Supernus Aims For IPO Backed By Unusual Royalty Deal
This article was originally published in Start Up
Executive Summary
CNS-focused Supernus Pharmaceuticals Inc. filed its intent to go public just before Christmas, making it the last biopharma to file in a year that ended with some cautious optimism about the IPO market. But Supernus stands apart from the year’s success stories in that most of its $157 million in financing in five years of existence has been non-dilutive. Thus, even if the company trims its offer price, investors are poised for a satisfying payoff.
CNS-focused Supernus Pharmaceuticals Inc. filed its intent to go public just before Christmas, making it the last biopharma to file in a year that ended with some cautious optimism about the IPO market. [See Deal] But Supernus stands apart from the year's success stories, especially Ironwood Pharmaceuticals Inc. and Aveo Pharmaceuticals Inc., in that most of its $157 million in financing in five years of existence has been non-dilutive. [See Deal] [See Deal] Thus, even if the company trims its offer price, investors are poised for a satisfying payoff. However, its ability to raise so much non-dilutive capital won't be easy to imitate, because it relied on the willingness of its former parent company, Shire PLC, to hand off cash-generating assets that were the key to Supernus' unusual financing.
Supernus was born when Shire spun out its formulation technology division in late 2005 into the hands of a venture syndicate led by New Enterprise Associates (NEA). [See Deal] Its lead compounds are extended-release anti-epileptic drugs, reformulated with its proprietary technology. SPN-538 (extended-release topiramate) is poised for an NDA filing this quarter, according to the Supernus prospectus, and Epliga (extended-release oxcarbazepine) is in Phase III studies. Supernus wants to piggyback on the NDAs of the original molecules ( Topamax and Trileptal, respectively).
With its IPO, the firm is aiming to raise $100 million, though that figure will likely change as the firm draws nearer to a possible debut. Nearly every biopharma IPO in 2010 encountered investor resistance, with many blunting their fundraising goals by 30% or more. ( See "US Biopharma IPOs: Market's Rally Passes Them By," this issue (Also see "US Biopharma IPOs: Market's Rally Passes Them By " - Scrip, 1 Feb, 2011.).) Pacira Pharmaceuticals Inc. continued the trend in 2011, taking a 33% discount on its February 2 IPO. [See Deal] If Supernus hits its target, it would be a fast exit for its venture backers, who invested $45 million across two Series A tranches. NEA owns 45% of the company. OrbiMed Partners and Abingworth each have 18%, and Shire retains 7%. (The VCs on Supernus' board either declined or did not respond to requests for comment.)
Supernus has stretched its venture dollars by turning trickling royalties attached to its formulation technology into a single, heftier cash payment. The technology has been used in the marketed products Carbatrol (carbamazepine), Equetro (carbamazepine), Adderall XR (mixed amphetamine and dextroamphetamine salts), Sanctura XR (trospium chloride), Oracea (doxycycline) and Intuniv (guanfacine). The royalties for Sanctura XR and Oracea were used to secure $75 million in debt raised in 2008. [See Deal] For Intuniv, an important product in Shire's portfolio, Supernus accepted in 2009 a one-time payment of $37 million to waive future royalty rights. All told, it's more than $110 million in non-dilutive financing.
There are trade-offs. The royalties from Sanctura XR, an overactive bladder treatment sold by Allergan Inc., and Oracea, a rosacea treatment marketed by Galderma SA, now go straight to the lenders instead of providing Supernus with steady cash flow. Combined, the payments totaled $25.6 million from 2007 through September 30, 2010. Moreover, Supernus is paying 16% interest, or $12 million annually, to its debt lenders. The first payment came right off the top of the $75 million and left Supernus with $63 million in proceeds to put into R&D, according to its prospectus.
Is the $63 million worth the high interest rate and loss of steady cash flow, as an alternative to selling equity and diluting the venture backers? "I would not say that as a general rule," says a person familiar with the company's financing strategy. "In a financial market crisis where dilution could be extreme, or in a case where royalties are not strategic to the company, then it is." And if the deal provides momentum to take Supernus to a $100 million IPO, or anywhere close to that target, the IPO cash stays with Supernus. It doesn't have to use a dime of it to pay down the royalty-based debt.
Supernus is the brainchild of Jack Khattar (the company's president and CEO), an executive committee member at Shire from 1999 to 2004 who ran the subsidiary, Shire Laboratories Inc., which ultimately spun out the start-up's technology. He first had the idea to take it independent when Shire told staff just before Christmas 2003 it would shut down the Laboratories' Maryland facility and move some jobs to Pennsylvania, according to reports at the time. It took Khattar nearly two years to turn the idea into reality, and he managed to convince Shire to part with royalties that otherwise would have flowed right to the specialty pharma's bottom line at a time when Shire was in the midst of an extensive overhaul.
"It's a very innovative structure; I'd love to see it replicated more," says Atlas Venture partner Bruce Booth, who has no ties to Supernus or its bond issue. But Booth says it's unlikely to spawn many imitators. Todd Davis of Cowen Healthcare Royalty Partners, which eventually bought some of the Supernus royalty-backed debt on the secondary market, agrees with Booth. "It's harder to convince large firms to spin out cash-flowing royalty assets, every penny of which is a penny toward earnings," Davis says. "To sell that asset is dilutive to earnings. They only want to sell cash-burning assets."
Shire knows well the benefits of royalty streams to income statements. Its royalties from GlaxoSmithKline PLC for the anti-retroviral treatment lamivudine totaled $531 million from 2007 to 2009. When Start-Up asked Shire why it was willing to give up the royalties tied to its formulation business, spokeswoman Jessica Mann wrote via email that the royalty rights belonged with the platform: "The Oracea and Sanctura products were third-party formulation customers for the drug formulation business at the time, so it was logical to enable the spin-out vehicle to retain these relationships – and any royalties subsequently generated."
At the time of the deal, Shire was reorganizing around its attention-deficit franchise and its rare disease group, bolstered by its 2005 acquisition of Transkaryotic Therapies Inc. ( See "Baked-In Goodness: Shire Buys New River for $2.6 Billion," IN VIVO , March 2007, and "Shire: Remodeling Specialty Pharma," IN VIVO , April 2006 (Also see "Baked-In Goodness: Shire Buys New River for $2.6 Billion" - In Vivo, 1 Mar, 2007.) (Also see "Shire: Remodeling Specialty Pharma" - In Vivo, 1 Apr, 2006.).) [See Deal]
Although Shire's Mann doesn't say so, it's possible Shire's 7% stake in Supernus, for which it paid nothing, was seen as potentially worth far more than the royalty streams, especially because neither Sanctura XR nor Oracea were yet approved at the time of the spin-out. Royalty investors generally don't sign deals for drugs until approval, so Shire was offloading a certain amount of regulatory risk to Supernus. With Intuniv, Shire is also potentially getting a bargain. For a $37 million lump sum, it avoids all future royalty payments on a product that's meant to continue Shire's leading ADHD franchise. (Recently launched in the US, Intuniv booked $37 million in third-quarter sales.)
Was it a good deal for Supernus? An IPO, with all proceeds funneled into R&D and commercializing its late-stage products, would make the cash the company might have earned from the royalty streams a distant memory. Supernus had $46 million in cash and equivalents on hand as of four months ago. That's just about what it has spent annually since 2008, including its $12 million debt interest, so no IPO likely means Supernus would have to raise cash some other way. If dilutive, it might not make current shareholders happy, most of all Khattar himself, who owns 11% of the company. As Start-Up went to press, Supernus began raising up to $25 million in debt and rights issues, presumably as a bridge to the IPO, a move that several biotechs have made recently. Khattar declined to comment.
– Alex Lash