Insmed Q3 Net Net Stock Analysis and Valuation

November 9, 2009 | Comments (16)

Insmed Inc continues to be a Benjamin Graham Net Net stock. As I mentioned in my October portfolio update, I was waiting for the quarterly results to be released before I took further action.

INSM Still a Net Net Stock

After a full quarter, INSM still remains as a net net selling below liquidation prices despite the market run up during October.

My initial cost basis of Insmed was at $0.86 based on a liquidation value of $0.91 at the time and now with prices in the mid 70c range, a look at the financial statements will provide a good indication of whether it will be worthwhile to double down on my existing small position or just hold onto it until more information breaks out.

Q3 Recent Developments

In my initial stock analysis of INSM, I stated my concern the company may easily burn through its cash received from the sale of its follow-on biologics (FOB) to Merck. I’ll get to the detailed numbers in later.

On the conference call, there was no Q&A session but a lot of the topics that people would have obviously asked were addressed. The most interesting point to note was that the board mentioned a merger or reverse merger.

This is something more similar to the impression I received in my initial analysis. INSM is basically running like a shell company. Lots of cash, a single product but no way to leverage it to its potential in its current state.

Since the company is looking to increase “shareholder value” a buyout is unlikely as current prices does not offer much shareholder value at all. It also seems like the board is more interested in continuing the operations of the company in some form or other.

I could endlessly continue speculating whether the company will merge or sell itself but that isn’t what’s important. Analyzing the financial statements to determine whether I can maintain my position is more important. The undergoing strategic review and results will come, it’s just a matter of time.

INSM Financial Statement Analysis

Since INSM has changed dramatically since one year ago, it’s pointless to compare with the previous years. Right now, the focus has to be on quarter versus quarter.

Income Statement Analysis

(Click for larger version)

insm-income-statement

  • Since the company’s only product, IPLEX, is being conserved for existing ALS patients, revenues decreased.
  • SG&A is still fairly high due to the legal fees but due to external finance, legal and consulting services with the ongoing strategic review.
  • Lower R&D expense now that FOB has gone to Merck.
  • Interest income would be a low earnings quality in a normal company but for INSM, consistent interest income is a must. Increase is good.

Balance Sheet Analysis

insm-balance-sheet

  • While accounts receivables and prepaid expenses went up, the big increase in percentage is because the numbers are fairly small so any small change will seem big. Compare this to the amount of decrease in liabilities.
  • Overall, liabilities decreased 22% compared to the previous quarter so the current management has been doing a good job.
  • Accoutns payable is down 18%
  • Payroll liabilities down 59% now that there are only 15 full time employees
  • Big reduction of income taxes. Probably due to the lack of revenue from now on.

Cash Flow Statement Analysis

insm-cash-flow-statement

When looking at the cash flow statement, keep in mind that the numbers are for the past 6months and 9months total cash flows. These numbers are not stated value except for certain items.

  • No warning signs in the cash flow statement. The cash burn seems to be steady at around $1m per quarter. i.e. at this rate, the company can basically keep the company going as it is for the next 110 quarters, which is 27 years. But that’s just a hypothetical number. Either way, I know INSM can stick around for a long time without going bankrupt.
  • The only reason why the cash at the end of period is reduced is because the company purchased more short term investments. As long as they are safe investments, I’m fine with it.

INSM Stock Price Calculation

insm-net-net

INSM’s current stock price is still below net net working capital by a decent amount. I still believe it to be very undervalued.

There is no point in running the discounted cash flow spreadsheet because I have to view INSM as a quarter by quarter basis. No reason to try and project cash flows. The same reason goes for the Benjamin Graham spreadsheet.

However, I can use an EPV valuation because the valuation technique looks at a snapshot of the company’s value at a specific given time.

insm-epv-stock-valuation

(Click to enlarge)

With a quick earnings power value, the value comes out to $1.40.

Considering all the numbers and the current situation of the company, I was quite glad that the company is operating better than I expected. While the company is losing money, it is being offset by reductions in expenses as the business continues to wind down. While a buyout isn’t as likely, any good news, however small, should send INSM back to shareholder value recovery.

The current valuation is very cheap compared to even the worst distressed situation so there is plenty of margin of safety.

INSM is still a small part of my portfolio but I doubled my position after earnings and am considering building a larger position.

Disclosure

I own shares at the time of writing.

  • slinj

    Jae, real good analysis, interesting enough, I was thinking INSM also after its quarterly release and may also put more in this week. In the press release, its Chairman mentioned “we have reviewed a number of high-quality opportunities”. and gauging from the way the company has been managed, I think the high quality opportunity isn’t just a management jargon and spin. If they are mindful of the value of their cash and are patient in seeking out opportunities, it is a very good sign.

  • http://www.oldschoolvalue.com Jae Jun

    I read that statement as well but I think they are more interested in finding a company to reverse merge with. Whether that will increase shareholder value is yet to be seen. They could easily waste their money on a bad merger but the board seems to be handling things pretty well.

    A buyout would be the best scenario but doesn’t seem likely at this point.

    I just hope they come to a decision quickly as I don’t like RBC getting paid for so long.

  • chanceum

    I spoke with the VP in charge of investor relations today. It does seem that the company is focused on M&A, since other than their exising inventory of IPLEX drug, they are not doing any active R&D or manufacturing. The situation with IPLEX is that it is in the early phase of drug approval, and so far studies have not shown significant survival advantage with patients with ALS, a progressive neurologic disorder. However, my take on it (as a medical provider) is that they don’t have enough money or drugs to complete any organized trials to move ahead on the research of the drug. If there are favorable findings from the remaining stock, they would need to find someone else to help fund or support the research required to get it approved.

    I don’t see that another company would want to buy INSM since its main value is its current assets, so the only likely scenario is that INSM would acquire another company. It’s almost like investing in INSM is investing in a venture capital company that will make the decision for you. How well that turns out is totally out of the hands of a small investor. I think too much of a gamble overall despite the great valuation.

  • http://www.oldschoolvalue.com Jae Jun

    That’s what I figured. The company is at a reverse merger more than anything.
    Thanks for the great information and I can see why you’re sitting out on this one. I need to get an update the next quarter as this quarter didn’t show us much.

  • chanceum

    Jae, reading about reverse mergers, seems like that is a situation where a private entity acquires a publicly traded co. which has ‘distressed assests.’ Seems like INSM isn’t in a distressed position. Wouldn’t it be more likely to do a reverse takeover or acquisition, buying out another company with a distressed position or leveraged assets. If that is the case, then wouldn’t that greatly improve the odds that it will increase INSM’s valuation? What do you think?

  • Mechanonuke

    Jae – I’ve been following your blow for a bit now, and regularly look into the ideas and discussions posted on the forum. Keep up the good job!

    I read thru a number of the quarterly/annual filings for INSM as well as the latest webcast.

    Some questions/comments:

    1. The references to ‘operating cash neutral’ during the past 2 quarters is interesting. It seems that the ~$130M sale of assets as well as ongoing operating income are being writen off by the “Accumulated Deficit” line item in the Balance sheet (or at least the future deferred income tax portion of that).[Item 6 in the latest 10-Q discusses income tax.]
    The latest quarter still indicates a ~$230M accumulated deficit. Do you think that there is any remaining deferred income tax portion after the ~130M? (If any remains it could be considered a non-cash company asset. Tho none may be left)

    2. From the webcast, the possibility of the company being sold in the short term is zero(imo). They mentioned something to the effect of building long-term shareholder value, along with Mergers, reverse-mergers, etc. All of this seems to indicate the the managers and directors are not ready to cash out yet.

    3. Chanceum’s Nov 23 analogy to VC, really strikes a cord with me also.

    4. A follow on from 2. and 3. It would be prudent to assess if the current management team has a track record of *proven* success with M&A. (i.e. who in the past 5 years was the driver behind the company success? It could be one or more people. Are those people still at the company? The comment in the webcast about not currently looking for a replacement CEO started this train of thought. More investigation seems a must here, I will dig a bit more to form an oppinion.)

    d

  • http://www.oldschoolvalue.com Jae Jun

    @ Mechanonuke,

    Great questions.

    1. I didn’t look too much into “Accumulated Deficit” because I always knew they were losing money to begin with but the difference is that I found INSM after they had sold their assets with low cash burn. But I dont believe they are writing off assets. I don’t believe you can under the title accumulated deficit. It’s just a carryover from previous losses.

    2. I think you are right about the company selling itself. I don’t believe they will as well.

    3. I’m not too sure how VC’s work but since they have the cash, if they can find something cheap and of good value, INSM will definitely go up. I’m just glad that INSM is below it’s net net value. Huge inefficiency at the moment.

    4. I didn’t think about going into management background. Something to try and find out but is management even famous enough that we can search him up?

  • Mechanonuke

    A bit more:

    1. I agree. The accumulated deficit seems to be a running total of profits/losses over the years. But from the losses there did seem to be deferred tax assets that they used to write off the ~130M (which I assume is classified as a capital gain. Actually maybe only a portion of this is a true capital gain – i.e. what they sold at minus what they paid initially roughly.)

    From the latest 10-Q, Section 6.
    “At December 31, 2008, the Company had net operating loss (“NOL”) carryforwards for income tax purposes of approximately $288 million,
    expiring in various years beginning in 2009. The deferred tax assets of approximately $119 million at December 31, 2008, arise primarily due to
    NOL carryforwards for income tax purposes. The Company projects that it will be able to utilize a portion of these NOL carryforwards and
    deferred tax assets in 2009 and has projected income tax expense for the year of $2.8 million, consisting primarily of Alternative Minimum
    Taxes (“AMT”) to be paid.”

    It seems that a part or all of the $119M was used. I was only wondering if they had anything left which would be regarded as deferred tax assets, after the gain on the 130M and the last 2 quarters had been accounted for.

    I suppose we will see in the 2009 annual report shortly, if the same information is provided in section 6.

  • Mechanonuke

    New item.
    5. I also noticed that March 2010 seems to be a ‘deadline’ of sorts for a number of things.

    a)The 5.5% notes become due on March 1, 2010. Not a big issue since the company is flush with cash, and they have redeemed most of the notes allready. Only $461K outstanding at Sept 31, 2009. (It’s too bad that there isn’t a transparent and liquid market for the notes, as some value could be obtained there, if the notes are underpriced.)

    b)The outstanding warrants issued in 2005 expire. In their words: “In connection with our May 2007 public stock offering, the exercise price of the 2005 Warrants was reduced to $1.21 per share and the
    2005 Warrants are currently exercisable into the aggregate of 3,615,320 shares of common stock. The 2005 Warrants will expire on March 15,
    2010.”

    IMO, I believe that the management/directors are hoping that the share price increases to > 1.21 such that the warrants are in the money. A bit of speculation. There is a 2 fold hidden positive here. One one hand, by having the warrants, there is some hope that the share price will go higher in order to excercise them. On the other hand, come March 2010, and the share price is below 1.21, the warrants expire, and they can be taken off the books from the liabilities section of the balance sheet.

    c)The iminent issue of being listed on the NASDAQ, creates pressure on management to act by March 15, 2010. Therefore, a long wait will likely not be needed to see the outcome of their recent, and yet undisclosed M&A efforts. Tho there is also a possible reverse-split if they can’t find any suitable option in time (This could actually create more value). In their own words:
    “By letter dated September 15, 2009, we were notified by the NASDAQ Listing Qualification Staff (the
    “Staff”) that the bid price for our common stock had closed below $1.00 per share for the previous 30 consecutive business days and that in
    accordance with NASDAQ marketplace rules, we have been granted a 180-calendar day period, or through March 15, 2010, to regain
    compliance with the Minimum Bid Price Requirement. If we fail to meet the Minimum Bid Price Requirement by March 15, 2010, our common
    stock may be delisted from the NASDAQ Capital Market. If a delisting from the NASDAQ Capital Market were to occur, our Common Stock
    would be eligible, upon the application of a market maker, to trade on the OTC Bulletin Board or in the “pink sheets.””

    d

  • Mechanonuke

    New item.

    6. I wish there was more information on the IFLEX supply commitment that the company has to their 60 Italian Phase II patients. The words “court-ordered” are a bit ominous to me. Need to find out what exactly the court order states, and the implications to the company. Need to eliminate the possibility of litigation (i.e. increase in cash burn rate) if the company has been ordered to do something that that they cannot currently fulfill, having sold their ‘FOB’ mfg facilities.

    In their own words:
    “At present there are approximately 60 patients who currently receive IPLEX(™), 12 in the U.S. and the remainder around the rest of the world.
    Most of the patients receive IPLEX™ pursuant to a court-ordered Expanded Access Program (EAP) for Amyotrophic Lateral Sclerosis (ALS) in
    Italy. The 12 U.S. patients are being treated for ALS under single patient Investigational New Drug applications approved by the U.S. Food and
    Drug Administration. We believe that we have sufficient IPLEX™ inventory to supply these patients through 2010.”

    d

  • http://www.oldschoolvalue.com Jae Jun

    I really like your points on no.5.
    A short term catalyst in the works. Most companies usually do something in the short run to create news in order to raise the price above $1 and if their warrants are on the line as well, it would be extra incentive to do so.

    If they don’t do anything about the warrants, it could also mean that management ins’t concerned with short term greed and is really focused on long term shareholder wealth.

  • Mechanonuke

    Jae,
    I saw your latest post on INSM. Wow…Point #5 really worked out well. Both for management in that they may have exercised their options, reduced their liability (may actually increase the NNWC value) and made you a bit of paper profit (hopefully)
    Most excellent. Good on you.

    Actually, I was thinking about INSM about 5-6 weeks ago and didn’t get a chance to write in. The thought was more speculative/ psychology related; mainly, that with INSM’s market price at ~$0.80-0.85 level and well below the NNWC value, there was almost no downside due to: a) low cash burn rate, b) large cash asset, c) that management was/is in the process of M&A activity in a sector that is generally undervalued and cash strapped, and maybe most importantly d) that whatever plan that management came/comes up with will boost the perception in potential buyer’s mind (i.e. a merger would be taken as a positive; a liquidation and disbursement of proceeds would be a positive; declaring a new CEO would be a positive; reverse-merger would be a positive; a small ‘cautious’ takeover would be a positive). Frankly, the only negatives I could think of at the time were due to a higher cash burn rate an/or an unsuccessful takeover attempt of another company – each of which seems unlikely in INSMs (then) current operating state.

    d

  • http://www.oldschoolvalue.com Jae Jun

    Very true indeed. I remembered about the warrants as I was going over the 10-K at it’s right at the exercise price and since the shares have increased slightly, insiders have definitely been exercising their options.

    I doubt we will ever see INSM below $1 again, but still close to a double from here, provided some good things happen.

  • Mechanonuke

    I think you’re right about the double. Well at least from the $0.78 level originally posted.

    On a side note. Any chance of a ‘free’ give away of the premium spreadsheets. Or perhaps a need for a tester for beta versions?
    (Obviously no techsupport for the beta required)

    d

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