unilife - still bullish after q2 2014 earnings

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Disclosure: I am long UNIS. (More…)

Earlier this week, the medical device company Unilife (UNIS) reported second-quarter results. The initial takeaway is that the story has not really changed, but we did have further confirmation of a potential debt deal in the works. In the words of CEO Alan Shortall (from the conference call):

Given our favorable outlook for 2014 and beyond, I reiterate that we have no intention of doing any type of large secondary offering. It is also my intention to avoid using the ATM in the foreseeable future. Shall we wish to strengthen our cash position outside of receipts from customers I expect it will be via a debt financing program with a leading global healthcare investor.

Unilife generated $5 million in the first quarter of 2014 from milestone payments, and a little over $6.2 million from their ATM facility. Adding this to the $7 million in cash they had at the end of 2013, we can assume (based on previous cash burn) that the company will continue to run into the end of the second quarter until they need debt financing. This buys them some time to negotiate very favorable terms for their debt financing, which should generate enough cash to bring the company into profitable territory.

The bears continue to believe that the company will need significant ATM financing to survive into the next quarter, but the numbers aren't pointing to this conclusion. Unilife invoiced an extra $20 million in the first quarter of 2014, which is added to the $4.3 million recorded in cash at the end of 2013. This is enough to bring Unilife to the end of the second quarter of 2014, so we can say that the company has about three to four months of operating based on current cash.

This is a generous amount of time for finalization of a debt deal. I will not deny that Unilife is giving us very little information on new or undisclosed supply contracts, but it's ridiculous to assume that they are being fabricated by company management. There are many competitive reasons to hold off on press releases that reveal information on existing supply contracts.

2014 Upside on Additional Big Pharma Contracts

Unilife has done an incredible job of convincing larger pharmaceutical companies to choose partnerships with them (and their product line). The known contracts that have already been disclosed (according to the recent quarterly earnings press release, linked to above) include:

Hikma Pharmaceuticals (HIK) for Unifill prefilled syringes
MedImmune/AstraZeneca (AZN) for Unilife wearable injectors
Unnamed company for Ocu-ject
Novartis (NVS) for use with an unnamed product designed for an early-stage indication
Sanofi (SNY) deal for Unifill syringes
As mentioned by the company during the earnings call, additional details on some of these contracts is not public information for competitive reasons. For example, if we look at this from Novartis' perspective, it would make little sense to allow Unilife to release information about a secret product/device product being developed to replace an existing therapy/procedure. However, there is little harm in disclosure of the contract itself.

With larger amounts of revenue from the Hikma prefilled syringe deal coming later this year, it seems likely that the company will go cash flow positive in the second half of 2014. But the bigger value driver of 2014 (in my opinion) would be the continued disclosures of big pharma supply contracts. Unilife investors have reacted very positively to these contracts upon their disclosure, and I see them as validations of the company's product line and as future revenue generators.

Short Sellers Are in Greater Danger of Seeing a Squeeze

Another factor that helps my position in Unilife is the enormous short interest in UNIS. 19.7 M shares of UNIS were short on Jan. 15, which is representative of 20% of shares outstanding.

If you check the history of UNIS short interest, you can see that there has been a consistent rise in short interest throughout 2013. If you check the price history, you can see that UNIS went from $2.33 to $4.40 per share by the end of the year. Based on this and the interest that is accumulating on these short positions, we can say that the majority of UNIS short positions are currently underwater (to varying degrees).

What makes it more dangerous for shorts going forward is the recent decrease in volume and the potential for a debt financing. Thin volume can be a serious issue for short sellers looking to exit large positions, since they are forced to buy back shares. If the position is large enough, and if the volume is thin enough, the "hole" will get bigger for a bear as they continue to exit the position. It is because of this liquidity issue that short squeezes can be so impactful on share price.

The second dangerous aspect of the short trade is the potential for a debt financing, which would eliminated the need for ATM financing. This seems to be a big part of the short thesis.

Unilife's Financing Options

As discussed on the earnings call, Unilife has the option to pursue non-dilutive debt financing from large and well-established firms. The company will not be able to announce the deal until it actually goes through. It's impossible for outsiders to determine exactly when this will happen, but we are expecting this within the next three months.

The reason that debt financing can take a long time is due to the vetting process, which requires thorough examination of every aspect about the company. This can take months, depending on the size of the company. Unilife, a company currently trading at a valuation of $394 million, might take a while to fully understand.

When the debt financing does occur, the misguided argument that Unilife does not have proper IP protection for its products will be nullified.