NLTX - Neoleukin Therapeutics: Strategic Review Play

2023-04-19 04:04:42 ET

Summary

• Neoleukin Therapeutics is a failed biopharma that recently laid off the majority of its workforce and announced a strategic review.
• The company currently trades at a wide 36% discount to its estimated net cash upon strategic review conclusion.
• While the strategic review outcome is uncertain, a highly credible management team gives some confidence in a shareholder-friendly outcome.

This is an interesting “strategic review of a busted biopharma” type of situation which was initially highlighted to Special Situation Subscribers in March. The stock has gone up 29% since my write-up, however, there seems to be substantial potential upside left here.

Neoleukin Therapeutics ( NLTX ) is a $44 million market cap failed biopharma. In Nov ’22, the company discontinued the development of its key program NL-201 and announced plans to cut 40% of its workforce. Last month, the company revealed a further 70% headcount reduction. Concurrently, NLTX hired a financial advisor and commenced a review of strategic alternatives. This month, the company appointed both interim CEO and CFO. The company has mentioned a company sale, merger, divestiture of assets and licensing among potential strategic review outcomes. While it is not clear what will be the end-game here, liquidation would be the preferred option. NLTX currently trades at a large 36% discount to its estimated net cash and 14% below its conservatively estimated liquidation value. The good part is that even if a winddown fails to materialize, the downside looks fairly well protected here as investors might simply opt to wait for the strategic review conclusion. Note that NLTX's market cap is calculated on a fully diluted basis, i.e. including pre-funded warrants and RSUs (55m shares outstanding in total).

What gives confidence in a shareholder-friendly outcome here is the unusually high credibility of NLTX’s management:

• The company’s chairman Todd Simpson is the CFO of cancer-focused biotechnology firm Seagen (NASDAQ: SGEN ). SGEN is currently being acquired by pharmaceutical giant Pfizer (NYSE: PFE ) in a $43bn transaction.
• Director Erin Lavelle was the COO of Alder Biopharmaceuticals. The company was bought by H. Lundbeck ( OTCPK:HLBBF ) in 2020 in a $2.3bn transaction. Before that, Lavelle had held a variety of roles at Amgen (NASDAQ: AMGN ).
• Director Martin Babler was the CEO of Principia Biopharma before the company was acquired by Sanofi ( SNY ) for $3.7bn in 2020.
• Director Rohan Palekar held CCO, COO and CEO roles at Avanir Pharmaceuticals during 2012-2017. The company was bought by Otsuka Pharmaceutical ( OTCPK:OTSKF ) for $3.5bn in 2015.

Another positive here is the fact that one of NLTX’s largest shareholders is Baker Bros (owns 8% on a fully diluted basis). Baker Bros is a reputable life sciences-focused hedge fund. The firm holds many other biopharma positions, with a total AUM of over $25bn. Baker currently controls one board seat at the company. NLTX’s shareholder base also includes Millennium Management (owns 3%) and Lynx1 Capital Management (4%).

Net Cash And Liquidation Value Estimates

Below is my attempt to estimate NLTX’s net cash upon the strategic review conclusion:

• $96m in cash and short-term investments as of Dec’22.
• Less $10m in restructuring costs. These include employee severance and benefits, contract termination costs and other. I come to this value by taking the upper end of the management’s estimated cost ranges. The management has guided for $6.3m-$8.3m in costs as part of the restructuring initiated in November. According to the company’s 10-K, $1.4m in severance was already paid during Q4’22. The company has stated that costs from the second restructuring in announced in March are expected to range between $2.5m and $3m. Out of these costs, $0.3m are expected to be non-cash expenses, however, I take the full $3m.
• Less $8m in cash burn until March. I estimate this based on the management’s cash runway projection provided in Nov’22 which implied a $30m cash burn per year.
• Less $10m in cash burn until September. NLTX’s cash burn stood at $14m-$16m per quarter during Q1-Q3’22 (i.e. before the recent restructurings). Given the massively reduced workforce and no R&D expenses, I think my cash burn estimate is appropriate, if not conservative. The management has noted that both headcount reductions are estimated to be completed by H1’23, however, judging by a decline in NLTX’s number of employees from 2021 to 2022 (down from 91 to 56), the first part of the restructuring has likely already been substantially completed.

This would leave $69m in cash as of Sep’23 vs the current market cap of $44m.

Going a step further, here’s what NLTX’s value might look like in a potential liquidation:

• $69m in cash and short-term investments as of Sep’23.
• Less $10m in accounts payable.
• Less $2.5m for lease termination penalty. NLTX leases a 33k square foot office space in Seattle. The potential penalty equates to one-year rent worth.
• Less $5m in winddown costs. This is my educated guess based on previous microcap liquidations. The estimate might be conservative given that most of NLTX’s severance has already been expensed during the announced restructurings which would leave fewer expenses for the potential final wind-down.

This suggests NLTX’s liquidation might reach $51m - a 16% premium to the current market cap. Note that my assumptions are fairly conservative and there might be some double counting as, for instance, some restructuring costs could already be included in accounts payables.

Risks

• NLTX is a microcap company and has limited liquidity. The average daily trading volume stood at only c. $250k over the last year.
• A company liquidation might not be in the cards here and the management might instead pursue other strategic alternatives, such as a reverse merger. While reverse mergers are not inherently value-destructive, there would be substantial uncertainty whether NLTX could find a good reverse merger target.
• NLTX's management’s ownership stake is insignificant at 4%. Having said that, I do not see any worrying impact on the management's ability to drive shareholder value here.

Neoleukin Therapeutics

Neoleukin uses computational methods to design proteins with specific pharmaceutical properties that potentially provide superior therapeutic benefits over native proteins. The company’s designed protein scaffolds are capable of demonstrating specific biological properties, including novel molecular interfaces, differential activation of specific cell types and increased stability, among others. NLTX’s key product candidate was designed to mimic the therapeutic activity of cytokines interleukin and could potentially be used to treat cancer. The company’s remaining pipeline is pre-clinical stage.

NLTX has failed to achieve any commercial and/or scientific success since going public through a reverse merger in 2019. The company’s key program was discontinued during the preliminary data of a Phase 1 study. Meanwhile, the business has burned c. $120m in cash. NLTX’s shares have plummeted over 70% since the reverse merger was completed and ~80% since early 2022. The company raised equity back in 2019 and 2020 at $8.40/share and $15.25/share respectively - this compares to the current share price of $0.78/share.

Conclusion

At the current share price levels, NLTX presents an interesting investment opportunity with a potential short-to-medium-term catalyst. Given the wide discount to net cash, liquidation seems to be the preferred option here. While the strategic review outcome is still uncertain, the management’s reputation and the presence of a large institutional shareholder lead me to believe that the margin of safety should be sufficient.

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