By Jennifer Van Brunt


Ariad Pharmaceuticals Inc. (NASDAQ:ARIA) recently raised an additional $5 million to boost its corporate coffers and help fund research and development efforts — including preclinical studies — on small-molecule drugs that block intracellular signaling pathways. The Cambridge, Mass., company had ended the third quarter 1998 with just under $15 million cash on hand; with a burn rate of $20 million to $24 million each year, the extra cash infusion should keep the company going through 1999.

With the public financing markets closed to it — as they are to virtually every biotechnology company these days — Ariad chose instead to sell convertible preferred stock to a group of institutional investors in a private placement. As such, it joined an ever-growing roster of biotech firms that have chosen this particular form of financing to raise desperately needed cash. But while convertible preferred stock offerings may be in vogue right now, some industry watchers are concerned that these transactions are not necessarily good for the biotech company — since there is a great temptation for short selling and quick profit taking on the part of momentum investors.

The financial institutions that participate in these deals, however, claim that there is every reason for them not to short the stock — if they want to preserve their good reputations. As well, these institutions are conservative by nature. Their mandate is to protect their capital investments in the long term, even when putting cash into very high-risk stocks — like biotech. And, according to several fund managers, with close to half the publicly traded biotech companies in need of cash — which they are unable to get through the public markets — the private placement is the only alternative left.

The idea behind convertible preferred stock offerings is to allow the company — and its investors — to profit from an upturn in stock price while protecting them both from downside surprises. In an ideal world, the stock price of a company with positive news to announce should go up. If convertible stock were converted at that point, profits would ensue. As well, many convertible offerings have been structured to provide an increasing discount for conversion the longer the investors wait to exercise their prerogative. This facet is meant to encourage investors to hold the stock for extended periods of time. And, in fact, many deals are structured so that the investors cannot convert their holdings for the first 90 days or so. Moreover, savvy companies will structure these deals around upcoming milestones. If the company is expecting to announce preliminary results of a Phase III trial on its lead product in the first quarter of 1999, for instance, it would include a provision that the investors could not convert until the beginning of April. This should work, as long as the clinical trial results are positive — and the stock pops up as a result. The risk, of course, is that investors who are interested in short-term gains may decide to sell rapidly when good news hits the wires, thus profiting from the discount. This is also fertile ground for short sellers, who might be tempted to short the stock, forcing its price down so they can buy it back at a lower value.

Of course, if the news is negative, the stock will crash. If the investors have a reset option on the conversion price, they will be protected. The company, however, might not be so fortunate. If its stock has already been trading at precariously low levels, a negative event could be the death knell — whether or not there's any preferred stock to be converted.

Deal Details

In Ariad's deal, which was completed in mid-November, the company sold 5,000 shares of Series C convertible preferred stock for $1,000 each. The preferred stock, which accrues interest at 5 percent annually, has to be held by the investors for the first 90 days. After that point, it can be converted into common stock at a price that is equal to either a variable conversion price or a maximum conversion price — whichever is lower. The variable price will be based on the average of the four lowest closing prices for the common stock during the 22 days preceding the date of conversion. The maximum price will be 120 percent of the variable price at a date within a three-month period, to be selected by the company.

According to Jay La Marche, Ariad's CFO, one distinct advantage of this financing was the fact that the company dealt directly with the principals — the institutions that will hold the stock. As well, "in deals like this, you want investors that are involved in the biotech industry," La Marche said. In Ariad's case, the institutions included Brown Simpson Asset Management, of New York, which has actually participated in many of the biotech sector's convertible preferred stock offerings. Another positive aspect of Ariad's deal, La Marche continued, is the fact that the stock is not convertible for the first 90 days. In the current market for biotech stocks, this is a real blessing: On Nov. 12, the day that Ariad announced its financing, its stock closed at $2.718. On Dec. 2, it had dropped even further, to close at $2.062, more than 50 percent lower than its 1997 closing price of $4.25. This is even lower than the average change in the 301 biotech and related stocks that are listed in the last two pages of BioWorld Financial Watch every week: On Dec. 2, the average stock was down about 16.5 percent from its Dec. 31, 1997, closing price (see the graph on p. 9 for average stock performance through Nov. 27, 1998).

Alliance Investors To Profit From Future Product Sales

Brown Simpson Asset Management also played a major role in Alliance Pharmaceutical Corp.'s financing in August. Alliance, based in San Diego, raised $6 million in a convertible preferred stock offering. The company (NASDAQ:ALLP) sold 100,000 shares of convertible stock to three institutional investors, including Brown Simpson. The preferred shares are convertible into common stock at $6.00 each through Jan. 3, 1999; after that point, certain adjustments may apply, based on the common stock's trading price at the time. There are no fixed discounts from market price in this transaction.

Alliance's common stock closed at $4.562 on Aug. 17, the day of the announcement. By Dec. 2, it had sunk to $3.343, down 54 percent from its 1997 closing price of $7.25.

This deal was structured in such a way that Alliance has the option to sell up to $14 million more in preferred shares to the same investors through early next year. The twist is the fact that the investors also get to participate in profits from future product sales. Provided that one of Alliance's three lead products (its ultrasound contrast agent Imagent is currently in Phase III trials) is approved for sale by the FDA by December 2003, the investors get a royalty of 0.4 percent to 1.6 percent on net sales for three years. Thus, the investors are protected even if Alliance's stock price does not improve by the beginning of the new year.

Ribi ImmunoChem Research Inc. (NASDAQ:RIBI) completed a convertible preferred stock offering on July 17. The company, based in Hamilton, Mont., raised $8.24 million through the sale of 8,240 shares of interest-bearing convertible preferred stock to institutional investor RGC International Investors LDC. There's a 90-day holding period on the stock; from the 91st day to the 120th, the conversion price is fixed at $6.04 per common share. After the 120 days, the conversion price floats on a price that is the lesser of the fixed conversion price or a five-day consecutive average market price over a 20-day trading period.

According to Vern Child, Ribi's vice president of finance, the investor has not yet converted any of the preferred shares, even though both the 90-day waiting period and the 120-day point (at which the conversion price was fixed) are long gone. For Ribi, it's just as well. The company's stock closed at $4.875 on July 17; by Dec. 2, it had dropped to $2.906 per share, a loss of 21 percent over the 1997 closing price of $3.687.

Shaman Pharmaceuticals Inc., of South San Francisco, also took this financing route, raising $14 million in a royalty-based convertible preferred stock offering in August. Shaman (NASDAQ:SHMN) sold 140,000 shares of Series C convertible preferred stock at $100 each to the investors. Each share of convertible stock will get either a $10 annual dividend (payable semi-annually in Shaman common stock) or a pro-rata share of a royalty on the firm's net sales of its experimental drug Provir for treating AIDS-related diarrhea — whichever is greater. The company's stock closed at $2.625 on Aug. 19, the day it announced this deal. By Dec. 2, it had shed a little more, closing at $2.375 per share, down 52 percent from its Dec. 31, 1997, closing price of $4.937.

These are not the only biotech firms that have raised much-needed cash via convertible preferred stock offerings since the summer. Others include Advanced Tissue Sciences Inc., of La Jolla, Calif., which raised $25 million in July; ID Biomedical Corp., of Vancouver, British Columbia, which garnered $4 million in September; and Worcester, Mass.-based Alpha-Beta Technology Inc., which received $3 million from a single institutional investor in October. All three of these companies have also seen their stock prices erode since they struck those financing deals. Advanced Tissue Sciences (NASDAQ:ATIS) was trading at $4.00 on July 13; by Dec. 2 it had dropped to $2.843 per share, 77 percent off its 1997 closing price. ID Biomedical (TSE:IDB) closed at C$5.40 on Sept. 14, but stood at C$3.250 on Dec. 2 (4 percent lower than its 1997 closing price of C$3.40). And Alpha-Beta (NASDAQ:ABTI), which closed at $1.25 per share on Oct. 22, 1998, ended Dec. 2 at $1.093 per share, down 58 percent on the year.

Even the fund managers who handle these financings claim that they're not the correct alternative for every company. But for those willing to place their bets, it could be a gamble worth taking. *