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 here, 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”.
Hey dt, wondering why this trade isn’t a best idea. Looks like the $VKIN trade with a longer timeline.
I have included it in quick pitches mainly because of liquidity and high risk of spike in borrow fees or borrow becoming unavailable altogether. If borrow fees increase to 100%, this idea would break-even (assuming the merger still closes in 3 months). The 40% upside indicated in the headline assumes borrow fees stay unchanged at the current 30%.
Hi DT, when you’re talking about a 40% return could you please specify the price for each stock when making that calculation?
That’s for Friday’s closing prices. AMTI = $0.1570/share and CYTH = $1.42/share.
$1.42 x 0.174 = $0.247
Borrow fees will consume = $2 (rounded up to whole dollar) x 30%/4 x 0.174 = $0.026.
So for each AMTI share you would get $0.22/share equivalent or 41% upside.
Hi DT, what do you think about doing this from the long side only given the borrowing issues i.e., long AMTI and sell the CYTH shares upon receipt?
Is this too risky because e.g., there may not be enough net cash in the new entity to support the ‘determined value’ plus the high likelihood of investors dumping their received shares (assuming the merger goes through)?
Long only might also work, but there is not much I can add about CYTH value or the likely trading range. For long-only trade to start losing money, CYTH shares would need to drop below $0.9/share. The company was trading at $0.75/share in Apr’23, but that was before new cash infusions from the private placements.
Recent private placements in CYTH stock:
– April private placement was done for 1.56m shares (+same number of warrants) at $0.835. Warrants have an exercise price of $0.71. This one was scooped up by company’s directors, management, and their affiliates. So maybe this is the floor?
– May private placement was done for 2.5m shares (+same number of warrants) at $0.835. Warrants have an exercise price of $0.71. All of this was acquired by Rafael Holdings.
– August private placement was done for 4m shares (+same number of warrants) at $1.25. Warrants have an exercise price also of $1.25. All of this was acquired by Rafael Holdings.
Unhedged upside shrank by 40%, as of this morning. (using CYTH bid, AMTI ask price)
Prices around 9:50am, just for future reference:
Bid/ask: CYTH $1.35/1.40, AMTI $0.17, 0.175 (both are illiquid, spread can be bigger with volume)
Upside using CYTH bid and AMTI ask: 1.35 x .174 = .235, divided by 0.175 = 34%.
Compared with Friday’s closing prices of $1.42 and 0.157, or upside = 57%.
This is a bad idea. I already hedged my positions last week and you guys are going to drive up my hedging costs;)
Cyclo just announced yesterday that they raised $2.1M by inducing holders of 71 cent warrants to purchase their shares in exchange for 95 cent warrants. In no particular order, I have some thoughts.
1) Doesn’t this pretty much predict Cyclo will be trading in sub dollar range until deal closes, more supply of shares means more selling pressure.
2) My math seems to say Cyclo is expecting AMTI to exchange $16M in net cash at closing for 7.6M shares, essentially AMTI shareholders are paying over $2/share for stock worth under a dollar now. Does that mean I should home my AMTI shares because when deal closes Cyclo price will rebound given how accretive this financing is?
3) Or should the AMTI board be walking away given deal is now worth only 16 cents per share and my math is that liquidation should pay in the 24 to 37 cents range even with the max $1M breakup fee + expenses. Does the dilution from the 3.3M (15%) in new warrants break Cyclo’s warranty of its capitalization in 4.01 of the merger agreement and void the requirement that AMTI pay any breakup fees?
Lets blow up this terrible merger.
https://nvariant.substack.com/p/amti-board-time-to-terminate-the
Interesting take, thank’s for sharing. However, betting on merger break/liquidation seems a bit risky. The company had $22.5m cash as of June. What liquidation value could we expect from this? Netting $10m for cashburn in H2 as suggested in the write-up (it will probably be less but you can assume it includes other merger costs and termination fee), $2.4m for accrued expenses and payables, $1m for lease termination and $1m for further severance, results in $8.1m vs $6.2m current AMTI market cap. From that, you still have to deduct any other remaining liquidation expenses and cash reserve for contingent liabilities, and then it becomes difficult to see any real upside here. My calculations are probably quite imprecise, but the idea is that the margin of safety is pretty tight.
The merger is contingent upon Cyclo receiving $16M in net cash at closing. Net cash is cash minus all liabilities, severance, and merger costs, and lease. Subtract $1M for max breakup fee (which arguably isn’t owed given Cyclos abrogation of their capitalization warranty), and $4.5M for additional severance/expenses and you have 24-25 cents per share (that’s directly from my worst case estimate). So the very merger agreement seems to disagree with your calculations.
Also I calculate burn rate in Q2 at only $3.5M once you back out SBC, D&A, non-cash lease costs and asset impairment charges. Over two quarters that adds $3M to your $8M estimate and gets you over 25 cents per share.
Lastly I don’t expect a liquidation, the CEO of AMTI is going to get a plum Cyclo board seat so the incentives are all wrong. But the massive decline in Cyclo stock price is a good opportunity for AMTI to negotiate some concessions. I don’t think Cyclo wants to give up that $16M in net cash they need so badly but increasing the shares Cyclo is giving up by at least 50% seems like the most likely compromise. This all depends upon if the AMTI CEO has the stones to renegotiate with the people he’s going to be sharing a board table with shortly. Given that I can understand any skepticism.
Where do you that the merger is contingent on Cyclo receiving $16m? I see $12.4m and the newest S-4 even says that “Cyclo will raise approximately $12.4 million in the Merger”.
$16M was my estimate of AMTI net cash. The $12.4M is at closing after legal costs of the merger, and is probably conservative since AMTI doesn’t want to give Cyclo an easy out if they came in a little low (not that Cyclo is going to pass up such a cheap financing opportunity).
big movement yesterday from Cyclo, and volume driven. AMTI up slightly. The spread is now more attarcative yes? I couldn’t find any news on Cyclo, anyone else?
Same. Plz help lol
I can only think of two things: First, good news on the business front, Phase 3 trial. This is good news for AMTI holders. Second, since Cyclo stock dropped on the merger news, the merger is now broken causing the stock to rise. This is bad news for AMTI holders. Except as DT pointed out, the chances are small because Cyclo need the cash from AMTI. Unless Cyclo got funding from another source.
Breaking the merger isn’t bad news for AMTI, odds are liquidation pays out well above 20 cents and maybe above 30 cents. At current Cyclo price however AMTI’s value is 27 cents, so its essentially a wash now.
One update from the new S4 is they set the closing cash requirement at a minimum of $12.4M, which from contract description seems very similar to a liquidation value. That works out to 31 cents at current share count. Obviously there might be some more expenses (and less expenses ie legal) and possibly some PSUs that participate, but likely close to 30 cents in the end had they chosen that path.
The problem is either one of those are pieces of developments require public disclosure. Otherwise, what’s happening right now is insider trading.
Either one of those developments**
The only public change has been Cyclo’s issuance of the preliminary S1 for the deal yesterday. I haven’t read all of it, but there is no change in the share issuance or any significant modifications that I’ve seen.
I suspect that there may be a buying effort by the existing shareholders to pump up the price and ensure AMTI shareholders vote for the deal. But if it keeps the price where it is now through closing, I withdraw my previous complaints!
I have not seen any news that would warrant such a sharp rise in CYTH price, we might be seeing a simple nano-cap pump mixed up with a short squeeze – at least on IB borrow availability is getting tighter, although the rates have not spiked yet.
There have been similar random spikes in CYTH shares previously as well, but hard to predict how long or how far this one will go, without understanding what is actually happening or who is pushing shares upwards.