Flexion Therapeutics (FLXN) – CVR – Multi-bagger Upside

Current Price: $0.77 (CVR only)

Offer Price: $3.70

Upside: 380%

Expiration Date: December 2030

This idea was shared by Joshua.

 

Situation Overview

On Monday October 11, 2021, Pacira Biosciences announced that it would be acquiring Flexion Therapeutics valuing the equity at $450m on a fully diluted basis and an EV of ~$550m. Flexion has one drug currently on the market, Zilretta, which is an extended release injection used to treat osteoarthritis (“OA”) of the knee. Zilretta, and two drugs, FX201 and FX301, currently in Phase 1b of clinical trials are all non-opioid pain relievers, which fits with Pacira’s strategy of becoming a leader in non-opioid pain management. Pacira will pay $8.50 per share for the acquisition, as well as a Contingent Value Right (“CVR”) with additional payments totaling another $8 per share should all the approval and sales milestones be met. The offer (excluding CVR) comes at 47% premium to the pre-announcement price of $5.78. The CVR milestones must be met by December 31, 2030, and are as follows:

  • $1.00 per share if total calendar year ZILRETTA net sales achieve $250m
  • $2.00 per share if total calendar year ZILRETTA net sales achieve $375m
  • $3.00 per share if total calendar year ZILRETTA net sales achieve $500m
  • $1.00 per share upon U.S. FDA approval of FX201
  • $1.00 per share upon U.S. FDA approval of FX301

The CVR will not be tradeable according to the 8-K, so once the transaction closes those wishing to have exposure to the CVR will likely have to transfer the economics via a participation agreement, thus taking counterparty risk. There are potential alternatives, such as setting up and SPV, or, if the buyer and seller both use the same prime broker, having the prime broker swap who the CVRs are held for the benefit of in street name. However, this requires both parties to agree on the structure and makes litigation more complicated since legal ownership has not been transferred via a purchase and sale agreement. There may be legal arguments that the Pacira cannot legally restrict an investor from assigning their rights to another party, and the CVR Trustee could potentially be pressured to maintain a ledger for
assignments or face litigation, but one should assume that after the deal closes, legal ownership rights will remain with the original holders and those who wish to have legal ownership will need to purchase FLXN shares prior to the closing of the merger.

 

Investment Thesis

With FLXN currently trading at $9.27, buyers are creating the CVR at $.77 ($9.27 Stock Price - $8.50 Cash Consideration). Paying $.77 (implied value of $38.7m, or 9.6% of the total potential value based on 50m shares out) for $8, or $402m, of potential payouts does appear to have the type of asymmetric risk/reward skew investors look for in these instruments. Nevertheless, accurately assessing the probability of meeting those milestones, as well as the timing of reaching the various milestones is essential to estimating the expected value and validating the investment’s merits. We estimate the expected value of the combined sales and approval milestones to be $3.70 (4.9x or 48% IRR to 3.8-yr WAL) undiscounted, and $2.17 (2.8x) on a present value basis. The term of the CVR is 9 years and there are no intermediate exploding dates, so this CVR is effectively a 9-year option on achieving any of the milestones. We estimate the WAL of the 1st milestone at 2.85 years and the 2nd at 3.8 years, with 3rd not being meaningful on a WAL basis due to the lower probability weights assigned.

Since Zilretta is already on track to generate ~$100-$110m of sales in 2021, we view reaching $250m in sales and the $1 milestone over the next 9 years as being 100%. The remaining $2 milestone at $375m and $3 at $500m of annual sales will be driven by the ability of Pacira to accelerate the adoption of Zilretta for the treatment of OA of the knee, which approximately 15m Americans are treated for annually, ~5.3m of whom receive ~8m injections annually for pain management. Zilretta has three primary advantages over the current use of cortisone steroid (CS) injections. One, Zilretta is formulated as an extended release, so pain relief is delivered over a 12 to 16-week period versus 8-10 weeks for CS; two, there is a lower dosage of steroidal anti-inflammatory, which results in less damage to the cartilage and joints; and three, Zilretta has a substantially lower impact on blood glucose levels over CS, which is critically important for the 20% of OA sufferers with diabetes. It is also unclear how many of the 2/3 of Americans who do not currently receive CS treatments for their OA of the knee area due to concerns regarding diabetes-related risks. We estimate that if Zilretta were to capture 17 % of the market (1.4m annual injections), it would result in annual sales of ~$417m, which would achieve $3 in milestone payments and 83% of the required $500m sales milestone and $3 payment. Moreover, Zilretta is in Phase 3 trials for use in treating shoulder OA and adhesive capsulitis (frozen shoulder). The company estimates that this could be a one-million injection per year market for Zilretta. The company also noted that ~40% of those with shoulder OA also suffer from diabetes. See "Potential Sales and Market Opportunity" section for full sales analysis.

 

CVR Expected Value Model

Using sell side analyst consensus estimates complied prior to the announcement of the merger and Flexion withdrawing 2021 sales guidance, it was estimated that Zilretta would achieve the $250m sales milestone by 2023, the $375m milestone by 2025 and the $500m milestone by 2027. The estimates imply that all 3 sales milestones, and $6 in CVR payments are achievable with ~2 years of cushion for slippage.

Source

 

Approval Process Milestones

The drug approval milestones are the highest risk/lowest probability given the length and time to complete. According to the FDA it takes 4-7 years to complete clinical trials and 12-18 months to receive FDA approval.

  • Phase 1: These trials usually enroll 20 to 100 healthy volunteers or people with the condition being studied and last several months. This phase measures safety by testing for any adverse side effects of the treatment, but not necessarily how effective the drug or device is.
  • Phase 2: Around 70% of potential new drugs enter Phase 2, which continues to measure safety, while also looking at how effective the treatment is and carefully investigating its side effects. Phase 2 trials recruit up to several hundred patients with the condition to take part. This phase typically lasts several months to two years.
  • Phase 3: Just 33% of drugs make it to Phase 3, which tests the potential treatment in the largest number of people. This phase measures both safety and effectiveness with many volunteers, sometimes thousands. Phase 3 trials last from one to four years.
  • FDA approval: After Phase 3, a pharmaceutical company may submit a New Drug Application (NDA) or a biologics license application (BLA) for the treatment to the Food and Drug Administration (FDA) which generally takes another 12-18 months.

According to a 2018 study done by MIT Sloan School of Management published in Biostatistics, 14% of new drugs make it from Phase 1 to approval. Approval rates ranged from a high of 33.4 percent in vaccines for infectious diseases to 3.4 percent for investigational cancer treatments. We view OA treatments as being somewhere in between the 14-33% range given that these are not high-risk, experimental treatments.

 

Other Risk Factors

Given that FLXN is trading above the $8.50 cash portion of the offer, the expected year-end closing, and the lack of antitrust issues, we view deal closing risk as effectively <1%. Another risk factor that must be considered is Pacira’s incentive to avoid triggering the milestone payments. By making the CVR nontransferable, the company is likely trying to disincentivize distressed and litigation funds from a repeat of the Genzyme and Bristol Meyers CVR litigation. That said, there are key distinctions from both of those CVRs. In Genzyme, the approval and sales milestones had to be met by a series of dates to trigger payments. Many of the more achievable milestones were front-loaded in the early years of the CVR which gave Sanofi (the buyer of Genzyme) the incentive to delay actions critical to achieving those milestones so that they would not be triggered. Ultimately Sanofi settled claims related to $800m in damages from their breaches of the CVR agreement for $315m (~40% of alleged damages under the second amended complaint). The terms of the Bristol Meyers CVR litigation were an all-or-nothing payout of $9 per share contingent on the approval of three drugs by a certain date, which was missed by less than 60 days, hence the litigation.

However, in both the Genzyme and BMY CVRs, neither of the drugs had received FDA approval, whereas Pacira is paying $550m cash for Zilretta including net debt of $100m that will be paid off, with an option on FX201 and FX301 which are 6-9 years from approval, if they are approved at all. On a conference call to discuss the transaction, management stated that they ran their deal model on Zilretta to the mid-2030s based on the current patent, with some positive comments based on their IP lawyers diligence that it could be extended to the late 2030s. Given that the CVR has a 9-year term, Pacira has a substantial financial incentive to get a return for its shareholders on its $550m investment and ensure that the drug’s commercial value is fully realized over the next 9 years. Management also believes there will be substantial synergies as a result, which given Zilretta is currently on track for ~$100m in sales in 2021 implies the expected substantial revenue growth.

 

Merger Rationale

Flexion currently has one drug on the market, Zilretta, which is a physician-administered drug to treat osteoarthritis (OA). The drug was approved by the FDA in October of 2017 and is an extended-release, non-opioid treatment for the condition. Zilretta is also in a phase 3 trial for shoulder OA while FX201 is in Phase 1b studies of musculoskeletal pain, including OA, and FX301 in phase 1b as a lower extremity nerve block for post-surgical pain. The acquisition aligns with the Pacira’s strategy of “expanding its nonopioid pain medication portfolio” according to the companies’ joint press release. Moreover, the press release states that with the addition of Zilretta, Pacira will be “better positioned to offer another treatment option to manage pain for knee OA at an earlier stage of the patient journey”. Flexion's FX201 and FX301 are complementary to PCRX’s products, Exparel and Iovera, and fit well into the company’s growth pillars in non-opioid pain management and the focus around offering patients an end-to-end solution along the neural pain pathway and would allow the company to better engage with physicians and patients across the same call points.

Pacira highlighted that it expects to capture double-digit operational synergies beginning in 2022 and for the deal to be significantly accretive thereafter, excluding one-time charges and integration costs. More specifically, Pacira noted that it only needs to capture ~30% of the operational synergies of the FLXN transaction to make this deal accretive in 2022. FLXN expects 3Q21 Zilretta net sales to be in the range of $21m-$23m for the quarter, which is well below consensus estimates of ~$33m and withdrew its full-year guidance for sales of Zelretta for FY 2021 of $120-$130m. Management noted that Q3 sales results, particularly in the second half of the quarter, were negatively impacted by: (i) temporary disruptions from rebate program modifications, (ii) covid-related challenges, and (iii) unforeseen manufacturing batch failures that resulted in short-dated Zilretta inventory, causing smaller order sizes by physicians and product returns from specialty distributors. Presumably, Pacira was aware of these issues and may have used them to its advantage in pushing for the large contingent value portion of the deal consideration. Sales of Zilretta had improved 80% YoY in Q2 and 15% in Q1 for a first 6 months total of $52.8m. Based on management’s midpoint guidance of $22.5m for Q3, full 2021 year sales are likely to be in the $100-$110m range.

From Flexion’s perspective, the willingness to sell at levels well below historical trading prices for the stock was likely driven by a levered balance sheet and ongoing operating losses. As with small many biopharma companies, Flexion had one drug, Zilretta, on the market that was in its early stages, as well as two in development. As a result, the company has been incurring substantial cash operating losses over the last 5 years of ~$600m. However, with the growth of Zilretta, the company had narrowed those losses from -$160m in 2018 to -$60m LTM. With FLXN also carrying $220m of debt on its balance sheet and cash and short-term investments having fallen from $392m in 2017 to $130m currently, there were certainly concerns about the company’s standalone ability to maximize the commercial value of Zilretta along with its two drugs in clinical trials. Marketing new drugs require significant investments in advertising, sales force, and rebates to gain market share. The high debt load for a small biopharma company, along with the cash burn likely prompted FLXN’s management and board to be receptive to an acquisition. The company has been public since 2014 and its stock price peaked in 2018 at ~$27 and had fallen to an all-time low of $4.76 in August of 2021, two months prior to the deal’s announcement.

 

Flexion’s Drug Portfolio

Zilretta (triamcinolone acetonide extended-release injectable suspension) is the first and only FDA-approved non-opioid extended-release therapy for osteoarthritis knee pain. Zilretta is administered by a physician and employs proprietary microsphere technology combining triamcinolone acetonide — a commonly administered, immediate-release corticosteroid — with a poly lactic-co-glycolic acid (PLGA) matrix to provide extended pain relief. The drug is an alternative to the standard cortisone injections, and Zilretta's extended-release formula ensures substantially lower doses are received and the company’s phase three trials showed that relief lasted a period of approximately 12 weeks and up to 16 weeks in some patients. This is a substantial improvement over cortisone steroid injections where relief typically lasts 6-8 weeks. Moreover, because of the side effects, cortisone injections can only be given to a patient a few times a year, leaving them with long periods of discomfort in between. According to the company’s clinical data, patients receive a significant improvement in pain, stiffness, and function compared to standard cortisone as measured by the WOMAC scale and without the side effects that a cortisone shot has.

As a result of the extended-release technology, Zilretta plasma levels are 10 times lower than what a standard cortisone shot generates, so patients do not experience the sudden spike in blood glucose levels that occur with cortisone. The company estimates that ~20% of those suffering from OA of the knee are diabetic as well. Given the substantially lower impact of Zilretta on glucose levels, it is much safer to use on patients who also suffer from diabetes. Additional known side effects of immediate-release cortisone shots include the acceleration of cartilage degeneration in the knee as well as joint damage. The company believes that those suffering from a chronic condition such as osteoarthritis will have significantly reduced complications than the side effects associated with high-dose cortisone shots given the extended-release nature of Zilretta. In addition, there should be less damage to cartilage and joints over time than with cortisone shots, which is a serious concern given OA is a chronic condition with no cure.

Initially, Zilretta was only approved for single use and the label carried the language “not intended for repeat administration”. However, in 2019 the company successfully lobbied the FDA to change the label which now states, "the efficacy and safety of repeat administration" of the drug "have not been demonstrated."

Other label revisions announced by the company in a December 26, 2019 press release, included:

  • Inclusion of a study description and safety data from a single-arm, open-label Phase 3 repeat administration trial;
  • Removal of a "misleading" statement describing a single secondary exploratory endpoint in the original Phase 3 pivotal trial which compared Zilretta to immediate-release triamcinolone acetonide crystalline suspension;
  • Inclusion of nonclinical toxicology data from previously submitted single and repeat administration studies in non-diseased animals.

Flexion recently presented new data on FX201, the company’s intra-articular gene therapy for OA knee pain. The Phase I study revealed that two patients in the low-dose cohort displayed robust improvements in pain levels at one-year post-treatment. FX201 was largely well-tolerated, however, two patients had “Grade 2 index-knee adverse events of pain, swelling, and effusion.” These events were perhaps connected to the treatment but were managed. It is important to note, that all five patients remained in this study up to 56 weeks post-treatment, which indicates that they did not seek an alternative treatment. Flexion is resuming their enrollment and expects data in the second half of this year, which should include data from synovial fluid to assess the biological activity of FX201. Flexion continues to enroll patients in the company’s Phase Ib trial for FX301 for postoperative pain and remains on track to share preliminary efficacy data later this year.

 

Potential Sales and Market Opportunity for Zilretta

Osteoarthritis, the most common joint disorder in the United States, affects the knee joints of 10 percent of all men, and 13 percent of all women over the age of 60. According to IQVIA claims data, in 2018 15.2m patients were treated for OA of the knee. However, Zilretta has been slow to gain market share, which is likely due to its initial label classifying it as being approved for a single-use only. The label change was approved at the end of 2019 just as the pandemic was beginning, and since Zilretta is administered by a physician, the pandemic certainly played a role its slower than anticipated market penetration, particularly since the elderly who are most affected by OA, were also the most vulnerable to Covid and likely more concerned about contracting it, than treating their OA.

Nevertheless, Zilretta currently has captured <1% of the market for patients being treated with injections for osteoarthritis knee pain, which the company estimated to be ~7.9m injections annually between steroids and hyaluronic acid (HA). One factor may be the cost of Zilretta, which is substantially higher than cortisone steroid injections. Zilretta is priced at ~$600 retail, and while it does have reimbursement from commercial insurers and Medicare/Medicaid (received its J code non-orally administered drug reimbursement code ~3 years ago), physicians have been slow to adopt it, perhaps due to its substantially higher cost versus cortisone steroids. A typical 20% copay would mean that the out-of-pocket is likely around $100-$120 versus $10-$20 copay on CS. With the proper training of the sales force and education of doctors and consumers, this should not be a high barrier to expanding the use of Zilretta, and if fact one of the rationales of the merger is the ability of Pacira to leverage its network and expertise with both doctors and insurers to drive sales and reimbursement rates.

Diabetics with OA of the knee represent a significant market opportunity for Zilretta given its low impact on glucose levels vs steroids. The CDC estimates that 17 percent of Americans between 45 and 64 years of age, and 25 percent of Americans 65 years and older have diabetes. FLXN's CEO stated on a Raymond James investor call that about 20% of OA knee patients are diabetics, which that market alone could represent up to 1.6m injections annually.

If Pacira invests the resources in educating doctors and patients regarding the benefits of Zilretta, particularly for those suffering from diabetes, then capturing just the 20% market share that suffers from diabetes over the 9-year life of the CVR would be 1.2m-1.58m (1.4m midpoint) injections annually using a range of 6m (25% haircut to IQVIA claims data) to 7.9m injections per year.

Assuming Zilretta’s wholesale cost is about 50% of its ~$600 retail cost per injection, implies sales of $300 per injection, or $360m annually, which covers the $275m Sales $1 milestone at the low end and the $375m Sales $2 milestone at the midpoint with $417m in sales, so $3 in Sales Milestone payments appears reasonably achievable.

Furthermore, it is reasonable to believe that if the appropriate efforts are made by Pacira to commercialize the drug, that doctors and patients would prefer the longer relief and reduced side effects provided by Zilretta’s extended relief formulation. Assuming that results in a pickup of an additional 5-10% of the market, that is another 300-600k annual injections and an additional $90-$180m of annual sales, for total of $450-$540m of annual sales using the low end 6m annual injections and midpoint of 7.5% market share results in $495m of sales, $5m shy of the $500m Sales $3 milestone payment. Using the midpoint of 6.95m annual injections and an additional 7.5% additional market share results in 521.5k annual injections and $156m of incremental annual sales, for a total of $516m in annual sales covering the 3rd Sales Milestone of $500m in annual sales resulting in the $3 milestone payment being made.

Zilretta is in Phase 3 trials use in treating shoulder OA and adhesive capsulitis (frozen shoulder). The company estimates that this could be a one-million injection per year market for Zilretta, in addition to OA of the knee. Zilretta’s lower impact on glucose levels makes it ideal for patients with diabetes, and management noted on the Q3 2020 earnings call that the prevalence of diabetic patients with adhesive capsulitis is almost 40%, double those with OA of the knee.

OA of all types, also known as degenerative joint disease, affects more than 30 million Americans and accounts for more than $185 billion in annual expenditures. The prevalence of OA is expected to continue to increase as a result of aging, obesity, and sports injuries. Non-opioid treatments for these conditions, which are chronic and do not have a cure, are a substantial, growing market opportunity as the average of the American population continues to grow. Moreover, OA symptoms are now manifesting in adults at much younger ages (see below), further expanding the potential market for pain management treatments.

Note: Q2 2021 Sales of Zilretta were $28.2m for a YTD total of $52.8m. The company guided to $22m in Q3 2021 and withdrew its $120-$130m guidance. We assume 2021 sales are between $100-$100m.

Note: There are 32 units in 1 injection of Zilretta and sales increased by 56,798 units in Q2 2021.

 

Alternative Treatments for OA of the Knee

Both Platelet Rich Plasma Therapy (“PRP”) injections and Hyaluronic Acid injections (“HA”) are alternative treatments for OA of the knee, however, they represent a small portion of the overall market for injections. PRP injections are not covered by commercial insurers or Medicare/Medicaid. While Medicare Part B covers HA, the efficacy of Hyaluronic Acid to treat OA of the knee is being called into question, and providers and insurers are starting to reduce or remove coverage for the treatment. AMP Biotech Research in its analysis of Zilretta cited, a recent review article (Bisicchia and Tudisco, Clin Cases Miner Bone Metab. 2017 May-Aug; 14(2): 182-185) which stated:

that analyzed prior primary and meta-analysis of a number of hyaluronic acid (HA) trials, concluded as follows: "Conflicting results have been reported in clinical studies and meta-analysis on the efficacy and safety of HA. Guidelines are controversial and "uncertain" recommendations are provided in most of the cases due to inconclusive evidence in literature.

PRP has shown effectiveness in some studies and has been used by famous athletes such as Kobe Bryant, it is not covered by insurance and costs $600-$800 per injection, which is $1,200-$1,600 annually assuming an injection every 6 months. As a result, it does not present significant competition to CS or Zilretta. AMP Biotech Research cites: "Your Guide to Injections for Knee Osteoarthritis" on everydayhealth.com and concluded there is not enough evidence to show a benefit of PRP over HA. However, AMP also cited peer-reviewed publications such as Guvendi et al (2018), which concluded that there is a long-term benefit of PRP over CSs, although there are limitations to this study, (e.g. it was not a blinded study). Kavadar et al. published another study that showed long-term benefit of PRP, although the benefit appeared better with multiple injections, but there was no placebo control group in this study (Kavadar et al. 2015).

 

Holders List

48 COMMENTS

  1. Terence

    Right after merger news, a few analysts downgraded FLXN to market perform. Apparently, they are not bullish on the CVR, creating this opportunity per write-up.

    1. Lukas

      The deal should close in Q4 of this year. The payout date is not stated, however, usually, the settlement comes in a week or two post-closing.

      1. tony

        Maybe its just me, but I am doubtful. 3 Months is very tight for a deal of this size unless serious DD was already done pre-announcement on October 11th.
        Will be happy to be wrong of course.

      2. Joshua

        All the due diligence was done prior to the announcement of the merger, which is standard practice. For a deal of this size, with no HSR/antitrust issues, closing by year end is not unreasonable assuming the minimum 20 business days for the proxy to be out prior the vote. If you read the transcript of the conf call on Oct 11 that Pacira held to discuss the transaction they discuss the extensive amount of dd that was done by Pacira

    2. snowball

      @joshua

      Note also that the second step merger relying on Section 251(h) will not require a vote or shareholder meeting (thus no 20-day waiting period).
      Theoretically they can complete the second step and close the deal immediately after making payments/issuing CVR’s to shareholders.

      ” If the Minimum Condition (as defined in Section 15 — “Conditions to the Offer”) and the other conditions to the Offer are satisfied or waived and we consummate the Offer, we intend to effect the Merger as soon as practicable pursuant to Section 251(h) of the General Corporation Law of the State of Delaware (the “DGCL”) without a meeting of Flexion stockholders and without a vote on the adoption of the Merger Agreement by Flexion stockholders.”

      1
      1. Joshua

        Thx. Would there be a minimum 20 days for a tender to be outstanding still? Presumably there may be some small portion wants to exercise appraisal rights that cannot be forced to accept the deal consideration.

      2. snowball

        For a Section 251(h) merger, the acquirer is allowed to close the deal first, and then give notice after the fact. Any stockholder seeking appraisal rights can then send in request within 20 days after receiving the notice.

        “Such notice may, and, if given on or after the effective date of the merger or consolidation, shall, also notify such stockholders of the effective date of the merger or consolidation. Any stockholder entitled to appraisal rights may, within 20 days after the date of giving such notice or, in the case of a merger approved pursuant to § 251(h) of this title, within the later of the consummation of the offer contemplated by § 251(h) of this title and 20 days after the date of giving such notice, demand in writing from the surviving or resulting corporation the appraisal of such holder’s share”

        1
  2. Noahsj

    Thanks for this, what are your thoughts on selling the May 20 2022 $10 Put options for $1.5, effectively gives you an entry price of $8.5, and I believe you would still have the CVR as you would be exercised when the deal closes. Am I missing something here?

    1
    1. nostradamus

      There’s no free lunch. Exercise price will be set for the cash consideration only. You won’t get the CVR’s as they’re not transferable.

      1
      1. tony

        That’s what I have done. Not sure how it works with those CVRs, but the OCC rules are clear in the sense that the put seller is entitled to any instruments distributed. Furthermore, those May puts will be accelerated of course.
        The risk is that the deal does not close, as I highlighted by the OP. Your loss will be large then.

        p.s. IB will send you this corp. act. email as soon as you sell those puts:

        1 FLXN CORPORATE ACTION: DECISION REQUIRED
        We have received information regarding an upcoming corporate action in the below stock. This corporate action presents several choices to the shareholder.

        FLXN (Company Name: FLEXION THERAPEUTICS INC)

        Election period starts: Oct 28, 2021 00:00 EDT
        Election period expires: Nov 18, 2021 13:00 EST

        After the election period has commenced, please access the election tool in one of the following manners
        Individual Account – through Account Management, follow the “Select CA Choice” icon from the Message Center Inquiry Ticket
        Multi-Account structure – through Account Management navigate to the Corp Action manager through the Support menu option
        Instructions may be submitted through this tool only until the above stated expiration date and time. If the election period has expired, elections may be submitted through a New Ticket and will be handled on a best-efforts only basis.

        Nov 10, 2021 12:55 EST

        1
      2. nostradamus

        The OCC rules are clear in the sense that the put seller is entitled to any instruments that can possibly be distributed. As the CVR’s are not transferable, they’re not part of the deliverable upon accelerated settlement.

        2
      3. Writser

        As nostradamus said, the options won’t be adjusted to reflect the CVR. See the memo here: https://infomemo.theocc.com/infomemos?number=49501 .

        “As indicated below, FLXN options will not be adjusted to reflect the expiration of the Offer and will not call for delivery of the contingent value rights (“CVR”). Call holders who wish to ensure entitlement to the contingent value rights may exercise their options sufficiently in advance of the expiration of the Offer and
        tender the FLXN shares received into the Offer.”

        3
      4. tony

        This is clear. Thanks Writser.

        We can sell Jan $10 puts for $1.5: if deal is delayed by a few weeks (not unheard of), we get the CVR for free.
        If deal closes before Jan expiry, we get our money back.

        No free lunch, but free upside.

      5. Brian

        Thanks for the idea. I just got $1.50 for the December 17 puts, which has a fighting chance of being a free lunch and creating the CVR for zero. Still of course have the risk of the deal breaking, but I view that as low, and if deal does close before Dec 17, I break even.

        1
      6. nostradamus

        Honestly, I’m not sure the risk/reward is that great. You need the chance for the deal to be extended (even though the tender expires next week and I don’t really see what would hold it up after that) past the December deadline to be about 2:1 compared to the deal breaking down if you look at the downsides. Both outcomes also seem very unlikely to me; almost certainly you just get your money back minus cost. These option prices are usually priced pretty efficiently.

      7. snowball

        I have a technical (and maybe foolish) question:

        Where can one find (presumably cheaper) ex-CVR-rights FLXN shares to deliver to put sellers?

        If one tenders his FLXN shares, he will receive cash and CVR, and will not have any ex-rights FLXN shares left in his hands.

        And any FLXN shares not tendered and that are still available on the market will still have rights to the CVR, which they will receive in the subsequent second-step merger.

        OCC states that the option seller will not call for delivery of the CVR, but the option buyer still have to deliver FLXN shares. They have to be able to find and deliver ex-CVR-rights FLXN shares in order to gain some advantage over the seller. My question is: where can they find them?

      8. nostradamus

        There’s no obligation to deliver FLXN shares after the deal closes; there’s an obligation to deliver the cash equivalent, i.e. $8.50 in cash.

      9. tony

        Or in the case of those $10 puts sold for $1.5, there is simply no incentive in exercising them.

      10. snowball

        I assume that the options will be terminated after the deal closes.
        So any exercise has to be done before the deal closes and thus before the CVR is issued/assigned to a specific owner, and therefore put sellers who get exercised will be entitled to the CVR’s.

        1
      11. nostradamus

        Why would the put buyer exercise before the deal closes? They’ve got a free shot at the deal not closing until the deal actually closes.

    2. snowball

      @Writser

      I think OCC’s determination “FLXN options will not be adjusted to require delivery of the contingent value rights” applies only to the event of of tender offer expiration, and not to the subsequent second step merger event.
      I am guessing that, after consummation of the second step merger, some adjustment will be made re the CVR. Maybe a cash value will be set in lieu of the delivering the CVR’s.
      Otherwise it’s hard to understand why there currently are very large bids at $1.5 for both Dec and Jan $7.5 calls. They are willing to pay $9 (= $7.5 strike+ $1.5 premium) for the certainty of losing at least $0.5 (if the deal closes and these calls are exercised to receive only $8.5 cash) ?

      “Possible Contract Adjustment:
      The Offer is being made with intention to subsequently effect a merger wherein all remaining FLXN Common Shares will be converted into the right to receive $8.50 net cash per share. Interpretation .03 to Article VI, Section 11A, of OCC’s By-Laws indicates a contract adjustment for FLXN options would be contemplated when and if the aforementioned intended merger is actually consummated. It is not known how quickly after the expiration of the Offer the intended merger or contract adjustment would be effected.
      Until such merger is consummated, FLXN option exercise would continue to call for delivery of the underlying security.
      FLXN options will not be adjusted to require delivery of the contingent value rights.”

      1
      1. nostradamus

        Snowball, there are very large bids for the calls right now because a buyer of a call has the right to exercise, and paying $1.50 for $7.50 calls while the share price right now is 9.20, puts the calls below intrinsic value and gives you $0.20 of immediate profit upon exercise. This has nothing to deal with the tender, it’s the same in every call option.

        You are making this way too complicated. Trust me, FLXN is the umpteenth time a company with options traded is bought out by cash + a (non-tradable) CVR. It’s also the umpteenth time the CVR’s are not part of the deliverable. This is common practice for the OCC, not some sort of unique situation.

        1
      2. Writser

        I’m not pretending to be an expert here and this is tricky stuff. As is option pricing. If the market says I am wrong I am probably wrong.

        However, I know for sure that late 2019 / early 2020 I participated in the ACHN merger. And if you look up the historical ACHN memo’s from 2019 and 2020 ( https://infomemo.theocc.com/infomemo/search-memo ) you can see on December 2 2019 and January 28 2020 memos saying that the contract deliverable was adjusted. When the deal closed there was some strange trading in the CVR’s. These options definitely did not include the CVR as a deliverable when ACHN stopped trading. And the deliverable contained zero value ascribed to the CVR, even though shares traded at a significant premium to the $6.30 cash consideration.

        Will the same happen here? I think so. Am I sure? No. Can I explain the pricing in the market? I haven’t looked at that.

      3. Writser

        I ment: *when the deal closed there was some strange trading in the options*

        And this case does appear to be slightly different because, unlike with the ACHN memo’s, I don’t see literally being said that the contract deliverable has been changed.

        Without looking, I guess what you are seeing in the option market is that the options should price in the CVR because you can exercise them at any time, right (American options)? I would think the options should price in the CVR because you can buy them, exercise them and sell the common, which has the CVR priced in. However, the question is what happens if you forget to exercise. In that case I think chances are you could get screwed.

        1
      4. snowball

        @wrister
        I appreciate all of your very helpful comments.

        I don’t stick to a particular view or position, and am motived by profit to do a 180 degree turn if the the side of the trade is more profitable.

        This complex situation is creating many mis-pricing opportunities, waiting to be discovered by us. That’s why discussions on this forum is so valuable.

        I am now thinking about selling $7.5 covered calls if I can get filled at break-even levels, and then hope a small fraction of my counterparties will forget to exercise (and be forced to accept just the $8.5 cash).

        1
  3. WeagleWeagle123

    I see you could sell the 10$ puts at around 1.20. Am I seeing this incorrectly or would this bring down your cost basis for the CVR down to .30 cents ?

      1. Brian

        These kinds of deals via tender offer tend to be extended, often more than once. Plus the company has to contend with shareholder lawsuits that were filed early in the month. I like the December option play

      2. tony

        the problem with the Dec OX is availability @ $1.5
        Size only available from Jan onwards.

    1. snowball

      @tony

      I don’t think bid availability at $1.5 is an issue.

      If we are right (that we as put sellers will likely receive the CVR’s), then I am willing to accept less than $1.5, and buyers bids are certainly more available at for example $1.3.

      If we are wrong (and this is quite likely as option markets are full of smart players), then being able to get filled at $1.5 doesn’t help us.

      I watched the activities of the several $10 put contracts in the past few days, and I saw some buyers who actively bid $1.5 from time to time, and I am wondering what they know that we don’t know.

      1. tony

        Lack of confidence is always the dilemma with any trade Snowball. I get over this by sizing my bets according to my conviction level (or otherwise I miss loads of trades).
        CVR is unlikely unless deal is delayed and options are exercised before then.
        $8.5 cash back is extremely likely as the OP says, deal closing risk <1%.
        So this is the trade here. Sell Jan puts $1.5 in the less likely scenario that the deal is delayed. Otherwise get your money back.

  4. Yardir

    the options play aside, how do you read when the payments are made, after the milestones are hit (if they are)?
    Are the payments done “immediately” after the individual milestones have been reached or is it all payed 2030?
    it’s not super obvious to me reading https://investor.pacira.com/node/14971/html -> section: “What is the CVR and how does it work?”

    1
    1. Joshua

      I suggest reading the CVR agreement attached to the merger 8-K. The Milestone payments are measured form the calendar quarter they are achieved, so for an annual sales milestone (all 4 quarters) is actually made in the following calendar year. The company is required to send out a notice to CVR holders within 60 days of the milestone being achieved that a payment is going to be made which will be paid via DTC for those held in street name within days of receipt of the Milestone Notice and Cash. On an approval, that would happen in the following quarter after the milestone is achieved (total of 70 days from end of the quarter achieved from announcement to payment). See exact language below from pdf page 118 of CVR agreement.

      Payment Procedures.
      (a) If any Milestone is achieved, then, in each case, on a date (a “Milestone Payment Date”) that is within sixty (60) days following the last day of such Calendar Quarter
      in which such Milestone is achieved, Parent will deliver to the Rights Agent (A) a notice (a “Milestone Notice”) indicating the achievement of such Milestone and that the Holders are entitled to
      receive the applicable Milestone Payment, and (B) cash, by wire transfer of immediately available funds to an account specified by the Rights Agent, equal to the aggregate amount necessary to
      pay the applicable Milestone Payment to all Holders pursuant to Section 4.2, along with any letter of instruction reasonably required by the Rights Agent.
      (b) The Rights Agent shall promptly, and in any event within ten (10) Business Days of receipt of a Milestone Notice and cash, by wire transfer of immediately available
      funds, equal to the aggregate amount necessary to pay the Milestone Payment to all Holders pursuant to Section 4.2 as well as any letter of instruction reasonably required by the Rights Agent,
      send each Holder at its registered address a copy of such Milestone Notice. If a Milestone Payment is payable to the Holders, then at the time the Rights Agent sends a copy of the Milestone
      Notice to the Holders, the Rights Agent shall also pay the Milestone Payment to each of the Holders in accordance with the corresponding letter of instruction (i) by electronic payment or check
      mailed to the address of such Holder reflected in the CVR Register as of 5:00 p.m. New York City time on the date of the Milestone Notice or (ii) with respect to any such Holder that is due an
      amount in excess of $100,000 in the aggregate who has provided the Rights Agent wiring instructions in writing as of the close of business on the date of the Milestone Notice, by wire transfer of
      immediately available funds to the account specified on such instructions.
      C

      3
  5. jkniss

    What about international sales of Zilretta? Are they subject to the CVR and if so are they baked into your estimates?

  6. Joshua

    I would advise reading the definition of Net Sales in the CVR agreement (pdf page 115) to understand the precise definition, but yes international sales (converted to USD) and sales to third party sublicenses are included in the sales milestone. However, the US is the primary market given that most European health care systems do no cover $600 injections($300 wholesale price).

  7. Joshua

    I would further note, that while the CVR’s themselves are not transferable, the economic benefits of the CVS can be transferred via a participation agreement or a proceeds letter. Several non-transferable CVRs trade this way, as well as CVRs that have been delisted such as BMY-R, whose ownership rights can assigned (transferred) via a PSA if the seller is a party to litigation funding, otherwise it also trades via participation or a proceeds letter. The docs are similar to bank debt or trade claims assignment or participation docs for anyone who has traded bank debt.

    1
    1. nostradamus

      Surely, by “trade this way” you mean over-the-counter for institutional investors only, correct? While I know BMY-R still “trades”, it doesn’t trade in a trading venue that’s accessible for us mortals as far as I know.

    2. tony

      That is exactly what I was looking into – I have drafted and traded loans that were not transferable/assignable via something we call a sub-participation. They stay on the original lender’s balance sheet but voting right and economic benefit are contractually agreed with a third party. This is usually done to circumvent restrictions imposed by a borrower were explicit approval is required to transfer a loan, and where such approval is not being granted. Now I am very interested to look further into how it works with CVRs – can you perhaps provide more information so I can get started?

      1. Joshua

        The document would be very similar to a loan participation and it will include reps and warranties similar to a claims trading doc regarding not taking any actions that could lead to impairment of the claim, potential recourse back to the seller in certain cases where there was bad faith or other misrepresentations etc. The big issue in trading on participation or proceeds letter is counterparty risk. If your counterparty goes under, which is a real possibility over a 9-year CVR life (just look at Lehman), then you are an unsecured creditor in the bankruptcy estate or receivership of the seller. I am new to the site, but if there is a way to DM me I can possibly share some sanitized examples of participation docs.

  8. snowball

    As the CVR’s are non-transferable, any idea what will happen to FLXN shorts after consummation of merger? Will they:
    (1) pay the lender only $8.5 to close out the loan?
    (2) be forced to buy FLXN at any price on the last day before delisting?
    (3) be on the hook for the borrow fee (however high it is) for the next ten year, as they have no way to buy/deliver CVR to the lender?

    1. nostradamus

      3. The borrow fee is generally (virtually always?) very low, as there’s plenty of borrow from people holding the CVR who can’t sell it either.

  9. dt

    We are removing FLXN from active cases as the merger closed and the stock is no longer tradeable. Any payouts on CVR will likely take at least a few years (expiry only in 2030).

    Joshua, thank you for sharing this idea and for continued discussion.

    Those who tried to arbitrage FLXN with options, please share updates with the board on how has that worked out.

    For tracking portfolio purposes we are marking this position at the last closing price of $9.12 – equivalent to $0.62 per CVR after the $8.5/share consideration will be distributed. We will update with CVR payouts down the line.

  10. Brian

    The November options were exercised over the weekend and I’ve received the merger shares. The shares state an effective date of 11/22, today, so it would seem those shares would receive the CVR. The December options remain outstanding so that is likely to be a wash.

    1. nostradamus

      Interesting, which broker? Interactive Brokers settled the November contracts for cash, not for shares (as I believe is correct)

    2. snowball

      OCC has determined on 19 November that all FLXN options (including the November options) will be settled by $8.5 cash and no CVR’s.
      see OCC memo #49615.

Leave a Reply