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Posts Tagged ‘CombiMatrix Corporation (NASDAQ:CBMX)’

In August last year Wes Gray and Andy Kern supplied the first Greenbackd guest post on CombiMatrix Corporation (NASDAQ:CBMX). The thesis was as follows:

There are a number of undervalued micro cap companies in this market, but not all values are created equal. Combimatrix (Symbol: CBMX) is a small biotech company that is tremendously undervalued by the market and has catalyst in place to realize its intrinsic value in the near term (~6months or less). Management is smart, downside is limited, and upside is huge( 100-200%+). There’s a lot to like at the current stock price.

Valuation

a. Cash

The company doesn’t appear to even remotely be a net-net by glancing at the balance sheet, however, closer inspection of the company’s contingent claims suggest otherwise. In 2005 the company won a lawsuit against National Union Fire Insurance relating to its director’s and officers’ insurance policy and was awarded a $32.1 million judgment by the US District Court. It was later awarded an additional $3.6 million by the court for attorneys’ fees and has continued to earn interest since this time.

National Union appealed, at which point the court required it to post an appellate bond of $39.2 million with the court. This means that the creditworthiness of National Union is not an issue and the only thing standing between CombiMatrix and the current value of the judgment is the Circuit Court. It appears very unlikely that the ruling will be overturned based on our legal due diligence: the decision was a bench verdict by a federal judge, and there were $0 dollars in punitive damages so the appeal theory is very weak. All briefs have been submitted to the court by both parties and only the oral hearing remains, meaning that a disbursement of the funds could happen soon. A decision is expected to be finalized by Q4 2009.

The $36mm lawsuit money and $10mm supplement represent $46mm. After the 20% lawyer fee we are left with ~30mm plus the $10mm supplemental (which we would likely do a settlement for 7mm to expediate process). Add back the $11mm cash balance on June 30, 2009 and the company is sitting on nearly $6.4 in cash per share (based on 7.5mm outstanding).

If we assume $3mm in cash burn and $12mm in liabilities (convert debt+misc liabilities+liquidation costs) at December 31, 2009, we are still left with a cash balance of [~$4.4] per share ($33mm/7.5mm s/o).

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CBMX has lodged the following notice:

On January 27, 2010, National Union Fire Ins. Co. of Pittsburgh, PA (“National Union”), Acacia Research Corporation and we entered into a settlement agreement (the “Settlement Agreement”), pursuant to which National Union has agreed to pay us $25.0 million by February 12, 2010 to settle the dispute. Consistent with the Settlement Agreement, we have not issued a press release with respect to this event as is our normal custom upon entry into material agreements.

The settlement seems to be at a reasonably substantial discount to the award, but this is a positive development. It will be interesting to see where the stock trades today.

[Full Disclosure: I have a holding in CBMX. 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.]

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On Wednesday we called for guest posts on Greenbackd-style stocks. Our first guest post is from Wes Gray on CombiMatrix Corporation (NASDAQ:CBMX). Wes is a former Marine who, along with several partners, launched his maiden hedge fund, “Empirical Search Strategies” a year ago. He’s also a PhD candidate at the University of Chicago Booth School of Business, helps to run the Empirical Finance Research Blog website and has written a book, Embedded: A Marine Corps Adviser Inside the Iraqi Army, which you can purchase from Amazon. Phew. Here’s Wes’s idea:

There are a number of undervalued micro cap companies in this market, but not all values are created equal. Combimatrix (Symbol: CBMX) is a small biotech company that is tremendously undervalued by the market and has catalyst in place to realize its intrinsic value in the near term (~6months or less). Management is smart, downside is limited, and upside is huge( 100-200%+). There’s a lot to like at the current stock price.

Valuation

a. Cash

The company doesn’t appear to even remotely be a net-net by glancing at the balance sheet, however, closer inspection of the company’s contingent claims suggest otherwise. In 2005 the company won a lawsuit against National Union Fire Insurance relating to its director’s and officers’ insurance policy and was awarded a $32.1 million judgment by the US District Court. It was later awarded an additional $3.6 million by the court for attorneys’ fees and has continued to earn interest since this time.

National Union appealed, at which point the court required it to post an appellate bond of $39.2 million with the court. This means that the creditworthiness of National Union is not an issue and the only thing standing between CombiMatrix and the current value of the judgment is the Circuit Court. It appears very unlikely that the ruling will be overturned based on our legal due diligence: the decision was a bench verdict by a federal judge, and there were $0 dollars in punitive damages so the appeal theory is very weak. All briefs have been submitted to the court by both parties and only the oral hearing remains, meaning that a disbursement of the funds could happen soon. A decision is expected to be finalized by Q4 2009.

The $36mm lawsuit money and $10mm supplement represent $46mm. After the 20% lawyer fee we are left with ~30mm plus the $10mm supplemental (which we would likely do a settlement for 7mm to expediate process). Add back the $11mm cash balance on June 30, 2009 and the company is sitting on nearly $6.4 in cash per share (based on 7.5mm outstanding).

If we assume $3mm in cash burn and $12mm in liabilities (convert debt+misc liabilities+liquidation costs) at December 31, 2009, we are still left with a cash balance of ~$4.4mm per share ($33mm/7.5mm s/o).

b. CMDX laboratory (creates diagnostic products)

We visited the lab facilities at the beginning of August 2009 and were highly impressed (Robert Embree rembree@cmdiagnostics.com is the director of operations and is happy to give shareholder tours). The lab churns out a variety of diagnostics, but its primary value is in the top 4 tests (they have 11 tests in total): Prenatal/PostnatalScan, Her2Scan, HemeScan, and ProstateScan. These tests alone are easily worth more than the current market cap of the company (See the Benchmark April 2, 2009 research report for details on valuation/DCF, etc.). The lab in its entirety is hard to value exactly, but various estimates from the lab director, CEO, DCF analysis, and industry insiders put it north of $150-$200mm in the current market environment. To back this claim, just recently EXAS sold the IP for an unfinished test that is similar to the CBMX PP test for $18.5mm in cash and our test is better!

However, let’s be ultra conservative and say they fire sale it for $50mm (While at the lab I collected estimates on the resale value of the equipment in the lab and estimated the actual property inside to be worth $10mm at a minimum).

c. CCA

This is where things get really interesting. The latest technology from Combimatrix blows our minds – they call it the comprehensive cancer screening test (CCA). To put it in non-mad-scientist terms, here is how we would explain it: the test takes a drop of blood and puts it on a microchip. The microchip then detects if you have a certain DNA sequences that can determine if you have a variety of cancers. With obvious benefits to just about everyone, the market potential for such a product is enormous. Here is a presentation on the CCA and another (.pdf).

The projected launch for CCA continues to be mid-2010 and management disclosed that it is evaluating technology that could accelerate launch to as soon as Q1, 2010. CombiMatrix intends to complete CCA study protocols in the current quarter and to complete CCA studies in the first half of next year in time to support product launch. Larger clinical studies are anticipated after launch. We estimate that the CCA’s total addressable market could be up to $12-$15 billion at $250- $300 per test. Estimated the value of the CCA asset is difficult, but the potential is absolutely mind-blowing and the test would revolutionize medicine. Certainly not worth 0, but potentially worth 100’s of millions, if not 1 billion if things continue on the current track.

d. Leuchemix

CMBX also owns a 1/3 stake in a company called Leuchemix, which is developing a leukemia drug. Recent test results indicate the drug is both effective and well tolerated by patients. Here is a summary of multiple conversations we have had with the CEO of Combimatrix on the value of Leuchemix: Assuming phase 1 is completed and looks good, and Phase II is completed and looks good also (hopefully by first half next year), then CBMX will partner the drug with a big pharma company to support the phase 3 costs. The value of the compound will be dependent on the data, which will directly correlate with the size and structure of the partnership. In the past 5 years or so, there have been two or three deals with pharma and biotech companies that have been anywhere from 500 MM to 2 Billion dollars. These deals are usually structured as some money upfront, money to support the trial, and then money to be paid upon achievement of milestones and then royalties. With a drug, there is always a chance of failure, despite what the previous data looks like. However, the phase 1 data looks good so far, and if phase 2 looks good as well, the valuation will be driven by how good. If it looks great, then CBMX can easily achieve the several hundred million dollar valuation. If it looks bad, then it could be worth nothing. And it could be anywhere in between. When Leuchemix does 40 patients, and all 40 respond, then the sky is the limit on valuation. If none respond, then it’s zero. If 10% respond, then it might be worth 20 million, etc. If half respond, then it would be worth a few hundred million.

The bottom line is that most drugs don’t make it. And there have been many failures in leukemia. The research will cost money to do phase 3 and that money will come from a partner once Leuchemix has good phase 2 data. So CBMX needs to finish the phase 1 and show good phase 2. In its current stage, the entire thing is worth $15mm in this environment where risk-taking is so low for early-stage projects.

e. Government contracts/misc.

The company has other products as well. One is the Influenza Detection system, which works with technology similar to that of the cancer-screening tests. This product line got a big boost with the outbreak of the H1N1 Swine Flu, which the system is able to detect. When the swine flu broke out earlier this year, the FDA issued the Emergency Use Authorization which approved two tests developed by other companies for immediate use to detect the H1N1 strain. CombiMatrix’s flu detection system is far more complex, accurate and comprehensive, and thus also more expensive. This makes it more appropriate in research settings, where it has already been used. But if the swine flu gets really bad (as CEO Amit Kumar describes it, “more pathogenic and communicable”) then this cost will not be as important and CombiMatrix’s test will likely be adopted.

In early April the Ontario Agency for Health Protection and Promotion verified CombiMatrix’s Influenza-Detection system. Ultimately, these tests may help guard against H5N1 bird flu outbreaks. As public health ministries become accustomed to CombiMatrix’s technology, there is a possibility that CBMX could win a large contract anywhere from $10m to $100m could be awarded to CombiMatrix based on an average cost of the CBMX’s ‘in-house’ oligo array automated system, which costs around $200-300k per unit plus additional fees for customizable chips. Governments may want to use this platform for military use or civilian outbreaks and so the size of any potential contract is highly variable. Regardless, Canadian validation is a step towards drawing investment from more government agencies. Already, China has expressed some interest and Canada has been interested since its outbreak of severe acute respiratory syndrome (SARS) in 2003. Additionally, in March 2009, NASA awarded CombiMatrix $858,000 from NASA over three years for the Company’s semiconductor microarray that can be used in automated genetic analyses suitable for use in satellites. Later this year, the Company plans to launch a cell phone-sized array reader that can monitor genetic changes to bacteria as researchers circle the Earth. Beyond government contracts, academia and other research laboratories are potential buyers of CombiMatrix’s platform technology that enables ‘in-house’ customizable array services. Sales to these institutions represented about one-third of total revenue on average.

Summary:

$4.4/s in “cash liquidation value”

+~$6/s CMDX lab ( $50mm conservative value, potentially worth $150mm+)

+~$4/s CCA technology ($30mm ultra conservative value to immediate buyer with huge option value)

+~$1/s 1/3 Leuchemix (conservatively worth $5mm in current state, but huge option value)

+~$1/s govt contracts/misc (worth $5mm+ based on comparable p/s ratios in the space)

=ultra conservative $16.4/s value versus current stock price of $6/s

Catalyst

1. CEO buying

Amit Kumar has purchased over 10,000 shares on the open market since November 2008 (6,000+ shares in August) and has reiterated numerous times in conference calls and private phone calls that he believes the equity is “grossly undervalued.”

2. Short interest (representing over 5% of s/o and over 10x average daily trading volume) may come under pressure as asset sales are announced.

3. Bidding process is about to begin.

Last week, the company announced that it has engaged multiple investment bankers to aid the company in an “effort to unlock shareholder value.” This could mean, according to CEO Amit Kumar, the sale of all or a portion of the business. This is the catalyst the stock needs to unlock the value in its underlying assets. Recently, comparable companies have successfully monetized their assets in the diagnostics space. For instance LabCorp (NYSE: LH) offered $4.55 per share of Monogram Biosciences (NASDAQ: MGRM) to acquire the company in July, for a total valuation of Monogram of $155 million (including the assumption of debt).

It’s hard to say how the market will value the various assets owned by CBMX, but one can be fairly certain that purchasing the stock around $6 creates a huge margin of safety for the patient investor.

[Full Disclosure: We have a holding in CBMX. 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.]

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