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Capstone Therapeutics’ Proposed Put Rights Put the Company’s Future in Investors’ Hands. Here’s How they Work, and Why.

Capstone Therapeutics (NASDAQ: CAPS)  got a lot of press today (DealBook, FierceBiotech, etc.) for the “put rights” it’s proposing to give its shareholders. 

If shareholders agree at Capstone’s May 21 AGM, they will each get “the right to require the Company … to purchase for cash all or a portion of [their] shares [for cash] on or about July 31, 2011.”  By then, Capstone will have the results of its Phase II POC trial for its lead compound, expects it will have some cash left in the bank, and wants to give investors the choice of whether to continue with the company or not.

Three aspects of the Capstone Puts are interesting:

  1. How do they work?
  2. Why would a company offer them?
  3. How did investors react?

1. How do Capstone Puts Work?

To get more information about how the Capstone Puts work, I checked out the company’s proxy statement.  Here are some of the highlights that make them workable for the company:

  • The Capstone Puts terminate on certain events: a change of control, or entry into an agreement for a partnering, development or any other transaction, whether commercial, investment or otherwise,  that the Board in its sole and absolute discretion determines is material.
  • The Capstone Puts are priced after paying off all liabilities: the redemption amount would be 90% of “available cash” as of June 30, 2011, with available cash defined as “Net Liquid Assets” less “Commitments and Contingencies.”  Commitments and Contingencies are ”all obligations and liabilities of the Company, including contingent obligations and liabilities.”
  • The Capstone Put process turns into dissolution or liquidation: if 100% of the puts are exercised, the Board would propose a plan of dissolution or liquidation to stockholders for approval in accordance with the Delaware General Corporation Law, instead of paying the formula price.

As you can see, some of these terms, like the conditions under which the put rights terminate, are similar to mandatory conversion provisions of convertible debentures.

Which brings us to…

2. Why Would a Company Offer Capstone Puts?

As the Reuters opinion piece by Robert Cyran says:

“the Capstone puts are valuable protection for investors. Biotech executives prefer not to throw themselves out of a job. Often, a new drug of questionable merit is suddenly found in the labs, [or the company merges] with a private biotech company, trading cash for a pipeline. … Shareholder activists have pushed similar companies … into liquidation, but the campaigns can be expensive and the payoff uncertain.”

Again, an idea similar to convertible debentures.  If convertible debentures come due without a mandatory conversion event, the holders will be able to demand the principal amount and may well be able to drive a restructuring or insolvency process.  The popularity of convertible debentures, particularly among biotech VCs in the last few years, attests to their value.  Unlike debentures, though, the Capstone Puts will be issued to all shareholders.

Another interesting aspect is that the Capstone Puts should ensure a floor for Capstone stock — based on the “available cash” — in the event the Phase II trial fails.

3. How did Investors React?

Capstone’s plan seems to be designed to provide added value for shareholders, so you might expect the shares to trade up on the news. 

Did it work?  Not exactly.  At the end of trading today, Capstone’s shares were at $1.03 — exactly where they closed yesterday. 

Maybe the added value is negated because the plan could also be perceived as a signal that the company lacks confidence in its program?  Maybe it’s just that no-one knows how they’ll turn out next year.  So…

My bottom line: Stay tuned for July, 2011.

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