AEterna Zentaris: A Falling Knife Worth Catching?

Starting in late August, with the initiation of a phase II trial for their flagship drug, AEterna Zentaris (NASDAQ: AEZS) saw a prolonged buying spree that I’ll call “The September Rally.” After The September Rally was set on fire by initiation of AEZS coverage by Roth Capital, with their very bullish price target of $1.75/share, trading got much more volatile.

We saw a particularly nasty drop on September 26th, when AEterna got discouraging news from the FDA about AEZS-130. A 1:6 reverse split announced by the company last Wednesday (October 3, 2012) wrecked the shares again, and gains from The September Rally have disappeared. Before we analyze this, lets review AEterna Zentaris.

AEterna Zentaris is a ~$60 million biotech company that is very focused on the NDA for AEZS-130, which is their orally administered re agonist that is used as a diagnostic for Adult Growth Hormone Deficiency (AGHD). AEZS-130 is also undergoing trials as a therapeutic in cancer-induced cachexia, although there will not be much attention on this program until phase II data comes out next year.

As of June 26, investors can view the company’s finalized phase III data for AEZS-130 as a diagnostic product for AGHD here. The orally administered ghrelin agonist AEZS-130 wasn’t actually put against the two main AGHD tests (insulin tolerance testing and arginine/Growth-hormone-releasing hormone), but it the study demonstrated that AEZS-130 was quite well tolerated. Adverse events were limited to such things as “unpleasant taste” and diarrhea (which was rare – in only 3.8% of AGHD patients).

AEterna Zentaris attempted to get fast-track designation for their AEZS-130 NDA back in July, but received an unsurprising rejection two months later. AEterna still plans to submit the NDA in early 2013, but will not be reviewed on a rolling basis by the FDA due to the fast-track rejection. This small setback seemed to upset AEZS shareholders immensely on September 26th, and the stock saw a 20% dive before the closing bell.

Those who have been following AEZS may also remember that the company received a delisting warning from NASDAQ in May (following a massive drop and subsequent decline in April due to the failure of perifosine). NASDAQ required that AEterna Zentaris would have to trade above $1/share for at least ten business days before November 12, 2012.

After the drop on September 26, which brought shares just above $.60 apiece, the threat of a NASDAQ delisting was much bigger. In order to regain compliance, AEZS would need to rally around 70% or so by the start of November. With no catalysts on the horizon, this seemed quite improbable.

Although investors are now punishing AEZS for it, a reverse stock split was the only real option that the company had. Still, recent trading implies that the market sees the AEZS reverse split as a negative. Since the threat of a NASDAQ delisting is only possible after a 68% drop in current share price (using Friday’s closing price of $3.09/share), AEterna Zentaris could issue new shares for tens of millions in extra cash before having to worry about sub $1/share again. Since the announcement of the reverse split, AEZS has dropped about 25%, mostly from these concerns.

The market generally hates stocks that have undergone reverse splits, which implies that AEZS will be weighted down for quite some time. There is also surprisingly low short interest on AEZS (about 1.85% of float) which provides ample room for short-sellers to jump in.

AEterna Zentaris has certainly been struggling since the failure of its former flagship compound perifosine, but maintains a ~$5 million/quarter R&D budget for its pipeline. The company also holds around $40 million in cash (as of June 30th), and does earn some royalty income from Cetrotide (which was licensed to Merck). While it operates at a loss of roughly $7.6 million/quarter, AEterna Zentaris claims that it is undergoing cost-cutting efforts that will reduce the cash burn-rate (meaning a slower share dilution rate in the future if successful).

We should also consider their phase II cancer drug AEZS-108, which was a big factor in Roth’s bullish price target. AEZS-108 may garner much more attention from the market if the FDA grants it “Special Protocol Assessment” for Phase III trials in endometrial cancer. The company was supposed to submit its SPA request in September, which means that we’ll see a letter from the FDA’s review team within 45 days (meaning mid-November at the latest).

If Roth Capital’s price target ($10.50/share adjusting for the 1:6 reverse split) can be considered accurate at this point, AEZS should be trading as much as 240% higher. Then again, even if AEterna Zentaris could shrug off the recent damage caused by the FDA’s rejection of fast-track for AEZS-130 plus the strong negativity associated with the 1:6 reverse split, the stock would gain an easy 50%. Should we be piling into AEZS then?

A Wall Street proverb says that a trader should “never try to catch a falling knife”, which is an idea quite applicable to the AEZS situation. There’s a lot of incentive to buy the stock for its growing value potential, but enough selling momentum to keep many traders waiting for AEZS shares to stabilize a bit. Since the AEZS-130 NDA shouldn’t be submitted until Q1 2013, there’s no need to rush.