OPTN - OptiNose: An Interesting Investment Opportunity

Summary

• OptiNose's current treatment of chronic sinusitis is both effective at treating this condition and bringing revenues.
• Their negative EBITDA and equity combined with their low cash pose a major flag of caution for investors.
• Their current situation will make or break the company if it can survive long enough for their supplementary filing to get approved in Q4 2023.

Introduction

OptiNose ( OPTN ) is currently at an inflection point that may determine whether this company makes or breaks itself. High caution is necessary for those investing in the company, however, I would not advise against investing as OptiNose presents an opportunity that can possibly pay off handsomely if things go right for management.

Pharma: Oversaturated

A massive problem I often see among pharmaceutical companies is that there's a huge quantity of companies, yet very little quality. It is in this industry where an investor's ability to find worthwhile companies to invest in is truly tested since for someone that is not studying medicine or is involved with the medical field in a professional manner, all pharmaceutical companies simply blend together. It becomes easier to fall back on tried and true medical companies like Pfizer ( PFE ), Eli Lilly ( LLY ) and Merck ( MRK ).

Some common characteristics with these companies can be likened to start-ups. Lack of revenues, sometimes they don't even have a product on the market, or they are known as a nobody in their industry. Or alternatively, they want to change an industry or a part of our lives. Most pharma companies do this, which makes it hard to find the companies that might actually survive and turn a profit.

A Product Out to Bring Profitability

So what makes OptiNose different? Well, it isn't different enough to be considered a strong buy, but I find some characteristics of the company rather intriguing.

For one, OptiNose actually has an FDA approved drug that is selling well. Their main product is XHANCE, which is a drug that uses their Exhalation Delivery System ((EDS)) technology to deploy the drug that they developed to treat chronic rhinosinusitis with or without nasal polyps more efficiently into the nasal passages of a patient.

So far from 2021's year-end results (since their 10-K won't be released until March), it seems that the treatment is seeing quite the adoption, which may be considered as a sign of success. This is an encouraging indicator that this company may actually manage to make themselves profitable later down the road.

Their revenues are also significant relative to their market cap. Over the trailing twelve months, OptiNose reported revenues of $78 million. While this is a big slowdown, it is also important to note that their drug was only approved for treatment of the chronic rhinosinusitis with nasal polyps; they still await for FDA approval of XHANCE for patients without nasal polyps, which consist of 2 thirds of their target market.

I also like that their product seems to touch a medical condition whose treatments seems to have their own inefficiencies. While it is convenient for pharma companies to not actually eliminate diseases permanently, as it provides them with an endless stream of revenue, this also opens the gateway for a new competitor to disrupt a small part of the industry as it is ultimately too large for just a handful of companies to control alone.

Risks

However, there is something that is important for me to note: not everything is sunshine and rainbows with OptiNose. If anything, the reaper may be coming for this stock when we take a quick look at their 10-Q; specifically, the balance sheet.

What do we see here? Cash has been decreasing since the end of 2021, and their current loans are due for payment within the next year. While this was glossed over in the Q3 earnings call for 2022, one analyst did point out in their question the concerning cash position that the company has.

But sort of given the current burn rate, right, you push the supplemental NDA filing out into 1Q if you get the standard 10-month review, now you're kind of almost at the end of next year. And when we look at the cash on the balance sheet, could you maybe talk about the balance sheet and sort of how you see that playing out? And do you feel confident based on the reduction in expenses next year that you have enough cash to make it through to some type of an approval.

Glen Santangelo, Jefferies

I'm gonna emphasize here: "Does OptiNose feel confident about their reduction of expenses next year that there's enough cash to make it through an approval by the FDA?"

Seems that I share some concerns with analysts to some extent, considering that they can't even make a positive EBITDA, which raises eyebrows for me. I certainly hope that expense reductions in 2023 are enough to slow down their cash depletion rate, but I still have a lot of doubts as there isn't any clear evidence that it is translating to something material.

Admittedly, it is noticeable, yet one could doubt if we'll see net income lower than -$15 million next quarter. For OptiNose's sake, it is imperative that they do at least reduce their cash bleed rate to $10 million per quarter and refinance their loans for a longer term to buy them enough time to eke out profitability and save themselves from bankruptcy.

I want to be honest, I am bullish on the company and the business itself and believe that in a perfect world without debt and cash burn they can succeed in rolling XHANCE into the market. Here's the thing, though: Their incoming dues combined with cash burn could imply they have less than one year to succeed. I also learned in Q3's earnings call that they're expected to file for FDA approval for regular chronic sinusitis in Q1 of 2023 only for that process to possibly be completed in Q4 of 2023. This means to me that they might not make it through without serious shareholder dilution or additional debt (which would pay down current debt). This in itself counters my bullish arguments that may come to a halt because of those problems.

I want to note: they have diluted shareholders before and made an offering before on November 30 that would have net proceeds of around $50 million. This may help the company's cash and debt position, if it is actually reflected in the balance sheet.

There is also another problem: Lack of profitability, high interest rate environments, negative EBITDA and negative equity might not be a helpful situation to help them finance new debt. In a risk-off environment, it may turn out to be difficult to finance new debt.

So what's the next possible option excluding bankruptcy? Two possibilities: Either they get bailed out by a larger company through a buyout, or they severely dilute shareholders again by offering at least 90 million shares at a price of $1.50 per share, which would be enough to pay off debt entirely and pay off any fees for issuing this large of an offering.

Even so, they'd still have to control their cash burn, which we'll see in the next two quarters how that pays out. They can't sell their assets alone because their current debt is higher than their total assets.

This is why I ultimately say it's an interesting opportunity. I like the business and it could be worth investing into, but it is a high risk, high reward situation with a highly risky path forward.

Valuation

Is it possible to provide a valuation for this company? To be honest, they make a material amount of revenues that makes the company trade at close to 2.5x revenues. That's at least a good sign that the company is not overvalued, nor do investors see it is going bankrupt soon.

However, they do have negative equity and are in a highly risky position. I wish I could say something peachy that their current valuation of around $1.75 is a good price target, but I do have to lower my expectations slightly to account for the possibility of another round of dilution.

So, let's assume that their share count grows to 150 million shares. Their current valuation is around $200 million. Their current market cap to revenue is 2.5x, with a potential for possibly breaking above 100 million.

Their negative equity is around $73 million, so we can fairly subtract that from the valuation to get around $127 million. For simplicity sake, let's lower that to $125 million.

This would mean that OptiNose's fair valuation would be around 83 cents per share with an outstanding share count of 150 million, or $1.13 with our current diluted share count. Know what you're risking if you choose to invest here, because the potential downside could be massive.

Conclusion

I believe that OptiNose presents an intriguing opportunity for those brave (or reckless) enough to stomach a potential loss of 50% or even 100% in the worst case scenario. While I'm bullish on the business, I'm cautious with the state of their balance sheet.

They somewhat stand out from other pharmaceutical companies by actually having a product approved by the FDA, however their current loans and negative equity present a major risk to shareholders.

For my rating this time, the current price target of $1 balances out a future of further dilution with one where it's not, but OptiNose finds themselves in a situation that is grounded on realism. Meanwhile, my rating of Hold on the stock would provide the subjective bias that this company might actually have a chance of surviving and having a massive payout, but it also reflects the caution that is necessary when investing in highly risky positions.

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