The Money Equation for Biotechs

Good morning, Armchair Army,

Welcome to today's edition of The Armchair Analyst, a 5-minute daily update on the ASX life-sciences sector.

Money makes the world go round.

… And the thing about early-stage biotech stocks is… they always need money.

Preclinical work costs money.

The IND costs money.

Phase 1 costs money; Phase 2 costs more.

Phase 3 ooft.

Manufacturing. Regulatory filing. Commercial team.

From an idea to commercialisation is a 15+ year journey.

The prize at the end is big.

A blockbuster drug can sell for billions of dollars… 

Every year.

(or be acquired for that amount in one go, as we saw with Myricx Bio, the Brandon Capital investment that sold for US$1.5 billion to Novartis last month)

Between the idea and the prize there's a very long tunnel with no revenue.

But there are stops along the way.

These stops are the value inflection points that increase the underlying value of the asset.

The main stop = data.

Clinical data.

But data costs money too.

So… we have to bridge the gap.

With cash.

The only question then is for a public company…

How much of my company or upside do I give up for this capital that will help me get there?

The cost of capital question.

Today I’m going to do a deep dive on the different types of capital that companies can access.

But first…

Control Bionics (ASX: CBL) completes FDA registration and listing for NeuroStrip™ device. (CBL | Held | Armchair Pick 🪑)

🪑 Great update.

This sets up CBL for future work in Medtech, with a number of research partners including the Mayo Clinic.

Also, it validates the technology to potential new customers in the Sports & Rehabilitation markets.

This is particularly important for the rehabilitation setting (stroke rehab, car accidents, etc.) where clinicians are more accustomed to working with registered devices.

Expect approvals in other markets to flow through soon (Europe, Australia, etc.)

Amplia Therapeutics (ASX: ATX) signs a collaboration agreement with Eli Lilly to evaluate its FAK inhibitor in combination with its KRAS. (ATX | Held)

🪑 This is big.

Well done to Chris and the whole team there. Bought some today.

Entropy Neurodynamics (ASX: ENP) receives HREC approval for a Phase 1b/2a trial of TRP-8803 across eight disorders. (ENP, not held)

🪑 I really like this update too.

Eight new disorders to test: anorexia, body dysmorphia, OCD, general anxiety, PTSD, treatment-resistant depression.

Some big opportunities there.

Noxopharm (ASX: NOX) announces new preclinical data showing its oligonucleotides boost immune response to 'immune-silent' cancer cell RNA. (NOX, not held)

🪑 I hung out with NOX’s CEO Olivier last Monday at Bio Connections. 

Was great to see this little biotech up there with CSL and TLX on stage. 

Some really interesting stuff the company is doing.

Lantheus Holdings (large radiopharma company) to be acquired for US$6.7 billion by Carreum. (WSJ)

🪑 For Telix and Clarity, this is a good update to peer comps.

For Radiopharma, I wonder where this leaves them. Lantheus is its largest shareholder, and didn’t increase its position in the last capital raise.

A big part of the Radiopharma story has been an “acquisition” from Lantheus.

Would love to get the company’s take on this deal - too early to evaluate if this is good or bad.

Micro-X Ltd (ASX: MX1) appoints Brian Gonzales as CEO, implements strategic reset focused on medical CT, and secures $8M convertible note financing. (MX1, not held)

Neurotech International (ASX: NTI) secures $4.5M through a placement. (NTI, held)

🪑 I participated in this one.

This funds them through to a result on their Phase 3 (Australia only) clinical trial for autism spectrum disorder.

A trade into results ~6 months, for me.

Lumos Diagnostics (ASX: LDX) secures a US$770K FebriDx® order from PHASE Scientific. (LDX, not held)

🪑 Nice. The big bet is that the PHASE deal starts to ramp up.

The question every early-stage company asks itself…

How much of my company OR upside am I going to give up… to raise the capital to get me to the next value inflection point?

There are many ways to slice the pie.

Equity. Debt. Royalty funding… and more.

So I want to do something a bit different.

A “tier list” of sorts for funding options for early-stage biotechs.

(And an example with a recent transaction from Dimerix about how the company board of directors think about this question)

The industry 1-wood. 

A placement to sophisticated investors at a discount, usually with an SPP bolted on so retail feels included.

Fast. Certain. Cash in the door.

But, dilutive to existing shareholders.

I’ve seen companies do this well; I’ve seen most do it poorly.

The ones that do it well:

The ones that do it poorly:

Verdict: A

But a lot depends on how it is run. A poor raise could drop down to a C.

An option is the right to buy shares at a fixed price by a fixed date.

If the stock is above the strike, holders exercise and the company gets the cash.

This can be a good (often serendipitous) way for companies to raise capital, as options get exercised.

No discount. No broker. No fees.

The dilution is identical to a raise, except the agreed price and timing are largely known to the market.

Which means that marginally “in the money” options can sometimes create a ceiling for companies - particularly as they get close to expiry.

A company should never rely on options exercise as a funding strategy, but rather a “nice to have” if their stock runs hard.

Verdict: B+

The cheapest capital there is. 

Non-dilutive funding from governments or foundations.

BUT, government grants tend to be harder for listed companies. 

If you get it… amazing.

But it’s not so easy (particularly for public companies).

Verdict: A+

Australia's R&D Tax Incentive refunds eligible small companies a chunk of their qualifying R&D spend. 

Lenders like Endpoints, Radium, Dare, and Rockford Capital will advance you most of that refund before the ATO gets around to paying it.

Generally, there is a 15-20% interest rate and a 1-3% “setup” fee.

The loan is secured against the R&D payment, and it helps companies smooth over periods to get that capital needed to the next key catalyst or inflection point.

While the R&D payments form a big part of the company’s funding strategy, the R&D advance is just to bring forward payments so that the company can reach a value inflection point earlier.

This timing premium comes at a cost of 15-20%.

A good trade most of the time.

Verdict: B+

A director OR major shareholder lends the company money directly (most of the time as a convertible note).

(Generally on favourable terms and unsecured)

Fast, usually cheap, and available.

BUT, there is probably a reason that the director is writing the cheque.

… the company has run out of money, and no one else will give it to them.

OR… someone will write the cheque, but the director or insider doesn’t want to dilute at this share price.

Often this will hang over the company as convertible debt, and make the NEXT capital raise more difficult.

Again, not a long-term funding strategy.

Verdict: C

Clean, non-dilutive.

Selling a legacy business or a program you were never going to run.

There is no ‘competitive tension’ for the assets on the scrap heap, so companies often sell these “cheap”.

Verdict: B

Debt that turns into equity, usually at a discount to the market price on the day it converts.

The mechanics are nasty. 

If conversion is priced off a trailing average, the lower your share price goes, the more shares the noteholder gets. 

The more shares they get, the more they can sell. 

The more they sell, the lower your share price goes.

Round and round.

This is what is known as a “debt death spiral”... and it is a register killer.

I’ve seen it work well in very limited circumstances. 

Specifically, when the debt is used to tide the company over to deliver one or two major catalysts that re-rate the stock in a short period of time. 

The company then raises capital and pays back the debt at a higher share price.

But that is the 1 in 100.

Verdict: F

A big pharma company comes along and pays you… 

Upfront fee + Milestones + Royalties FOR exclusive right to sell that drug in a particular region.

The partner keeps all the revenue, and pays you a royalty.

BUT they are the one that has to build the commercial infrastructure to actually sell the product, and take on all of the sales execution risk.

The later that you licence the drug (Phase 3 and beyond), the better deal generally.

It is also contingent on the company’s ability to actually do a deal.

Verdict: A+

A bigger player in your field buys a slice of you.

Shares for cash.

But… these are not the same investors that will take a 20% pop in share price and sell on the market.

They are long-term, sticky holders (and can sometimes be done at a premium to the existing share price).

Again, this is not always available.

Verdict: A+

Now this one is common in the US (for late-stage assets) but rare in Australia.

(Because frankly, we don’t have that many companies at Phase 3 in our public markets)

Debt that needs to be paid back BUT it is “secured” against future milestone payments, if the drug is successful.

That’s the big IF, and it is a huge risk for the lender.

This means that the lender will get a “multiple” of their investment paid back from milestone payments.

If it fails… 

Well, it doesn’t really matter… the stock was cooked anyway.

Verdict: A

To illustrate the decisions that ASX-listed companies go through when evaluating how to finance clinical trials, I want to use Dimerix (ASX: DXB | not held).

Dimerix is a Phase 3 company developing a treatment for a rare kidney disease called FSGS.

The challenge for the company is that since it made the decision NOT to pursue accelerated approvals, it has needed to “bridge” the financing gap before its Phase 3 readout in March 2028.

(Can read more of my take here: 'Timing' or 'Time in' the Market? The Dimerix (ASX: DXB) Story)

So, which option do they take?

Raise capital?

The 1-wood.

Or do something a bit more creative.

Option 2: The milestone financing deal.

They chose option 2.

Last month, the company signed a $10 million loan facility with its #1 shareholder, Peter Meurs (and intends to secure another $40 million on similar terms)

The disclosed terms:

Now, assuming DXB is able to secure the $50 million on “substantially similar terms” (as mentioned in the announcement), how did they come to this decision?

Let’s see how it stacks up against a capital raise at ~25 cents (a slight discount to today’s price):

At a $150 million market cap, the market is pricing DXB at ~8% of its headline milestone pool of $1.9 billion.

Raising capital from its market cap is much more expensive than raising it from future milestones.

For Dimerix, the company’s market cap would need to be close to $500 million to get somewhere close to the value with an equity raise.

It’s important to note that they still need to secure the second $40 million tranche, but I did want to just use this example for illustrative purposes.

ALSO, the loan matures about six weeks before the data. 

So the company will need to find a way to finance the repayment of the loan (not the milestone payments).

Through either licencing more regions… LATAM, India, etc… through an equity raise close to results, or extend the loan until after the results.

Biotechs always need money.

Most retail investors run one mental model.

Company needs money → company does a raise → shares get diluted → annoyed.

But the true cost of capital is a different equation.

How much of my company OR upside am I going to give up… to raise the capital to get me to the next value inflection point?

For a capital raise.

You keep all the upside and own less of it through dilution.

The licensing deal. The royalty deal. The asset sale?

You keep every share and own less of what those shares are entitled to.

The last element is the risk.

What is the risk that this doesn’t work, the trial fails, and the asset/company is worthless?

That risk is factored into the capital cost.

The higher the risk, the more expensive the capital.

I want to leave you with this.

… whatever path that the company chooses, there is only one thing that actually matters.

Is that money being spent well?

If the answer is YES, then the company should be in good stead, and even the most expensive capital can seem cheap… if they use it wisely.

See you all tomorrow.

The Armchair Analyst.