Shares of drug maker Omeros Corporation (NASDAQ:OMER) are down 17% as of 3:53 p.m. EST today. The culprit behind the decline is a scathing short-seller report from FourWorld Capital Management; the piece describes how Omeros’s failure to develop medically necessary product, and grim prospects for the rest of its pipeline, raises concerns about default on its term loan.
These kinds of long-winded short-selling pieces tend to trigger a drastic price movement, and it just so happens that the author of the piece will profit from that very decline. At the same time, the report does bring up enough valid points to give pause to anyone thinking of using the stock drop to pick up shares at a discount. This looks like a no-win situation for investors. Let’s take a closer look.
FourWorld believes all regulatory and legislative options to extend pass-through Medicare reimbursement status past January 1, 2018 for its only marketed product have been singularly unsuccessful and are now no longer viable. FourWorld forecasts a $400 million funding shortfall and believes the fair value for Omeros common stock is $4/share.
Omeros markets a single patented and FDA-approved medication, called Omidria, a cocktail of legacy generic pupil dilation and pain relief drugs that can be used in cataract surgeries. Medicare’s pass-through reimbursement system has allowed Omeros to charge providers up to $465 per dose of Omidria, a gross price mark-up for a product whose ingredients cost, as FourWorld understands, approximately $2.50 per dose and whose two-ingredient alternatives, proven and easily obtainable since at least the 1950s, are priced at about $30 a dose.
In its report, FourWorld notes that Medicare, describing Omidria as a “nice-to-have” but not a “need-to-have” product, ended “pass-through” reimbursement for the drug as of January 1. As a result, FourWorld expects Omeros will be required to reduce the price of Omidria by up to 90% to prevent a mass exodus to less expensive and, as FourWorld reports, equally effective options.
Loss of the Medicare safety net and exposure of its sole commercial product to potentially lethal competition has placed Omeros in a triple bind: even as it plies providers with free samples of Omidria to retain them as customers, channel checks indicate that eye surgeons and wholesalers are cutting back on their procurement of the drug now that the cost charged by Omeros is no longer covered by taxpayers.
Simultaneously, FourWorld explains that Omeros has been repurchasing, at full price, unused Omidria inventory from customers. Additionally, the company’s own OmidriaAssure program pays providers the difference between their cost for Omidria and patient insurance.
Throughout 2017 Omeros affirmed its optimism that a pass-through extension would be forthcoming. But reality may have caught Omeros investors by surprise. The company has pinned its hopes on two pieces of legislation – HR 4679 and HR 4683 – that conceivably provided a path back to Medicare support for Omidria. But the Bipartisan Budget Act of 2018 – signed into law on February 9 – included 377 pages on healthcare spending but nothing that extended reimbursement status. FourWorld and its government affairs experts believe that this omission essentially kills all hope for the two bills. FourWorld notes that all of Omeros’ assets are pledged as collateral under its $125 million term loan agreement, essentially leaving shareholders at the mercy of the performance of Omidria.
Based on FourWorld’s interviews with cataract surgeons, the report says, “Omidria would need to reprice at a 90% discount to start being of interest. We believe these cost cuts represent the bare minimum cut to Omidria’s price for OMER to have any chance of defending its current market share.”
The report goes on to forecast an 80% year-over-year revenue decline for Omidria, given that “Omeros has exhausted all viable regulatory and legislative options to extend reimbursement status.”
New York-based FourWorld Capital is an SEC-registered investment advisor focusing on event-driven investment opportunities. The firm was founded by John Addis, formerly head of Americas Equity Finance at Bank of America Merrill Lynch.
“Omeros markets a single commercial product that has little clinical benefit which surgeons we’ve consulted are unwilling to pay for,” Mr. Addis said. “Loss of Medicare reimbursement has removed the drug’s financial lifeline the company’s financial underpinning.”
He continued, “Investors should have a clear understanding that Omeros is facing massive cash flow burn and resulting credit risk under its term loan agreement. The situation might be arguably brighter if there were viable therapies in the company’s pipeline, but our research indicates that the pipeline is highly uncertain, pledged to creditors, and at best years away.”
As outlined by FourWorld’s research, Omeros is subject to challenging covenants and possible termination provisions under its $125 million term loan agreement. Owing to the loss of its Medicare support and lack of viable therapies in the company’s pipeline beyond this year, the company is unlikely to ever again meet either its minimum revenue or market cap tests, which are required to be met annually under the terms of the loan agreement.
The company’s debt capacity presents a formidable dilemma. FourWorld’s research shows that Omeros has $45 million in debt capacity expiring on March 21, 2018. If this debt is drawn in full, it puts further pressure on the market cap test – if fully drawn, the minimum requirement under the loan would be $800 million versus Omeros closing market cap on Feb 9th of just above $600 million. If the debt remains undrawn, the capacity will expire and Omeros will almost certainly need to seek liquidity elsewhere, via either a large and dilutive equity offering or additional debt.
According to FourWorld’s report, Omeros disclosed to investors that, irrespective of Congress’s decision on Medicare pass-through for Omidria, the company has, in its words, “incremental sources of funds” to finance the business only until November 9. FourWorld’s report continues: “Given the covenants in the Term Loan, we believe there are few incremental funds at its disposal, and the Company will be facing a budget crisis in the face of collapsing OMIDRIA revenues and rising operating expenses. The logical place to turn will be the capital markets – which we believe equates to an imminent large equity offering and likely multiple additional equity offerings over the next 12 to 24 months.”
“To address the near-term liquidity needs we forecast above,” the report concludes, “we estimate that Omeros will need to do a $150 million equity offering in the very near future, with at least $90 million used to repay the [lender’s] Loan and the remaining $60 million, together with the remaining cash on hand, to fund its operations for 2018. In subsequent years, we believe Omeros will need to raise an additional $100 million per year to fund its operations until drugs in its pipeline either produce material revenues or reach milestones that have significant collateral value to justify a debt offering (e.g. full FDA approval), which we estimate will not happen until 2022, if at all. In total, we estimate that current investors could be looking at approximately $400 million in capital raising requirements over the next four years.”