Merger Arbitrage – 40% Upside
This is an intriguing merger arbitrage setup between two nano-cap biopharmas with an eye-watering 57% spread. The key reasons for the spread is expensive hedging and some uncertainty on the final exchange ratio. Over the last two weeks borrow rates for the buyer’s stock have hovered at around 30%-35%. With the merger expected to close in Q4’23, hedging would consume c. one-third of the spread. So if borrow rates/availability remains unchanged (which is a very big IF) and the merger takes 3 months to close, arbitrageurs would make a 40% return in a quarter. Due to the tiny sizes of both companies and limited trading liquidity, there is a risk hedging fees will spike upwards or the borrow will become unavailable forcing buy-ins.
Applied Molecular Transport is getting acquired by its peer Cyclo Therapeutics. AMTI shareholders will receive 0.174 CYTH shares per each AMTI. The exchange ratio is subject to adjustments that depend on AMTI’s net cash upon closing but these are unlikely to be material. The transaction will require shareholder support on both sides, and I expect both approvals to pass easily.
The exchange ratio will be determined by dividing AMTI’s net cash at the time of closing by the number of outstanding shares and then dividing the result by 1.63 (which was determined to be the value of buyer’s shares). For the exchange ratio to drop below the 0.174x suggested in the press release, AMTI’s net cash at closing would need to be less than $12.4m. This appears unlikely as AMTI’s net cash stood at $22.5m as of Jun’23 while the expected cash burn over the next two quarters will probably be c. $10m as per the latest cash runway guidance (see , page 7). The high cashburn observed during H1’23 is not really indicative of the current level of expenses, as during that time the company was implementing full restructuring, reducing workforce by 83%, selling all tangible assets, exiting operating lease liabilities, and switching to fully remote work. This was the result of AMTI’s key asset AMT-101 failing a phase 2 trial for the treatment of ulcerative colitis in Dec’22. As of June 30, the restructuring was substantially complete and cash burn levels are expected to be materially lower going forward. The $5m/quarter cashburn for an empty cash shell still seems way too excessive and maybe there is a chance actual expenses will turn amount to be lower resulting in a more favorable exchange ratio.
The likelihood of the buyer abandoning the transaction is minimal. For CYTH, this merger is effectively an equity financing round, allowing the company to raise cash amid a tougher financing environment in the biopharma industry. As part of the transaction, CYTH will acquire AMTI’s estimated $12m in net cash upon closing in exchange for issuing c. $11m worth of stock. CYTH’s key asset Trappsol Cyclo (treatment for Niemann-Pick Disease Type C1) is currently in a phase 3 study. The company expects to complete patient enrollment by the end of 2023 and report topline results by Q4’24. Meanwhile, CYTH is continuing to burn cash with less than two-quarters of runway left. Pro-forma for the recent equity raise (common stock + warrants), CYTH will likely have only $1m-$2m in gross cash by the end of the year compared to $4m-$5m in quarterly cash burn. The transaction will extend the buyer’s cash runway till H2’24 and allow the company to focus on the development program without the immediate pressure on liquidity. If the trial progresses successfully, CYTH might be in a position to seek financing at better terms down the road.
CYTH management holds a 7% stake while Rafael Holdings, which was the sole participant in two of the recent equity raises and controls one board seat, owns 41% of the company (on a fully diluted basis, i.e. if in-the-money warrants are exercised). Rafael has interests in several other clinical/early-stage pharmaceutical companies.
I would expect the approval from AMTI’s equity holders to also proceed smoothly. AMTI’s management owns 22% of outstanding shares (on a fully diluted basis) and former director/chief scientific officer Randall Mrsny owns an additional 8%. A further 8% of fully diluted shares are in the form of performance stock units recently distributed to employees. These vest upon strategic transaction or involuntary employee termination (i.e. the above-mentioned restructuring plan), but not sure how many of these shares will have a vote in the merger. The remaining shareholder base includes EPIQ Capital (19%) and Founders Fund (10%). Any opposition from these shareholders appears unlikely. AMTI is now a cash shell and the offer values AMTI at a substantial 30% premium to the pre-announcement prices and close to its expected net cash levels upon closing. AMTI’s shareholders would likely be worse off if the merger were to break given the high guided cash burn ($5m per quarter). There is also a threat of delisting as AMTI has recently received a letter from Nasdaq, claiming that the company is a “public shell” and that continued listing “is no longer warranted”.