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Synergy Pharmaceuticals: A Misjudged Secondary Offering


Nov. 14, 2017 10:46 AM ET|

About: Synergy Pharmaceuticals, Inc. (SGYP)
John Engle
Value, special situations, Deep Value, Growth
(1,083 followers)
Summary

Synergy announced Monday that it would raise $56 million in a secondary offering; the market reacted poorly to news.

The move was unexpected given the company’s cash position and access to non-dilutive capital; it has clearly shaken confidence.

Synergy’s long-term prospects remain positive, but they are colored by reduced confidence in management and fears about further unexpected dilution.

Well, that was a fairly inauspicious start to the week. On the morning of Monday, November 13th Synergy Pharmaceuticals (SGYP) announced a secondary offering of its shares, blindsiding many investors and sending the stock into a tailspin.

The move was doubly strange, not having been telegraphed at all during the earnings call at the start of the month, and seemingly unnecessary given current cash reserves and access to non-dilutive debt financing.

Let’s take a look at the latest development for Synergy and what it means for the company in the short-term and long-term.

Well That was Unexpected

The decision to issue a secondary offering is surprising, and far from heartening. It is personally frustrating as well given the bullish case I have made to date (including a positive article published here on Friday). Synergy still has value, but this move is definitely unsettling.

During Q3 2017, Synergy successfully secured a debt facility worth $300 million and has drawn $100 million of it so far. A 9.5% interest rate is quite dear, but reasonable given the nature and risk profile of the company. What Synergy did not disclose during conference calls, nor bother to highlight except on a 10-Q report, was that this loan was subject to the company having a certain amount of cash at the end of January 31st to obtain the next tranche. I am struck in particular by a statement from CFO Gary Gemignani during the last earnings call:

    Under the terms of the agreement, we have access to an additional $100 million on or before February 28, 2018 and up to two additional tranches of up to $50 million on or before March 29, 2019 subject to certain conditions. While I cannot comment on specific conditions required to access the additional tranches beyond what’s publicly disclosed, I can tell you that we are confident in our ability to meet the conditions that will allow us to access to the additional capital if and when we need it.

That looks a lot like obfuscation in hindsight, bordering on deliberate misdirection. Perhaps we should have been paying more attention to the fine print, but that sort of comment is beneath an executive of a serious public company (I have been kicking myself today, and I am sure many other analysts are as well. I suppose my only consolation is that they missed it too. Misery loves company!).

With the supposed ability to draw on $200 million in non-dilutive capital and $117.8 million in cash and equivalents, the frustratingly high burn rate of about $50 million per quarter looked manageable. Synergy’s aim has always had to be to boost revenues, and it has been doing so at a geometric rate since Trulance, its treatment for chronic idiopathic constipation, hit the market this year. The cost of going it alone was always expected to be high, but it appeared manageable in light of the company’s resources.

Thus a secondary offering of 21,705,426 new shares, each with a warrant to purchase a further share, is extremely galling. The offering is priced at $2.58 per share to raise $56 million before expenses. The new capital will be enough to finance operations for another quarter.

How Not to Do a Secondary

The most bizarre part of the offering is the inclusion of the warrant, which gives the ability to purchase a further share within two years with an exercise price of $2.86 per share. A warrant does nothing to raise funds in the short-term, and is a rather perverse tool to employ in an offering, especially when the ostensible aim would be for significantly greater share price appreciation between now and November 2019.

Even without the warrants being exercised, the share float will be expanded by nearly 10%. That increase is doubled, if the warrants are all exercised. That is far from encouraging.

The warrant represents an egregious error on the part of Synergy’s finance team. Clearly they were convinced they needed to offer a sweetener as inducement to subscribers, which is standard in these cases. But this was too sweet by a long shot.

The Dangers of Losing Confidence

All of this builds up to a question: Can we trust Synergy management? They failed to telegraph this secondary offering at all, and have given a sweet deal to new subscribers at the expense of current shareholders. The question is especially pertinent given the company’s claims after its last secondary offering, in January, that it would not do it again. For those of us holding for a longer-term capital appreciation, the specter of dilution will be omnipresent.

That makes capital appreciation even harder over the next while, as investors will be skeptical of buying in when there is a threat that their stake might be diluted without notice or clear reason. That is deeply unfortunate because the company growth story has really been starting to take shape.

The expensive and challenging effort of bringing a new drug to market without a licensing partner has always been a risk overhanging Synergy, but it has been working well to carve out the beginnings of a market share for Trulance. With this new secondary, the share price will likely struggle to pick up as much vigor, even as prescriptions and revenues grow.

Investor’s-Eye View

After this shellacking, it is understandable that lots of investors would shy away. Falling below $2.50, it may take some time before enough market confidence is restored to lift it all that much higher. I previously called $2.50 a floor – and it probably was before the secondary. Shares are already down close to 10%, reflecting fairly accurate (in a day-on-day sense) the increase in the float.

Given all that, there is probably not too much further it can fall barring more terrible news. There could be a bit of downward pressure from tax selling, but any impact from that will be temporary. With a PDUFA date set for January 24th 2018 for Trulance’s indication expansion for irritable bowel syndrome with constipation, there is more good news than bad on the horizon.

The case for Trulance remains strong, and thus so does the case for Synergy. But it may take the market a while to see that. Especially with the loss of confidence in management’s statements.

Disclosure: I am/we are long SGYP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.