Deep Restructuring Play in Biotech

It’s been a while since I’ve written about a particular company, and frankly its not because I don’t have the time … I just haven’t really found any worth writing about. Whether its a new IPO, or Amazon’s buyout of Whole Foods, one event or another seems to kick the market past 6th gear and into overdrive. However, like I mentioned in my investors newsletter, and like I alluded to in previous pieces, what I think about the general market means absolutely nothing. It shouldn’t mean anything to you, the reader, and it shouldn’t mean anything to those that choose to put their money with me. My job is to find value. Period. It’s important that I stress this because when most people think of finding value, they assume that most of the value to be sought is during bear markets. We haven’t had a bear market in eight years now (since I started investing). To be on the sidelines during a bull run like this for the sake of “not being able to find value” is an atrocious and poisonous mistake to capital and intellect. Sure it might not have been a bear market where deals are found just by running a simple screener, closing your eyes, and landing on a net-net within seconds, but to make excuses is to attempt to cover up a lack of dedication and research.

I’ve mentioned numerous times how I overvalued I think the market is, but looking at my current portfolio; out of my 10 positions, 4 of them are long US equities. That’s 40% of my portfolio long US Equities. One of them is a pure momentum play, but the others are what I consider deep value, net – net picks. Even in this bull market you can still find deals, you just have to look extremely hard. Peter Lynch said it best, “Whoever turns over the most rocks will generally win.” Let’s turn over another rock.

OVASCIENCE, INC. – A Restructuring Has Begun

OvaScience Inc is a biotechnology company focused on discovering, developing, and commercializing new fertility treatment options for women. The company’s patented technology is based on a new fertility treatment option, “the newly discovered Egg precursor cells.” Augment, the first treatment, is designed to improve egg health: Energy-producing mitochondria from a patient’s own EggPC cells are added to the patient’s mature eggs. The OvaPrime treatment is a fertility treatment that could allow a woman to increase her own egg reserve. The OvaTure treatment is a potential next-generation fertility treatment that could allow a woman produce healthy, young, fertilizable eggs without hormone injections.

If there’s one thing I don’t know about biotechnology it’s this company. I know what I’m about to say may sound crazy to the Warren Buffett diehards out there, so hold on to your seats: I don’t think you have to fully understand a business in order to recognize the intrinsic value of that business. Now, I could be completely wrong on that, and only time will tell if my personal thesis comes to fruition. I think it’s important to stretch the theories of the greats that came before me. Ben Graham stressed diversity amongst net-nets, never worrying about knowing the business inside and out. Nevertheless, let’s get on to the analysis.

Recent Restructuring

After falling 76% over the course of the year, OVAS decided to make changes, starting at the top. Christopher Kroeger was named new CEO of the OVAS, and shortly thereafter cut half of their staff (BizJournals.com). The slashing of the staff accompanied by a new CEO always perks my interest. In searching for value, you’re not going to find it on shiny glistening balance sheets. You’re going to find it on balance sheets and ratios and margins that make you initially go, “Why would anyone invest in that?!” Michael Burry refers to these such companies having the “Ick!” factor. OVAS definitely passes that test with flying colors.

Anytime a company hires on a new CEO, it proves valuable to do a little research on the “new guy” to see where he could potentially take the company, and if he/she has any record of past successes in the industry. According to the BizJournal.com article about the new hire, “Kroeger is widely known for his role overseeing the sale of Cardioxyl to Bristol-Myers Squibb (NYSE: BMY) for $2.1 billion in 2015.” This is important because if Kroeger can do something similar to a company like OVAS, it could be a very profitable M&A scenario for shareholders of OVAS. Kroeger thinks there is value in OVAS as well, saying, “[I’d] been looking for a new biotech CEO role late last year. [I] chose the job at OvaScience [sic] because of its incredible foundational science and an unmet medical need.”

The Company is cutting costs, slashing jobs, and refocusing on two developments instead of the three they were focused on over the course of the past year. The areas Kroeger wants to hone in on are called “egg precursor cell development”, which are immature egg cells in the lining of the ovaries. Their goal is to turn those immature egg cells into matured, new fertilizable eggs. The second treatment is called OvaTure. OvaTure’s goal is to fertilize the egg cells without injecting hormones. This idea is very interesting because without injecting hormones, some women would no longer have to suffer from drastic hormone swings and imbalances.

Finally, and most importantly regarding the restructuring is the elimination of certain costs of doing business. After firing half of the staff, OVAS saved around $10 Million on their balance sheets, which already carry an excess of cash compared to their Market Cap. This savings will ensure that OVAS’ cash reserves last into the first quarter of 2020. This is the definition of a slow cash burn, but more convincing is it seems to be a deliberate effort to reduce cash burn.

The Fundamentals

With the restructuring story clear in your head, let’s dig into the fundamentals to see how much value can be extracted. We’ll start with the ugly, because there’s plenty of it. OVAS has horrible margins, even compared to their industry they’re abysmal. With an operating margin of -13,010% and Net Margin of -13,227% it ranks OVAS lower than 93% of the companies in the industry. ROE comes in at -64.09% and ROA arrives at -57.82%. However, as bad as those numbers look, you have to take them in context.

Operating Margin, for instance, actually increased since last year, where it was, and this isn’t a typo, -25,992.42%. Net Margin increased from -26,432.85% in 2015. Although Gross Margin decreased from 2015 to 2016, looking at quarterly data suggests that more recent trends proved for the better. From December 16 to March 17, Gross Margin increased from -1,084.30% to -326.98%.

Moving on to Net Income, we’re also seeing trending improvements. Net Income in the last quarter of 2016 was -$82.26MM compared to the most recent quarter in 2017 of -$75.4MM. Cash levels have decreased since 2015 when it peaked at $126.66MM, and it now sits at $99.1MM, which is still more cash than its market cap. Free Cash Flow hasn’t increased that much since the last quarter, with an increase of around $2.6MM.

OVAS has no debt, an EV-to-EBITDA of 0.52.

Price Action

www.tradingview-1

Taking a look at the daily charts, we can see the tremendous avalanche of price destruction that has taken place over the last year or so. However, what is interesting to note is the recent spike in buying starting at about last week (or the time the new CEO was brought on). The weekly chart is also close to depicting a buying signal, so I will be patiently watching this stock for a more advanced move. IT rose around 30% over the course of a couple of days before retreating close to 10% on trading day Friday. The price action dictates a safe entry point, and if I were to buy I would wait until around 1.90ish and set my stop around 1.00 – 1.10. This is the benefit of looking at distressed companies that the market deems worthless.

OVAS could be the opportunity to buy a dollar for $0.50. Like Michael Burry says, I would love to buy a volatile company worth a dollar that’s trading at $0.50 than a steady company worth a dollar trading at $1.10.

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