SSI Weekly – Quick Pitches For SIOX, CTLT, OTIC

SIOX – Liquidation – 21% upside

CTLT – Rumored Takeover – Upside TBD

OTIC – Liquidation – 18% Upside

 

NEW QUICK PITCHES

Sio Gene Therapies (SIOX) – Liquidation – 21% upside
A failed biopharma liquidation was previously covered on SSI in October and December. The liquidation proposal is subject to shareholder approval – the meeting will be held in Q1’23 and is very likely to pass.

SIOX has recently issued a preliminary proxy statement, indicating that initial distribution will fall between $0.38-$0.42/share (vs current $0.41/share price). This is lower than I expected in my last highlight, but the main difference in calculations seems to be the very high contingency reserve of $6m-$7m that the management has booked for potential future liabilities. There is a chance that some of it will get returned/distributed eventually. Other than that, at current prices the situation has been materially derisked as you will get full or almost full investment back shortly with the initial distribution. $0.38/share seems like the absolute worst scenario now. On top of that, you’re getting an option to receive additional distributions up to $0.09/share for a total upside of 15%-21% depending on where the initial distribution will land. Additional distributions might come from:

• $0.036/share – the CVR related to Arvelle Therapeutics sale in 2021, subject to certain future milestones being met. The total CVR amount was $7m, however, it seems that in Q2’21 (see page 13) SIOX already collected $4.3m related to a milestone that was met in March’21. Therefore, the remaining potential payment from this CVR is $2.7m or $0.036/share. The timeline and visibility of the actual milestones have not been shared.
• $0.04-$0.053/share – partial distribution of current contingency reserves. I’m basing this on the notion that the current $6m-$7m estimate for reserves seems way too conservative compared to other biopharma liqudiations. MTCR reserved $1m-$3.5m for contingent/potential future liabilities (page 24). OTIC reserved $2.3m (page 32), although OTIC management even sees a chance to return $1.5m out of that. Obviously, there is a risk that SIOX management will find a way where to waste the reserved cash and nothing will get returned. The presence of certain large shareholders, Roivant Sciences with a 25% stake and hedge fund Suvretta Capital with 8%, gives some confidence that shareholder returns will be maximized. Thus my thinking that a further $3-$4m of contingency reserves could be eventually returned to shareholders. This would result in incremental distribution of $0.04-$0.053 per SIOX share.

SIOX is about to get delisted from Nasdaq on March 11 but should stay tradeable on the OTC markets for a few more weeks. However, management intends to completely close transfer books and discontinue trading of the stock following the shareholder approval of the liquidation plan.

Calculation of liquidating distribution estimates can be found on the 30th page of the proxy:

 

Catalent (CTLT) – Rumored Takeover – Upside TBD
A potential takeover in the pharmaceutical contract development and manufacturing (CDMO) space. The industry is complex and the companies involved are quite large, and the market is most likely correct in pricing this situation. However, there are a couple of aspects that make this setup worth tracking. A couple of weeks ago, Bloomberg reported that contract drug manufacturer Catalent ($13bn market cap) received takeover interest from life sciences giant Danaher. The report mentioned that DHR’s offer valued CTLT at ‘a significant premium’ to the trading levels. CTLT stock is already up 26% since the rumors appeared, however, there seems to be plenty of headroom left if the rumors turn out to be true. CTLT currently trades at 14x TTM EBITDA. This compares to the average CDMO take-out multiple of 23.5x from 28 transactions since 2017. CTLT peers are also trading at higher multiples – LONN.SW at 19.1x TTM EBITDA, WST 21.5x, and much more diversified competitor TMO at 21.4x. These companies have somewhat higher margins of 27%-34% vs 26% for CTLT. At 20x multiple CTLT would be worth $111/share, or 66% above the current prices.

Danaher is a $189bn life sciences behemoth, that is known as a serial acquirer. Back in 2021 DHR acquired Aldevron, another CDMO player, for $9.6bn. The buyout of CTLT would allow the company to continue its expansion in the CDMO space in an effort to compete with its main peer Thermo Fisher which also previously acquired CDMO player Patheon back in 2017 at 17x EBITDA multiple. The addition of CTLT would add a number of services to DHR’s portfolio, including biologics, gene and cell therapy (which the company has been particularly bullish on), drug delivery tech services, and packaging capabilities, among others.

One potential risk is that such a combination could potentially get blocked by antitrust regulators. However, CDMO space seems to be highly fragmented with the top 10 players holding less than 20% of the market (as of 2020). Catalent was ranked sixth by revenues globally, whereas DHR’s Aldevron is not even included in the top 10. Hence, the combination of the two would seemingly have only a limited effect on competition.

 

Otonomy (OTIC) – Liquidation – 20% Upside (uncertain)
This is a tiny, $7m market cap, failed biopharma liquidation. Despite its tiny size, the stock is surprisingly liquid with daily volume reaching $1m on some of the days. Aside from the red flags of being day-traders penny stock, the setup appears like a free option with a potential 18% upside.

After a couple of failed development trials last year, the company initiated a strategic review and shortly afterward announced plans to lay off all of its employees and wind down. OTIC is currently trading just below the lower end of the expected liquidation proceeds of $0.11-$0.13/share. Management intends to make initial distribution of $0.11/share followed by potential future payments of up to $0.02/share in total if the current contingency reserve proves to be too conservative. The initial distribution is expected to be completed over the next few months. Shareholder vote is set for March 24 certificate of dissolution is expected to be obtained shortly afterwards. OTIC will also discontinue trading after the shareholders’ approval.

However, the main issue with this case is that management’s liquidation estimates lack detail and seem quite optimistic. Here are the calculations from the proxy:

• Cash as of Dec’22 was $10.7m.
• plus $4.3m additional proceeds should come from the recent sale of portfolio assets. However, it’s puzzling why in the proxy management labels these proceeds as ‘potential’.
• less $5m in estimated expenses from January through March. $5m just seems too low given it is also supposed to include ‘certain severance-related expenses incurred in December 2022’. The severance payments alone were previously projected at $5m. On top of that, the company will likely incur some amount of final liquidation expenses and will burn some cash during the current quarter. As a reference point, MTCR – another failed biopharma liquidation at a very similar stage – estimates final dissolution expenses at around $1m and cash burn for 3 months through March at around $3m. SIOX (another liquidation case covered above) estimates cash burn from Jan’23 at around $2m. So overall, it’s not easy to see how management will be able to reign in all of these costs inside the $5m estimate.
• less reserve for contingent liabilities of $2.3m. The amount seems reasonable and in line with MTCR’s reserves of $1.5m-$3.5m.

This brings management’s projected cash available for distribution to $7.7m or $0.11/share. On top of that, management sees a chance to return up to $1.5m ($0.02/share) from the $2.3m of contingency reserve.

29% of OTIC is owned by large fund managers and hedge funds. Management owns another 10%.

Calculations table from the proxy: