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Repros Therapeutics Financing A Biotech Game Changer?


This morning's deal creates short squeeze potential.


The single constant in the development-stage biotech space my firm covers is the need for these companies to raise money. This has become something of a blood sport in recent years, with hedge funds shorting the beejeebers out of any company that looks to need financing.

Minyanville's Why Wall Street Will Never Be the Same That short is about as low risk trade there is in any market. Buying pressure from larger players disappears as they figure they can get their shares in the financing. The short sellers figure they can also participate in the deal, getting shares to cover that short. Even if they don't participate in the deal, average discounts run 10-20% in this space. The stock then almost always heads to the deal price at least for a little while.

Is this illegal? Most of the time, yes. I even wrote about an SEC crackdown on the practice in July 2004. I can count the percentage of funds busted for illegality of the total population of rule breakers on one hand.

There's nothing like an unfulfilled threat of regulatory action to embolden aggressive traders. I'm seeing almost any company who has to finance in the next 12-15 months have short interest pressure. I've wondered how long it would take before management teams and existing holders started to do something about it.

I might have my answer today.

I want to call your attention to this morning's release from a biotech company called Repros Therapeutics (RPRX). My firm has been covering the company for some time, and I've marveled at the complete disconnect between the potential value of their drugs (billion plus) and their market cap ($78 million). The stock is really a poster child for much of the structural afflictions in the sector, as its price has declined despite a string of positive data from its trials.

I believe the deal announced this morning has the potential to create a significant short squeeze. I'll explain why, but let's go through the deal mechanics first because they are unusual.

Repros will sell the remaining 2.4 million shares under its current shelf at $6.50, a 6.9% premium over the current price and a 22.4% bonus from the recent short-inspired lows. This will provide an aggregate of $15.6 million in financing to Repros.

But that's not all…

The participants in this deal have also agreed to purchase an additional $10 million in shares at a minimum stock price of $7.80, or a 28.3% bonus to the current share price. This purchase is automatically triggered when Repros falls under $10 million in cash reserves. If Repros shares climb above $7.80 on the open market, then the price of the offering will be at that higher price.

In one fell swoop, Repros has secured two rounds of financing. The total $25.6 million in cash will get Repros through data from the two Phase III anemia trials and the two Phase III fibroid trials for their lead drug, Proellex.

The key here is Repros did not go outside to get this funding. Current large shareholders have taken down both the initial $15.6 million and the future $10 million. They did this at a premium to the market, because doing it at a discount doesn't help them given they are current holders.

Now here's why I think we're going to see a short squeeze…

Repros has seen significant increases in short interest as hedge funds bet they would get a piece of this financing. Management and the large holders got together to craft this deal. The deal effectively thumbs the nose at the short sellers who drove the price down, expecting to see a deal at a discount or even participate in the deal.

My firm has been saying for months now the amount of shares provided to funds outside the core Repros ownership group was either going to be zero or smaller, but apparently these short sellers aren't our clients. This was a failed bet by the short sellers, as those who did the financing were existing holders who were not short.

Repros now has plenty of cash to get through the release of key data. I would be very surprised to see those data come back negative. In fact, I've never talked to anyone who thought these trials would fail. That means the short interest comes mostly from gaming the financing deal, a game the short sellers just lost.

Since the deal structure actually penalizes current holders for selling their shares, and because I know the largest holders pretty well, I can say with some certainty the current holders are not going to sell their shares. That means there could be a nice little short squeeze on this announcement.

Please know that betting on short squeezes is a tough way to make money. So take the time to learn the company's fundamentals before you climb aboard. Invest based upon the now-improved fundamentals and be happily surprised if you get a boost from the short squeeze.

I believe this type of financing deal is a harbinger of things to come. Short sellers have essentially had their way with biotech stocks around the time that financings are completed. Management teams and, most especially, existing holders have shrugged their collective shoulders and accepted such shenanigans as a cost of doing business in the sector.

With capital so much more precious now, I believe the kind of coordinated funding package seen in this Repros deal will become much more popular. It is a natural maturation of the CEFFs done by Kingsbridge and others, or of the single-product financing deals done by Symphony and Deerfield.

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