PRDS - Pardes Biosciences: Strategic Review Is Likely To End Up In A Privatization

2023-05-02 09:58:49 ET

Summary

• Pardes Biosciences is a busted biopharma that is exploring strategic alternatives and trades at a wide 30% discount to its net cash.
• The company recently received a buyout proposal from its major shareholder/SPAC sponsor.
• Pardes Biosciences is likely to be acquired at a 4%+ premium to current share price levels.
• The downside seems to be protected by the large net cash position vs the market cap.

Yet another failed biopharma that is exploring strategic alternatives and trading at a wide discount to its net cash. A number of these have popped on my radar recently, including Neuoleukin Therapeutics which I recently highlighted here . I generally like these setups as a wide discount to net cash provides a sufficient margin of safety while awaiting a strategic review outcome. The situation covered in this article has a particularly interesting angle to it as the company might get acquired shortly.

Pardes Biosciences ( PRDS ) is a $120m market cap busted biopharma/SPAC. In early April, the company suspended its only clinical development program, laid off 85% of its workforce, and launched a strategic review. I subsequently highlighted the situation to Special Situation Investing subscribers. PRDS seemed to be an interesting strategic review play as the company was trading at a wide 44% discount to net cash.

What has happened since? Well, PRDS’s share price has been climbing steadily and is now up 23% since my initial highlight. Last week, the company received a non-binding buyout proposal from its major shareholder and SPAC sponsor Foresite Capital Management (owns 27%). The potential acquirer did not specify the offer price. Foresite noted that a potential transaction would require approvals from a special committee of independent directors as well as the majority of PRDS’s disinterested shareholders. Foresite has stated that it is not interested in any other strategic alternatives. In my view, the recent buyout offer gives an opportunity to potentially generate a short-term mid-single-digit return. I expect a short timeline here as the potential acquirer is incentivized to complete the transaction swiftly given PRDS’s ongoing cash burn. Nonetheless, the situation involves several risks which are detailed below. The downside to the pre-strategic review announcement price levels is significant at 32%.

While the offer price was not specified, I expect both sides to come to an agreement at a 4%+ premium to current share price levels. PRDS’s pipeline likely has little value to Foresite as the company recently terminated the development of its only clinical drug. Instead, Foresite’s potential endgame here might be to acquire PRDS at a discount to net cash and potentially liquidate it. PRDS trades at $1.95/share vs my estimated net cash value of $2.23/share at the end of Jun’23 (see calculations below). The current discount to net cash seems slightly too wide and to receive equity holder approval a price bump from current levels might be needed. A potential offer at $2.03/share would come at a 4% premium to trading levels while still leaving a 9% discount to the estimated net cash. This would allow Foresite to net a quite sizable $13m in estimated net cash less the merger consideration. Worth noting that there might be incremental future proceeds from an ongoing Enanta Pharmaceuticals’ patent infringement claim against Pfizer related to the pharma giant’s Covid pill Paxlovid. Apparently, PRDS asked for patent protection for its pill drug candidate before Enanta. Potential litigation claims might be significant given that Paxlovid’s sales reached $19bn in 2022 alone. Having said that, at the moment this seems to be a nice optionality and not the primary reason behind Foresite’s interest in the company.

I expect both the special committee and disinterested shareholders to approve the potential merger bid at a premium to current share price levels. Such an offer would come at a tiny discount to PRDS’s potential liquidation value while allowing equity holders to immediately realize value vs hypothetical liquidating distributions which would take several years to be fully paid out. Other options, such as a reverse merger, now seem less likely given PRDS’s relatively low amount of NOLs ($66m). Another positive here is that PRDS’s Chief Development Officer recently left the company, likely indicating that the pursuit of a new development program is out of the cards here.

Worth noting that one of PRDS’s shareholders BML Investment Partners disclosed its 8% stake when the company was trading at c. $1.20/share, suggesting that in a merger scenario, the shareholder would cash out at a substantial premium. Another shareholder Lynx1 Capital Management (owns 5%) acquired its shares at c. $2/share, implying that the equity holder is not likely to oppose an acquisition proposal coming above this level. PRDS’s management owns 12% (excluding shares held by the CEO of Foresite).

PRDS went public in 2021 via a SPAC with Foresite Capital Management. The company was engaged in developing pomotrelvir - a treatment against COVID-19. After successful pre-clinical and phase 1 trial results, the company’s lead candidate was eventually discontinued after a failed phase 2 study. The company burned c. $135m in cash since going public.

Net Cash Calculations

Below is my attempt to estimate PRDS’s net cash upon merger consummation:

• $173m in cash as of March 31. The figure has been reported by the company with the strategic review announcement .
• Less $5.7m in restructuring costs, including employee salaries, severance, and other expenses.
• Less $1m in wind-down expenses related to the company’s chemical, manufacturing, and control operations and contractual costs. The management has not specified the amount of these expenses, however, given that PRDS does not own any manufacturing facilities in China, these costs are likely to be minimal.
• Less $20m for accrued expenses and payables as of Dec’22.
• Less $5m in cash burn during Q2’23. PRDS used to burn $23m-$27m in cash during recent quarters, primarily driven by high research ad development expenses ($70m in 2022). The management has noted that R&D activities related to the company’s key drug have been fully wound down. Given that PRDS laid off 85% of its workforce, a cash burn rate of $5m per quarter going forward seems reasonable.
• Less $3m in merger-related expenses.

This leads to an estimated net cash position of $138m or $2.23/share as of Jun’23 and compares to the current market cap of $120m. Note that there might be double counting in my estimates as, for example, some of the accrued expenses and payables might have already been covered during Q1’23.

Risks

• Given the non-binding nature of the acquisition offer, there is a possibility of the proposed merger falling through. In such a case, PRDS's management might pursue other strategic alternatives, such as a reverse merger which could possibly lead to a substantial share price decline. Worth noting that Foresite was a SPAC sponsor of another busted biopharma Gemini Therapeutics. After a strategic review launched in Feb'22, Gemini Therapeutics eventually ended up announcing a reverse merger with Disc Medicine in Aug'22 (closed in Dec'22). The setup eventually worked out quite well for Gemini shareholders as the share price has jumped to $3.46/share currently (adjusted for a 10:1 reverse split) vs $1.4 when the strategic review was launched. Having said that, there would be substantial uncertainty about whether PRDS could find a good reverse merger target.
• My upside calculations are admittedly speculative and the merger proposal might instead come at no premium to current levels. Given that the PRDS stock has already jumped 48% since the strategic review announcement, a potential offer at current share price levels might be justified as coming at an already substantial premium and thus be accepted by equity holders.
• PRDS is a micro-cap biopharma and has limited trading liquidity, with an average daily trading volume of c. $540k over the last year. Limited liquidity implies that investors might be unable to sell the stock at market prices.

Foresite Capital Management

Foresite Capital Management is a healthcare and life sciences-focused venture capital firm with an AUM of c. $4bn. The firm has made a high number of investments in biopharma companies, including successful/profitable investments in 10x Genomics, Aerie Pharmaceuticals, and Juno Therapeutics. Foresite is generally a passive investor. The firm’s founder James Tananbaum sits on the PRDS board.

Conclusion

I believe PRDS currently presents an interesting investment opportunity. I expect the potential merger to be the near-term catalyst that could lead to a short-term mid-single-digit upside. Meanwhile, investors are getting this merger optionality with a limited downside given the significant discount to the company’s net cash position.

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