Biotech companies pour millions of dollars into research programs that may or may not pan out, and money to fund that research can come from issuing stock or taking on debt. Debt isn't always a bad thing, but too much debt can signal that a company may struggle to cover its interest expense or unravel if clinical trials fail. Because debt poses a big risk to investors, it may be wise to think carefully before buying shares in these three companies, all of which boast high debt-to-capital ratios.
First, what is the debt-to-capital ratio?
The debt-to-capital ratio is a simple calculation that divides the total amount of short- and long-term debt owed by a company's shareholder equity, including total common stock and preferred stock, and its net debt, or debt minus cash and cash-like investments.
In short, the debt-to-capital ratio clues you into how much money a company has raised via debt and how able a company may be to handle its debt obligations.
Got it? Great. Now let's take a closer look at these three heavily indebted companies.
No. 1: Merrimack Pharmaceuticals (NASDAQ:MACK) -- debt-to-capital ratio of 349%
Cancer research is expensive. Very expensive. And researching pancreatic cancer drugs is especially risky, because the failure rate in pancreatic cancer is higher than it is in other cancer indications. Given that backdrop, it may not be too shocking to learn that pancreatic cancer drug maker Merrimack Pharmaceuticals makes this list of high-debt-to-capital biotech companies.
Merrimack Pharmaceuticals has invested big money in the development of Onivyde, a second-line therapy for pancreatic cancer patients who have previously been treated with the commonly used gemcitabine. And those investments have saddled shareholders with $258 million in long-term debt that cost the company about $19.2 million in interest expense last year.
Given that Onivyde's sales totaled just $4.3 million in the fourth quarter and that it's guiding for total operating expenses of at least $245 million this year, investors need to weigh the company's debt burden against its potential to accelerate Onivyde's sales. If all goes Merrimack's way, then management thinks Onivyde could be an $800 million opportunity. If not, then Merrimack is going to have to deliver another winner out of its pipeline.
No. 2: Amarin Corporation plc (NASDAQ:AMRN) -- debt-to-capital ratio of 212%
Up until now, the FDA has hamstrung Amarin's ability to market all the potential benefits of Vascepa, its highly purified fish-oil pill.
Vascepa is used to treat patients diagnosed with very high triglyceride levels, a condition that could be associated with a higher rate of risk of heart attack or stroke. The very-high patient population, however, is pretty small, and since cardiovascular trials involve thousands of patients, and that makes them costly, Amarin's current revenue run rate is disappointing.
The company's efforts to expand Vascepa's use to moderate to high triglyceride patients hit a wall when the FDA questioned its ability to reduce cardiovascular risks. However, Vascepa did significantly reduce triglycerides in that patient population, so Amarin sued the FDA to be able to relay that information to doctors.
In March, Amarin reached an agreement with the FDA that allows it to pitch this benefit, and that could cause Vascepa's sales to march up from their current $100 million-a-year annualized pace. Investors hope that will be the case, given that Amarin spent $152 million on operating expenses in 2015, and it sports about $115 million in combined short- and long-term debt.
No. 3: Synergy Pharmaceuticals (NASDAQ:SGYP) -- debt-to-capital ratio of 158%
In a bid to challenge Ironwood Pharmaceuticals' (NASDAQ:IRWD) fast-growing constipation drug Linzess, Synergy Pharmaceuticals has developed plecanatide.
The company reported results from two phase 3 studies last year showing that plecanatide effectively alleviates constipation, but costs associated with those trials and to build up a sales and marketing team that can support an eventual commercial launch have taken a toll on the company's balance sheet.
Synergy Pharmaceuticals came into this year with about $112 million in cash and cash-like investments and $151.6 million in long-term debt. The company reported last month, however, that some of its debt burden has been alleviated by debt holders agreeing to swap their convertible debt for shares.
Specifically, senior notes holders exchanged $79.7 million worth of their debt for 36.2 million shares, including 872,000 shares issued for interest owed, for an average price of $3.02. After the conversion, $71.5 million of these notes, which carry an interest rate of 7.5% and are due in 2019, remain.
Synergy Pharmaceuticals filed for plecanatide's approval in January, and a low incidence rate of diarrhea in patients has me thinking it could pose a reasonable threat to Linzess (if the FDA approves it), but this stock still has a less than bulletproof balance sheet that makes it far from a risk-free bet.
Tying it together
A high debt-to-capital ratio isn't always a deal-breaker for investors, but it can highlight a stock that requires deeper digging. Investors in high-debt-to-capital companies need to weigh the risks associated with carrying that debt, the potential sales (and trajectory of sales) of drugs in development, and the likelihood that debt can eventually be paid off. In the case of these three companies, investors may be better off focusing on other ideas instead, at least until there's more evidence that their respective drugs will be winners.
Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.