Letter number 121 of July 2019

  • NEW

News : Interview with the Finance Director of a listed biotech company

As the authors of the Vernimmen, based solely on the fact that we’re interested in finance, we are lucky enough to meet people who are really passionate about it. This month, we want to share our conversation with Cyrille Tupin, finance director at Cerenis Therapeutics, a listed French biotech company. Cyrille Tupin has held this position since Cerenis was set up in 2005[1]. After starting out in audit (independent and Big 4 audit firm) in France and internationally (Canada), Cyrille Tupin decided to join a new start-up.

What’s so special about a biotech company?

Yes, a biotech is a rather special type of animal:

  • It only has costs and no sales.
  • Product development takes a very long time, 5 to 10 years at least, and requires large amounts of money (a Phase II study on a therapy costs around €30-40m) with potential earnings only realised in the long term.
  • The probability of projects being discontinued is not zero which means that the volatility of future results is very high.
  • It is practically always raising funds.
  • Its business is very complex and difficult for non-specialists to understand.

Can you give us a brief description of the products being developed by Cerenis?

Cerenis is developing therapies based on HDL (High-density Lipoprotein or “good cholesterol”. The company has a portfolio of several products in different stages of development and targeting different pathologies (cardio-vascular disease, orphan metabolic diseases and cancer).

Tell us about the funding stages Cerenis went through.

Cerenis went through the standard funding stages for a start-up: series A, B and C and an IPO. Briefly:

  • Series A brought in funding for the initial production of HDL.
  • Series B funded Phase I and half of Phase II of a treatment aimed at reducing the risk of cardio-vascular disease.
  • Series C funded the end of Phase II and the development in orphan diseases.
  • The IPO in 2015 raised funds to obtain liquidity and also to fund a second Phase II for cardio-vascular diseases and Phase III of the orphan diseases treatment.

Cerenis has raised a total of €170m.

What are the pros and cons of venture capital funds having a stake in the company versus a fragmented shareholder base?

Venture capital funds (BPI France, Alta, Sofinnova, Healthcap, TVM Life Science) are generally on the Board of Directors (they typically have more than 10% of the capital). They are also very involved and employ professionals specialised in biotechnologies. On the other hand, funds that have a more “tax-break” approach are passive and make no contribution to reflection and developments. They can even be a handicap when the funds mature and there is heavy pressure to provide liquidity.

Interacting with specialised funds is very enriching and, in our case, when the funds exited, independent directors replaced the funds’ representatives. In my opinion, this is often a second-best solution as some independent directors clearly do not have the same motivation. This is why, at the time of the IPO and the 2018 capital increase, we gave members of the Board the opportunity to invest in Cerenis shares.

How much of your time do you spend on fundraising?

I’d say 30% or 4 years spent fundraising (out of the 13 years I’ve been with the company). But far from being repetitive, the diversity of the investors (early stage funds, specialised biotech funds, private individuals, etc.) and the company’s situations (launch, R&D breakthrough, failure of research programme and redirection) make it a fascinating exercise.

I’m a sort of emergency room doctor for finance, always prepared to swing into action to raise funds when there is an investor interest as valuations in the biotech sector can rise or drop very suddenly. It’s difficult to raise funds when your share price has just fallen by 50-75% following disappointing clinical trials. When money is available, you have to take it as companies don’t die from having too much equity, but from having too little.

In your view, is being listed an advantage or a drawback for Cerenis?

First I should say that it was a natural development that was necessary for us. Venture capitalist funds had financed our development over 10 years or so, but in 2015 we were getting to a stage where they had to obtain liquidity. The stock market was very attractive for biotech companies (2014 was the year in which the largest number ever of biotech companies listed their shares on the stock exchange, over 70!) and the IPO enabled us to raise €53.4m. There were “traditional” asset managers (specifically JP Morgan Asset Management and AXA Investment Managers) that came on board. The public also took an interest in the company.

Following the failure of the cardio-vascular diseases second Phase II in March 2017, the share price fell sharply. The company’s market capitalisation was then too low to be of interest to traditional asset managers. So they exited, sometimes very suddenly. With the exception of the remaining stake held by some venture capitalist funds and management, the capital is now mainly held by retail investors, often with small shareholdings.

The risk is that the share’s low liquidity will now lead to very high volatility, even if there is no news on the progress of clinical research.

But we’re not looking for excuses. If one of our research programmes underway is successful, we’re going to have to list our shares on a US market because it’s in the US that this model for externalising medical research to small entities like Cerenis was invented, and that’s where there are funds that are able to put up much larger amounts than here and with real medical expertise among specialised investors, something that’s hard to find here, except maybe at BPI.

What explains the fact that small retail investors are shareholders of Cerenis?

These investors, who together hold just under 50% of our capital, often feel impacted by what we’re doing. They want to contribute to the progress of medical research and they want their money to help to find a cure for cancer, prevent strokes or treat orphan diseases. Sometimes they themselves or their family members have been confronted with the diseases for which we’re trying to find treatments.

What phases were the most complicated for you to manage?

Unsurprisingly, the headcount reduction which followed the failure of the cardio-vascular diseases Phase II was a defining moment. We went from 120 people including consultants and subcontractors to only seven today. Today headcount is reduced to the bare minimum so that we can minimise cash burn on anything that is not directly related to clinical studies. The definition of my role as finance director is thus very, very broad, but that’s also what makes it so exciting!

And the next steps for Cerenis?

Cerenis’ management is convinced that HDL-based therapies have medical potential that has barely been explored.

Developments in orphan diseases are clearly the most promising in the short term. Although the underlying market is small, success in this field would enable us to prove the effectiveness of HDLs which would revive interest in developing treatments in the cardio-vascular field.

We recently raised funds from management, the directors and a few investors to fund the first steps in finding out whether HDLs could be used to deliver treatments in oncology and make them more effective.

The failure of phase III of the orphan diseases programme led the Board of Directors to assess the various strategic options open to Cerenis. From among these options, Cerenis decided to enter into exclusive negotiations
with another company on a possible merger through absorption. The aim is to integrate a new drug candidate in order to relaunch research and development and at the same time, maximise the value of the existing portfolio for investors.

That said, let’s not forget that the ultimate goal of biotech companies is to improve patients’ wellbeing and quality of life. This is why betting on biotechnologies is not what’s risky, it’s betting against them that is.

Before being acquired by Johnson & Johnson for $30bn, Actelion experienced two phase III failures and nearly packed the whole thing in. So, we’re allowed to have hope and as shown by our share price, the jury’s still out.


[1] Since our interview, Cyrille Tupin has been appointed Deputy CEO.

Statistics : Capital structure of different sectors 2008-2018

Net debt / EBITDA graph shows that level of debt has materially increased in all sectors. Stronger increases are for the Telecom sector (net debt to EBITDA jumping form 1.9x to 4.4x) and the Energy sector (from 1.3x to 3.6x).

Increase in leverage seems much less while looking EBITDA to interest. This is obviously due to the sharp decrease in interest rates. Therefore, debt level seems sustainable…

as long as interest rates do not increase again.

Research : Cash over the very long term

With Simon Gueguen, Senior Lecturer at the University of Cergy-Pontoise

When seeking to explain recent phenomena, a long-term analysis is often very helpful. Since the early 1980s, we have seen a major increase in the share of cash as a percentage of total assets. For US companies, the liquidity/total assets ratio rose from 10% in 1980 to over 20% today. Graham and Leavy[1]  decided to analyse this trend by taking a very long look back in time and studying corporate cash determinants going right back to 1920.

This increase in the amount of cash that companies are keeping on their books is generally explained by the increase in volatility of cash flows (resulting in companies keeping cash as a precautionary measure) and by the decrease in the opportunity cost of cash (i.e., interest rates). But the historical approach used in the study helps provide a better understanding of the trend. Graham and Leavy studied US listed companies (on the NYSE, Amex and the NASDAQ) between 1920 and 2014.

The first observation, simple but crucial, is that the increase in corporate cash is only real if companies are equally weighted. If we look at the same ratio in an aggregated manner, the increase is barely perceptible. The explanation is simple: the whole of the increase is attributable to small growth companies that have been listed since the 1980s (mostly on the Nasdaq). Over the same period, for existing companies, there is no increase in their corporate cash.

Next, Graham and Leavy show that, company by company, the factors that impact on the amount of corporate cash have remained virtually unchanged for a century. For example, companies that keep the most cash are:

  • Very small companies as they have a higher cost of financing and they need cash for future projects.
  • Companies with a market value that is higher than their book value which is an indicator of investment opportunities.
  • Companies with the most volatile cash flows as they need available cash in case of a shortfall.

With regard to corporate cash aggregated over a century, purely macroeconomic figures (interest rates, economic growth) do not provide much explanation. Three factors dominate and alone explain 48% of changes observed: companies’ cash flows (aggregated), investments and productivity[2]. These results suggest that the level of corporate cash varies mostly on the basis of their revenue and investment expenditure. Although target levels may exist, there are major fluctuations around these targets depending on cash inflows and outflows.

Finally, Graham and Leavy confirm that a substantial portion of the increase in corporate cash since the early 2000s is linked to US taxation and cash repatriation (cash blocked in foreign subsidiaries). An increase that was just as spectacular was seen in the 1930s and 1940s but there is a different explanation for that. Companies needed available cash in a context of international crisis and conflict.

The general message to take away from the article is that the increase in corporate cash at listed companies is generally attributable to new entrants and tax considerations. So a conclusion should not be drawn that there has been a radical change in the way that companies manage their cash.


[1] J.-R. Graham and M.-T. Leavy (2018), “The evolution of corporate cash”, Review of Financial Studies, vol. 31, pages 4 288 to 4 344.

[2] Measured here by the ratio of sales to total assets.


Q&A : Riddles for the summer

You will find answers at the end of this section.

1 - If the question "one bird in the hand is worth two in the bush (in a year's time)": what is the discount rate used by common sense in this saying? should not be a problem for you, will you be able to find the monthly interest rate with capitalized interest after one month equivalent to this actuarial rate?

2 - Thanks to your hard work, and also to the reading of the Vernimmen you must confess, you have identified a company that seems very promising to you with inexpensive shares. You buy 10 of its shares for 50 € each. Three years later, the price is 600 € and you consider that the perspectives that the company traces are still poorly reflected in its price. So you decide to buy an additional 100 shares for €600 each.

One year later, the price reaches 1000 € and you decide to sell all the shares at that price.

Which of the 2 purchases, the first or second purchase, was the most interesting from a financial point of view for you?


3 - Which large country has average payment terms exceeding those of Greece (90 days) and Italy (86 days)? 

4 - You have an investment project to carry out in the Maldives and you want to get into debt for 7 years in local currency. 
You have received two proposals: 
The third bank in the Maldives Islands offers you a loan of 10 million over 7 years at 7% provided you make a deposit of 5 million over the same period, with interest at 3%.
An investment fund offers you a loan of 5 million over 7 years at an interest rate of 12%.
What is your choice? Why? Does the bank deposit of the first solution qualify as cash under IFRS? And in finance, are you justified in including it in the calculation of net debt? 

*       *      *

1 - The answer to the first question is 100% (= (2-1)/1).

The answer to the second question is 6%, not 8.3% (which is only the proportional rate, but not an equivalent rate), because (1+ 6%)^12 = 2 which is the ratio between the future sum (2) and the current sum (1). If necessary, chapter 17 of the Vernimmen is there to refresh your memory.

2 - You have made a great investment by buying 10 shares at 50 €, which 4 years later are worth 1000 €. Your IRR is 111%. On the second purchase, your IRR is much lower (67% in one year) while being very correct! But it is nevertheless the most interesting one from a financial point of view for you. It is the one that has enriched you the most: €40,000 compared to €9,500 for the first.

Here we find the idea that net present value is a better indicator than IRR for comparing two investments. Having a very high rate of return on a small amount of money makes you feel good. It is certainly an intellectual satisfaction, but it will not change your life. It is better to have a smaller IRR on a much larger amount.

3 - Well, this is China with 92 days where one in four companies is paid four months after delivery (Source Euler Hermes).

4 - The first proposal costs you 700,000 - 150,000= 550,000 per year compared to 600,000 for the second. But that's not enough reason to accept this first offer, because you know that in finance you can't separate risk from return, and return from risk. 

The first solution involves a credit risk of 5 million on a bank whose solvency is probably difficult to assess for a corporate financier, especially since the Maldives is probably not Switzerland! It is better to pay 50,000 more each year than to take that risk. 
A deposit with a term of more than 3 months cannot qualify under IFRS as a liquid asset. It will be a long term financial asset.
In valuation, it will qualify as a reduction of financial debt. In financial analysis, we are more in favour of leaving it as a non-operating financial asset.


New : Comments posted on Facebook

Regularly on the Vernimmen.com Facebook page[1] we publish comments on financial news that we deem to be of interest. Here are some of the comments published over the last month.


Imperial Brands will pay less dividends than expected and invest more in future products

The twelfth largest dividend payer in the United Kingdom, cigarette manufacturer Imperial Brands (Winston, Gauloises) has just announced that its dividend will no longer increase by 10% per year as it has been doing since 11 years now in order to be able to finance additional investments in its e-cigarette division, which seems to have a brighter future than traditional cigarettes.
The stock market price did not collapse, it rose on the day of the announcement and rose by more than 3% over the week.
A new illustration that investors are first and foremost looking for value-creating investments, rather than just dividends.


FCA Renault merger

If it is achieved (we are talking about a closing in autumn 2020, in almost 18 months' time), the new group would align, without taking into account Nissan and Mitsubishi, 8.5 million vehicles sold per year with the Fiat, Chrysler, Renault, Alfa Romeo, Jeep, Dacia, Lancia, RAM, Lada, Abarth, and Samsung Motors brands. Based on current prices, its market capitalization would be €33 billion, only 40% higher than that of Ferrari (€24 billion), which sells 10,000 cars per year (sic), and half that of Hermès. Impressive, isn't it? It is true that the 2019 P/E ratio of FCA and Renault, which are in cyclical segments, is 4, compared with 38 for Ferrari and 46 for Hermès. 

With operating margins of 24%, Ferrari is perceived as a growing luxury brand and valued as such (Renault and FCA have a 5% operating margin, Hermès 35%).
Ferrari was demerged from FCA in 2016, which is making possible today for FCA and Renault to announce a marriage of equals, at least in terms of market parity.


Shares can have a negative value!

This is always a source of surprise for our students, but it can sometimes happen that the seller is obliged to pay the buyer for the buyer to agree to buy its shares. In other words, this results in a negative selling price for the shares of the company sold. We had another example last week when the retail group Auchan sold its Italian subsidiary (€3.6bn in sales with 14,600 employees), which has been losing money since 2011, for a negative price representing, according to the statements of the Auchan CEO, 2.5 years of losses for its Italian subsidiary. 
Technically, the seller recapitalizes the company to be sold through a capital increase which, in this example, brings the cash net of all financial and bank debt to 2.5 times the losses. Then the seller sells the shares to the buyer for one euro. The buyer then finds in the acquired company the financial means to finance part of the turn-around. By recapitalizing the loss-making subsidiary, the seller makes an investment with a short payback period (2.5 years for Auchan). This type of outcome is often preferred to a liquidation that could cost it less, but would not be without consequences for its image and would be in contradiction with socially responsible behaviour, especially if the group is otherwise profitable.
It goes without saying that this is only possible when the company to be sold is an unlisted company, as in the case of Auchan's Italian subsidiary.


Vodafone reduces its dividend by 40%.

Another example that shows that, no, companies faced with the choice between making investments and paying dividends do not choose the dividend over investment, whether those who consider the economy as a field in which to deploy their ideologies and not as a field of facts like it or not.

It was the second-last European phone company not to have reduced its dividend, Swisscom being the last one. Vodafone will thus be able to finance more easily the deployment of 5G in Germany and Italy, its acquisitions in Germany and Eastern Europe (Liberty Global's cable assets for €17.5 billion) while facing the burden of a net debt that will become more significant (currently €27 billion, or about twice EBITDA).

Investors knew that this choice would be made because when a company as Vodafone has a dividend yield (dividend/price) of 9%, it is clear that the dividend is not sustainable, unless the company enters a liquidation process that is not the one chosen by Vodafone. In the UK, where investors are very attached to the dividend, because it finances pensions (capitalization system and not repartition system), cutting a dividend is always complicated, above all when the company pays a large dividend (Vodafone pays the 7th largest dividend on the London stock exchange).


[1]  Like it here