Forward Pharma: promising net-net with a tax risk
Forward Pharma A/S (symbol FWP in the US) used to get revenue from a royalty agreement on dimethyl fumarate. It lost patent opposition actions and entered a legal settlement. It is using settlement proceeds to fund the last lawsuit, related to a European patent. If all litigation works out well for the company the earliest time the company expects to receive royalties is somewhere in 2026.
The European patent was overturned in a patent opposition action. The company appealed this decision of the Opposition Division. In September 2021 the appeal was dismissed. In January 2022 management appealed against the decision to dismiss the appeal, alleging the appeal body made a procedural error. Management thinks their argument is compelling but estimates low chances on success.
When this second appeal succeeds the case will probably be sent back to the Opposition Division. Then this body could still decide against the company. But otherwise the company is entitled to 10% royalties on sales of dimethyl fumarate against multiple sclerosis from January 2021.
Currently I estimate the liquidation value of Forward Pharma (FWP) at 70 million USD, almost all excess cash. At a share price of 5.24 USD the market cap is only 36.8 million USD (with 1 ADS is 14 shares and 98.26 million shares). In 2021 losses were 1.9 million USD, in 2020 and 2019 losses were 6.4 and 4.2 million USD respectively (see page F-5 of SEC 20-F form).
Loss making net-net that do not pay a dividend have better chances on high returns compared to other net-nets. But from a more fundamental point of view, what needs to happen for a good outcome for net-net investors? What scenario(s) would be best for them?
Basically, there are 3 possible outcomes:
Litigation succeeds and the company gets enormous royalties, from 2026 earliest.
Litigation fails and the company goes into liquidation.
Litigation fails and the company does some kind of reverse merger transaction with a private company.
Litigation fails with subsequent liquidation
The second case is much more likely than the first case, according to management. In that case shareholders will be paid nearly twice the current share price. For example, if the current appeal on the dismissal of the previous appeal is not going to be admitted then litigation stops. Such a decision could be received within 7-8 months, but could also be received very soon. A soon refusal to review this second appeal might be the best scenario for old-fashioned cigar butt investors.
It is also possible the appeal on the appeal is admitted for review. Then the company will need to wait up to 2 years before the review is complete. That would be disappointing for cigar-butt investors. However they might be able to sell for a good price if the stock price suddenly increases on news that the appeal is going to be reviewed. So, there might good be potential for quick short-term gains.
Conservative cigar-butt investors might want to assume litigation only fails in the last step, when the Opposition Division would decide again to invalidate the patent. Those cigar-butt investors might be able to sell for a good profit into news the new appeal is going to be reviewed. They might be able to buy back in some time later when sentiment cools off again.
Litigation fails with subsequent reverse merger
Being a party in a reverse merger is what happens to many failed American biotechs. The buyer can formally be the listed company and the private company is being acquired in a share exchange. The new business has ample liquidity to continue development. Moreover, once profitable, the new business might be able to monetize tax losses of the buyer. Because Pharma Forward is a Danish company this scenario might be much less likely compared to when Forward Pharma were incorporated in the US. But even if this scenario becomes reality returns can still be great depending on how successful management will be in negotiations and on successes of the new business.
German tax claim
Net-nets are risky investments. This one is no exception. A key audit matter for 2020 and 2021 was an ongoing tax audit in Germany.
The issue is an intercompany transaction in 2017. Allegedly, this transaction would have resulted in a huge taxable profit if it had been done at arms length. If the German tax completes the tax audit concluding the transaction was not done at arms length the company might have to pay about 80 million EUR.
I think it will be very difficult to prove this, but maybe not impossible. That it takes so long to sort this out supports my view. I do not expect the company will have to pay this claim. And if they have to pay they probably can still reach a good settlement, worst case for 40 million EUR.
At the current market cap such a settlement would put cigar butt investors at a loss of about 20%. In addition, this issue is a second reason why a reverse merger transaction is not so likely.
I like this net-net because its returns are independent from the world economy, for country diversification and because of its great statistical properties (large discount to NCAV, loss making and no dividends). Apart from the tax risk chances to lose on this one seem to be small. Unfortunately, there is no such thing as a free lunch.
Disclosure: Long Forward Pharma.