Thursday, April 11, 2013

The Real Private Equity: Alchemy versus Science


The Real Private Equity: Alchemy versus Science

Chimerix, a Durham based biopharmaceutical company, is about to go public by raising $85 million.  I thought I’d read Chimerix’s prospectus, since I’ve read the regulatory filings of two other local companies on the verge of going public:  Quintiles and Ply Gem[1].  I’ll leave it for others to judge the scientific and commercial merits of Chimerix, but the company’s business is summarized as follows:

Chimerix is a biopharmaceutical company committed to the discovery, development and commercialization of novel, oral antiviral therapeutics that are designed to transform patient care in areas of high unmet medical need. Our proprietary lipid technology has given rise to two clinical-stage compounds, CMX001 and CMX157, which have demonstrated the potential for enhanced antiviral activity and safety in convenient, orally administered dosing regimens.[2]

I’m almost always optimistic and rather awed when I read the descriptions of the objectives and research undertaken by biopharmaceutical companies.  However, I don’t know how to make a judgment about the prospects of these companies.  Unlike mainstream private equity (leveraged buyouts under a more benign name) biopharmaceutical investing is about long-term investment.  Chimerix is just one example.

Law Firm Trust Clients (1999)

In my cynical mode, I went searching through the company’s prospectus for a list of banking fees and consulting arrangements between the private equity sponsors (venture capitalists in this case) and the company.  Of course, there aren’t any.  Unlike in a leveraged buyout, where everyone gets to haul away their share of the company’s cash as fees, Chimerix’s investors haven’t taken any money out of the company.  In fact, several of the investors intend to put more money into the company by participating in the IPO to the tune of $20 million.

Chimerix has been developing its potential products for thirteen years and warns investors the complete development and marketing authorization “will take a number of years and is subject to significant uncertainty.”[3]  Before the IPO, the company had raised over $100 million in investment capital from at least six rounds of financing, since its founding in 2000.  By the way, the second largest investor has been the government with $66 million in commitments to fund the company’s research.  Chimerix’s revenues are only $33.7 million, but come from licensing agreements, grants, and contracts, rather than sales. As best as I can tell, one of the original VC investors, Sanderling, has participated in every round of financing in the last 13 years, and several have made multiple investments over the years.  Comparing the company’s limited regulatory filings over the years with the prospectus, you get some hints about how much work went into assembling and reassembling the management and scientific teams.[4]  The longest serving senior member of the current management team has only been with the company since 2009.[5]

Buyout firms tout their operational expertise, but emphasize their financial engineering skills in order to turn a profit for their investors.  Venture capital is the complete opposite.[6]  The folks running Chimerix, whether directors or officers, come with scientific and business backgrounds.  By contrast, most buyout-owned companies are staffed by people who spent a great deal of time in or around Wall Street. 

The compensation arrangements at Chimerix and most emerging biopharmaceutrical companies, while high compared to the average American’s, are modest compared to buyout funds.[7]  While the key employees could become extremely rich it will only happen if the company can get much closer to developing marketable products.  In the buyout world, many of the key folks are already rich, and will get even richer, which may not depend on the success of the company.

Venture investing is not all virtue and focus on the long-term success of science.  Reading between the lines of the prospectus and evaluating each of the six rounds of financing is revealing.  There are hints about the sharp elbows that pushed certain employees out of the company and diluted some of the early investors.[8]  Moreover, it’s clear from the number of shares being reserved for options[9] that investors in the IPO will undoubtedly be diluted as the company continues to consume capital.  And that’s assuming Chimerix is successful.

After reading Chimerix’s prospectus and thinking about the hundreds of biopharmaceutical prospectuses I’ve read over the years, I’m left to wonder why anyone would undertake such a difficult task.  It seems much easier to buy an existing company, leverage it up, pay yourself a bunch of fees and dividends, and then take it public.  Thankfully, there are still investors willing to make the long-term bet.  Think of it this way; if all leveraged buy out firms disappeared, our economy would go on pretty much as it is.  If all the biopharmaceutical venture firms went away, we’d have something to worry about.

  



[1] See, “Quintiles Files to Go Public: The Details Matter [February, 20, 2013],” and “The True Power of the Alignment of Interest: Ply Gem Holdings [April 8, 2013]”
[3] Ibid. p. 52
[4] Of the senior executives and directors who were listed in the companies $2.2 million financing in 2002, only Timothy Wollaeger, a partner with Sanderling appears in the prospectus.  All the other folks have changed.
[5] Kenneth Mock joined as COO in 2009, and is now the CEO.  The newest member of the management team, the Chief Development Officer, Michael Rogers signed on last month, and the Chief Medical Officer, Michelle Berry was hired in November 2012.
[6] During the Internet bubble, venture capital investing was relatively easy.  A business plan was enough to raise money and quickly go public.
[7] The CEO of Chimerix makes $427,000 as a base salary, which is probably less than half of what a buy-out CEO would receive.  At Chimerix, the CEO cash bonus is limited to 30% of the base. A buy-out CEO would expect two to three times his base as a bonus.  Obviously, Chimerix is much smaller than many buyouts, but the key difference is that biopharmaceuticals have to pour their available capital into R&D, and clinical trials.  On other hand, key executives are rewarded with stock options and restricted stock.  Of course, buy-out executives get those as well.
[8] For example, there’s a curious transition in the last couple of years in the positions of Chief Medical Officer and Chief Scientific Officer.  From 2009 until early 2012, Gwendolyn Painter and George Painter held these positions as consultants and employees.  George Painter was also on the board until February 2012.  For the remainder of 2012, the company paid Dorothy Margolskee $854,000 to be interim CMO.  The company also parted ways with Michael Grindel at the end of 2012.  He had been the head of Development and Program Management, and was replaced by Michael Roger in March.  I suspect there are some messy stories behind these moves.
[9]  The company has 2.6 million options already outstanding at an average exercise prices of $2.45 per share, 704,225 shares reserved for an employee stock purchase plan, and 1.8 million shares reserved under its 2012 and 2013 stock plans.  In addition, there are 1.6 million warrants outstanding exercisable at $7.26.

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