Tag Archives: microcap

An Example of Financing Risk in a Microcap Biotech Stock

I previously blogged about financing risks associated with microcap biotech companies. In this post, I wanted examine a real-life example of a microcap biotech that recently had to raise capital.

On February 12th, ImmunoCellular Therapeutics (IMUC) raised approximately $14.6 million. Prior to the raise, IMUC shares were trading around $0.70/share; the stock price fell to about $0.57/share immediately after the financing – a drop of almost 20%. Should investors have known that there was a risk of getting diluted?

If you look at IMUC’s 10-Q, you see that the company had about $23.5 million in cash on September 30, 2014. The company’s historical burn rate was about $10 million a year, so by the end of 2014, IMUC would have had about 2 years of runway. Earlier in September 2014, management had announced the goal of initiating a Phase 3 trial in 2015. Management had stated that the Phase 3 trial could enroll 600 patients. The average cost for a Phase 3 cancer clinical trial is about $75,000 per patient, so the company needed approximately $45 million to fund just the Phase 3 trial. This should have raised red flags for investors.

Larry Smith had brought up concerns about financing, but the analyst covering IMUC at Roth Capital barely mentioned it. In his last note on November 14, 2014, the Roth analyst had a buy rating with a price target of $3/share. Which bank helped IMUC raise money in the last round? Roth Capital. Despite having a ‘Chinese Wall’ separating research from banking, sell-side analysts can still be hesitant to highlight a company’s risks fearing the loss of potential banking business.

Were there other warning signs? On December 11th, 2014, management filed an S-1 to try to raise $20 million. That didn’t work out so well, so IMUC tried to raise again on January 21st, 2015. This time, management wanted to raise $26.5 million but sweetened the pot with 30% warrant coverage. Again, institutional investors didn’t bite, so the company tried a third time on February 10th to raise $30.8 million with 70% warrant coverage. Ultimately, IMUC was only able to raise $14.6 million – enough to start the Phase 3 trial but not enough to complete it. Clearly, there was not much appetite from institutional investors.

What happens now that IMUC raised money? Institutional investors, such as Sabby, who received 26.65 million shares at $0.60, can now sell them anytime the price is $0.60 or more to get back what was originally invested and just keep their warrants for any upside in the future. This creates selling pressure around $0.60/share in the near-term until the institutional investors sell all of the stocks they received from the financing. Assuming half a million shares traded a day, it will take over 50 trading days for the new investors to sell all their shares. In the long-term, IMUC still has financing risk, since the company has to raise additional capital to finish its Phase 3 trial.


This example of financing will hopefully give you an idea of some warning signs to look out for before in investing in microcap biotech stocks.


Remember Financing Risk When Investing in Microcap Biotech Stocks

Investing in publicly-traded, early-stage, microcap biotech stocks can be very profitable. For example, if you had invested in shares of Advaxis (ADXS) in 2014 which traded at less than $4 for most of the year, you could have made at least a 75% return, as shares are now higher than $7 (at the time of this writing). However, investors can often get enamored with a technology and sometimes overlook the financial risks associated with early-stage biotechnology companies.

Since most early-stage biotechs do not generate revenue, they often have to raise capital to fund development of their pipeline products. Publicly-traded companies usually raise capital from institutional investors (i.e. hedge funds or mutual funds) in follow-on offerings. To entice institutional investors, companies will sometimes offer shares at a discount to the open market price and warrants in return for capital. When companies issue new shares to raise money, the current shareholders get diluted, and share prices typically drop.

Depending on the discount and warrants offered, there can be a near-term overhang that prevents price appreciation even after an offering is completed. While some new investors may be long-term shareholders, others will start selling shares right away, which keeps a downward pressure on the share price. For example, let’s say a stock is trading at $1.50/share and an investor receives one million shares at $1.00 and 50% warrant coverage at an exercise price of $1.00. The investor can then sell all of their shares at $1.00/share or more to get their principal back and keep the warrants (which were free) to enjoy any future increase in share price.

Before investing in early-stage biotechs, remember to take a look at the balance sheet to see how much cash is left. Management will want to have at least enough cash to last a year. A company’s past expenses will give you an idea of the burn rate, but also consider the cost of clinical trials that have yet to be initiated. Management will typically raise capital after positive news and stock price appreciation. Also, keep in mind that sell-side analysts do not always mention financing risks, because they want their investment bankers to raise capital for the company; so be wary of buy recommendations.

In a future post, I will give you an real-life example of what happens when a microcap biotech company raises money.