July 1, 2015

The Risk-Reward of Provectus Biopharmaceuticals: Management

Image source
When I wrote my follow-up investment letter Why I Remain Long Provectus Biopharmaceuticals (March 2015) I did not include a treatment of risk (like I did in my initial letter Why I'm Long Provectus Pharmaceuticals, September 2013). I see our investment's singular risk as the company's management team; more specifically, their ability (or lack thereof) to put Provectus in a position to be monetized at or near a value commensurate with their drug's worth.

Provectus has been and remains an "early stage" privately-held company that happens to be publicly traded — "early stage" in that the founding team remains in charge, and their culture, principles and viewpoints are largely unchanged. The key risk of management also is the source of an investor's potentially substantial reward, by understanding the drug's worth and trying to protect its economics. The risk of an investment in Provectus (primarily from the vantage point of today's share price) is mostly if not completely mitigated by the clinical value proposition of its investigational drug (PV-10/Rose Bengal). Our [presumed] return on investment, and whether that return ultimately is commensurate with our risk over time should be exclusively determined by management, which is very unlikely to change through until the company is acquired.

In that first investment letter I wrote investors often misjudge risk in the context of return. That a so-called safe asset or security should provide a safe return does not mean the expected return is commensurate or high enough for the risk incurred. Conversely a so-called risky security may have the potential to generate a robust return, but that does not mean the associated risk is commensurate or too high for the amount of return expected. I say now what I said then, Provectus' stock's risk-reward profile is out of whack. Nowhere is risk-reward better illustrated than by the drug itself. With a pristine safety profile and having robust efficacy, PV-10 metaphorically is an investment fund with a high Sharpe Ratio: low bond-like volatility (denominator) and high equity-like performance (numerator).

In my original letter I also asked what if I'm wrong, and what would that scenario look like. Four major risks came to mind, along with a grab bag of perfunctory ones, but only one still stands out today.

1. Safety. Could there be unexpected adverse events in the future? What I wrote then should apply now:
Possibly, but given Rose Bengal's near century of historical safety, PV-10's pristine safety profile in clinical trials and the compassionate use program, and no clinical trial insurance claims related to adverse events, it may be unlikely.
Recently published (via a poster at a medical conference) Phase 1 liver data certainly warrants requisite diligence, review and consideration in regards to the risks to safety (above) and efficacy (below). See ESMO World GI Poster (July 1, 2015) on the blog's Current News page.

2. Efficacy. Could there be poor clinical results in the future? What I wrote then should apply now:
Possibly, but given the repeatability, reproducibility and veracity of historical pre-clinical and clinical results [in multiple species for multiple indications by multiples clinicians and researchers], it may be unlikely.
3. Regulatory clarity. Could more time be required to confirm the regulatory path for [melanoma]? I wrote then:
Possibly, and this is the likely scenario if I am wrong. I am prepared for more time to elapse for regulatory clarity to be achieved. Management may have to raise additional capital to fund operations until such time as this ambiguity is resolved to their satisfaction. This, however, is finite and can be bounded by several millions of dollars or several percentage points of potential dilution. This downside risk, however, is more than commensurate with the upside return when the regulatory ambiguity is resolved. 
Shareholders may incur further dilution if management has to conduct a pivotal [melanoma] Phase 3 trial. I am prepared for this outcome because the dilution caused by raising capital to carry out the trial should be made up by a higher valuation resulting from Phase 3 trial results that are projected to exceed Phase 2 results. Dilution may be mitigated or unnecessary if upfront and milestone payments from consummated regional license transactions in China and/or India materialize beforehand. Casual observers overestimate the cost and potential duration of a trial.
Substantial dilution has since occurred, painfully and frustratingly so for shareholders (although for me, not so much in terms of how much but how). As a very simple parameter to calculate dilution total shares outstanding increased from 143.7 million (common stock, convertible preferred stock, Series A 8% convertible preferred stock)(9/30/13) to at least 203.5 million (common stock) (6/30/15) — or at least more than 40%. PV-10's initial pathway to regulatory clarity, however, has since been resolved: a pivotal Phase 3 trial for locally advanced cutaneous melanoma. In addition, the recent first-time release of clinical liver data should allow investors to evaluate and price its potential contribution to Provectus' extrinsic value.

Grab bag of risks. What I wrote then:
There are common risks most if not all biotechnology company stocks face: dealing with the FDA can be at times a complex and opaque process, clinical trials fail, seeking funding can be a long, arduous and dilutive process, and the industry itself is prone to bubbles and busts that contribute to generically rising and falling share prices.
4. Monetizing worth: Could Management be unable to monetize the Company at a valuation commensurate with their innovation? Not only does what I wrote then still apply now, but it has always been and will be the key risk to my investment thesis — will the [presumed] return we generate be commensurate with the risk we took along the way:
Possibly, even though in the recent TWST interview Management said they believe they "…could potentially do something along the lines of a Celgene-Abraxis type transaction, where Celgene acquired Abraxis for $2.9 billion upfront…" Bridging the valuation gap between a $134 million market capitalization and a multi-billion payout should require definitive regulatory clarity, sizeable commercial validation, and a copious amount of stock market exuberance.
In my original letter I made clear my assessment of management, and my view of them in the context of my investment thesis (and thus our investment in Provectus):
Provectus is the story of an old molecule, a business scientist ([Chairman and CEO Dr. Craig Dees, PhD]), two scientists ([President Dr. Tim Scott, PhD and CTO Dr. Eric Wachter, PhD]), a businessman (Peter Culpepper), more than a decade of clinical development and a journey that began in the [late-]1990s... 
Management historically has relied on the input of a stable of high and low quality advisors and consultants in its decision-making, making many good and several questionable decisions and choices along the way. Provectus has eschewed playing Wall Street's game for the most part, and has suffered to some degree because of it. Some company wounds, non-fatal as they are, however, have been self-inflicted. Management possesses a sufficient threshold level of competence and integrity to warrant my support, and seeks to sufficiently protect the economics of Provectus's innovation for shareholders to warrant my continued holding of Company stock. 
Management is innovative, having repurposed an old diagnostic compound as an anti-cancer and dermatology agent. They are intelligent, understanding the value of the molecule's safety history while working through the regulatory process. 
Management are a non-traditional, atypical and unrecognized biotechnology company management team without significant drug development experience and no prior drug approvals under their collective belts, prior to Provectus. Backing Management was undertaken with eyes wide open because I believe innovation, intelligence, pragmatism and integrity ultimately trump inexperience. 
I have been critical of some Management choices [and continue to be]. 
I remain supportive of Management, believe they are focused on and capable of fully monetizing their innovation for the benefit of shareholders and themselves, and would not advocate changing horses as the finish line approaches.
There are certain and different skillsets and personalities that benefit the roles and responsibilities a company and its leadership require during each phase of its life cycle. Provectus' leadership, and frankly their style, has not really changed (or changed slowly in certain places or instances). The same faces, strengths and weaknesses remain from the beginning but perhaps are more experienced and hardened, and a little to a lot wiser as a result of their trials and tribulations to date.

Dees et al. should be lauded for their reproducibility (see blog post Reproducibility, the Hallmark of Western Science), among other things, and perhaps even have their upgrade efforts recognized (see blog post Upgrade Cycle), while more than chastised for certain aspects of their leadership as managers, directors and public company stewards (see, for example, blog post Proxy Vote).

I feel comfortable, as a former early stage venture capitalist, with the track record (of investment return) we achieved and the professional experiences we developed (as individuals and as an investment team) supporting founding teams as they sought to start, build, grow and/or monetize their companies. On balance and for now, I support Provectus management in their pursuit of selling PV-10 (and PH-10) and the company for what they believe it's worth.

No comments:

Post a Comment