Biotech companies are attracted to licensing deals for a variety of important reasons: 1) to provide an alternative source of capital from the licensee to fund R&D and commercial operations including, but not limited to, advancement of the asset(s) in question; 2) access to a potentially skilled and experienced development partner with clinical and regulatory experience; ) to access commercial expertise and scale to effectively maximize the revenue opportunity; 4) to find regional expertise to maximize the asset in a broader set of territories and 5) to provide validation for the underlying asset, technology, and management. Furthermore, when the licensor receives an upfront payment, they are diluting only the value of their specific asset(s) as opposed to the entire equity of the company.
Some partnering deals also have a downside, namely dilution of the asset and potentially giving up commercialization rights, which often comprise the future value of a company. More specifically, some deals render the licensor company as just “mailboxes” that collect deal checks.
Public money-losing biotechs always need to raise capital. They are voracious consumers of capital that generally require infusions of equity on a semi-regular basis. Even companies that just raised capital are always thinking about the timing of their next raise. Unfortunately, there are really only two ways of reducing the cash burn (defined as cash on the balance sheet divided by annual burn) without financing: 1) by increasing the numerator (cash) or 2) decreasing the denominator (the burn). Sell-side partnering transactions can be a highly effective way to mitigate this equity raise cycle in a returns–generating fashion.
Upfront and milestones
That upfront payment from license transactions often serves to reduce the financing overhang by adding cash to the balance sheet without selling additional equity. Hopefully the company received enough upfront to materially impact the years of cash. Near-term achievable milestones are also highly valued since they can defray capital raise requirements when equity is likely the most expensive.
The other way of reducing the amount needed to raise is by reducing the burn of the company, therefore extending the runway (the denominator). Besides cutting people and programs, license transactions that pay for the ongoing R&D costs of a program that contributed significantly to the burn of the company can have an even bigger impact than the upfront payments received. For example, a $50M upfront has less of an impact than a partner potentially paying for $100M in R&D costs for that program over the next two years. In that scenario, there would be a $150M cash swing, $100M in R&D savings plus $50M in additional costs.
The stock price impact
Locust Walk has conducted research to analyze the impact of licensing transactions on the stock prices for publicly traded biotech companies with market caps less than $400M at the time of the announcement. What we found was interesting but not surprising. For upfronts greater than $20M, a more material transaction, one month after a licensing deal, we see a general pattern of a 38% stock price lift. While roughly 3% of that uplift can be attributed to general biotech market conditions, that uplift percentage is still a 35% increase. Upfronts worth less than $20M we did not see any significant difference in the stock performance. In an upcoming white paper on the subject, we will be examining additional factors to better determine the impact on the stock performance.
After a transaction, the opportunity to raise even more money on the heels of an increased stock price are greater, further extending the runway. Additionally, a licensing deal can give the company more time to focus on developing an additional asset.
The equity raise paradox
Smaller companies typically have a more difficult time raising capital due to the capital requirements often becoming a large percentage of their market cap. Most often follow-ons, PIPEs and ATMs occur at a discount and lead to material reductions in stock price because of short sellers going into the deal. Depending on the situation, a company might be able to raise more money and reduce burn from a licensing deal far better than they can raise capital leaving a much higher stock price on the other side of the deal.
Companies that have easier access to capital, such as the larger biotechs and those with a robust investor base and liquidity, likely wouldn’t get paid enough in upfront or defer enough of the R&D expenses to justify partnerships including the US as a territory. Often the market has priced in the company commercializing in the US. Those companies are often too “expensive” to do a partnership and are better off raising equity capital representing a smaller percentage of their market cap. For example, a $50M raise for a $200M market cap company represents 20% fully diluted ($50M raise / $250M post-money) vs 10% fully diluted for a $450M market cap company ($50M raise / $500M post-money).
The expectations game
While we are not professional investors, one thing that is apparent from the data is that the level of expectation for a partnership and what the results of the deal reveal are key to the receptivity of the market. If, for example, the market is placing no value on pipeline assets or is not expecting a strong transaction and a deal emerges from an earlier stage program or a better deal than expected, that typically leads to a positive stock market response as the following two examples illustrate. If, however, the deal expectations were larger than the reality, that can lead to a reduction in market value. In summary, a company needs to understand what is expected by investors and then make sure to delight them to the upside.
It’s critical for companies to evaluate all their partnering and financing options prior to making such an important strategic decision. For additional insights into how to optimally position your company for success in a sell-side partnership (public or private companies), please contact us to further discuss.
Geoff Meyerson, CEO & Co-founder, Locust Walk
Arjun Nair, Analyst, Locust Walk
Juliet Solit, Summer Analyst, Locust Walk