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Merrimack Pharmaceuticals - Long Thesis UPDATE

Approximately two weeks ago, Seven Corners published its long thesis on Merrimack Pharmaceuticals (MACK). [Please see our full writeup in our Research section here.] Since then several material events have transpired, giving a bit more clarity to the MACK investment thesis, as follows:


On July 25th the company announced that it will be returning half of its cash to shareholders in the form of a $20 million special dividend, equaling $1.50/share (see full PR here). The special dividend is payable on September 5, 2019 to stockholders of record as of the close of business on August 28, 2019. Note that, due to the size of the dividend versus the market cap, the ex-dividend date for the special dividend will be September 6, 2019, the first trading day following the payment date [see explanation of rules for large dividends here]. In our original writeup, we noted that a special dividend was expected in Q3 2019 (the actual $1.50/share amount exceeded our estimate of a range of $1.27 to 1.42 per share) and that this would de-risk the MACK investment. Importantly, in the special dividend PR, MACK's management reaffirmed that "[o]ur remaining cash balance is anticipated to support operations into 2027, when we estimate the longest-term potential Ipsen milestone may be achieved."This implies that MACK's expected cash burn for the next eight years is just ~$2.5MM/year ($20MM current cash divided by 8), much lower than our prior estimates. It is nice to see the foregoing aspects of the long thesis playing out so quickly (and favorably to expectations).


The company issued its Q2 2019 Form 10-Q on July 17th without any earnings press release. The takeaway here is the balance sheet (since MACK has now completely ceased operations and, per page 6 of the 10-Q, has no current employees):

As noted above, MACK ended Q2 with $40MM in cash and cash equivalents and minimal long-term liabilities. The cash/CE figure was about $9MM below our prior estimate principally because the company reduced its payables more than we had expected. Although MACK's current book value per share is just $3, this figure excludes the value attributable to $455MM in potential CVR payments from Ipsen and another $54.5MM in potential CVR payments from 14ner Oncology (discussed in our original writeup). Investors should also bear in mind the company's nearly $250MM in NOLs, which are yet another "hidden asset", as they are excluded from the balance sheet due to a valuation allowance against the full amount.

Below we present our updated valuation calculations for MACK, showing that despite the recent uptick in the stock price, shares still have significant upside to our fair value estimates of $9.36/share (excluding any value for the NOLs) and $10.86/share (ascribing a conservative $1.51/share value to the NOLs):

Overall, MACK shares have appreciated about 14% since we released our long thesis on July 16th:


The activist investor group headed by JFL Capital Management and 22NW Fund recently filed an update to their previously filed Form 13D [see here for full filing]. Collectively, this group owns an aggregate of 2,500,526 MACK shares, constituting approximately 18.7% of the shares outstanding. In the amended 13D, the group states that "JFL Partners resubmitted its nomination of [Jason M. Aryeh, Aron R. English, Joseph F. Lawler, M.D., Ph.D., and Kenneth Lin, M.D. as] Nominees for election to the Board at the Annual Meeting following the Issuer’s disclosure that the Annual Meeting will be held on September 11, 2019". Given that there are no significant MACK shareholders represented on the board of directors other than chairman Gary Crocker (if one excludes unexercised stock options from the ownership amounts listed on page 16 of the Form 10-K/A filed in late April), we believe that the activist group deserves significant representation on the board.

We hope the incumbent board will realize that it is in the interests of all of MACK's owners, i.e., the shareholders, to have more (rather than less) true shareholders on the board (as opposed to board members who expect endless free grants of stock courtesy of the shareholders, but who are unwilling to put any real skin in the game via significant open market stock purchases), and will act accordingly by offering the activists a sufficient number of seats to avoid a full-on proxy contest, which would be a completely avoidable and unnecessary waste of company assets. One logical solution would be for MACK to expand it board from 6 to 10 directors, allowing all four of the activists' nominees to join the board, while not giving full control of the board to a group currently owning less than 20% of the stock.


One factor that may be restraining MACK's shares from reaching our fair value estimates is the contingent nature of the CVRs MACK owns. Investors are normally skeptical of ascribing value to payments that may or may not occur and which appear to lie far into the future (it could be a number of years before any of the Ipsen Onivyde drug trials reach the FDA approval stage, triggering the largest CVR payments). Why pay up today for something that won't happen for 3 or 4 years (if at all)?

Investors should bear in mind, however, that an alternative monetization scenario exists to simply waiting many years for the Onivyde trials to conclude: namely, selling the CVRs back to Ipsen or to another financial buyer. Ipsen's stock has appreciated significantly during the current bull market and its market capitalization now stands at a robust EUR 8.64B (USD 9.6B) [source]:

We think it not unreasonable to believe that Ipsen might be willing to repurchase the MACK Onivyde CVRs for, say, 20-30% of their face value (which would equate to a payment of between $90MM to $135MM, or $6.75 to $10 per MACK share). By using its stock as currency, Ipsen could effect this repurchase for just 1% to 1.4% of its current market cap, thereby avoiding taking on debt while simultaneously removing a large contingent liability from its balance sheet. Note that Ipsen obviously believes in Onivyde, otherwise they wouldn't be spending significant amounts of capital on the two currently-running drug trials (for first-line treatment of pancreatic cancer and small cell lung cancer). For MACK, accepting payment for the CVRs in Ipsen stock could potentially avoid a large tax bill, thereby preserving all of MACK's NOLs for future use. Most importantly from the perspective of MACK shareholders, such a transaction could occur at any time (assuming agreement on a purchase price, form of consideration, etc.), significantly advancing the date of monetization and thus removing the lingering uncertainly about the timing and realizability of the CVR payments. Quite literally, we think such a transaction this could present a "win-win" scenario for everyone involved. In addition, if Ipsen were unwilling to negotiate, there is no reason MACK could not monetize the CVRs by selling them to another financial buyer for cash for some agreed-upon percentage of face value.

If the Onivyde CVRs were sold back to Ipsen, MACK would be left as a debt-free, cash-rich, publicly-traded shell with significant tax assets (note that we assume that most, if not all, of any payment received from Ipsen would be distributed to MACK shareholders as a special dividend). While we have only ascribed $1.51/share for MACK's tax assets in our valuation above, there is a very attractive upside scenario possible if the JFL / 22NW activist group gains a meaningful number of board seats in the pending proxy contest. We note that one of the activists' director nominees, Jason M. Aryeh [see full bio here], has been on the board of Ligand Pharmaceuticals (LGND) since late 2006. While Aryeh was on its board, LGND significantly overhauled its prior business model around the time of the 2008/2009 financial crisis, acquiring new drug assets and utilizing its ample NOLs. LGND shares have appreciated from single digits in 2010 to triple digits currently, beating the overall stock market handily. Could a similar situation play out with respect to MACK over the next decade? Obviously, it is far too early to tell, however at the current trading price of MACK stock we think investors are getting an extremely cheap (if not outright free) option on such a upside bonanza.


In our original MACK writeup, we stated that "no trials are currently active" for Onivyde other than for the two key CVR payments (SSLC and pancreatic cancer). However, a reader helpfully pointed out that Ispen is actually currently running a Phase 1 trial for Onivyde for breast cancer--see the 6th box in the "Phase I" column below [source here]:


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