egg health by extracting mitochondria from EggPC cells and injecting them into normal eggs.
  • Ovaprime - increase egg reserves by taking a woman’s own EggPC cells and injecting them into her ovaries. 
  • Ovature - A woman’s own EggPC cells are matured into healthy, young fertilizable eggs outside the body.

The company currently has minimal revenue because the AUGMENT treatment has not been a commercial success.

On December 2016, OVAS stock dropped to as low as $1.3, in response to an announced restructuring, summaries of which are below:

  • The company will stop expansion of AUGMENT and reduce its workforce by ~30%.
  • CEO and COO both stepped down. Founder Michelle Dipp took over the firm.
  • As a result of its corporate restructuring, the Company anticipates that operating cash burn will be between $45 million and $50 million in 2017, excluding one-time cash items of approximately $7 million to $8 million related to the restructuring. The Company may also incur further restructuring charges related to the restructuring plan. 
  • These changes will enable the Company to extend its cash position into the first quarter of 2019 and increase its focus on the development of OvaPrimeSM and OvaTureSM. The restructuring is expected to be completed in the first half of 2017.

Post the restructuring, the new goals/milestones are shown in the below slide (from company presentation)

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