Greenbackd

Neurobiological Technologies Inc (NASDAQ:NTII) is a particularly interesting play. Prima facie, it appears to be a cash-burning biotechnology stock trading at a premium to its liquidating value. In other words, a stock we wouldn’t touch with a ten foot pole. On closer inspection, however, it becomes clear that NTII is trading at its net cash value, has other readily valuable assets and offers the possibility of substantial additional upside. At its $0.53 close on Friday, NTII has a market capitalization of just $14.3M, which is right on our $14.5M estimate for its net cash value. Our estimate for its liquidating value is around 50% higher at $21.9M or $0.81 per share with the possibility that it is significantly higher again. Three activist investors, Biotechnology Value Fund (BVF), Millennium Technology Value Partners and Highland Capital Management, hold approximately 45% of NTII’s outstanding stock and have called for its liquidation. We’re adding it to the Greenbackd Portfolio.

About NTII

NTII is a biopharmaceutical company historically focused on developing treatments for central nervous system conditions and other serious unmet medical needs. The company recently terminated development of its most advanced product candidate, Viprinex^TM. The company has the right to receive royalty payments from the sales of Namenda (memantine HCL), an approved drug marketed for Alzheimer’s disease, and potential milestone and royalty payments from the development of XERECEPT, an investigational drug which has completed a Phase 3 clinical trial for the treatment of swelling associated with cerebral tumors. Additionally, NTII’s earlier stage pipeline includes rights to a protein in preclinical development for the treatment of Alzheimer’s disease. The company’s investor relations website is here.

The value proposition

NTII has no material ongoing operations as of December 2008. It continued to burn cash through the last quarter.  According to the most recent 10Q, however, its cash burn rate should now be “significantly curtailed since the Viprinex program for acute ischemic stroke was terminated in December 2008.” The summary of our estimate for the company’s liquidation value is set out below (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

There are two unusual elements in our summary balance sheet:

1. Total Liabilities, carried in the balance sheet at $24.6M, have been adjusted down to 35% to remove $16M attributable to deferred revenue and warrant liability. We would not normally adjust the Total Liabilities at all. We have excluded these amounts from the Total Liabilities in this instance because the company “[does] not believe these items will ever require cash payments from us” (see Liquidity and Capital Resources in the most recent 10Q).
2. Long Term Investments, carried in the balance sheet at $9M, have only been discounted by 20%, rather than our usual 80%. The Long Term Investments are predominantly AAA-rated auction rate securities (ARS) that continue to pay interest. The figure for the ARS in the balance sheet reflects the ARS’s purchase price less impairment charges of $1.6M at December 31, 2008. From the most recent 10Q:

Beginning in February 2008, failed auctions occurred throughout the ARS market, and since then all auctions for NTI’s ARS have been unsuccessful. While the credit rating of these securities remains high and the ARS are paying interest according to their terms, as a result of the potentially long maturity and lack of liquidity for ARS, the Company believes the value of the ARS in NTI’s portfolio has been impaired. During the fiscal year ended June 30, 2008, the Company recorded an impairment charge to reduce the carrying value of the ARS. The impairment charge was based on a model of discounted future cash flows and assumptions regarding interest rates. The Company has also recorded an unrealized loss of $1,360,000 on its ARS at December 31, 2008 based on a decrease in the estimated fair value since the impairment charge was initially recorded. Due to recent wide and rapid fluctuations in the credit markets, combined with the Company’s low forecasted operating expenses in comparison to its cash and investments balances, the Company believes the current fiscal year decline in estimated market price for the ARS to be temporary. The Company believes it has the ability to hold its ARS until recovery of the temporary decline in value. All other unrealized gains and losses were immaterial. The Company has classified its ARS as long-term at December 31, 2008, and all other investments are classified as short-term.

Accordingly, we believe that a 20% discount to the value of the ARS carried in the Long Term Investments is sufficient, if overly cautious.

XERECEPT®

NTII sold the rights to XERECEPT to Celtic Pharmaceuticals in 2005. Celtic Pharmaceuticals has continued to develop XERECEPT and recently announced that it has retained an investment bank to assist with the sale of XERECEPT. NTII is entitled to receive between 13% and 22% of the net proceeds received by Celtic Pharmaceuticals upon the sale of XERECEPT. We don’t know if the sale process will be successful or if NTII will receive any payment, but it does present the possibility of additional value to stockholders of NTII.

Off-balance sheet arrangements

According to the 10Q, NTII has “no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our consolidated financial condition, changes in our consolidated financial condition, revenues or expenses, consolidated results of operations, liquidity, capital expenditures or capital resources.”

Contractual obligations

NTII’s noncancelable contractual obligations set out in its 10Q are as follows:

• Active ingredient production/purification and operation of a snake farm. Raw venom of the Malayan pit viper was the starting material for the active ingredient in Viprinex, and was produced by Nordmark in Germany where Nordmark maintained a colony of snakes in a manufacturing facility. We agreed to make monthly payments to Nordmark for our supply of the active ingredient and for the fully burdened costs of operating the snake farm until such time as either 1) the agreement is terminated pursuant to specified terms or 2) commercial production commences. If the agreement is terminated by us prior to commercialization, we are required to make a termination payment of up to €2.8 million (or approximately $3.7 million at the December 31, 2008 exchange rate) to Nordmark. We have notified Nordmark of our intent to terminate the agreement and remove the snakes located at the facility. Under the terms of the agreement, we are responsible for specified operating costs of the facility as long as the snakes are at the facility. We have identified several reptile zoos willing to take snakes, and are in process of completing the arrangements for the transfer of the snakes. We cannot estimate the costs for this process, but we currently expect it to be completed by March 31, 2009.
• Clinical Research Organizations. We had agreements in place with several Clinical Research Organizations for work needed on the clinical trials in various foreign countries. We generally paid the CROs on a monthly or quarterly basis for work as it was performed, and the terms of most of the agreements allow them to be cancelled with no obligations beyond the costs incurred by the CROs to the time of termination. Our CROs have closed down the clinical trial and are in the process of reconciling pass-through costs for the clinical trial and amounts we have paid compared to actual costs incurred. We have accrued expenses as of December 31, 2008 which we believe are appropriate under the agreements, and are holding further payments to the CROs until we are satisfied that all costs are justified under the agreements. We expect resolution with all CROs in the third or fourth quarter of our fiscal year ending June 30, 2009.
• Medical facilities conducting the clinical trials. We generally pay medical facilities for each patient enrolled into our trials, and withhold a portion of total site compensation until all data required in the clinical trial protocol is received. The portion withheld is recorded as a liability in our consolidated financial statements. As we receive the final data from each site we authorize the release of the final payments called for under the agreements. We expect this process to be completed by March 31, 2009.
• Data management. We pay outside service organizations on a monthly or quarterly basis for services related to managing the data collected from the clinical trial. We have recorded an accrued liability for the charges we expect to incur, and the service organizations are in process of reconciling the payments from NTI to the actual charges incurred. We expect this process to be completed by June 30, 2009.
• License agreement for Viprinex. We have an exclusive worldwide license for all human therapeutic indications for Viprinex from Abbott. Under this license, we have an obligation to use commercially reasonable efforts to develop Viprinex for the treatment of acute ischemic stroke. If we do not use commercially reasonable efforts to develop Viprinex for stroke Abbott may reclaim rights to develop the product. While no license maintenance payments are required to Abbott, milestone payments of up to $2 million would be due upon various regulatory approvals of Viprinex, along with royalty payments based on worldwide Viprinex sales. In the event we sublicense the rights to Viprinex, additional payments may be due to Abbott based on the terms of the sublicense. We have the right to terminate the agreement upon providing 90 days notice to Abbott, and Abbott has the right to terminate the agreement only in the event of our breach. We presently do not intend to develop Viprinex further under the license from Abbott and expect rights will ultimately be returned under the terms of the agreement. Upon returning the rights to Abbott, we are also required to return all drug material, data and intellectual property to Abbott.
• Employees. All of our employees are employed on an “at-will” basis.
• Buck Institute for Age Research. We have entered into agreements with Buck for rights to preclinical proteins for the treatment of Alzheimer’s disease and Huntington’s disease. The research programs under these agreements may be extended annually and we have the right to terminate the agreements upon 60 days notice if we determine the research program objectives cannot be substantially met. In addition, we have certain milestone obligations to Buck in the event that specified research goals are met. We have notified Buck that we do not intend to extend the research program for Huntington’s disease, and are currently reviewing the Buck proposal for the second year of the Alzheimer’s disease research program.

While these contractual obligations are significant relative to NTII’s net assets, we believe that NTII’s interest income and the royalty revenue ($2m in the last quarter) should wash these obligations for the next 12 months, or at least reduce the cash burn rate to between $1M and $2M. The royalty ends in 2009.

The catalyst

Three large shareholders, BVF, Millennium Technology Value Partners and Highland Capital, hold 45% of NTII’s outstanding stock. BVF initiated its position in June last year, disclosing a 19.7% holding. According to a later 13D amendment,  BVF sent a letter on December 23, 2008 calling on NTII’s board:

…to exercise its fiduciary duty to shareholders by winding up NTII in order to return cash to shareholders as quickly and efficiently as possible. The letter explains that costs associated with a liquidation could be limited by immediate, decisive action because  [NTII]’s remaining assets are financial and passive in nature requiring negligible activity to manage. The letter calls on [NTII] to take immediate action to maximize shareholder value by returning capital to shareholders, consistent with its fiduciary duties, and to refrain from engaging investment bankers or other advisors (except for the sole purpose of winding up the company), whose self-interests would likely lead to a further drain of capital.

Samuel L. Schwerin (Managing Partner of Millennium Technology Value Partners) filed a 13D amendment on  January 6, 2009 disclosing a 7.7% holding (which includes the Millennium Technology Value Partners’ holdings disclosed below). Schwerin’s purpose for the filing is as follows:

On January 6, 2009, in the context of the failure of the clinical trial for Viprinex, [NTII]’s primary asset, Millennium Technology Value Partners delivered a letter urging [NTII] to take immediate and decisive action to monetize the remaining value of [NTII]’s assets for the benefit of its shareholders. The letter details Millennium’s belief that the only remaining course of action for [NTII]’s management and board to pursue is the immediate dissolution and liquidation of the company. Millennium has communicated to management that such dissolution should take the form of an immediate distribution of cash to shareholders, followed by an efficient and timely monetization of remaining assets in a manner designed to maximize proceeds to shareholders. Millennium’s letter further suggests that during nearly a dozen conversations between management of [NTII] and Millennium over the past year, management made assurances to Millennium that contingency liquidation plans had been developed in the event of failed Viprinex trials. Millennium expressed its strong belief that these plans should be implemented immediately and that there is no need, nor reason, to waste time or shareholder resources on advisors or to delay the liquidation process in order to explore risky alternative strategies, courses that Millennium believes are likely to result in further diminution of value for all shareholders.

Highland Capital disclosed a 17.6% holding in its original 13D notice filed January 9, 2009. According to the notice:

Highland Capital delivered a letter to NTII requesting the expeditious wind down of [NTII]’s business. In the letter, Highland Capital expressed its belief that, due to the failure of the Viprinex program, [NTII] has no incremental value as an ongoing concern. Highland Capital expressed a strong belief that the only way to return value to the shareholders is through liquidation of [NTII]’s assets. The letter notes that [NTII] is seeking to hire a new CEO and President, and that such action shows an intention to continue operations. Highland Capital believes that the Board should immediately decide to liquidate [NTII], and that hiring a new CEO and President is unnecessary if such action is to be taken.. Highland Capital expressly lists various assets, including cash, currently held by [NTII] which are all capable of near-term liquidation. Highland Capital asserts that it is [NTII]’s Board of Directors’ fiduciary duty to the public shareholders to liquidate these assets, wind down business, and return all proceeds to the public shareholders. Highland Capital expressed concern that the Board was considering “strategic options” to continue business which would result in the immediate degradation and eventual loss of all shareholder value.

Millennium Technology Value Partners disclosed a 3.7% holding in its original 13D filing dated January 23, 2009. Annexed to the filing was the following letter:

The Board of Directors of Neurobiological Technologies, Inc.
c/o Abraham E. Cohen, Chairman of the Board
2000 Powell Street, Suite 800
Emeryville, CA 94608

Dear Members of the Board:

As you know, on January 6, 2009 Millennium Technology Value Partners L.P. (“Millennium”) delivered a letter to the Board of Neurobiological Technologies, Inc. (“NTI” or the “Company”) urging it to take immediate and decisive action to monetize and distribute the Company’s remaining assets for the benefit of shareholders. We have since learned through a review of public filings and discussions with you that the Company has received correspondence from stockholders representing 65% of NTI shares expressing a similar point of view. This would appear to constitute a clear mandate from the stockholders of the Company for you to take immediate action to commence an orderly liquidation. We are disappointed that in the face of such an overwhelming directive from your stockholders, you are able to act other than with absolute immediacy to carry out the will of your constituency.

Over the past 14 months, management and members of the Board repeatedly assured Millennium that contingency plans involving liquidation had been developed and would be implemented immediately should Viprinex fail. Now that Viprinex has failed, we can’t help but wonder, where is the contingency plan and why hasn’t it been implemented? While we appreciate the Company’s January 13 announcement regarding the reduction of staff and the trimming of costs, the ultimate inaction on the Board’s behalf is alarming. Trimming costs merely lowers the cash burn and slows the rate of decline in shareholder value. It does not stop the decline, and more importantly, it does not seek to return maximum value to shareholders.

We are further concerned by discussions involving the potential engagement of financial advisors. As you know, financial and strategic advisors often require a considerable period of time to “evaluate strategic alternatives” and are compensated in such a way as to place an inherent bias against recommending liquidation, which in NTI’s case, is the best, and most immediate, course of action. There is no need, nor reason, to waste time or shareholder resources on advisors or to delay the liquidation process in order to explore risky alternative strategies, courses certain to result in further diminution of value for all shareholders, when the majority of the stockholders of the Company appear to have already made their views perfectly clear. The Board should understand that any action that it takes that would require the approval of its stockholders — other than the prompt liquidation of the Company — will not receive sufficient votes to pass. Accordingly, and by definition, any such attempts would clearly constitute a waste of corporate assets.

Recent discussions with management and members of the Board have further confirmed that “the process of exploring alternatives is ultimately most likely to conclude that liquidation is the best course of action for the shareholders of NTI.” Yet 37 days have passed since the failure of Viprinex, “the sole major asset of the Company,” without the Board communicating or enacting a plan designed to maximize shareholder value through the dissolution and liquidation of NTI assets. We have even gone so far as to outline a plan of liquidation to the Company that we believe could be approved by a substantial majority of the Company’s stockholders. In that plan, excess cash would be immediately distributed to shareholders, with the remaining assets to be liquidated in a timely and orderly manner over the coming months by a shareholder appointed fiduciary, with all proceeds being distributed directly to shareholders immediately upon receipt.

Should the Board have any question that the plan outlined above is in the best interests of shareholders, and that any attempts to pursue an alternative course of action would be over the objection of your stockholders, then we urge you to call a Special Meeting to allow the shareholders to reinforce our own conclusions and those suggested in correspondence from shareholders representing 65% of NTI stock.

To reiterate what we said in our January 6, 2009 letter and have repeated numerous times during our discussions with management, we believe that any action other than the immediate dissolution and liquidation of the Company is an irresponsible waste of corporate assets and will result in a severe impairment of shareholder value. We trust that the best interests of NTI shareholders continue to be of utmost importance to you, the members of the Board, and look forward to your prompt response. If either the Board or management has any questions about the appropriate liquidation plan and how best to implement it, we would welcome the opportunity to discuss it further.

With every day that you fail to take action, the value of the Company declines. We urge you to consider very carefully your primary obligations to your stockholders, and the consequences of your failure to honor these obligations.

Respectfully,

Samuel L. Schwerin
Managing Partner

Conclusion

At its $0.53 close on Friday, NTII is trading at its net cash value and around two-thirds of our estimate of its $0.81 per share liquidating value. The difference between our estimates for NTII’s net cash value and its liquidation value is the $9M in ARS, which we’ve discounted by 20% to $7.2M, and which the company believes will eventually yield full value. The possibility exists that the upside might be even greater if NTII receives a portion of the net proceeds paid to Celtic Pharmaceuticals upon a sale of XERECEPT. With stockholders representing 45% (note that Samuel L. Schwerin estimates 65%) of the outstanding stock of NTII calling for its liquidation, we feel the company will be under some pressure to accede and that should lead to a reasonably quick resolution. NTII is reminiscent of our position in Avigen Inc (NASDAQ:AVGN), which seems to be working out well. We’re adding it to the Greenbackd Portfolio.

NTII closed yesterday at $0.53.

The S&P500 Index closed yesterday at 770.05.

[Full Disclosure:  We do not have a holding in NTII. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]