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Activist Investor Situation of the Day - Cypress Bioscience, Inc. (CYPB)

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August 13, 2010 – Comments (2) | RELATED TICKERS: CYPB.DL

As I have mentioned in a couple of recent posts, I have become increasingly interested in activist investor situations.  If you can find them early enough, this sort of situation is great because many times the activist investors, such as hedge funds, etc..., often attempt to purchase the entire company, push for the company to be sold, or at the very least agitate significant changes in either a company's management, the Board of Directors, or operations to unlock hidden value.   

There's pluses and minuses to following activist investors.  On the plus side, you know that there's a good chance that there is a decent chance that something positive will happen to a company's stock...and happen fast.  A perfect example of this is the CAPS purchase that I made in  Penwest Pharmaceuticals (PPCO) after I found out that an activist investor named Kevin Tang had invested in the company (link).  Less than a week after my CAPS pick of the stock, the company was bought out at a 26% premium to my starting price.  Will every investment in a special situation like following activist investors result in a 1350% annualized return?  Probably not, though it is a pleasant fiction to think of ;).

On the minus side, the stocks of companies that are involved in this type of situation have often risen significantly as a result of them.  If one doesn't get in early enough, they miss a significant chunk of the potential gain and risk seeing the stock price fall to its pre-activist investor activity level, resulting in at least a temporary loss.  

This is why I have been stepping up my research efforts on activist investing.  I'm going to try to get in on as many of these situations as possible, as early as possible as long as they meet two criteria.  1) the company that I am picking must be at least reasonably attractive on its own, without the activist investor involvement.  

This eliminates situations like Barnes & Noble (BKS) from consideration.  2) the activist investor that is attempting to influence the company must have a reasonably successful track record.  This one is a little more difficult to quantify.  I have been creating a list of activist investors who have been successful with stocks that I follow in the past.  This will provide me with a nice subset of investors to follow.

Anyhow without further ado, I bring you my latest activist play for CAPS...Cypress Bioscience (CYPB).  

 

An activist Hedge-fund operator Ramius LLC has been in a battle with the company, attempting to take it over.  Now obviously I would have liked to have purchased a stake in CYPB prior to the media catching onto the fact that Ramius is interested in buying the company.  I have seen it on a list of stocks that are trading at or near their cash values in the past and should have just snagged it then.  Hindsight is always 20-20 I suppose.  

On August 3rd, CYPB's stock skyrocketed 22% after Ramius offered $4/share for the company (link).  

Just three days later, On August 6th Cypress rejected the Ramius offer stating that it significantly undervalues the company and saying the following (link):

"We have concluded you do not have a proper purpose for the inspection of Cypress' books and records and we will take all necessary action to defend that position and protect the interests of the other Cypress stockholders,"

Two days ago Ramius sent a letter to Cypress stating that it has raised its offer for the company to $4.00/share in cash and the retention of a 50% stake in the company's drug BL-1020 by current shareholders.  Cypress paid $30 million for the rights to BL-1020, so Ramius values a 50% stake in it at another $0.37/share, making its total offer in its eyes $4.37/share.  Ramius also said that it is willing to consider raising its offer if...it is granted limited due diligence and the Company agrees to negotiate in good faith around consummating a transaction (link).

Clearly there is a real potential for Cypress to be bought out by Ramius.  So how much of a premium are we talking about from the stock's current level?  CYPB is currently trading at $3.82/share.  A $4/share cash offer is only 4.71% higher than today's price.  If one adds in an additional $0.37 for the 50% interest in a drug that I know absolutely nothing about the deal premium rises to 14.4%...a lot better.  The question is how existing shareholders would monetize or even be given their interest in the drug.  I have no idea at this point.

A 4.7% to 14.4% upside in a weak market with the potential for an increased bid is a fairly attractive opportunity at first glance.  Have I mentioned that I wish I had picked up Cypress earlier when I found it on the cheap stocks screen :)?  This brings us to the two questions that I mentioned earlier...How successful has Ramius been in its activist activities in the past and B) how cheap is Cypress Bioscience at this level without the offer.

According to a Barron's piece that I came across a few weeks ago, in the recent past Ramius has filed five 13Ds with activist investor intentions. In those five instances, the stocks of these companies has risen 16.5% versus a loss of 12.3% for the S&P 500 over the same time period. That's an outperformance of 28.8%.  So Ramius has a solid track record.

Onto the company itself.  I don't know enough about biotech to judge the merits of Cypress's products on my own, so let's look at the company's liquidation value.  As of March 31st, CYPB had the following assets (source):

Cash And Cash Equivalents: $30.575 million (100%)

Short Term Investments: $106.717 million (100%)

Net Receivables: $6.623 million (0%)

Other Current Assets: $1.313 million (0%)

Property Plant and Equipment: $1.197 million (25%)

Goodwill: $21.929 (0%)

Other Assets: $0.779 million (0%)

Let's be as conservative as possible here and assign full value to the cash / cash equivalents / short term investments, a 75% haircut to property, plant, and equipment, and nothing to net receivables, other current assets, or goodwill.

Assuming no value for goodwill means that all of the research Cypress has done and all of the drugs that it has the rights to are worth absolutely nothing.  Obviously, this probably is not the case, but we're trying to be uber-conservative here.

OK when we add all of the above up it comes out to a conservative estimate of a liquidation value of around $138 million.

We need to subtract from that the company's $3.264 in accounts payable and $5.202 million in other current liabilities from that and we arrive at a rough, back-of-the-envelope liquidation value of around $130 million.

There's another line item on the balance sheet for $22.12 million called "Deferred Long Term Liability Charges."  If I was going to put real money to work here I would have to look into exactly what that is.

Back to the $130 million figure.  This compares fairly favorably with the company's $147.5 million market cap given the fact that we assumed absolutely zero value for Cypress' drugs and research. The down side appears to be fairly limited here.

Is this situation perfect?  No.  I would have liked to have entered CYPB when it was trading for two dollars and change several weeks ago.  Then this trade was a slam dunk.  Ramius obviously thought so too.  I still feel as though the potential upside and limited downside make this a viable CAPS trade.

Deej 

2 Comments – Post Your Own

#1) On August 13, 2010 at 1:09 PM, zzlangerhans (99.77) wrote:

It's interesting to see an "outsider"' view of one of my little pets, as it helps me understand how investors of different philosophies valuate unprofitable companies like developmental small pharmas and baby biotechs. In this case, I can see some important perspectives I might have overlooked, but also the hazards of walking into a trade while missing critical fundamental info.

When I analyze a new company for my database, one of the first things I look at is the five year price chart. I then research the catalytic events for the stock over that time period using Yahoo Finance, the Fool, the Street, and the company website. After that I focus in on the most recent year, then the most recent three months. This background is vital to understanding the value and direction of the stock in the present moment. A current financial snapshot is woefully insufficient.

A five year review would have told you that the main catalyst and value driver for the stock were phase III trials, NDA submission, and eventual FDA approval of fibromyalgia drug milnacipran, now marketed as Savella. A one year review would have told you that Cypress's last good days were in the summer of 2009, before it became clear that Savella was destined to perform poorly. In fact, the efficacy and side effect profile post-approval has been so poor that a consumer group has petitioned the FDA to revoke approval of the drug. Sales have been anemic and Cypress recently opted to discontinue their copromotion and sales activities with partner Forest.

Small pharmas centered around one unprofitable drug tend to trade at cash, or even below cash, on the mentality that the company will simply continue to lose money. This is what Cypress was doing until June when they licensed BL-1020 from privately held Israeli firm BioLineRx for 30M upfront and up to 160M in developmental milestones. The street hated the deal and the share price cratered. Cypress was betting all its cash reserves on an unproven new drug, and the "value" players ran. Of course, with no internal pipeline, Cypress really had no other choice besides selling itself.

Looking at financials from March 31 is like dating a girl whose match.com profile picture was taken seven years ago. The most recent earnings came out on August 9 and tell a different story. Cash and short-term investments are now 105M, not 137M. The 30M line item for "restricted cash" is the escrowed payment to BioLineRx, which has now been released. Your "conservative" valuation of Cypress's intellectual property is zero, but I find this to be a very liberal estimate. Remember that potential 160M that Cypress owes BioLineRx.

So what is Ramius thinking? I don't know for sure, but I suspect they have their minds on the cash and little interest in BL-1020. Can they take over the company and kill the BioLineRx deal? After the 30M payment it doesn't seem worth the cost and effort. Do your figures on Ramius' 13D effects include the initial share price bump after the offer is made? If so, 80% outperformance is already written into the stock. The share price can sink back down to 3 and Ramius will still get their 28.8%.

I've tried to figure out Deferred Long Term Liability Charges myself before. It's a common line item in the money-losing companies I follow, and my best understanding is that it refers to deferral of income tax liabilities. I have no idea how it affects valuation.

My take on Cypress? Fly it up the CAPS pole and see who salutes, by all means. Way too dangerous and unpredictable for real money. I'd let Cypress and Ramius fight it out and then take a closer look at Cypress and BL-1020 if Ramius walks away and the share price drops back down to 2. 

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#2) On August 13, 2010 at 2:09 PM, TMFDeej (99.33) wrote:

Thanks for sharing your thoughts zz.  I know that you're certainly much more of an expert on biotech than I am.  I'm playing this stock for more of the activist investor angle than the merits of the company's pipeline.  

You're right about using the old balance sheet data.  I used what was listed on Yahoo! because I didn't want to invest too much time surfing around for data on a stock that I knew I wasn't going to put real money into.  The margin of safety just isn't great enough here.  I still have a strong feeling that the combination of Ramius and Cypress will end up being a positive CAPS trade.  We'll see.

Deej 

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