The author of this article has a short position in the company.
Q: What would you do if your company had:
- accumulated losses of $58 million,
- no commercially available product,
- a “going concern” from its auditors,
- largely run out of cash,
- was expected to incur significant losses for the foreseeable future,
- no strategic investors,
- questionable strategic partnerships,
- insiders who want to sell 15% of their personal stock for proceeds of $2 million
- faced significant regulatory and other hurdles, and
- a weak (but well paid) Board of Directors?
A: Take advantage of the JOBS Act and the hot equity markets by doing an IPO that gives you an equity market cap of $80 million and a valuation 220% higher than the last equity raise done only seven months earlier. Then, after selling the stock (presumably to lots of retail investors), support the stock with (what we consider to be) highly speculative research and perhaps some paid promotion.
Senestech (“SNES” or the “Company”) has developed and is seeking to commercialize a proprietary technology for managing animal pest populations through fertility control. This product would compete with, among other things, rodenticides (aka poison). Its product, ContraPest, induces the gradual loss of eggs in female rats and disruption of sperm in male rats. The company has conducted some tests (such as the NYC subway system in 2013) which proved the product effective. Yet, the company still generates no revenue from product sales. On the surface the product sounds amazing which is why we were intrigued why no strategic investor (a pest control company, etc.) had ever invested in the company since it was founded in 2004. As it turns out, SNES faces numerous challenges before Contrapest can generate significant product revenue, including but not limited to:
- The much touted EPA license SenesTech received for Contrapest is very limited and only allows the product to be used in liquid form, for indoor use and within 1 foot around external perimeters of buildings. The product must also be placed in bait stations and handled only by licensed applicators. These limitations greatly reduce the product’s market size and desirability.
- As noted by the Roth analyst (although we do not believe SNES has widely mentioned this) “In the rush to seek early EPA approval of Contrapest, SNES did not complete required studies to determine shelf life and storage stability, such as the ability to withstand temperature extremes.” So, without knowing the shelf life expiration or storage parameters of Contrapest, how aggressively will third parties manufacture and/or purchase the product?
- Even if there is demand for the product, SenesTech has limited salesforce and manufacturing capabilities so it will rely heavily on third parties to do much of this work. As discussed below, we have grave concerns about the willingness/ability of these third parties to do such work.
- We wonder if pesticide companies such as Neogen will be eager to market Contrapest as it will likely greatly reduce the more frequent and recurring revenue from its existing sales of rodenticides. Put another way, do you think a razor blade manufacturer would be interested in promoting a product which reduces hair growth and thus reduces the need to shave?
- SenesTech must gain approval from individual states and in some instances municipalities. To date, 14 states and Washington D.C. have approved the use of Contrapest.
Despite the hot equity markets, SenesTech had trouble getting its IPO done on December 8th by Roth, Craig-Hallum and Aegis.
- had to reduce the price range from the original $12 – $14 a share range down to $9 – $11, and then ultimately priced below the range at $8.
- (we assume because they were having difficulty getting the deal done) towards the end of the deal added another underwriter, Aegis Capital, which tends to have a very retail oriented customer base.
Weak Financial Position Pre-IPO
- SenesTech received a “Going Concern” from its auditors for its last audit which was for the year ended 2015.
- In 2016, the company did some financing prior to the IPO but as of November 18, 2016, (less than one month before the IPO priced) SNES had cash of only $440,000 (and lots of liabilities). Considering SNES lost $7 million in the first 9 months of 2016 and the company expects to continue burning cash, this cash balance seems dangerously low so we assume the company badly needed to do this IPO.
IPO Pricing Premium To Latest Equity Raise
The last equity raise SenesTech did before the IPO closed in May 2016 in which SNES raised $6.2 million by selling stock in a rights offering at $2.50 per share. Seven month later the company priced its IPO at $8.00 per share, a 220% increase from where insiders had recently invested. We wonder why investors today would pay $8 a shares today when (i) insiders were only willing to pay $2.50 a share seven months ago and (ii) the top two executives were willing to sell ~15% of their shares in the IPO at $8.
Insider Selling In IPO
As part of the IPO, SNES’s top two executives offered to sell $2 million of stock (~15% of their personal holdings) thru the over allotment option. There has been no announcement regarding the exercise of the shoe. We don’t often see insiders selling stock in an IPO and we can only wonder if the company’s prospects are so bright, why is management trying to sell shares?
To be fair we must also mention that one Director, Grover Wickersham, bought $500k of stock after the IPO. However, considering (i) his total compensation in 2015 as a Board Member was $2.3 million and (ii) his annual Board Compensation will be $95k plus 20k options, his recent investment doesn’t seen that large to us.
In addition to the approximate 10.1 million shares outstanding, SenesTech also has 1 million currently exercisable at 81c (wtd avg). Based on the company’s current stock price, this implies management is sitting on a paper profit on these options alone of $7 million, which is pretty remarkable for a company which we think was almost broke only a few months ago.
Questionable Domestic Strategic Partnership
The company does not currently have significant manufacturing or sales capabilities. As a result, in May 2014 it entered into an agreement with Neogen Corp. (ticker NEOG), a $2.5 billion market cap company that develops and markets products used in food and animal safety. Neogen sells rodenticides and the sales of these products would be greatly reduced by sales of Contrapest. Neogen was granted an exclusive license in North America to manufacture, distribute and sell Contrapest. The agreement is filed as an exhibit to the S-1 and requires Neogen to make certain milestone payments and pay certain fees/royalties. Importantly, we believe the agreement provides Neogen with many “outs” should it decide not to aggressively pursue this product.
Neogen has publicly said very little about this agreement. However, in a report about Neogen dated September 28, 2016 the research firm Hilliard Lyons stated :
“As a reminder to investors, SenesTech