price of $10.75 per share. In a letter to the board,New  Castle  Partners  stated  that  they  continued  to  believe  thatthere  was  significant  value  inherent  in  the  company’s  businessassets  despite  the  Gehl  board’s  failure  to  take  any  actions  toattempt  to  maximize  shareholder  value.  They  stated  that  theybelieved  the  company  needed  to  aggressively  pursue  strategicalternatives.  To  date,  the  board  had  not  pursued  such  alterna-tives. Subject to a definitive agreement and normal due diligence,they offered $18.00 per share in cash for the company. Within four
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hours after New Castle delivered that letter to the Gehl Company,the board issued a press release summarily rejecting the offer.
In the press release, the company indicated that it intended toremain independent and would not have any discussion with anypotential buyers. In a follow-up letter from New Castle pointingout that their offer would provide immediate liquidity to all of thecompany  shareholders  as  well  as  a  significant  premium  to  themarket price, they stated that the board’s rejection of the offer,which was announced in a press release, indicated that the offerwas not given serious consideration by the board. The offer wassummarily rejected, with no indication that the board consultedwith an investment banking firm or relied on a fairness opinion tojustify  the  rejection.  Instead  of  giving  any  consideration  to  theoffer, it appeared that the board spent its time preparing a pressrelease attempting to belittle the all-cash offer. Neither the boardnor any representatives of the company ever made any attempt todirectly contact New Castle or CIC.
On  February  9,  2001,  Heartland  advisors,  an  entity  that  wasunaffiliated  with  New  Castle  or  CIC,  again  filing  their  amendedSchedule  13-D,  reported  its  beneficial  ownership  of  approxi-mately 6.1 percent of the outstanding shares of Gehl. It is widelyacknowledged that Heartland was one of the principal sellers ofstock to CIC, as is evidenced by its decline in ownership from 10.7percent to 6.1 percent. Heartland advisors again sent a letter toeach member of the Gehl board, dated February 8, 2001, whichexpressed  Heartland’s  dismay  with  the  Gehl  board’s  failure  toconsider  the  interests  of  the  shareholders  by  rejecting  the  NewCastle  offer  and  reiterating  its  previously  expressed  concernsover  management’s  failure  to  engage  independent  advisors  toexplore  strategic  alternatives  to  enhance  shareholder  value.  Inthe letter, Heartland advisors state that “. . . a board is elected torepresent  shareholders,  not  management.  Both  the  board  andmanagement  have  a  fiduciary  responsibility  to  diligently  and  ingood faith represent the shareholders. It is difficult to understandhow the apparent cursory review of the CIC Equity Partners Lim-ited  offer  can  be  construed  as  adequately  discharging  yourresponsibilities  to  shareholders.  Your  capricious  actions  haveresulted in a shareholder lawsuit that will require company fundsto defend and could result in further losses to the company. It is
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time  you  exercise  your  responsibilities  to  all  shareholders.  Weurge  you  to  appoint  a  committee  of  independent  directors  topromptly review the CIC proposal. We also reiterate our previousrecommendation  to  engage  professional  advisors  to  assist  theindependent directors with respect to the proposed transactionsand actions to return value to shareholders.”
Again, it’s interesting to see that company management at themoment decided to reject out of hand the desires of their largestshareholders. At the time, a number of lawsuits were being filedagainst the company based on fiduciary obligations of directorsand disgruntled shareholders. Essentially now the company hadopened itself up to liability from plaintiff’s attorneys filing classaction lawsuits against the company. The class action was filed onDecember 27, 2000, in the Circuit Court of the State of Wisconsinby a shareholder of the company. The complaint names the com-pany and the directors of the company as defendants and allegesamong other things that the company’s directors breeched theirrespective fiduciary duties in refusing to discuss an offer from athird party to purchase the company. The complaint requests thatthe circuit court, among other things, declare the action a properclass  action,  instruct  the  directors  to  exercise  their  fiduciaryduties, giving due consideration to any proposed business combi-nation  and/or  to  adequately  ensure  that  no  conflicts  of  interestexist  between  the  directors  and  their  fiduciary  obligations,  andaward the costs and disbursements of the action, including rea-sonable attorney’s fees and expert’s fees.
As the legal and shareholder pressure mounted, the companybegan going through the motions as required by its legal obliga-tions. On May 9, 2001, the company issued a press release indi-cating  that  it  had  retained  a  local  investment  banking  firm  toassist the board of directors in a review process to explore strate-gic alternatives and to maximize shareholder value.
In  the  press  release,  the  company  indicated  that  the  boardwould  evaluate  proposals  from  U.S.  and  international  entities.The board would compare the values that might be realized fromvarious  strategic  alternatives  to  the  long-term  value  it  couldexpect  to  realize  for  shareholders  from  continuing  to  executeGehl’s strategic plan as an independent public company pursuingits  growth  strategies.  Effectively,  the  company,  with  this  pressrelease,  indicated  that  it  would  consider  putting  itself  in  play.
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However, the language in the press release remained highly con-ditional and was predicated on a comparison of strategic alterna-tives as compared to pursuing its own growth strategies. Insidersclose to the situation agree that the company had no intention offollowing through on any potential actions, but had to go throughthe motions to create a defense due to the litigation at hand.
By September 2001, the company announced what could nowbe  considered  a  rather  predictable  outcome  based  on  the  prioractions of the management team. Issued on September 27, 2001,the press release indicated that the company unanimously deter-mined that executing the company’s strategic plan would createmost value for shareholders. The company was to restructure toincrease profitability, including an extensive revision of its manu-facturing  operations.  In  addition,  the  company  announced  anopen-market repurchase of up to 500,000 shares of stock. Therewas  nothing  in  the  press  release  that  indicated  anything  moreabout  the  company’s  actions  with  regard  to  maximizing  share-holder value by accepting or reviewing offers other than that theCIC/New Castle offer was evaluated and rejected as a part of thecompany’s strategic review.
But the story is certainly not over yet. On December 7, 2001,the New Castle group sold its interest in the Gehl Company to anAustrian  manufacturer  of  construction  equipment,  Neuson  Ag,for $20.00 a share, according to documents filed with the SEC. Atthe  time,  Neuson  had  a  12.9  percent  stake  in  Gehl.  When  thetransaction occurred, Gehl shares were selling at approximately$14.50  per  share.  After  the  announcement  of  the  transactions,Gehl  shares  rose  to  $16.27  a  share  in  trading  volume  that  wasthree times the typical daily activity level. The transaction effec-tively ended the New Castle attempt to buy the company and toremove Gehl as the company’s chairman and from the board ofdirectors.  In  its  most  recent  proxy  filing  of  March  4,  2004,  theGehl  Company  listed  Neuson  Ag  as  a  14.4  percent  shareholder.This  makes  them  the  largest  single  shareholder  of  commonequity. As of May 28, 2004, the company’s shares were trading at$16.90 in the open market. This is only 90 percent of book valueand 7.5 times current cash flow. The market now seems to under-stand that this company should be priced at a substantial discountbecause management is not at all willing to act in the interest ofshareholders. In addition, the market may be indicating that the
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largest part of the skid-steer industry consolidation is over, andthe  new  dynamic  will  work  against  a  small  company  like  Gehl.Gehl’s shares continue to trade at a discount to the New Castlecash  offer  and  at  a  significant  discount  to  the  other  offersreceived in the past. The jury remains out as to whether the com-pany will be able to successfully reposition itself and execute itslong-term business plan to add shareholder value, but it is clearlyindicative of a case where management put its interests ahead ofshareholder interests in an attempt to keep control of the com-pany, although the managers had little or no financial interest inthe company at the time.
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CHAPTER 11
Pozen CompanyCase Study
This chapter will attempt to answer the following questions:
• How do you identify development-stage companies with high
potential?
• What  issues  should  you  consider  when  analyzing  develop-
ment-stage companies?
As discussed earlier in this book, there are opportunities in themicro  cap  arena  to  find  companies  that  are  emerging  with  newproducts  and  new  services  that  are  yet  untested  in  the  market-place.  These  companies  typically  represent  the  highest-riskopportunities in the micro cap arena; however, they often presentthe highest-reward profile as well. In many instances, these arecompanies with products in the development pipeline that have afunding  need  to  complete  the  creation  and  distribution  of  theproposed product. In most instances, venture capital has fundedthe critical early stages of the development process, and the com-pany then requires a larger investment to complete the commer-cialization of the product or process. Although they are high risk,these deals should be considered for a small percentage of yourmicro cap portfolio.
It is interesting to note that when you look back historically,these  companies  and  opportunities  tend  to  appear  in  clusters
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with a generally similar set of circumstances. For example, dur-ing  the  late  1990s,  many  dot-com  companies  raised  moneythrough initial public offerings, some of which ascended to multi-billion-dollar market capitalization and others of which promptlycollapsed  and  disappeared  into  the  micro  cap  world.  In  manyinstances, it is possible to review the wreckage of these compa-nies and find opportunities in real companies with real businessmodels  that  are  executing  their  business  plans  and  are  well-funded as a result of their public offering.
One  area  in  particular  where  there  are  fairly  consistent  andongoing offerings for development-stage companies is the phar-maceutical and biotechnology company arena. These companiesoften demonstrate the control of a new technology or a new phar-macological agent and require continuing funding for the devel-opment  and  distribution  of  the  proposed  new  drug  or  product.These opportunities are interesting because after the fanfare andhype  that  surround  the  IPO  subside,  the  newly  public  companyoften stumbles in some way, only to be completely abandoned bythe  mainstream  analysts  and  investors  on  Wall  Street.  It  is  notunusual for such a company to turn into a micro cap company. Ifgiven time, management frequently has the opportunity to com-plete the execution of its business plan and move the valuation ofthe company to higher levels. It is important to note that not everycompany  will  successfully  execute  its  business  plan,  and  manywill ultimately fail; however, if there is a good opportunity or ifthe  company  has  a  good  product  opportunity,  finding  a  largercompany to absorb it is normally the endgame for a small com-pany like this when the business is not executing to plan.
An  interesting  example  that  fits  this  paradigm  is  the  PozenCompany.  Pozen,  a  pharmaceutical  development  companyattempting  to  build  a  portfolio  of  products  with  commercialpotential in targeted therapeutic areas, became a public companyin  October  2000.  The  initial  area  of  focus  for  the  company  wasmigraine  headaches,  where  they  had  built  a  portfolio  of  fourpotential  products  through  a  combination  of  compound  mixinginnovation and licensing. Their lead product, thought to have themost  potential,  was  a  development-stage  drug  created  to  be  anoral  first-line  therapy  for  the  treatment  of  migraine  headaches.(See Figure 11.1.)
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FIGURE 11.1 Pozen Company price chart.
As of September 2000, Pozen had completed Phase Three clin-ical trials of MT100, its oral therapy for migraines. At the time ofits IPO, the company was conducting two additional Phase Threeclinical trials, which were expected to be completed by the end ofthe  year  2000.  The  company  expected  to  begin  Phase  Three  orPhase  Two  clinical  trials  for  two  additional  migraine  drug  com-pound candidates in the first half of 2001.
As described in the IPO documents, migraine is characterizedby recurring attacks of headache that are often accompanied byvisual, auditory, and/or stomach disturbances. The typical migrainepatient  experiences  attacks  throughout  his  or  her  adult  life.Migraine attacks vary in duration and severity, depending on thecondition of the patient and the patient’s environment. There area variety of oral, injectable, and intranasal therapies that are cur-rently available to treat migraine. The company estimated that theglobal sales of prescription pharmaceuticals for the treatment ofmigraine were approximately $2 billion in 2001.
Triptans  are  the  family  of  drugs  most  commonly  prescribedfor the treatment of migraine attacks. According to industry sta-tistics, triptans represented approximately $1.1 billion of sales inthe  United  States  in  1999  and  were  estimated  to  be  $1.2  billion
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dollars of sales in 2000. Although triptans are effective in treatingmigraines,  they  have  several  significant  side  effects,  includingpotentially dangerous cardiac events. Also, not all patients treatedwith triptans achieve pain relief from their migraine headaches.
MT100,  Pozen’s  proprietary  migraine  drug  candidate,  com-bines a number of commercially available agents that relieve nau-sea, enhance gastric emptying, and act as anti-inflammatory andanalgesic  agents.  The  data  from  clinical  trials  on  2,250  patientswho received MT100 in Phase Two and Phase Three analysis sug-gest that MT100 provides more rapid and sustained migraine painrelief than a placebo and as compared to the individual compo-nent compounds of MT100. Pozen also indicated that data fromthe trials on MT100 proved that the compound was as effective intreating migraines as Imitrex, the leading triptan in terms of U.S.sales. In addition, the company demonstrated that MT100, beinggenerally well tolerated, also showed no indication of any seriouscardiovascular side effects.
In its IPO, the company proposed to offer five million sharesat a price of $15 per share to raise a total after fees and expensesof  approximately  $70  million.  Upon  completion  of  the  offering,the company would have approximately 26.5 million shares out-standing. The prospectus pointed out that since its inception in1996, the company had had no revenue and had incurred an accu-mulated deficit of approximately $34 million. The prospectus alsopointed out that the biggest risks to the company were negativeor unfavorable results from its drug trial programs and the possi-bility that even with favorable results, there was no certainty thatit could obtain regulatory approval for its potential products.
However, a careful examination of the deal did indicate thatthere were a number of good factors related to the Pozen project.To begin with, 100 percent of the net capital raised, or approxi-mately $70 million, was going directly to the company for the fol-lowing purposes: About 65 percent of the funds would be used forthe development, approval, and commercialization of new prod-ucts; approximately 25 percent of the funds would be allocated toacquire  products  that  are  complementary  to  the  company’s  in-process development product line; and approximately 10 percentof  the  funds  would  be  used  for  general  corporate  and  workingcapital purposes. The fact that all the net proceeds were going forcorporate development purposes and no significant shareholders
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were cashing out on the IPO is normally a good indication of thelong-term prospects for a company. After all, these shareholdershad put up and spent over $40 million to get this company to thepoint of going public, and none of them were cashing out. Uponcompletion  of  the  new  equity  offering,  the  company  was  esti-mated to have a pro forma net tangible book value per share ofapproximately $3.39. Prior to the offering date, the company hadfunded net proceeds through the private placement of preferredstock, resulting in aggregate total proceeds net to the companyof  approximately  $39  million.  As  of  June  30,  2000,  the  quarterend prior to the company’s IPO, it retained cash in equivalence of$13.8  million  on  the  balance  sheet,  available  to  fund  operatingactivities.
At the time of the offering, the company had a total of 18 full-time employees, all based out of the headquarters in Chapel Hill,North Carolina. Of the 18 employees, 14 held advanced degreesand  6  had  Ph.D.  degrees  in  pharmacology.  The  company’s  man-agement team read very much like a who’s who of the pharma-ceutical development, biotechnology, and pharmaceutical businesscommunity.  The  key  officers  and  directors  took  reasonablesalaries  considering  their  broad  industry  experience  and  werecompensated  more  heavily  through  the  use  of  stock,  whichhelped align their financial interests with those of the company.After the IPO, about 20 percent of the company would be ownedprimarily  by  management  and  approximately  28  percent  of  thecompany would be owned by three different equity venture capi-tal  funds  that  had  participated  in  the  initial  funding  of  the  drugdevelopment. In addition, the existing shareholders would agreeto  a  lockup  provision  that  prevented  any  of  them  from  sellingshares for the first 180 days after the date the company went pub-lic. In total, it looked like the company had a fairly good opportu-nity  to  successfully  execute  its  public  offering  and  to  moveforward  with  the  continued  development  of  the  proposed  phar-maceutical agents.
The  company  completed  its  IPO  on  October  13,  2000,  at  anoffering  price  of  $15.00  per  share.  By  December  2000,  the  com-pany’s share price had reached an all-time high of $21.88. That’swhen  the  trouble  began.  In  June  2001,  the  U.S.  Food  and  DrugAdministration (FDA) requested that the company conduct a two-year carcinogenicity study of the effects of MT100 in rats, prior to
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the approval of the MT100 new drug application. In the best-casescenario, this put the company two and a half years away fromreceiving  approval,  much  further  out  than  initially  indicated  bythe original business plan. On June 26, 2001, Pozen submitted newdata to the FDA in support of its request that the agency recon-sider the need for the company to conduct the two-year carcino-genicity  study.  The  new  data  consisted  of  genotoxicity  studyresults and an expert report from two leading genotoxocologists.The  company  believed  that  the  data  would  address  the  FDA’sconcerns about the genotoxic potential of MT100. The added timeneeded  to  complete  the  required  study  by  the  FDA  caused  thestock’s price to decline sharply. Unfortunately, it was ultimatelydetermined  that  the  company  would  have  to  complete  therequired  studies  by  the  FDA  for  its  MT100  drug,  and  the  shareprice slumped to $5.00 by the end of 2002. Near the end of the firstquarter  of  2003,  the  company’s  shares  experienced  selling  pres-sure as a number of institutional shareholders sold their holdings,and the stock price slumped to a range of $2.25 to $3.00 a share asthe first quarter of 2003 ended.
During  March  2003,  a  small  window  of  opportunity  opened,and an investor could acquire company shares at approximately1.5 times the net tangible assets that were on the books. Thoseassets comprised primarily cash and cash equivalence and short-term cash investments. The intangible assets owned by the com-pany were a series of patents related to Pozen’s drug developmentactivities, the value of which was carried at nominal valuation onthe books and made it difficult to determine what real net valuethose intangible assets had.
During  the  second  half  of  2003,  the  company’s  prospectsimproved  with  a  series  of  newsworthy  events.  In  July,  Pozenentered into an agreement with GlaxoSmithKline for the devel-opment  and  commercialization  of  proprietary  combinations  oftriptan and long-acting, nonsteroid, anti-inflammatory drugs thatmay  improve  the  effectiveness  of  acute  treatment  and  providesubstantial  pain  relief  for  migraine  headaches.  The  announce-ment triggered a $25 million initial payment to Pozen by Glaxo-SmithKline  and  allowed  the  two  companies  to  actively  begincollaboration for clinical development and commercialization ofrelevant  combinations  of  MT400,  one  of  Pozen’s  developmentpipeline drugs.
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In September 2003, Pozen announced the results of a PhaseThree  study  demonstrating  that  its  primary  development  drug,MT100, provided superior sustained pain relief over a placebo forpatients in the early treatment of migraine. The data showed goodefficacy relative to a placebo, with MT100 being administered asan oral, first-line therapy for the treatment of migraine headaches.Those two events helped push the stock price back up to nearly$18  per  share  by  October  2003.  Investors  who  had  purchasedshares in the $2 to $3 range in March of that year would have seentheir stock price appreciate to the $16 to $18 range during August,September, and the early part of October 2003, a six- to ninefoldincrease in the share price.
On October 20, 2003, the company announced that its MT300migraine  treatment  received  a  nonapprovable  letter  from  theFDA. This caused the stock price to plunge, and by January 2004the  share  price  had  declined  by  50  percent  and  was  trading  atapproximately  $9  per  share.  On  January  28,  2004,  the  companyreported  positive  results  from  its  MT100  migraine  study,  andagain the share price moved higher; however, it was important tonote that as the share price moved higher, a number of insidersmoved quickly to sell a large percentage of their holdings into thestrength in the stock, probably an indicator that valuation levelswere abnormally high relative to the going-forward prospects forthe company.
On June 1, 2004, the company announced that the FDA hadissued a nonapproval letter concerning the new drug applicationfor MT100, its primary product for the oral treatment of migraineheadaches.  In  the  letter  from  the  FDA,  the  agency  noted  thatPozen demonstrated unambiguous, statistically significant supe-riority of MT100 compared to an appropriate control on a validmeasure of pain as well as on three associated symptoms of nau-sea, photophobia, and phonophobia in one study. However, theynoted that MT100 did not clearly meet these criteria in the secondstudy. This disappointing news caused the stock price to plungeonce again, and as we conclude this report, on June 18, 2004, theshare price closed at $6.51, back to levels indicative of results in2002.
The company’s financial condition is beginning to deteriorate.Pozen currently has a cash burn rate of approximately $2.5 mil-lion  per  fiscal  quarter  or  about  $10  million  a  year.  Based  on  its
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most recent fiscal quarter, which ended March 30, 2004, the com-pany had cash in equivalence of approximately $56 million on thebalance  sheet.  This  would  indicate  that  at  the  current  rate,  thecompany could exist for about five and a half more years beforerunning out of cash. However, with the FDA’s rejection of MT300and the company’s primary product, MT100, it is hard to envisionhow  Pozen  can  recover  through  the  development  of  new  prod-ucts.  There  may  be  some  opportunity  in  the  GlaxoSmithKlinejoint-venture development; however, that is in its early stages andit is difficult to make that determination.
There  was  a  small  window  of  opportunity  to  make  a  largereturn  as  an  investor  in  this  company.  If  one  had  purchasedshares  during  the  time  period  when  they  were  trading  at  a  lowmultiple of tangible book value and held onto them, pending sev-eral positive announcements, a large potential return might havebeen accomplished. It is important to note that at that time, Pozenwas  actively  promoting  the  stock  and  discussing  with  potentialinvestors the opportunities the company felt it had in going for-ward. However, it is easy to see how these companies are fraughtwith  potential  risk,  and  knowledgeable  investors  should  studythem  carefully  and  attempt  to  determine  appropriate  entry  andexit  points  when  using  them  as  part  of  their  portfolios.  In  anydevelopment-stage  company  it  is  usually  advisable  to  “take  theseed money off the table,” as is often said by micro cap investors.Thus, when a development-stage company doubles in price, sell-ing back half the position and letting the gain remain invested is apopular risk control method.
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CHAPTER 12
PrivateInvestments inPublic Equities(PIPEs)
This chapter will attempt to answer the following questions:
• What are PIPEs?• How can they be used to find micro cap opportunities?
Private investments in public equities, also known as PIPEs, havedramatically changed the capital market landscape for small andmicro  cap  companies.  In  addition,  PIPEs  are  another  excellentarea  of  research  for  potential  micro  cap  investments.  A  PIPEtransaction is a negotiated private sale of a public issuer’s equityor equity-related securities to institutional investors. The sale isconditioned  upon