Innovent Ditches Low-Value Stake Sale After Investor Outcry

Key Takeaways:

• Innovent said its intention was to demonstrate executives’ commitment to the overseas business, but the deal was dropped after a backlash over pricing
• The biopharma group has covered losses amounting to 600 million yuan at the Fortvita unit over the past two years, but the business was valued at just 570 million yuan for the proposed transaction

By Molly Wen

Drug developer Innovent Biologics Inc. (1801.HK) has been left nursing a self-inflicted wound after an equity deal involving its overseas business unit went dramatically awry.

Even as China’s biopharma sector is finally basking in bullish sentiment, Innovent’s actions triggered a share slide that wiped nearly HK$10 billion ($1.29 billion) off its market value in a single day. The company’s bosses held a conference call to address the issue but could not brake a four-day fall that cost the firm more than HK$16 billion in overall valuation.

The root of the problem was a proposed equity deal in which a company controlled by Innovent’s founder and CEO, Michael Yu, was due to buy a 20.39% stake in Fortvita, a wholly owned Innovent subsidiary responsible for the drug firm’s international business.

Investors took fright at the unexpectedly low value placed on the business for the purposes of the stake sale, forcing Innovent to announce on Nov. 3 it was abandoning the unpopular deal.

It had taken less than two weeks for the arrangement to unravel. The saga began on Oct. 25, when Innovent issued a statement after the close of trade saying Fortvita had agreed to sell the stake to Yu’s Lostrancos for $20.5 million, diluting the parent’s holdings from 100% to 79.61% at completion.

The deal would have shifted equity around within Innovent’s close business circle. Yu, the sole director of Lostrancos, holds 82.93% of the company’s shares, while the rest are held by an executive director of Innovent, Ronald Xi, and an independent third-party investor.

Little public information is available about Fortvita. At the business update on Oct. 29, a few days into the controversy, Yu explained that Innovent had been recruiting clinical staff and setting up laboratory facilities for a strategic push into overseas markets from 2021. Meanwhile, since 2018 it had gathered all its overseas operations in the United States, Europe and Singapore under Fortvita, an entity wholly owned by the listed company, he said.

Innovent did go into any detail about Fortvita’s overseas pipeline interests, merely emphasizing that the research projects were all in the early stages. The ensuing uncertainty about future prospects carries higher investment risks but, conversely, divestment at this stage could limit the potential for profits in the long run. When finally forced to ditch the deal, Innovent said it still reaffirmed its “positive outlook on growing its international business and Fortvita’s role in driving these efforts toward the long-term goal of becoming a global biopharmaceutical company”.

Drug prices in developed overseas markets are much higher than in the domestic arena, where discounts for China’s national medical insurance system put a tight cap on profit margins. Therefore, international sales are an important means to drive higher returns in China’s biopharma sector. An anti-cancer injection developed by Innovent was tipped to become the first domestically produced PD-1 drug to break into the U.S. market. However, U.S. drug regulators denied an application for Innovent’s sintilimab injection in 2022, citing a lack of clinical testing on European and American patients.

Valuation Shortfall

Innovent has been less vocal about its international ambitions since that setback, but the company is not giving up on overseas markets, where Fortvita is still conducting clinical trials. For example, Innovent is working on a candidate drug – IBI343 – that has the potential to become a best-in-class treatment for a type of cancer originating in pancreatic ducts.  The drug has been granted fast track status by the U.S. medicines watchdog and is about to start U.S. clinical trials. Another promising drug, IBI363, uses a PD-1/IL-2 bispecific antibody fusion protein to target tumors and is going through clinical studies in China, the U.S. and Australia.

But developing new drugs is a very expensive business. Fortvita incurred losses of 331 million yuan ($46.6 million) in 2022 and 271 million yuan in 2023 that were all borne by Innovent. Using an asset-based calculation, Fortvita as a whole was valued at just $80.03 million in the aborted equity transaction, less than the sum transfused into the company over the past two years.

Independent valuer Ernst & Young said inherent risks associated with Fortvita’s drug development, as well as a lack of financial forecasts and relevant comparatives, meant it could not use standard income or market approaches to assess the firm’s value. Therefore, it calculated total assets of approximately $234 million, including bank balances and cash, prepayments and other receivables, machinery and equipment, intangible assets and right-of-use assets, and then deducted total liabilities of approximately $154 million to arrive at the valuation figure.

The low number came as a shock to investors who felt it undervalued a biopharmaceutical company with promising drug pipelines. The asset-based equation does not take account of the potential for future revenue when a drug comes onto the market or is licensed externally. The market jitters were exacerbated by the fact that the would-be purchaser, as head of the parent company, would have insights into the product outlook and the progress of business negotiations.

The plot thickened when the Hong Kong Stock Exchange revealed that Yu reduced his Innovent holdings by 3.25 million shares on Sept. 30 and Oct. 2, before the ill-fated deal was disclosed. The proceeds of HK$152 million are similar to the amount Lostrancos offered to pay for the Fortvita stake. In other words, Yu effectively exchanged holdings in Innovent for the more risky but potentially more lucrative equity in an overseas subsidiary.

But the proposed equity shuffle battered Innovent’s share price and caused an outcry among major shareholders. At a briefing on Monday morning, Yu admitted he had not anticipated such a strong reaction. The decision to cancel the disputed deal was made after consultations with shareholders, investors and company directors in different regions.

Judging from Innovent’s finances, there was no need for executives to invest in the oversea subsidiary. As of the middle of this year, the company’s cash and cash equivalents of 10.1 billion yuan could amply cover Fortvita’s research and development expenses. After the share-price plunge, Innovent’s price-to-sales (P/S) ratio stands at about 7 times, still slightly above the 6 times for BeiGene BGNE.

Pulling the plug on the deal may not affect earnings, but the saga exposes potential issues with decision-making and management oversight at Innovent. Some investors may question their confidence in the company going forward.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.