VXGN has now also attracted the attention of BA Value Investors, which has disclosed an activist holding and called on VXGN to “act promptly to reduce the size of the board to three directors; reduce director compensation; change to a smaller audit firm; terminate the lease of its facilities; otherwise cut costs; make an immediate $10 million distribution to shareholders; make a subsequent distribution of substantially all the remaining cash after settling the lease termination; distribute any royalty income to shareholders; and explore ways to monetize the public company value of the Issuer and use of its net operating losses.”
VXGN is up 20.8% since we initiated the position. At its $0.58 close yesterday, it has a market capitalization of $19.2M. We last estimated the company’s liquidation value to be around $25.4M or $0.77 per share. VXGN has other potentially valuable assets, including a “state-of-the-art biopharmaceutical manufacturing facility with a 1,000-liter bioreactor that can be used to make cell culture or microbial biologic products” and rights to specified percentages of future net sales relating to its anthrax vaccine product candidate and related technology. The authors of the letter ajudge VXGN’s liquidation value to be significantly higher at $2.12 per share:
July 14, 2009
Mr. Kevin L. Reilly
349 Oyster Point Blvd.
South San Francisco, CA 94080
VaxGen’s Board of Directors:
Kevin L. Reilly, Chairman
James P. Panek
Franklin M. Berger, CFA
Lori F. Rafield, Ph.D.
Re: Letter from Shareholders of VaxGen Corporation
Dear Mr. Reilly and Members of the Board of Directors:
The current modus operandi is untenable. Although there are no agreements, arrangements or understandings with any other shareholders, it is clear that a substantial portion of the shareholders of VaxGen Corporation (“VaxGen” or the “Company”) oppose the actions of the Board of Directors (the “Board”). We seek an immediate change to the mode of operations and the composition of the Board. The Board and Management spend the Company’s valuable precious resources of cash every day, lavishly on themselves and to maintain some semblance of operations even though there has been no product development or business operations for more than 18 months. Furthermore, since March 2008, for 15 months the Company has purportedly sought out a partner, merger or sale, but after more than 60 Company Board and Committee meetings during 2008 alone and at least four offers of terms, none has been shared with the shareholders of the Company for consideration.
Worse yet, there appears to be no plan by the Board or Management to change the status quo and each day the Board, Management and others consume the remaining valuable resources. In short, that appears to be the plan.
As a brief overview, the Management and Board have embarked upon a failed merger that garnered virtually no support from its shareholders, and was opposed by ISS, and continued on that path until the date of the special shareholders meeting and scheduled vote, spending lavishly in a failed effort to close it; attempted to implement substantial new options to itself, a plan opposed by ISS and the shareholders, which was withdrawn; continually paid itself outrageous sums of the shareholders money over the past three years; rejected highly qualified outside board members with deep, broad healthcare company experience supported by its shareholders; held many Board and Committee meetings with nothing to show for it; formed a new Strategic Transactions Committee that is highly paid but that has produced no deals for the shareholders to consider or for any outside valuation experts to formally review; spent lavishly on accountants, auditors and counsel; failed to successfully hire any outside professional negotiators and finally extinguish or remove the outstanding lease obligations; distributed no cash to the shareholders despite holding excess amounts; formed no special purpose entity to hold any royalty and milestone rights and payments for the benefit of its shareholders; and thus generally failed in its fiduciary duties to shareholders.
The list of grievances and imponderables over the actions of VaxGen’s Board and Management in the past 24 months is long, and only partially reviewed in more depth here:
1) In 2007, the Board signed a letter of intent and announced its intentions to present to shareholders for a vote to merge with Raven biotechnologies inc. (“Raven”). There is no evidence ever shown to shareholders that validate any broad support for this merger at any time by any large percentage of shares owned. However, the Board and Management vigorously promoted and supported this merger; they went on road shows, held private and public meetings, and espoused the benefits of such a merger. Raven was a very early development stage biotechnology that had been in business for 9 years with little to show for it. It had burned through over $100 million of cash. It possessed one product candidate that had completed a Phase I clinical trial, and Raven, according to its public statements, intended to partner this candidate if it ever showed further positive clinical trial results. All other product development work being conducted by Raven involved preclinical (i.e. non-human) testing and this was the focus on the Raven presentation describing the company. In informal discussions with large VaxGen shareholders it was hard to find any one who supported the proposed transaction, yet the Board and Management continued to pursue it, preparing for a proxy vote in February or March 2008. Management publicly stated many times that they had the support of the shareholders for approval of the transaction, and maintained this position until the proxy vote was to be counted, making many public statements regarding the supposed broad support. On the morning of the special shareholders meeting and vote, March 28, 2008, Management and the Board decided to remove its recommendation for the merger since their was not sufficient support for such a transaction—in fact, the proxies for voting that had already been submitted overwhelmingly voted against the transaction as outlined by Management at that meeting. Management also indicated at that time that the Company would undertake the repayment of more than $5 million in bridge loans that had already been forwarded to Raven in cash. Raven, we understand but have not been able to definitely confirm, was subsumed into another biotechnology company for less than $10 million – a value that would have all but wiped out VaxGen’s shareholders’ value along with VaxGen’s cash and assets. While it cannot definitely be established, we are left to believe that a motivating factor of the proposed merger with Raven was the future management team of the combined companies that would have left many of the VaxGen Management in lucrative positions. Institutional Shareholder Services (“ISS”) issued its unbiased well-researched report publicly recommending a vote against the merger. Without broad support, Management and the Board continued to spend valuable resources to seek to gain approval for the Raven merger. The Company states, “the process of identifying, negotiating and seeking stockholder approval to the proposed Raven merger was time consuming and expensive. For example, we recorded $2.3 million of costs, primarily professional fees, related to the proposed merger with Raven, during the year ended December 31, 2008.” These do not include the Company’s remaining cash burn during this period of time, which we will see was, and remains, substantial.
2) Management and the Board added a second provision for shareholders to vote on in its proxy vote for the Raven merger—a new option pool that equated to 22% new dilution to VaxGen shareholders, not including any new dilution from the proposed Raven merger. ISS issued its unbiased well-researched report publicly recommending a vote against this proposal as well, citing the violation of the VaxGen articles of incorporation that limited any new option pool to a lower percentage in any year. Management and the Board had ignored that provision and sought out shareholder approval anyway, which was never brought to a formal vote as per the above events outlined.
3) To retain Management during the undertaking of the Raven merger and beyond, in 2008 alone, retention cash payments were made to the Company’s three chief officers totaling $388,000 (Panek, Pfeffer, Whitehead). Furthermore, total compensation of these three officers alone totaled $5.3 million in 2006-2008 ($1.9 million CEO, $1.7 million CFO, $1.6 million Corporate/Business Development); these figures exclude compensation and severance to the prior CEO, who resigned with large cash severances in 2007, and all other Management or Board Members.
a. The Company’s President & CEO (and Board Member) received a cash payment of $193,050 in 2009 and resigned his position as CEO but remains President and a Board Member still earning $193,050 annually and is eligible for severance payments. His total compensation in 2008 was $667,000 (including a $209,000 option award and a $58,500 bonus), in 2007 was $777,000 (including a $147,000 option award and a $230,500 bonus), and in 2006 was $487,000 (including a $79,000 option award and a $45,750 bonus).
b. Total compensation for the Senior Vice President & CFO in 2008 was $577,000 (including a $88,000 option award and a $400,979 cash severance), in 2007 was $754,000 (including a $280,000 option award and a $165,000 bonus), and in 2006 was $414,000 (including a $154,000 option award and a $41,250 bonus). After payout of a large severance, he was employed by another public biotechnology company in less than 30 days of resigning from VaxGen.
c. Total compensation for the Vice President, Corporate & Business Development in 2008 was $613,000 (including a $75,000 option award and a $377,737 cash severance), in 2007 was $544,000 (including a $60,000 option award and a $195,000 bonus), and in 2006 was $442,000 (including a $80,000 option award and a $40,000 bonus).
4) The Board of Directors annual compensation is similarly high for a company with no ongoing operations. In 2008, the compensation for only those members of the Board that are both compensated as members and still remained on the Board at year end (which includes four members and excludes the three members that resigned as well as the President & CEO who is not compensated as a Board member) aggregates to $552,623 (of which $44,665 was an option award and the remaining $508,000 was cash). Surprisingly, the cash compensation of these same Board members has increased for 2009 to $878,000, or 73%. A portion of this increase is a full year of service as compared to a partial year, but certain Board members actually received a substantial cash compensation increase—a raise—in August 2008. In fact, one Board member received a 60% raise and another received an 80% raise, both of which serve on the Strategic Transactions Committee and were already the two highest compensated members. In the most conservative accounting, for the entire compensation of the Board of Directors (7 compensated members during 2008) the cash portion was $612,597 in 2008 and is slated to be at minimum of $878,000 in 2009 (just 4 compensated members), a 37% aggregate increase.
5) The Board formally rejected a highly qualified Board candidate with broad healthcare and life science board of director experience, including the current Chairmanship of a public company and current service on two other public-company boards, who was strongly supported by major shareholders. The Board’s stated reasoning for rejection was a lack of biotechnology company experience, which appears irrelevant to this holding company at the time of rejection and in its current form.
6) The Board has apparently been very busy with little to show for it. There were 62 full Board or Board Committee meetings held just in 2008. Of these, 34 of them were full Board meetings, 13 were Audit Committee meetings, 8 were Compensation Committee meetings and 7 were Nominating and Governance Committee meetings. The Board’s Strategic Transactions Committee was formed to take advantage of the valuable assets of the Company to secure a transaction to create greater value for its shareholders. It only holds ad hoc meetings, so those meetings were not included in the totals above. However, despite all of these meetings (the expenses for which Board members are compensated), there have been zero transactions for the shareholders to consider or even discuss presented in the past 15 months.
7) The Strategic Transactions Committee currently receives annual compensation totaling $708,000, but at the same time this Committee has not produced any possible transactions scenarios to be made public to the shareholders over the past 15 months. Management stated publicly at the most recent annual shareholders meeting in December 2008 that 4 formal transactions had been proposed in the year between March and December 2008—the shareholders have not been made aware what those transaction terms are nor what outside valuation analyses were performed for the Board, as required. Rather, these transactions, as well as any others discussed since, have all been rendered not acceptable by the Board or Special Committee. The Board has determined that doing nothing has been better than any other alternative. The Board has stated that it initially only sought out biotech companies for interest; later it expanded this search to diagnostic and medical technology companies; but it never opened the search to all types of companies, without any viable reason for failing to do so. With cash and milestone/royalties as the sole assets of the Company, limiting the type of company sought out for a transaction appears wholly insufficient.
8) To our knowledge, the Board has not hired a professional lease termination negotiator (other than outside corporate counsel or real estate agency) in order to negotiate an end to the remaining lease obligations. This task was left primarily to the President whose training is in other areas of expertise. Consequently, nothing has been accomplished regarding the termination of its existing lease obligations to date, which remains problematic.
9) Presumably to maintain its status as a public company entity with no operating business, Management and the Board have deemed it necessary to spend $2.7 million in audit and tax fees in 2007, and continue this in 2008 by spending an additional $666,000. It continues to retain the same audit and tax accountants.
In spite of these actions, substantial value remains in VaxGen today, but it continues to be squandered quickly and surgically. The Company burned $2.2 million in cash during just the first three months of 2009. At this current rate the Company will burn $0.27 per share in cash just this year, which is more than 50% of the Company’s current market value. As of April 1, 2009, the Company has valuable assets remaining in its cash and cash equivalents, investment securities, assets held for sale, and restricted cash, which total $39.0 million ($37.9 million of Financial Assets, as defined by the Company); the Company has Current Liabilities of $0.7 million. The remaining other long-term liabilities are its lease obligations, which are approximately $2.4 million per year through 2013 and approximately $2.6 million per year thereafter until expiration in 2016.
Excluding the lease obligations, the net financial assets alone of $37.2 million equate to $1.12 per share. The EBS royalties (assuming a 6% royalty rate and a $500 million contract as contemplated by NIH/HHS and EBS) of $30 million and milestones of $6 million total $36 million of potential additional future value (based clearly on assumptions, none of which are assured), or $1.09 per share. Adding $1.12 and $1.09 equals $2.21 per share. The current trading price of the Company’s stock is $0.50 per share (and the 52 week range is $0.33-0.79)—this definitively implies no confidence in the current Board or Management to maximize the value of VaxGen for its shareholders as it spends the remaining assets.
In a tip to the possible plans of the current Management and Board, the Company states most recently that, “we may use some or all of our remaining resources, including available cash, while we seek to identify a strategic transaction; we may fail to identify an appropriate transaction…we may use a portion or all of our remaining resources seeking to identify and complete a strategic transaction, but ultimately be unable to do so. Even if completed, such a transaction may not provide us with a pipeline or return value to stockholders, and either outcome could cause our stockholders to lose some or all of their investment in our common stock.”
The shareholders of VaxGen implore the Board that drastic changes must now occur. In late 2008 assurance were given by Management to us that dramatic actions would be taken within a matter of two months, but this has not occurred. No longer can the status quo suffice and the outflow of the remaining cash be squandered in payments to the Management & Board or to any outside service providers.
We, as shareholders, owners of the business, demand that the Board take the following actions within the next 20 calendar days:
1) Each member of the Board of Directors, regardless of Committee participation or Chairmanship, immediately agree to lower total compensation to $1 per year per person, retroactive to January 1, 2009 or accept the resignation of each non-participating Board member in the new plan. Welcome at least two new board members ready to serve for $1 per year in total compensation, who are highly qualified to address the current situation and who are proposed and supported by the shareholders signing here.
2) Immediately hire at least one new highly qualified professional lease termination negotiator or mediator (other than Company’s outside counsel or outside commercial real estate firm) to resolve an exit to the remaining lease within 30 days.
3) Immediately establish a Special Purpose Entity (“SPE”) that will contain upon transfer all of the rights, royalties, milestones and other payments from Emergent Biosolutions (“EBS”) for the sale of the rPA product candidate, structured such that it could be dividended out to shareholders. Also, in agreement with the public comments at the most recent annual meeting by Management, file and make public the EBS contract and all of its terms without redactions so that the potential future cash payments may be precisely calculated by its owners.
4) Make no further cash payments for any retention, severance or exit, or otherwise of any kind, to any member of the Board or Management.
5) Immediately distribute a minimum of $0.50 per share in cash to shareholders in a Special Dividend—announce the form of plan within 10 days.
Management and the Board may spend additional precious cash and assets to defend its actions, but we sincerely do not wish them to do so, nor do we believe this is the best use of the Company’s resources. In summary, many of the prior actions of the Board and Management do not appear to be in the best interests of the shareholders of the Company, with whom your fiduciary responsibilities reside.
Change is inevitable, either through pursuing the shareholders’ interest as outlined herewith, or by changing the Board of Directors to represent the owners of VaxGen, its shareholders, who have been ignored too long. We are open to meeting with you at any time you are available to further discuss these or other topics. We can be reached to schedule a meeting at 415-495-1010.
C. Fred Toney
Ruediger Naumann-Etienne, Ph.D.
cc: Pat McBaine – Gruber & McBaine Capital Management
Mark Boyer, Mitch Soboleski – ROI Capital
Evan McCulloch – Franklin Advisors
Jonathan Harris – Morgan Stanley Smith Barney
Robert Andreatta, Steve Krognes – Genentech, Inc.
Dan Weston – WestCap Management
Steven Bronson – BA Value Investors
David Sandberg – Red Oak Partners
Kalimah Salahuddin, Luke Evnin, Ph.D. – MPM Capital
John Plexico, Tim Lynch – Stonepine Capital
Daniel Gold – QVT Financial