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Opportunities and Threats.
Source of Finance.
AdAlta is a biotechnology company headquartered in Melbourne Australia that is looking into developing new generation protein therapeutics to challenge the way diseases are treated and bringing about new changes into the medicine world to increase the efficiency od treatments. The company has developed a human protein called the i-body that combines small molecules and antibodies benefits and creating a powerful final treatment for certain diseases. The core business of the company is to focus on diseases such as fibrosis and inflammatory illnesses such as cancer. The other important business of the company is to research on other diseases and develop any solutions for other more common diseases as well. While focusing on the core business, the company has developed i-bodies that have long loops and are able to bind themselves to multiple wide range of targets and thus have a high applicability (Karadag, 2015).
According to the chairman’s letter, the company during the year 2019 has hit major milestones by commencing human trials of their product AD-214 to treat idiopathic pulmonary fibrosis (Richeldi, et al., 2017). To develop a product for treatment of diseases is a very challenging road since a lot of medical precedents need to be met and research needs to be done to begin human clinical trials. The company has worked hard enough and reached the desired position to begin these trials. The competitive landscape for this disease is small and this can help the company achieve and deliver short term returns to its investors. This treatment medicine and i-body is currently the core business of the company and it intends to research and develop the product with increased efficacy and lesser side effects so that the treatment can be marketed soon and people can benefit from the medicine and treatment procedures as soon as possible. Since the competitive landscape is limited, the company is leading the development of this treatment and building partnerships with international companies to further improve their efficiency. The company has been in partnership with a UK based research organization Excellerate Bioscience which evaluates the discoveries made by AdAlta and choses drug candidates based on their research for testing and commercializing the results of the test.
Being one of the leading companies in its industry, AdAlta delivers top performance and controls a huge market share and intends to penetrate new markets. With this strength, the company intends to protect its current market share but also intends to use the opportunity that their esteemed reputation allows them to further tap into new markets and become the top choice for the consumers for treatment of illnesses that the company addresses. In terms of the direct business opportunity that exists for the company, AdAlta can aim to decrease the transportation cost of their shipments which can directly help them in either lowering the cost of their product and increase profitability based on current prices, or transfer that decreased cost benefit to its consumers and increase their current market share. This decrease in prices and dilution can also help the company increase its competitive advantage over its competitors (Cockburn, 2016). Also, as the world moves towards a more digital approach to marketing, the company can focus on using online platforms to develop an awareness of their product this decreasing the marketing cost as well as increasing the market share by reaching consumers internationally as well (Miglani, et al., 2015).
As for the threats, the company has been rather slow in introducing new products into the market which has affected their current market share negatively. Since the product is to be distributed in international arena, the company can face lawsuits from different governments and countries based on inability to meet their laws in development of the product. While there exists an opportunity to achieve new market share through online platforms, that can also serve as a threat to the existing physical infrastructure that the company has worked so hard to build. Further the new environmental regulations being introduced can also pose a threat to the current practices of the company (Nel, 2019).
After discussing the opportunities and threats that the company faces in front of it, we get a better understanding of how well the company is performing currently and how it can improve based on the opportunities that exist, or can face difficult times based on the intensity of the threats. Currently, the company is on the verge of introducing its I-body into the market, which can prove quite beneficial for the company in terms of profitability and current standing in the market share.
AdAlta has a relatively easier capital structure with zero debt which makes it a company completely dependent on raising finance through equity. While there are benefits of having a zero-debt financing policy, there are downsides to it as well. Debt is cheaper than equity, which is why it is a relatively good way to finance operations in a company however having a debt based capital structure also means debt holders have a higher claim on company’s asset in the event of liquidation (Curtis, et al., 2020). This makes it easy for the company to market its shares if it has low debt structure or a zero-debt structure. While it looks attractive to the investor, for the company itself, it is usually a better choice to have a mixed structure to lower the cost of financing. Debt also helps in claiming tax benefits which you cannot in an equity-based capital structure.
Since the company focuses on its equity-based structure, capital can only be raised through shares, and thus the company proceeded with its Initial Public Offering in 2016 where it intended to raise at least AU$ 10 million by issuing 40 million new shares into the market which were oversubscribed. These shares were offered at AUD 0.25 a piece and during this time for 6 to 24 months, the shares held by the directors and major existing shareholders were subject to escrow so that they could not be sold. This IPO was offered by the company to finance its work on AD-114 candidate drug; however, we have seen that the company has further enhanced that drug into AD-214 by combining 2 i-bodies of AD-114 candidates.
The company depends on a zero debt based debt structure which means it finances all its operations through raising money through equity as it already carried out its IPO in 2016 and then offering rights and options to raise further money for the financing part of their operations. With a low growth rate, the company hardly justifies its no debt policy however there are projects in the pipeline that may help the company improve its growth rate and justify its choice of revenue flexibility over capital returns. Having a zero long term debt on its balance sheet, the company has very limited solvency issues, which is a way to market the company’s investment opportunity to the potential investors (Nissim & Penman, 2017). The company with its current ratio of 5.04 suggests that there is a lot of idle cash held by the company which is a downside. At the time being, the zero debt capital structure might be optimal for the company but as it develops more products in the future, it will need to make changes to its capital structure in order to increase growth and reach optimal performance.
The company has not paid any dividends to its shareholders yet, as starting to pay dividend is a high precedent to set, since if ever the company does not pay its dividend in the future, it may raise concerns about their performance, and inject a bearish attitude for its shareholders. The company has not yet used any payout scheme since it is still on the verge of a major breakthrough, and once we see the product doing well, then only benefits for the shareholders can be announced.
As for the valuation of the company according to its ratios, the company currently has a price to book ratio of 3.22. with this P/B ratio, it seems that the company stock is a bit overvalued and the price will come down a little in the future. For the year 2019, the company made a loss of 5.9 Million which is worse than its loss of 3.8 Million in the year 2018. While we see the company making a loss, it is important to note that company is at the brink of a breakthrough in its stage of human trials, for which research is costly, and once the product is successfully tested, the company may show positive results and a higher net profit (Conrad, 2015). The current earning per share for the shareholders is negative, at -0.06 for each share held. Return on assets for the company is at -86.09 and a return on equity is at -102.36. These figures might show that it is a bad investment but it should be noted that the company once it starts selling its product into the markets for consumer use, it will be very beneficial for the shareholders if the product is successful, and with ahigh growth potential, the shareholders will benefit more.
As the CFO of the company, based on the current payout structure, it is understandable the company has not issued any dividends yet, since the company has not made optimal sales due to its heavy research and still time left to launch the new product for the company. However, since the only way of raising capital for the company is to offer shares, or gather money from existing shareholders, the company needs to be thoughtful of inducing a perception for the investor that their investment here is secure and profitable. While the debt policy of the company is zero currently, and that is attractive for the shareholders, at some point in time in the future, the company may have to shift to a mixed capital structure, and thus the company leadership needs to be mindful of the way they create benefits for the shareholders (Bolton & Freixas, 2018). As the CFO of the company I would suggest offering a rights issue and offering bonus shares to our shareholders, as that will raise money and give our shareholders a better proportion of investment in our company, and by pitching the success of the i-body AD-214 the company may be able to increase the investor sentiment and create a more positive outlook.
Being the CFO of AdAlta, I would recommend that the company capital structure be modified to have a mixture of debt and equity to raise financing for the company. Since the company spends a lot of resources in research and development, the constant need of financing is always there, and offering shares and diluting shareholders equity is not the best option. However, a debt induced structure would seem more beneficial since debt can allow the company cheap financing and a higher value on their shares for the shareholders (Faulkender & Petersen, 2016). Long term debt is cheaper, and company by using a more mixed structure can help the company in raising financing more quickly and at a cheaper finance rate.
Bolton, P. & Freixas, X., 2018. Equity, bonds, and bank debt: Capital structure and financial market equilibrium under asymmetric information.. Journal of Political Economy, 108(2), pp. 324-351.
Cockburn, I., 2016. The changing structure of the pharmaceutical industry.. Health Affairs, 23(1), pp. 10-22.
Conrad, C., 2015. Incentives, risk and compensation schemes: Experimental evidence on the importance of risk adequate compensation.. Applied Economics and Finance, 2(4), pp. 50-55.
Curtis, A., McVay, S. & Toynbee, S., 2020. The changing implications of research and development expenditures for future profitability.. Review of Accounting Studies, pp. 1-33.
Faulkender, M. & Petersen, M., 2016. Does the source of capital affect capital structure?. The Review of Financial Studies., 19(1), pp. 45-79.
Karadag, H., 2015. Financial management challenges in Business enterprises: A strategic management approach.. EMAJ: Emerging Markets Journal, 5(1), pp. 26-40.
Miglani, S., Ahmed, K. & Henry, D., 2015. Voluntary corporate governance structure and financial distress: Evidence from Australia.. Journal of Contemporary Accounting & Economics, 11(1), pp. 18-30.
Nel, W., 2019. Methods of choice in the valuation of ordinary shareholders' equity: evidence from theory and practice.. Meditari: Research Journal of the School of Accounting Sciences, 17(2), pp. 117-135.
Nissim, D. & Penman, S., 2017. Ratio analysis and equity valuation: From research to practice.. Review of accounting studies, 6(1), pp. 109-154.
Richeldi, L., Collard, H. & Jones, M., 2017. Idiopathic pulmonary fibrosis.. The Lancet, 389(10082), pp. 1941-1952.
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