Aqua Bounty case Analysis

Business Finance

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For the exclusive use of B. Quan, 2020. 9-213-047 REV: JANUARY 16, 2014 LUCY WHITE STEVE BURN-MURDOCH Aqua Bounty Elliot Entis, CEO of Aqua Bounty Technologies, gazed across the snow-covered fields as he pondered his next move. It was February 2006, and Entis was facing his biggest decision yet – how to value the firm ahead of its initial public offering (IPO). Waltham-based Aqua Bounty was a young biotechnology company at the cutting edge of the rapidly growing aquaculture industry. The firm had developed genetically modified strains of salmon and trout that could grow to full size far more quickly than conventional fish. If licensed by the FDA, these fish would represent the first ever genetically modified animals approved for human consumption. However, Aqua Bounty had not yet received regulatory approval for these products, still less begun to produce them on a commercial scale and, typically for a young biotech firm, was still running at a considerable loss. In 2005, the firm had lost over $5 million on revenues of around $1 million, taking cumulative losses over the firm’s history to $30 million1. To fund the development and commercialization of its pipeline products, the firm planned to raise capital on the equity markets. Entis and his team had to decide how to price the firm ahead of its IPO. Too high a valuation would dissuade investors, while too low a figure would significantly dilute the stake held by the management team and existing investors. Aqua Bounty Established in 1992 as a division of the biotech company A/F Protein, Aqua Bounty began investigating the genetic properties of fish in order to identify and isolate the genes or gene sequences linked with growth hormones in fish. In 1993, the company obtained the exclusive licensing rights to a gene construct derived from Arctic fish that it believed could be applied to other fish species with a view to speeding up the development of commercially-farmed fish. In order to develop and commercialize the aquaculture applications of its discovery, Aqua Bounty was spun off as an independent entity in March 2000. By this point, the company had invested around $4 million in its research, raised through a series of private placements. Research facilities for salmon were centered on Prince Edward Island, Canada. However, recognizing the rapid growth of 1 Aqua Bounty Technologies IPO Prospectus, March 2006 ________________________________________________________________________________________________________________ Professor Lucy White and Research Associate Steve Burn-Murdoch prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2012, 2014 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School. This document is authorized for use only by Bowen Quan in Corporate Valuation Spring 2020 taught by VLADIMIR IVANOV, American University from Jan 2020 to Jul 2020. For the exclusive use of B. Quan, 2020. 213-047 Aqua Bounty the South American market, and the fact that American consumers were likely to be more receptive to the notion of genetically modified fish than their European counterparts, Aqua Bounty had also taken steps to enter the Chilean market. In 2000, the firm had created a joint venture, Aqua Bounty Farms Chile, with Fundacion Chile, a local organization tasked with bringing together public and private sector actors for the commercialization of new technologies. Once approval to import AquAdvantage fish into the United States was received, Aqua Bounty planned to begin selling modified eggs and juvenile fish (broodstock) to commercial farmers in Chile. Efforts to develop the company’s genetically modified (GM) fish continued apace, and Aqua Bounty was soon able to produce fish stock for commercial farmers (broodstock) capable of reaching market size approximately twice as quickly as their conventional counterparts. However, the field quickly attracted considerable attention from environmental campaigners opposed to the concept of genetically modified products. Although the concept had been embraced in agriculture, with GM varieties making up 20% of all crop seed sales worldwide, the technique had not yet been approved for animal cultivation. Given the controversial nature of the product, Aqua Bounty had gone to considerable lengths to demonstrate the safety of their AquAdvantage fish. Although easier regulatory paths were available, the firm chose to pursue the FDA’s onerous New Animal Drug Application (NADA) process, in order to conclusively prove the safety of the fish. By early 2006, the firm had authorized seven major studies conducted under the US Food and Drug Administration (FDA) practices to assess their salmon, none of which had found any nutritional differences between AquAdvantage fish and conventionally farmed varieties. However, the firm was still waiting for FDA approval of the safety of the fish, which it hoped to receive within 18 months. Once this had been obtained, a further submission would be required to allow the FDA to consider the environmental implications of farming rapidly-growing fish, although Aqua Bounty expected this to be a more straightforward process. Facing a long and uncertain route to market for its genetically modified fin-fish products, Aqua Bounty continued to search for additional aquaculture products that might offer some diversification to their product line. A partnership with a shrimp producer in San Diego led to the company locating its shrimp research efforts on the West Coast. After the partner company folded, Aqua Bounty took over its R&D unit, which was incorporated as a wholly-owned subsidiary, Aqua Bounty Pacific, in 2002. At this time, while studying how growth hormones act on the immune systems of fish and shellfish, the firm found that growth peptides appeared to offer health benefits to commerciallyfarmed shrimp. Seizing upon the opportunity, Entis’ team began developing a range of products aimed at shrimp farmers. By this point, the firm had grown to include a small regulatory team, headquartered in St. John, Newfoundland, and around 10 researchers, along with in-kind support from a number of scientists in academic institutions in the US and Canada. Aqua Bounty’s first shrimp therapeutic drug, the immune-system enhancer Shrimp IMS, was launched in Mexico in 2004. By 2006, the company had built a pipeline of products for commercial shrimp-farmers, including Shrimp IMS, the anti-viral drug VPX and a range of shrimp diagnostic kits. Given the regulatory delays surrounding the firm’s AquAdvantage line, Shrimp IMS was the only product to contribute to Aqua Bounty’s revenues in 2005. See Exhibits 1 and 2 for the firm’s income statement and balance sheet since 2002. 2 This document is authorized for use only by Bowen Quan in Corporate Valuation Spring 2020 taught by VLADIMIR IVANOV, American University from Jan 2020 to Jul 2020. For the exclusive use of B. Quan, 2020. Aqua Bounty 213-047 AquAdvantage Fish Stocks Commercial fish farming experienced rapid growth during the 1990s, with growth particularly strong in South American countries that bred fish for sale into the North American market. By 2006, the industry generated annual revenues of over $6bn, and was growing at over 5% a year (Exhibit 3), with growth rates of 7-8% a year expected in Asia and Latin America. The most common farmed species were the Atlantic Salmon and the Rainbow Trout. For these fish, eggs would generally be produced in specialized hatcheries before being transferred to freshwater tanks upon hatching, where they were then grown for around 15 months. At this stage the young fish would typically be transferred to sea cages until they reached a marketable size - normally at around 28-36 months of age. Aqua Bounty had developed new strains of fish that could reach marketable size in around half the time of standard fish. By placing the salmon growth hormone under the control of a gene switch from an edible arctic fish, called the Ocean Pout, Aqua Bounty was able to ensure year-around production of salmon growth hormone (as opposed to seasonal production) to speed growth throughout the early stages of development. More importantly, the location of production of the growth hormone within the salmon ensured that a higher percentage than usual was actually used for growth and the total concentration of the hormone within the fish remained at levels found in the wild. Although these fish did not reach a larger final size than their standard counterparts, by accelerating growth in the early stages they could reach a marketable size in around half the time. In the case of salmon, this would reduce farming time from 28-36 months to 18 months; trout farming time might be reduced from 8-12 months to just four. This had a number benefits, both economic and environmental. Central to the product’s attractiveness to farmers was the fact that it would allow them to double production without increasing the size of farm or capital investment. Exhibit 4 illustrates the growth rate of Aqua Bounty salmon relative to standard fish. While the opportunity presented by AquAdvantage fish was sizeable, numerous obstacles remained as Aqua Bounty sought to bring the fish to market. Regulatory approval from the FDA was required before salmon bred from Aqua Bounty eggs or broodstock could be sold into the US market. Moreover, under the New Animal Drug Application (NADA) framework, additional precautions such as ensuring the sterility of genetically modified fish to prevent them from breeding with their natural counterparts were required before approval for scaled-up manufacturing would be granted. Further uncertainty stemmed from the fact that consumers might not be particularly receptive to genetically modified fish, even if they were shown to be safe for human consumption. While the firm had worked closely with the FDA over recent years, conducting a number of studies demonstrating that the fish were not harmful to humans, they were still waiting to receive approval for the product, and were unsure of how consumers would react to the fish. In order to secure regulatory approval for their products, Aqua Bounty anticipated the need for some additional investments over the next three years. Given the level of controversy surrounding genetically modified products, the firm believed they had around a one in three chance of gaining full approval for commercial production of AquAdvantage fish. While there was no certainty over how long the approval process would take, Aqua Bounty’s best estimate based on past dealings with the regulator was that a final decision would be received in around three years’ time. The firm’s best estimates of revenues and associated costs from the product, assuming FDA approval was received, are laid out in Exhibit 5. Given the revolutionary nature of the product, however, actual revenues might be considerably higher or lower than this, and Entis knew that he would have a clearer sense of what to expect if and when FDA approval was received. Although 3 This document is authorized for use only by Bowen Quan in Corporate Valuation Spring 2020 taught by VLADIMIR IVANOV, American University from Jan 2020 to Jul 2020. For the exclusive use of B. Quan, 2020. 213-047 Aqua Bounty Aqua Bounty’s licensing approach meant CAPEX requirements were negligible and net working capital was unlikely to change over time, the firm would face considerable commercialization costs associated with the roll-out of the products, in the event that approval was received for them to begin commercial production of AquAdvantage broodstock. Shrimp Aquaculture Since the 1970s shrimp farming had grown from a highly fragmented industry based almost exclusively in South East Asia to a global industry worth over $10bn. While 80% of production remained in South East Asia, Latin American shrimp production had grown to represent 20% of the total. Much of the shrimp produced in Latin America was exported to the United States, which at 500,000 tons represented the largest single importer. Shrimp were generally farmed in sea water coastal ponds, which, until the 1980s, had typically been stocked with young wild shrimp caught by local fisherman. However, with the depletion of the fishing grounds, farmers had increasingly begun to take shrimp from hatcheries where adult shrimp were maintained for reproductive purposes. This not only ensured supply, but also eliminated one route for the introduction of infection. Disease had repeatedly affected the shrimp farming industry. However, with substantial growth only beginning in the 1980s and limited knowledge of shrimp immunology, there had been limited development of options to control disease amongst farmed shrimp. The global nature of the industry meant that diseases could spread rapidly across the world. As a result, the shrimp industry had been badly affected by disease on a number of occasions, with both bacterial and virus-borne maladies proving troublesome. Farmers looking to protect or treat their shrimp had few options. Outbreaks of bacterial infections could be treated by antibiotics, but the efficacy of such treatments was limited, and excessive use of antibiotics was a cause of environmental concern. Indeed the misuse of agents such as chloramphenicol had been known to lead to import bans on treated shrimp. Few options existed for the prevention or treatment of bacterial infections. As a result, the market opportunity in shrimp therapeutics and disease defense was significant. Since commencing work on shrimp therapeutics in 2002, Aqua Bounty had developed two means of providing farmed shrimp with effective protection. Shrimp IMS was developed from a growth hormone which, administered in small quantities to shrimp, proved capable of boosting the immune system and general disease-resistance of shrimp in commercial farms. The product was successfully launched in Mexico in 2004, and Aqua Bounty planned to roll it out across South America and Asia in the near future. The second treatment, VPX, was designed specifically to prevent shrimp developing white spot syndrome virus (WSSV), one of the most common and virulent shrimp pathogens. Following extensive research, Aqua Bounty identified a peptide that, when supplied to shrimp in their feed, would limit the chance of the virus being absorbed, and thus efficiently protect shrimp from WSSV infection. Successful laboratory and small-scale manufacturing trials had already been completed, and the firm hoped to launch the product within 12 months. The potential market was large, and Aqua Bounty believed that up to 25% of shrimp feed sold globally might contain VPX within ten years. Finally, Aqua Bounty had developed diagnostic kits that would allow commercial farmers to test for the presence of common diseases in their shrimp stock and receive real-time results on the health of their flock. By 2006, the kits had been trialed on a small-scale in Asia, and plans were afoot to roll-out the product across South America. Based on the revenue projections given in Exhibit 6, Aqua Bounty’s advisors had valued Aqua Bounty’s shrimp therapeutics business between £35m and £50m. 4 This document is authorized for use only by Bowen Quan in Corporate Valuation Spring 2020 taught by VLADIMIR IVANOV, American University from Jan 2020 to Jul 2020. For the exclusive use of B. Quan, 2020. Aqua Bounty 213-047 The IPO Process Since spinning out from its parent in 2000, Aqua Bounty had raised a further $12 million in smallscale equity financings and debt issuances which were subsequently converted into common shares. By 2005, the long wait for regulatory approval had eaten into Aqua Bounty’s capital reserves, and the firm was in need of additional investment. Rather than seek further small-scale funding from individual investors, Entis believed that a public offering would be the best way of raising the substantial amount of capital required to continue the development and commercialization of the firm’s key product lines. Moreover, the success of laboratory and field trials left Aqua Bounty’s management confident that they would be able to attract equity capital. Armed with the results from the latest set of trials, Entis embarked on an extensive tour of the US. Starting on Wall Street and finishing in California, he met with more than thirty individuals and institutions to test their appetite for investing. Frustratingly, there was little interest in Aqua Bounty. It appeared that US investors had little knowledge of aquaculture, while the few individuals who had previously invested in the space had typically lost money. It was only when an associate connected Entis with the British investment bank Nomura Code Securities that he began to gain traction. The European market was much more familiar with the aquaculture industry, and the bank was confident that Aqua Bounty would be able to attract the investment it required. As a relatively small-cap company, Aqua Bounty would be eligible to list on London’s Alternative Investment Market (AIM), which did not require a minimum market capitalization or number of shares placed. This contrasted with the US-based NASDAQ, which operated a tiered system according to the size of the firm hoping to list, and required firms to be above a minimum size even for its lowest-tier, the NASDAQ Capital Market (see Exhibit 7). A further attraction of the AIM was that the regulatory requirements for listing were less onerous than those of other markets. Following the passage of the Sarbanes-Oxley Act in July 2002, US-listed public companies faced strict requirements on financial reporting and corporate governance. These were particularly problematic for smaller companies such as Aqua Bounty, for which the costs of compliance could be significant. Indeed one study found the average compliance cost in 2006 to be over $3 million.2 Listing on the AIM required only compliance with the lighter-touch Financial Services Authority regulations, and the passage of the Sarbanes-Oxley Act coincided with a sharp increase in AIM listings (see Exhibit 8). One final attraction of a European listing was a perception that the market appetite for agriculturallyoriented biotech IPOs was high, as evidenced by recent successful offerings such as that of Devgen (see Exhibit 9). Pricing the IPO Given Aqua Bounty’s early stage of development and unusual range of products, valuing the firm was challenging. Two aspects were particularly problematic. Firstly, there was enormous uncertainty around the company’s future revenues, driven by the degree of regulatory uncertainty surrounding its AquAdvantage products, along with the unpredictability of the product’s route to market. Secondly, due to the unique nature of Aqua Bounty’s operations, the firm suffered from a 2 http://www.financialexecutives.org/KenticoCMS/News---Publications/Press-Room/2006-press-releases/FEI-Survey-Sarbanes-Oxley-Compliance-Costs-are-Dr.aspx 5 This document is authorized for use only by Bowen Quan in Corporate Valuation Spring 2020 taught by VLADIMIR IVANOV, American University from Jan 2020 to Jul 2020. For the exclusive use of B. Quan, 2020. 213-047 Aqua Bounty dearth of comparable companies. Entis knew of only one firm operating in somewhat similar fields – Devgen, a Belgian agricultural biotech firm which had developed pioneering genetically modified agriculture products ...
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