Synergy Pharmaceuticals ‘Evaluating All Options’: Does That Mean A Formal Strategic Review?

Investment Thesis

Despite the missteps by Synergy (SGYP) management that have taken a toll on the share price for more than a year, it remains there is little doubt that Trulance is a highly differentiated product with a patent extending until March 2032 and it remains only one of three FDA approved products within a market that is projected to reach $3.2 Billion by 2021.

While avoiding the elephant in the room (the shareholder insurrection over performance), in the most recent conference call Synergy CEO Troy Hamilton sought to address the issues by stating:

Our management team, along with our Board and (unnamed) advisors, will focus on identifying, evaluating and executing on any and all strategic opportunities that have the potential to maximize near and long-term shareholder value.

While some may believe that the company looking at “any and all strategic options” going forward is a step in the right direction, I would argue that speaking in generalities about options lacks the specificity needed. Rather than the generality of “all options,” the company needs a clearly defined and focused formal strategic review to ensure the company arrives at the single best option.

A Grounded View of the Situation

What was missing were the words I longed to hearWe are conducting a formal Strategic Review as a means to offer clarity on the companys longer term direction. I would also have liked to hear Synergy had hired some notable firm to aid in the process. But, we are talking about Synergy managementsono such luck.

Having long ago suggested the choice for Synergy was not in going it alone, my concern with management causes me to wonder aloudDo they really know where are you going, and how will they know when they get there?

Lets talk about the FDA approved products in the market.

Prior to Amitiza (2006) and Linzess (2012), it was basically diet, Raisin Brand, Wheaties and Metamucil that were prescribed by healthcare providers. Although Amitiza was the first FDA approved product and has grown to about $450 Million in annual revenues, it was Linzess that soon set the pace in prescriptions for the IBS-C and CIC market. In 2013, its first year of sales, total revenue for Linzess was about $117 Million. By 2015, after the move to direct to consumer marketing, Linzess had grown to $445 Million. In 2016, sales increased to $626 million and 2017 saw robust growth continuing as Linzess brought in $701 Million; and Linzess growth continued in the first quarter of 2018, with revenues up 8%. By the way, Allergan’s (AGN) claim of an 8% increase over the previous quarter is an interesting juxtaposition to slide #5, line 3, on the Synergy 2018 Q1 Earnings Call Slides, which says that Trulance is the only CIC/IBS-C brand to show a positive growth quarter over quarter. It does cause one to pause and reflect whom should we believeAllergan or Synergy?

If you doing the math, Linzess has seen a 6X increase since its introduction. And, in the belief the best is yet to come, Ironwood (NASDAQ:IRWD) (the developer) and Allergan (the commercializer) tout the drug as having the potential for $2 Billion in annual sales.

Alas, at its current rate of growth, it will take Trulance three years to roughly achieve the sales of Linzess in its first year (which is roughly the current sales of Amitiza, developed by Sucampo Pharmaceuticals, Inc and acquired by Mallinckrodt (MNK)). As if not problematic enough, for Trulance to achieve the $701 Million in revenues Linzess reached in four years, it will take Synergy forever! Okay maybe not forever because they do not have forever. Their patent protection ends March 2032 and revenues tend to roughly peak about 5 years after commercialization begins.

Now, beyond lagging the leaders, Trulance sales raises a more immediate issue. Synergy needs $61 million in sales this year or it will be forced to repay back the CRG loan immediately. However, at the current scripts rate, it will be impossible to achieve this goal even if sales doubled beginning in the third quarter. Still, lets pretend it does hit $61 Million and shareholders have no fear of default. So, at that pace of sales it would take Trulance about 7.5 years to hit the current Amitiza annual sales. And, if you are counting, getting to the current Linzess sales would require over 12 years; which leaves about 2 years on the patent life. Just saying!

So is there any doubt why shareholders are unhappy? Well, that and the architect of the sales and marketing approach that got the company to this point is the very person operating as CEO (Troy Hamilton), while the former CEO (Gary Jacob) is now Executive Chairman, a role that scarily infers operational input; but I digress.

My point is that this does not engender confidence because these are the very managers that have made and will make the strategic decisions and, to be certain, strategic decisions are never simple to make. Moreover, they sometimes go wrong because of human shortcomings due to gaps in education and/or experience; which creates distortions and misperceptions often resulting in over-optimism, over-confidence, risk aversion, misunderstood time horizons, and under-estimation of risks and challenges. Or, exactly what we have seen from Synergy senior management.

Yet, we are told that much is under consideration by management. Are we investors to take heart or not? Well, why not use Troy Hamiltons own words for consideration?

During my transition to the CEO role in the first quarter, I worked closely with internal and external stakeholders to better align our organization with our core mission of creating exceptional value for our patients, customers and shareholders.

I cannot help but admit it is true that the value for shareholders lay with the cheap shares being offered for sale, specifically, at more than 3X lower than when Trulance was approved. (Okay that was a derisive comment, but there is more from Hamilton to consider.)

Now let me elaborate on some of the other potential opportunities we are evaluating. In the U.S., these options include potential partnering for Trulance to more broadly reach into the primary care market, as well as bringing in other products that could leverage our commercial infrastructure and GI expertise to drive revenues without the need for a larger infrastructure. Outside the U.S., we continue to pursue licensing deals for Trulance in markets with favorable commercial dynamics, like we did with Canada. And finally, on a corporate level, we are actively evaluating different options to enhance our pipeline like the partnership with the National Cancer Institute, while also actively working on strategic transactions such as potential partnerships and M&A. Our management team, along with our Board and (unnamed) advisors, will focus on identifying, evaluating and executing on any and all strategic opportunities that have the potential to maximize near and long-term shareholder value. We expect to provide further updates on or before we report our second quarter 2018 results.

Good, Synergy has established a deadline and, in so doing, created expectations. But you know what they say about deadlines? They better not be missed or management credibility would take another hit that it could hardly afford.

Now, Hamilton’s words might sound reasonable to some. To me, they seem more aspirational than how one would phrase a thoughtful strategic review. But, I could be wrong. So, how about a comparison? Why not the words from the CEO of Allergan? For that, I give you Brent Saunders. Yes, the CEO of the commercialization arm of Linzess; which, by the way, was up 8% in the most recent quarterly report (but I said that already). Here is how he discusses an actual strategic review

So against this backdrop of strong business momentum, consistent execution and capital allocation, it is clear that there is a disconnect between our business performance and stock performance. We announced last month a review of strategic actions focused on unlocking shareholder value and frankly there is no better time to do a strategic review than when the underlying business is solid. As such, we are evaluating a range of strategic options in comparison to the business outlook and the inherent value of the company.

Now, did we hear Troy Hamilton invoke the words strategic review? No, we did not. So, is Synergy doing a strategic review or drawing up a wish list? To be clear, capable managers do the former in a planful manner, while at Christmas, kids do the latter in a playful manner.

What is a Formal Strategic Review?

If interested, you can pay Harvard Business Review $9.50 for the right to read an article about it. However, if you have read this far why not allow me to offer my educated view?

Although less complex than some may think, a strategic review does take time to complete because a company must assess whether they have the capabilities necessary to take advantage of a competitive market they seek to compete within. Only then can the strategic review result in identifying the options available and make clear the choices that provide the best opportunity for prospective success.

A strategic review begins with the understanding that the company will take action. So, at its essence, a strategic review is a decisional document and that means it must contain facts. But, what facts? Generally, there is a range of facts that a strategic review seeks to uncover and the discussion of them below should make it clear why there is a need for outside advisors more capable of avoiding the groupthink that pervades all too many organizations. Among the areas to consider are the following:

Business plans: Are they supported by logical strategies that offer the opportunity for success? What is the size of the employee base? Are their existing capabilities and knowledge sufficient to enable the company to carry out the planned strategies? (Size matters but so does knowledge because it informs capabilities and engages relationships with buyers.)

Organizational structure: What does the organizational structure look like? Is it effectively supporting the business based on some measures of success (e.g., revenue growth)? Can it support business development in the future why/why not? How productive is the business operationally? What does their supply chain look like is it efficient or inefficient, why? What are their related costs? What contracts might they have and how would change of control affect them?

Market: Is there a profitable market for Synergys products? What is the market growth potential (we know it is significant, as the product market is dominated by non-prescriptive palliatives)? What is the product market geography regional, national, international? How will Synergy’s products fit into the market? Will it require stealing share from market leaders or is the market growing organically? Who is the competition and what is the competitive environment? Are there barriers for new entrants, what are they, and are the resources available to fully commercialize upon entry? Do they have the requisite customer relationships? Are there acquisitions within the industry and/or product market and what has been the effect?

Financials: Is there revenue and is it recurring and consistent over time? Are there one time revenue or expenses to be considered? What do their financial statements look like for the past five years? Is there debt what kind? What does their cash flow look like? (These are major issues when considering Synergys cash burn rate and what is needed to get to cash flow positive. This demands a realistic assessment of the revenue stream over the next 3-5 years including product pricing, as it will determine financial needs and could lead to dilution, default or other credit issues.)

Cost structure: What are the expense trends? What has happened with G&A leading up to and subsequent to commercialization (this would involve evaluating the decision to bring sales and marketing in-house and incurring the subsequent fixed costs)? What is the companys fixed asset value? Is capital improvement needed, where and how much would that be?

Value Chain: Synergy has an incomplete value chain and, as such, outsources its manufacturing, which adds to the cost structure. As Synergy has duly noted, if any of their suppliers were to limit or terminate production or otherwise fail to meet the quality or delivery requirements needed to satisfy the supply, the process of locating and qualifying alternate sources could require several months to scale up and would create production delays. Moreover there is only a single source of API, which creates production risks. Further, if Synergy changes or adds manufacturers, the FDA may demand approval of the changes, which could require new testing by the manufacturer and compliance inspections to ensure the manufacturer is conforming to all applicable laws and regulations, including good manufacturing practices, or GMP.

Intellectual Property: What patents does Synergy hold and for how long? (We know Synergy has an extended patent to 2032 on Trulance. This is important as it affects decisions about partnerships and M&A opportunities.)

Information Technology: What are Synergys systems and how do they enable business operations? Is there need for greater investment in IT?

Fixed Assets: What is the net book value of Synergys assets?

Liabilities: Are accounts payable up to date if not why not? What leases exist and what are the agreements? What debt exists and what effect might change of control have on it? How would change of control affect the loans? Are there unrecorded liabilities lawsuits, guarantees, fees and what is the nature of them?

Equity: How many shareholders are there? What are the classes of stock? Are there options, warrants, preferred or restricted stock and what is the conversion rate? Are there any stock buyback obligations?

Taxes: Is Synergy paying the correct taxes? Are there any undisclosed tax liabilities?

Sales & Marketing: Does Synergy have the marketing capability to get products to a broad range of customers? Does the company have recognizably branded products and does current marketing meet the product market commercialization needs for now and the future why/why not? (This is a main area of concern, as managements view of effective commercialization seems to be in conflict with the shareholders view of robust commercialization, based on a comparison with Linzess and Amitiza.)

Legal: Does Synergy face any legal issues current lawsuits? Have there been previous lawsuits for what reasons and what was the outcome? What contracts exist and what are the commitments and over what time? What are the charter bylaws, board minutes, audit committee minutes, shareholder minutes to be reviewed? How might they affect partnerships or the sale of the company?

Based on the above being included in a formal strategic review, there should be sufficient clarity about the next steps toward success. Of course, how one defines success depends on whether one is a shareholder or member of management. Still, what is left is critical to business success and requires the evaluation of the capabilities possessed by Synergy, within the context of the market opportunity, that enables a projected assessment of the potential value of the firm.

To be certain, value has nothing to do with market cap. The market cap of a firm is merely a calculation tied to stock price and the number of shares outstanding, which does not take into consideration the various assets of the company, including its pipeline potential. So, the question of value is about determining how the company can best employ its assets in ways that are aligned with the market opportunities and, in so doing, determine how the company can best deliver value to shareholders. In short, it is about effective commercialization.

Consequently, what the strategic review would seek to determine is the value of the company based on the key market opportunities and the underlying challenged noted previously:

Market demand moving from 95% OTC market to prescription drugs, combined with demographic changes in population, means less need to steal market share from existing competition Greater healthcare provider education expands awareness Partnerships to more robustly commercialize Trulance inside and outside the US Medicare and Medicaid opportunities under new HHA & FDA directives, leading to expanded Medicare Part D & Medicaid coverage Increasing patient access to healthcare, with greater awareness of gut health Pricing as a differentiated product Dolcanitide is pipeline candidate currently being explored for ulcerative colitis and opioid induced constipation Sustainable financial backing
Linzess three year plus lead in marketing development, has (DTC) direct to consumer advertising in place. The acquisition of Amitiza (Sucampo) by Mallinckrodt provides strong distribution capabilities with wholesalers and retail pharmacies that might move the needle upward on its current $450 Million annual sales Direct-To-Consumer ads significantly draw prescriptions away from competitors. The Kellogg School of Management research findings showed that revenue for branded advertised drugs are up to 24% higher when there is an absence of a rivals advertising. Concluding Thoughts

Any self-respecting consulting company (unnamed advisors?) doing a strategic analysis would make it clear that it is no surprise Synergy has struggled; as small pharma/biotech firms often lack an effective commercial reach that exists in large firms with structured sales and marketing capabilities, replete with established relationships with healthcare providers that ensure a quicker time to and greater time in peak revenues.

The reality is that bigger firms with their established value chain capabilities have the scale that allows an acceleration of the drug into the product market. The Little Engine That Could is a great childrens book, one that provides children with a nice lesson of perseverance. But, in the world of business competition it usually comes down to a matter of bigger really being better, because size infers greater knowledge and more capabilities.

Synergys claims of success notwithstanding, the robust commercialization of Trulance that shareholders have expected since the FDA gave approval in December 2016 remains an elusive goal, and the degradation of the share price a travesty. Management has not only failed to deliver the commercialization expected, but they have unnecessarily diluted shareholders due to poor planning, poor timing, and poor decision-making. Now, this gives one pause to wonder Will shareholders see the search for “all options” fails to rise to the level of a much needed and formalized strategic review?

Perhaps it is as the late, great Stephen Hawking once said:

The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.

Disclosure: I am/we are long SGYP, AGN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.