While you longs are still in shock, I'll try to explain to you why you're losing so bad.
First, consider some stock XYZ currently trading at $6 7/8. How much are you willing to pay for a share? About $6 7/8. Now, what if I try to sell you a restricted share of XYZ, which is restricted in that it has a long-term call option sold against it, with an exercise price of $7 1/4. If you buy my restricted share, the owner of the call option may demand that you sell them the share for $7 1/4. If things go well for the company, the stock XYZ will appreciate in value and the option holder will certainly call away your share. Thus, your upside is limited to $7 1/4. On the other hand, if things go poorly for the company, the option holder will not exercise, and you're stuck with a loser than might drop all the way to zero. So, how much will you pay for my restricted share? Certainly less than $6 7/8.
Next, lets consider development stage biotech companies in general. A majority of them will go bankrupt, but a few will be ten-baggers. People who buy biotech stocks accept the risk that many will go bankrupt because they know a few will be ten-baggers.
Finally, let's consider the specific ASCT deal. ASCT gave away call options on all shares. This limits your upside, but leaves you with all the downside risk. Unlimited upside is the reason people buy biotech stocks. The deal makes the shares less valuable than before the deal was announced. How much did the company receive for selling all of these call options? Not much. They received a loan of $40 million, not a payment of $40. The interest rate is lower than they would get on a bank loan, so that's worth something. On the other hand, as part of the deal they are lowering the price on lots of warrants, which is giving away all the value of the low interest rate on the loan.
So, let's consider what happens if ASCT spends the $40 million and nothing much pans out. Then, Alpharma decides not to excercise their call option, and demmands repayment of $40 million. But ASCT already spent that money, so how do they pay? This is the scenario where the stock goes to zero. On the other hand, what if ASCT develops some products that look very promising? Then Alpharma buys ASCT for $140 million. Where does that cash go? Not to the shareholders! First, all debts must be paid, including the $40 million to Alpharma, plus $10 million in long-term debt they already hold. Assuming that they don't take on any more debt over the next few years, there will be $90 million for the shareholders. How many shares will there be? There are already 7 million outstanding. As part of this deal, 2.4 million new shares will be issued. Further, there are an additional 3 million options currently issued, which will certainly be excercised before a buyout. That's a total of 12.4 million shares, assuming the company doesn't issue any more options. Thus, the maximum you'll ever get for this stock is $7.25.
How much would you pay for a development stage biotech company who's downside is zero and who's upside is $7.25? |
