Quick Pitch: Zynerba Pharmaceuticals (ZYNE)

Merger Arbitrage + CVR – Multibagger Upside

A tiny clinical-stage biopharma Zynerba Pharmaceuticals is getting acquired by a much larger $2bn market cap peer Harmony Biosciences (HRMY). Despite the nano-cap size of ZYNE, the daily trading volume is fairly high, around $900k. The consideration per share is $1.1059 in cash + nontradeable CVR that could pay out up to $2.5444. ZYNE currently trades at $1.30/share, implying a CVR price of $0.19/share. The merger itself is very likely to close, with the timeline set for Q4’23.

The CVR is comprised of multiple components, most of which are conditioned on the success of ZYNE’s key asset Zygel, which focuses on treating FXS (rare gene disorder) and is currently in Phase 3 trial. The intriguing part is Milestone 1, upon which $0.2747 would be paid out solely on the trial completion, regardless of the trial’s outcome. This represents a 41% upside to the current price of the CVR. In addition to Milestone 1, the CVR also has the potential to generate substantial multi-bagger returns over the next several years if FXS treatment achieves regulatory approval and is successfully commercialized.

The terms of CVR distribution:

• Milestone 1: $0.2747 for the completion of ZYNE’s Phase 3 trial for FXS before June 2026. The merger agreement defines this milestone as the “completion of the last patient’s last visit in the Pivotal Study for the Product.”
• Milestone 2: $0.1831 to $0.5494 for the success of the FXS Phase 3 trial, contingent on the trial meeting its primary endpoint with statistical significance. The payout amount depends on the timeline:
  • $0.5494 – if the primary endpoint is met through December 2024;
  • $0.3663 – if the primary endpoint is met through June 2025;
  • $0.1831 – if the primary endpoint is met through June 2025.
• Milestone 3: $0.6389 for FDA approval for FXS treatment. There is no deadline or expiration date for this milestone.
• Milestone 4: $0.2707 for FDA approval for a second indication beyond FXS. Zygel is also getting tested for treatments of 22q (DiGeorge syndrome) and autism spectrum disorder and has shown positive results in Phase 2 studies for both. However, the company has so far delayed the start of Phase 3 trials due to financing difficulties. There is no deadline or expiration date for this milestone.
• Milestone 5: $0.2702 for Zygel reaching $250m in aggregate net sales inclusive of all indications by the end of 2030.
• Milestone 6: $0.5405 for Zygel reaching $500m in aggregate net sales inclusive of all indications by the end of 2030.

The most likely part of the CVR to be paid out is Milestone 1, which requires the buyer to simply complete the Phase 3 trial on time. The buyer should be well incentivized to push the treatment development forward, and the mid-2026 deadline seems to provide a sufficient time buffer, given that this Phase 3 trial has already been ongoing for 2 years (launched in Sep’2021).

Although the likelihood of Milestone 1 being paid out might appear fairly high on paper, there are some risks that investors should be aware of. The main risk here is that HRMY, the buyer, might decide to cancel the trial before completion at some point down the road. This could happen for a variety of reasons, including enrollment issues, lack of efficacy, or adverse effects – these are the main reasons trials get canceled before completion. In this particular instance, cancellation due to adverse effects is unlikely given the good safety profile demonstrated in the Phase 2 trial. Trial cancellation due to efficacy failure as evidenced by the initial cohort of patients is an obvious risk in any trial. However, I think the biggest concern here might be enrollment issues given that ZYNE has already extended FXS trial timeline twice due to this reason.

FXS Phase 3 trial results were initially expected by H2 2023. However, in December 2022, the company released an update saying that the trial had been facing significant difficulties in patient enrollment due to “high rates of RSV, influenza, and COVID-19.” The results were then delayed until H1 2024. The revised timeline was communicated in the 10-K and Q1 2023 reports. However, any comments on the timeline were removed from the Q2 2023 earnings report without any explanation. During the recent M&A call, management said that they would not be able to commit to the previous timeline and would provide an update only after the merger closes when they would have “a closer look at everything.” This lack of communication is concerning, but the potential enrollment difficulties are somewhat understandable given that FXS is a rare genetic disease with a patient population of only 80,000 in the US. ZYNE is only targeting patients from 3 to 22 years of age, and 80% of the test group is required to have complete methylation of the FMR1 gene, which is present in less than 60% of all FXS patients.

The merger itself is very likely to receive shareholder approval and close as expected in Q4’23. The cash portion of the offer comes at over 3x premium to pre-announcement prices. Zynerba’s management holds a 13% stake in the company and there are no other significant shareholders of note. HRMY, the buyer, is a commercial-stage biopharma focused on rare neurological diseases looking to diversify the portfolio with orphan rare neurologic disorder treatments. ZYNE development programs seem to fit the bill. This is a small acquisition for HRMY and the buyer noted the ability to fund the full consideration (cash and CVR) from cash on hand.

ZYNE develops transdermal cannabinoid therapies (CBD gel) for neuropsychiatric disorders. Its lead asset is Zygel, which is currently being tested for FXS (phase 3), 22q (finished phase 2), and autism spectrum disorder (finished phase 2). FXS is a rare genetic disorder caused by changes in the FMR1 gene that results in intellectual disabilities (learning, developmental, social, etc.) ranging from mild to severe, depending on the methylation of the FMR1 gene. 22q is a genetic disorder that causes congenital heart problems, specific facial features, development, intellectual disabilities, etc. There are currently no FDA-approved therapies to treat either FXS or 22q. Cannabidiol, the active ingredient in Zygel, has been granted orphan drug designation by the FDA and EMA for the treatment of FXS and for the treatment of 22q. Additionally, Zygel has received FDA Fast Track designation for the treatment of behavioral symptoms in patients with FXS.