Strategic review / NOL shell: Upside TBD
This is a bet alongside Kevin Tang, a prominent biopharma investor, who recently filed a 13D disclosing a 10% stake in Allakos (ALLK). Allakos is a struggling biopharma company that has failed multiple drug programs, with its last remaining trial failing on January 27 due to a lack of clinical efficacy. Following this, the company laid off 75% of its workforce and launched a strategic review. Tang began accumulating shares immediately after the announcement, building his position at an average price of $0.27/share—around the current trading level. While his exact strategy and potential activist role remain unclear, he likely sees value in ALLK’s remaining cash balance and its nearly $1 billion in federal NOLs. The thesis here is to wait and see whether Tang takes action or if the strategic review leads to a transaction. At current levels, the downside appears well protected.
On the conference call, ALLK’s management framed the strategic review and expected cash at the end of Q2’25 like this:
We will explore the usual things. And we’ll do that for a period of time. And if something comes up, we’ll pursue it. If not, we’ll continue with the wind down of the company.
<…>
The Company estimates that cash used in restructuring activities to closeout AK006 development, including severance and contractual payments to vendors, will be approximately $34 million to $38 million. The Company also estimates that a significant majority of these restructuring costs will be paid over the first and second quarters of 2025.
The Company estimates it will have cash, cash equivalents and investments in a range of approximately $35 million to $40 million at June 30, 2025.
I suppose the ‘usual things’ primarily refer to a reverse merger. A strong hint in that direction is the large NOL balance and management’s decision to provide forward cash guidance. I don’t recall any other busted biopharma (aside from those already in liquidation mode) sharing expected cash guidance two quarters ahead. This may well be a flashing neon sign for potential suitors. The chances of ALLK getting liquidated are minimal. The guided $35–$40M cash range at the end of Q2 seems reasonable: starting with $81M in year-end cash and then subtracting ~$10M for restructuring/severance costs, ~$16M for Q3’24 liabilities, a few million for lease termination, and a further ~$15M for administrative cash burn through Q2.
The company has retained 15 employees to “explore strategic alternatives, maintain compliance with regulatory and financial reporting requirements, and wind-down the phase 1 clinical trial”. So I am guessing that by the end of Q2, when the clinical trial will be fully wound down, this figure will be reduced to a few executives.
So at the end of Q2 ALLK will have:
- $35m-$40m in cash (or $0.37-$0.42/share), this compares to current market cap of $24m;
- $894m in federal NOLs and $847m in state NOLs – these figures are as of Dec’23, so will probably be slightly higher after 6 more quarters of losses;
- Some IP, however, even management didn’t sound particularly optimistic about the prospects of monetizing any IP/technology behind the failed drugs (see the conference call here).
- Few executives with ongoing cash burn of a few million per quarter.
While the seemingly large discount to the expected cash balance is intriguing, any reverse merger would likely trigger substantial severance and change-of-control payments for key executives. The latest proxy shows $6.3M in change-of-control packages for the three remaining executives alone. These may be renegotiated in a potential transaction, but regardless, when factoring in executive severance, change-of-control payments, and a few million in additional expenses beyond Q2, the cash balance quickly shrinks to levels close to the current market cap.
But then ALLK has close to $1bn in federal NOLs (net operating loss carry-forwards), which might result in significant additional value. These are quite hard to quantify, as all depends on what kind of company ALLK will find to reverse-merge into and how much of these NOLs will the buyer be able to utilize. Assuming the buyer is able to fully utilize these NOLs, the value from saved federal taxes (at 21% rate) would be c. $190m. Discounting that over 12 years at 10%, I arrive at $60m NPV of federal NOL tax savings, or $0.63/share.
The buyers are obviously unlikely to pay full NPV for these NOLs. A couple of other NOL shells are trading in the market at c. 30% ot present value of their NOLs. E.g. LOGC (covered on SSI here) is currently looking for a reverse merger to monetize its NOLs and trades substantially above net cash, with federal NOLs priced in at 32% of their net present value. TPHS, another NOL shell, has its federal NOLs is also trading at 30% of NPV of its NOLs, though this comparison is shakier as TPHS has no net cash and trades more like an illiquid option itself.
But even at only 30% of NPV, ALLK NOLs could result in incremental value of $0.19/share for shareholders. So if via reverse merger the buyer agrees to pay something along the lines of $0.46/share, they would be getting $0.27+/share in cash (after all expenses and severance) and NOLs at a 30% discount to NPV.
So, expecting a transaction that would value ALLK at around $0.45-$0.5/share does not seem to be very far-fetched.
The biggest risk is that management drags things out and keeps burning cash – they are paid very well to continue doing that. There are two counter points to that:
- The presence of an activist Kevin Tang, who already owns 10% and was rushing to accumulate the position (in only 6 days). Tang himself could create a catalyst, either by placing a bid, or helping the company find a buyer.
- Despite high ongoing compensation, ALLK’s management is also incentivized to find a deal. The three remaining execs own only 4% combined, but they’re set to receive massive change-of-control severance payouts totaling $6.3m.
If management doesn’t find a reverse-merger target and winds down the company soon after Q2 2025, downside would likely be fairly limited – my liquidation value estimates in this scenario are $0.20-$0.28/share.
Note: for ALLK share count I have used 95m, that is 89.3m shares outstanding as of Nov and further 5.7m in RSUs which would vest upon change of control.
Tang’s 13D filing shows that he was scooping up shares at prices as high as $0.62/share on Jan 27. That was probably pre-market trading as open-market trading during the day peaked at just $0.31/share. That was likely just a very tiny fraction of his total buys, but it still shows that he was probably rushing quite a bit. Later he was also buying shares in the open market at up to $0.30/share.
“Note: for ALLK share count I have used 95m, that is 89.3m shares outstanding as of Nov and further 5.7m in RSUs which would vest upon change of control.”
Would you please provide a reference for this? In terms of RSU I got 624,212 (301,575 + 126,640+ 195,997).
There were a lot of options etc. but all those had exercises prices far in excess of the liquidation value so I must be misunderstanding what was reported.
For the NOLs to be useful they would presumably have to find quite a large profitable business in short order – what probability do you assign to that occurring?
Also for the acquirer, do you think having to give up a massive amount of cash to pay the change in control benefits would discourage them from dealing with ALLK? My thought is, if a large profitable business is interested, they would have no need for the current execs…. the current management seem to have the incentive to engage in a change of control and find a high paying job….. perhaps that is more likely for them with a reverse merger into another cash burning biotech in which case they’ll get the change in control benefits, possibly maintain a high salary in the new entity, and simultaneously that would result in zero value to the NOLs…. I guess that’s where Tang’s involvement will be key.
Thanks for the questions:
– The latest Q3 report shows 5.7m RSUs outstanding. The proxy filing indicates that in a change of control scenario (without cause), 3.7m RSUs would vest for the three key executives. I’m conservatively assuming the remaining RSUs would also vest, though that’s not fully clear.
– Options are out of the money, so I am not adding these to the share count.
– I have no idea what are the chances that ALLK will find a large profitable business to merger into. Your guess is at good as mine. But what I did in the calculations above is to value these NOLs at 30% of their fully utilized NPV, in line where the other two NOL shells are trading. Maybe that 30% needs to be cut further. My aim was simply to show that these NOLs could have substantial value relative to the current share price, and then speculate that maybe this is also what Tang is seeing.
– There aren’t many precedents of NOL shells successfully finding targets to merge with. One is WMIH/NS merger in 2018, where NOLs where valued at their full created DTA amount. The market appears to be assigning a decent chance that LOGC will pull it off as well.
– The change of control package applies only in the case of a termination/resignation. At least this is how I understood the proxy. I think the executives are incentivized to get these termination packages and pursue a reverse merger. There are other hints as well (e.g. cash signaling in the PR). A buyer could potentially renegotiate the change-of-control packages a bit as part of a deal.
This is intriguing, but I feel like there’s dozens of biotechs that go bust with every year with NOLs, and I can’t find a single example of a large pharma company reverse-merging into one to utilize the NOLs. Why so rare?
Or is there reason to believe ALLK wouldn’t be limited to the biotech/pharma space? But that would seem even more of a “first-ever.”
On the other hand, Tang must see something.
Very torn. Wish we had some accounting experts lurking here.
I am curious why busted biopharma stocks rarely do reverse mergers with targets from other industries.
I assume the immediate reason is that targets from the same industry are willing to pay more for the shell.
But that’s very puzzling too. If it’s just a cash shell, why is “same industry” a factor? For a pharma target, what’s the special advantage of reverse-merging into ALLK vs. LOGC?
Maybe shareholder base is “sticky”, and by merging into ALLK one can immediately gain a bio-pharma shareholder base?
In many jurisdictions, significant changes to a business’s identity—such as shifting industries (e.g., from pharma to real estate)—can limit or disqualify the use of Net Operating Losses (NOLs). For example, in the United States, IRC Section 382 imposes strict limits on NOL utilization following an “ownership change” (typically when more than 50% of a company’s equity changes hands within three years). These limitations are even more pronounced if the business undergoes a complete transformation in operations or sector.
Similarly, in Germany, the Körperschaftsteuergesetz (KStG) includes rules that restrict NOL carryforwards if there are major changes to the company’s ownership or business model. The UK’s Corporation Tax Act has comparable provisions that may disallow loss relief when a company substantially changes its trade (don’t even get me started about the rules in Italy!).
Tax authorities may also challenge NOL usage post-merger if the transformation is deemed excessive or inconsistent with the original business purpose. These risks and legal hurdles likely explain why reverse mergers are more common within the same industry.
So the NOL doesn’t seem to be worth much for ALLK, because it’s very hard to find small AND profitable biopharma firms to merge into.
The target has to be small (50% ownership changes hands.
But then how can such a small company produce enough profits to use the 894m in federal NOLs and $847m in state NOLs?
In a reverse merger doesn’t the transaction require more than 50% change in ownership thereby allowing the private company to have a controlling stake and becoming the public company?
@snowball:
My understanding of 26 U.S. Code § 382 is that if more than 50% of ownership changes hands, the NOLs don’t disappear but become subject to an annual usage limit:
Annual Limit = Fair Market Value of Loss Corporation x Long-term Tax-exempt Rate
You can find the relevant section here:
https://www.law.cornell.edu/uscode/text/26/382
Look at the transaction history of John Malone (the Cable Cowboy!) to study how to avoid taxation, Reverse Morris Trust etc. – he is really good at tax engineering :-)
Suppose Company A (a private biopharma startup) merges with Shell Company B (a public biopharma with NOLs). By staying within the same industry, Company A:
– reduces the risk of NOL disqualification under both Section 382 and related provisions about business continuity;
– gains access to a pre-built shareholder base familiar with the biopharma industry;
– maintains some value from NOLs, even if the annual limitation applies.
@G98:
Yes, exactly. As described, the NOLs (for U.S. tax purposes) don’t disappear but become subject to the annual limit under Section 382.
As always, DYODD!
Just one last comment regarding the NOLs and maybe the author can comment about this:
$60m NPV of federal NOL tax savings and $0.19/share as an incremental NOL value (30% of NPV) while within reason assumes optimal conditions, e. g. a very large, profitable entity as a buyer capable of stretching the NOLs over a long period.
Curious to see what Kevin Tang is up to, I bought an observer position.
Interesting discussion-I’ll throw in my two cents as well.
As incubatec noted above, Section 382 doesn’t completely block the use of NOLs in an acquisition; it just limits how much can be used each year. The cap is based on the purchase price multiplied by the highest long-term federal interest rate from the past three months.
For example, if ALLK is valued at $40m in a reverse merger and the max rate in the last three months is 4.8%, then about $2m of NOL carryforward could be used annually. Over 12 years, that would total around $24m. But the present value at a 10% discount rate would only be about $7.6m. The buyer could price ALLK higher to increase the allowance, but that wouldn’t be a cheap investment since the yield matches the interest rate. On the other hand, if you have a very stable business, it’s a pretty much guaranteed return, so for the right buyer, it could still be worth it.
The bigger issue is the requirement to continue the business in a substantially similar form. The pool of private biopharma companies that could scale up to profitability within the next 3–4 years and justify paying a premium for NOLs is probably pretty limited. A merger with an already public biopharma approaching a profitability inflection might be a more realistic scenario, but both paths seem like long shots.
LOGC’s case is a bit different. It had an actual operating business, which could probably be classified as both logistics and possibly online retailing, making it more appealing to a broader range of buyers interested in NOLs. That likely explains why these two shells are priced so differently.
This doesn’t mean ALLK’s NOLs are worthless, but they’re clearly worth much less than LOGC’s, as the market seems to be suggesting.
IRC section 382: https://www.law.cornell.edu/uscode/text/26/382
IRC federal rates: https://www.irs.gov/applicable-federal-rates
Good explanation of how this all works: https://breakingintowallstreet.com/kb/ma-and-merger-models/section-382/
Maybe Section 382 in the US and similar provisions in other countries? From a few Google searches, it looks like tax-loss trafficking is viewed as abuse of loss carry-forwards.
Yes, does anyone know where a company would go to seek out a merger with NOLs?
Are there any IB doing this?
Does somebody have any information or experience on this?
Would you mind rephrasing your question, as I am not sure I am getting it correctly.
The company with large NOLs, would usually hire investment bankers and these would try to find a suitable reverse merger target. But not sure if this is what you were asking for.
@dt, are you assuming that there will be additional $0.07/share (or $19m) of expenses if ALLK goes the liquidation route, vs a reverse merger where you expect cash to be $0.27+/share?
“my liquidation value estimates in this scenario are $0.20-$0.28/share.”
Re Kevin Tang, was this the first time he bought into a cash shell at price levels not at a significant discount to the expected cash value?
I’m assuming $13m-$16m in total, roughly broken down as $9m in remaining severance, $3-$5m in liquidation expenses + further cash burn and $1-$2m set aside for a contingency reserve. But all of this assumes management doesn’t drag its feet wrapping things up after Q2.
As for Tang, that’s been my impression so far. Can’t say for sure if this is the first time he’s ever bought at expected cash balance (vs large discount), but he’s definitely been pretty conservative in these setups. I covered some of his bids on similar companies in the ACRS write-up. Posting the excerpt below:
“The latest proxy shows $6.3M in change-of-control packages for the three remaining executives alone.”
According to the proxy, I think $6.3m is for Robert Alexander alone.
There are another $2.2m and $4.5m for Baird Radford and Adam Tomasi, respectively.
So the total is $13m (or $0.14/share).
However, in a liquidation scenario, the three executives are terminated not in connection with a change of control, then they are paid $2.4m, $0.64m, $1.74m, respectively, for a total of $4.8m, saving $8.2m (or $0.09/share) vs in a reverse merger.
I’ve only counted the cash severance for this. And I’ve also added total outstanding RSUs as of Q3 to the diluted share count. There were no outstanding PSUs at the time.
Some of the $13M is equity which is worth a lot less now vs end of 23
cash merger 33c
Great outcome!
I had highlighted ALLK setup again in the weekly newsletter last Friday, but apparently forgot to copy it here in the comments section:
So it looks like Tang is buying the cash at a slight discount and, at the end of the day, the NOLs proved mostly worthless? Or is that an unfair reading?
Yes, that is correct.
My understanding is that most of the NOLs would be void in this merger due to change of control. So Tang is buying only cash + any proceeds from sale of IP/assets.
Kevin Tang is son of Oscar Tang, and from a very prominent old money family. I guess this kind of cash shells can be useful in some way for him.