Discovery's Costly Debt Delay

There's always a debate about whether development-stage drugmakers should engage in raising needed cash before or after a pivotal binary event, such as an FDA regulatory decision. Discovery Labs (Nasdaq: DSCO  ) announced a new financing agreement yesterday that will allow it to do both.

A development-stage drugmaker with no marketed drugs, like Discovery, has few opportunities to raise the cash needed to advance its drugs through clinical testing. Drugmakers in this situation are generally left with two choices: giving up at least part of the upside to their lead drugs and partnering them out, or engaging in some form of dilutive financing.

The deal that Discovery inked yesterday allows it to sell up to $60 million worth of newly issued shares to a private investment group at times of its choosing. The size of the cash raise could end up being far smaller, though, because there is a limit on the number of shares -- a little more than 19 million -- that Discovery can sell. (At its current share price, this would mean a maximum possible cash raise of around $30 million.)

The fact that Discovery can choose when to sell its shares is a nice component of this deal, and it’s one that development-stage pharmas like Discovery, Cyclacel Pharmaceuticals (Nasdaq: CYCC  ) , or Alexza Pharmaceuticals (Nasdaq: ALXA  ) seem to be entering into more and more recently. (It can act as sort of a reverse version of dollar-cost averaging.)

This will allow Discovery to put off at least some of its financing needs until a more opportunistic (and hopefully less dilutive) higher share price arrives. With $42 million in cash on its balance sheet, plus several other sources it can use to raise funds, Discovery does have some wiggle room on when it needs to use this financing facility.

Any dilutive financing that Discovery does in the coming weeks could have happened on much cheaper terms had it not received a third consecutive FDA approvable letter for its lead drug, Surfaxin, this month. In a best-case scenario, Discovery hopes to file a response and receive another FDA approvable-letter decision in the next four months, but this process could potentially take months longer if the FDA thinks Discovery's response requires a longer review time.

Drugmakers have two choices. They can hedge their bets and do a financing or partnership before an upcoming pivotal FDA decision or clinical-trial results announcement, which is what Theravance (Nasdaq: THRX  ) did earlier in the year. Or they can wait until after the event occurs and hope for a positive outcome and a financing on cheaper terms. Unfortunately for Discovery, it rolled snake eyes. Its future dilutive financings may cost it much more than if it had hedged its bets and done a financing before the FDA Surfaxin decision.