Entries Tagged 'Financial Management' ↓

Options for Avalon’s Board

Best Option: Raise debt capital, pledging whatever assets it can, and use that for two purposes:
(a) do the biotech drug development with a strict performance based incremental investment
(b) start a service based revenue stream that can generate some operating cash.

Avalon Board and CXOs have to figure out what services they can offer to the industry, like taking outsourcing work from other larger companies…they should do something extra along with R&D work if they are serious about keeping the company afloat. There are many biotechs struggling in the market doing pure-play R&D, and equity capital won’t come easily especially with no results to show with the previous $30 million from last year.

Second Best Option: Sell the partial rights of work-in-progress research to a larger biotech or pharma who can afford to use the research, and get cash in return.

Either way, existing investors should be very cautious to put more money into the business at this stage.

Background Business Developments

Thursday, August 14, 2008; Washington Post Page D01

 Avalon Pharmaceuticals told investors yesterday that it will not be able to continue operations past this year if it can’t secure more funding. The Germantown biotech said its second-quarter loss narrowed to $5.6 million, from $5.8 million in the comparable period last year. Revenue was $137,000 for the quarter ended June 30, up from $78,000, thanks to its collaboration with Novartis Institutes for BioMedical Research. But Avalon’s cash, equivalents and marketable securities totalled $16.7 million, an amount that restrains its plans.

“We are acutely aware of our need to raise additional capital in the near term and are vigorously exploring a number of options,” C. Eric Winzer, Avalon’s CFO, said during a conference call with investors.  

To thin its expenses, Avalon will cut a third of its employees, reducing its workforce to about 35 people. The biotech, which focuses on cancer therapies, will stop work on its most advanced drug candidate and focus on AVN316, a drug that inhibits a cell pathway containing several proteins that play a role in the start and spread of cancer.

Avalon has partnerships with Merck and other firms to investigate compounds to fight several ailments, including cancer. Avalon could receive up to $200 million in milestone, regulatory and other payments as part of its Merck agreement, a partnership created last year to attack a target previously regarded as “undruggable.”

The decision to stop work on AVN994, which targets an enzyme that is sometimes overproduced in some cancer cells, especially blood malignancies, surprised analysts. AVN316 is better understood and appreciated by big pharmaceutical companies, Kenneth C. Carter, Avalon’s chief executive, told investors. “We believe our focus on these other programs will provide better shareholder value in the near term and long term,” Carter said.

Last year Avalon raised $30 million in private stock placements to fund its drug pipeline programs. Shares fell 29 percent yesterday, closing at 73 cents, the company’s lowest since going public in 2005.

Slow clinical drug development, which is typical of biotechs, coupled with poor market conditions, have hampered financing, said George B. Zavoico, an analyst with Cantor Fitzgerald in New York. Like small, struggling biotechs before it, Avalon now faces partnering with another company, debt financing or selling itself. But the big drug companies are losing patent protection on high-revenue products. “There is a little bit of reluctance to enter into partnership as easily and generously as when they were collecting billions of dollars off blockbuster drugs,” Zavoico said. “They see their revenue streams tightening up.”

Capital structure is part of fundamental business strategy, and top-level driver for Financial Management. And every business owner/board should have a map for how capital will be obtained for various projects.

Capital structure decides what combination of debt and equity will be used to finance the business projects. And it thereby decides the value basic parameters like cost of capital, earnings per share and valuation.

Arriving at the capital structure will depend on multiple factors: owner/shareholder expectations, industry type, tax policy-high corporate rates favor debt, and overall corporate risk.

Assuming there are real projects to deliver real growth (an important assumption), then if company’s equity investors expect the stock to go up 10%+ per year, and if the company can borrow money at 6%, then the company should have some debt as a source of capital.

Now, the point to note here is that it will benefit the equity investors and share price to have some debt, but overuse of debt (over-leverage) is not healthy because it increases the risk in the company’s earnings stream, which in turn tends to lower the valuation and hence the share price.

So each business owner/board will have to find their zone of comfort and create a capital structure policy that makes a trade-off between risk and return, which is acceptable to all investors.