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Stone Street Advisors, Stone Street Advisors LLC (14 clicks)
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Initial Thoughts On Unilife's New Debt Financing
Mar. 18, 2014 6:38 AM ET | About: UNIS
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary

The debt is a $40mm 6-year term loan with terms leaning heavily in favor of Orbimed.
There are 2x $10mm additional tranches in each of the next two years, subject to terms & conditions.
Severely increases UNIS' debt ratio (D/E) while making debt service coverage (EBITDA/debt payments) even more negative.
UNIS will be paying up to 4% in royalties to Orbimed.
The deal essentially buys UNIS time, while putting the company under further financial distress and giving up a not-insignificant portion of revenues.
Since I started looking at Unilife (UNIS), I've been extremely concerned with the company's liquidity and solvency situation. They've been burning through cash like it's going out of style and operating expenses are already very high and have kept growing at a fast pace. Operating losses every year meant the company already has significant negative debt service coverage ratios (i.e. they burn cash to pay debt service rather than using operating income to pay interest/principal). At the end of the last quarter (Dec 31), they were already highly levered with a Debt/(book) Equity ratio of ~0.74, placing UNIS in an elite group of companies --- 0.74% of the 6,795 stocks in the Finviz.com database -- with such high leverage and negative margins.

Since the press release didn't provide much information about the terms of the financing arrangement, I'm going to make a few assumptions based off my experience as an Investment Banker (credit origination/structuring) and years of experience as an analyst. We know a few terms: 6 year tenor, interest-only payments at 10.25% current rate, and $10 million additional in December 2014 and another $10 million in December 2015, along with UNIS giving up 2.75% (max) royalties on revenues to OrbiMed (this figure changes).

That is what we know, but from that and other material in the press release we can make some further conclusions with a fairly high degree of confidence, at least until UNIS files the credit agreement with the SEC. CEO Shortall said UNIS chose to only take $40mm upfront. This is nonsense. I can virtually guarantee you that OrbiMed was dictating every single part of the deal terms and they, not UNIS, structured the deal thusly.

Moving on…

After reading the 8-k filed Friday last week, I think it's a fair assumption to say this debt is senior secured first lien (pari passu) with the mortgage with Metro Bank UNIS already has secured by substantially all of its PP&E, since OrbiMed wouldn't likely lend without being at the very top of the capital structure. Interestingly, UNIS seems to be using at least some of its key intellectual property (patents) as security for the Orbimed loans through Unitract Syringe Pty Limited in addition to other (physical) assets. I didn't expect this, but in hindsight it makes sense. If UNIS defaults, Orbimed will be able to go after not just the physical assets but IP as well. Given their expertise in biotech, and their existing portfolio of firms, they may actually be able to monetize the IP better & faster than UNIS can if the company defaults! (not joking)

The 8-k provides further information on the rate on the new debt; the greater of Libor+925 or 925+100bps (floor of 10.255) with L+1425bps in event of default, although default requires UNIS to repay 100% of the outstanding loan amounts. (This will be clarified in the credit agreement to be filed with the next 10-q). Asset sales and other actions by UNIS require immediate payment to Orbimed of the net proceeds received. Voluntary payments can be made at any time, but are subject to a 6% prepayment premium (i.e. penalty). By giving up 2.75% of revenues to OrbiMed on the first $50mm in revenue, an additional 1.0% on the next $50mm, and 0.25% on any revenue > $100mm, UNIS is effectively giving up part of the company (read: effective dilution) as stockholders will be getting that much less (up to 4% less) EPS, and that much less money with which to make interest (and principal) payments on their debt. Since UNIS previously had little cash on their balance sheet and will continue to have operating losses for the foreseeable future, they'll be using the proceeds from this deal to make interest payments on the existing and new debt, which should come in around $6-10mm/year going forward.

This brings me to my next set of questions/points.

The pre-existing debt contained customary incurrence and maintenance covenants (e.g. debt service coverage ratio above X EBITDA/debt service, total or long-term debt/book equity below Y, limits on issuing new debt, etc). I haven't read the credit agreements for all of UNIS' debt but I find it curious that a 200% increase in long-term debt from 12/31/2013 that decreases (ceteris paribus) debt service coverage and severely increases the debt ratio doesn't violate any of the covenants on the pre-existing debt.

The 8-k says UNIS amended the terms of its agreement with Metro Bank and repaid some of that debt with the proceeds of the Orbimed loan (net proceeds came out to $31.4mm), refinancing part of the Metro mortgage. If we want to be optimistic, UNIS was able to renegotiate terms on pre-existing debt with lenient incurrence/maintenance covenants, and the Orbimed loan covenants are similarly loose.

Given the content and language in the 8-k and other terms which are in favor of Orbimed, I don't think this is the case, however, as UNIS would likely have elaborated if it was. That said, UNIS must, pro-forma, be pushing the covenants on its pre-existing debt close to the point of technical default, since they'll now be running with negative debt coverage for at least the next 18-24 months (likely longer), and not far away from breaching the covenants on the new debt. Book long-term debt/equity also ramps up from ~0.74 (high) to 2.25 (VERY high), making UNIS the 23rd most highly geared company with operating losses per Finviz.com database and putting it in the 96th percentile (that's bad) among all stocks by LT debt/equity.

This new debt may help the company keep operating another year or so, at best (UNIS lost $41mm in just 9 months last year), but absent a(ny) new large deals with significant up-front revenue and product sales - UNIS has been poor at ramping up their production and actually selling product - this debt financing isn't the super fantastic development longs are making it out to be. As I and others have explained in exacting detail, UNIS isn't hitting milestones or signing new customers as promised, and there's no sign that they will any time soon. Ultimately, the question boils down to whether UNIS will be able to actually make major progress before the money runs out or they breach one or more covenants.

As always,

CAVEAT EMPTOR