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BioPharm Executive: No Free Lunch

10/28/2008 9:15:42 PM

No Free Lunch

Looking for free money? Biotech may seem to have just the thing for you. Numerous companies are now trading under their cash value, meaning they could theoretically empty their bank accounts and pay out a dividend greater than their stock price. Or put another way, you could buy these companies for less than their cash per share, and get their technology as well as tangible assets for free. (This is known as having a negative enterprise value, and it's not something analysts or business school students are all that used to encountering.)

Sounds like the investing steal of the century, right? Well...maybe. When this last happened on a widespread basis, in 2003, buying companies under cash made for a good short-term play in a few cases. But in the long run, it was more often than not a losing bet. Companies that get that beaten down, even in a brutal market that doles out punishment for little reason, find it hard to climb back. Buying Human Genome Sciences when it traded under cash value in 2003 was smart--as long as you sold in 2004 or 2005. Now the stock is worth far less than it was at its post-genomic nadir, because its cash pile has continued to dwindle.

A few bits of bad clinical news have recently added new members to the negative enterprise value club--Avigen, for instance, which now has $1.89 in cash but a stock price of only 63 cents after the failure of its multiple sclerosis drug in phase 2. Avigen management may decide to take their ball and go home, liquidating assets and distributing the proceeds to shareholders. That would roughly triple the money of anyone who buys here. But don't count on it happening. I don't know about Avigen management specifically, but most company execs are either cynically interested in keeping their jobs, or are honestly convinced they can "add value" to their company's assets long after that ceases to be realistic, or some odd psychological stew of the two.

Nevertheless, some companies in this situation--and Avigen may be one of them--will attract buy-out offers. Shareholders and board members are going to be loathe to accept a cash takeover offer worth less than the company's own cash balance, but stock-based deals may win approval, since they give shareholders in a failed company an ownership stake in a company with better chances of success. A pennies-on-the-dollar deal will go down better if there's a chance those pennies will appreciate. Companies with decent cash balances and well-supported stock prices, meanwhile, may have a rare opportunity to pick up valuable assets for virtually nothing.

The upshot of all this will be that the strong get stronger as the weak are subsumed. And as disruptive as the whole process is, especially to employees caught in the middle, that at least is something to feel good about. A biotech industry with fewer, stronger companies is a stronger industry.

--Karl Thiel

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