Swelled Heads - Cephalon makes an informed bet
CBOE Time-Premium Index, from Barron's Weekly
When Cephalon revealed plans last week to sell a half-million of its common shares so it could buy call options on 2.5 million of them, investors had to wonder if the fledgling biotechnology company saw a brighter future in trading options than in making drugs. Had management lost its head?
Quite the opposite, it seems. Cephalon is making a calculated - and, dare we say, informed - bet that its prospects are about to get a whole lot better. The West Chester, Pa.-based company is gambling that a Food and Drug Administration advisory panel, scheduled to meet May 8, will give it the long-awaited green light to begin marketing its Myotrophin drug for the treatment of Lou Gehrig's disease, the degenerative and fatal nerve condition.
If that happens - and Cephalon knows its odds better, perhaps, than anyone but the FDA panel - the biotech start-up will be on the hook to make a $16 million payment to a limited partnership of high-net-worth individuals strung together by PaineWebber in 1992. Two years later, it will owe the partnership a payment of $40 million cash or $42 million in stock. It is also obligated to make a royalty payment of
10% of Myotrophin sales to the partnership over an 11-year period.
In addition, it needs money to make and market Myotrophin, which Cephalon is developing with Chiron Corp. as partner. Then, too, it needs more dough to fund development and marketing of a drug for narcolepsy. What's more, the biotech company is considering buying out the limited partnership, a move it estimates could cost $125 million.
So Cephalon could find itself squeezed for cash. But since the credit markets aren't typically very responsive to companies with no history of profit or products, and since the equity markets have turned somewhat hostile, Cephalon cooked up the off-exchange call-buying scheme with Swiss Bank's SBC Warburg unit. ``Clever''
and ``creative,'' most Wall Streeters called the plan. No one recalls a precedent.
``It provides us with cash when we need it most,'' says Kevin Buchi, chief financial officer of Cephalon. Buchi adds that the transaction hinges upon the Securities and Exchange Commission granting approval for the sale of the stock that will be used to buy the options. While terms of the agreement have yet to be negotiated, Buchi says the company hopes to raise $45 million, exclusive of the $10 million, or $20 a share, expected to be generated by the stock sale to Warburg, in the ``best case.''
The purchase price, strike price, appreciation cap and other specifics that might indicate just how bullish a bet Cephalon is making on itself have yet to be determined. Filings indicate the options will have a term of six months. Warburg officials didn't return calls.
Of course, how much the company ultimately reaps depends a lot on whether the stock appreciates and by how much. The company, for one, is confident of the outcome. Maybe too confident, some say. Certainly the disclosure of the plan and the favorable outlook for the drug provided a floor for the shares during the market's sharp selloff late last week. Also, if the transaction is allowed, Warburg will be using
the underlying shares to hedge its exposure, which could add strength.
``It's a very interesting way to give a signal,'' says Emmett Harty, an equity derivatives specialist at Cantor Fitzgerald's Parallax Group division.
Says Gregory McMurran, chief investment officer of Analytic-TSA, a Los Angeles-based options specialist, ``If you can get away with it, what a great deal!''
Now, my point is how we play to profit from this action??
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