TESARO Inc (NASDAQ:TSRO) just announced an equity offering, and the company has taken a considerable hit as a result. It’s down more than 12% on the news, and there’s some added selling pressure compounding the decline heading into the Thursday close. We think there might be an opportunity to take advantage of this decline, and get in at a discount ahead of a recovery.
First, let’s look at what’s happened, and try to address why.
Tesaro, for those not familiar with the company, is a biopharmaceutical company with a focus on the oncology sector. Its lead development asset, the asset that is closest linked to the latest decline (for reasons we’ll get to in a little more detail shortly) is called niraparib, and it’s targeting an ovarian cancer indication. We don’t really need to go into the indication in too much detail here, but suffice to say, ovarian cancer is a serious problem in the US, accounting for close to 6% of all cancer deaths in women annually, and affecting more than 1.3% of the population.
The current SOC is a combination of chemo and radiotherapy, and there are some down-the-line immuno-oncology treatments that have come to the fore over the last few years, and that are now offered as treatments when SOC fails to work, or stops working in patients for which it has previously done some good.
The current lead of these back up therapies is called Lynparza, and it’s currently commercialized by pharmaceutical behemoth, AstraZeneca plc (ADR) (NYSE:AZN). There’s a key difference between the two (despite the similarities in their respective MOAs) and that’s that Tesaro is trying to get its niraparib approved for treating women for which two previous therapies have failed. Lynparza is approved in women for which three previous treatments have failed. This means that, if approved, niraparib could leapfrog Lynparza in the market. The latter generates just shy of $100 million a year, and has only been on the market for a couple of years, so there’s considerable potential for revenues generation (we’re talking peak in excess of $1.5 billion at latest estimates) for Tesaro if the company can get an FDA nod on its application.
And that application looks pretty solid. The company completed a rolling submission earlier this year, and the FDA will look at the drug (and make a final decision) likely at some point during the third quarter of 2017.
So, with a solid application, a potential blockbuster market, and the opportunity to leap frog an industry behemoth on commercialization, why is the company selling off?
Well, this is where the fickleness of markets come in to play.
Generally, investors see an equity issue raise as bad, because it results in dilution. That is, through the issue of an extra X number of shares, against the same market capitalization, each of the available shares pre-issue become worth less. Technically, that’s correct, so technically, there’s a mathematical justification for price to revalue to the downside, and correct against the fresh outstanding figure to represent the same pre-value market cap.
Of course, and as we’ve seen here, the selling is often over excitable, and price corrects too far to the downside. That, in itself, is an opportunity to get in at a discount, in most cases. But here, we’ve got something else – something things rings true for a lot of other companies in this situation, especially in development stage biotech.
It’s that the capital raised is going to be used to add value. Value add translates to a higher per share price, based on an increased market capitalization and vice versa. Therefore, if a company uses the capital efficiently, the value raise should offset the dilution that the equity issue creates.
In this instance, the company is raising capital to fund a commercialization and marketing run for niraparib, on the assumption that the FDA will give the drug a green light next summer. This happens pretty much every time a new drug comes nears decision day, especially at this end of the market, and if the drug gets approval, the approval alone serves to catalyze value beyond that lost through dilution. Then comes marketing, and that adds value in of itself.
That’s why we think there’s an opportunity here.