Nuvectra Corp. (NVTRQ) commenced Chpt. 11 bankruptcy proceedings on November 12th 2019. The share price took a nose dive from $1.39 to $0.22, since then it's been trading in the $0.10-0.20 range.
Upon first glance it looks like game over for the common, but sometimes looks can be deceiving.
Let's take a step back in time.
In March 2016 Integer (Formerly Greatbatch) spun off QiG Group LLC which converted into Nuvectra Corp shortly before the completion of the spin-off. Nuvectra became a publicly listed medical device company and it's common stock was floated on the Nasdaq under the ticker NVTR. You can read about the spin-off here.
As part of the spin-off Nuvectra received some intellectual property for use in the development of medical devices for the treatment of neurological disorders and chronic pain. NVTR's primary product for development was Algovita, an FDA approved implantable medical device utilizing a spinal cord stimulation (SCS) system for the treatment of chronic pain of the trunk and limbs.
Unfortunately the spin-off agreement meant Nevectra was tied into a 5 year manufacturing contract with Integer which resulted in poor margins for the Algovita product.
Despite the fact that the Algovita product was doing around $47 Mil in annual revenue and growing, it was unprofitable and Nuvectra ran into problems. The gross margin on Algovita was below the industry standard for such products but Nuvectra's hands were tied. Sales weren't the problem, profits were.
Losses began to mount and in August 2019 Nuvectra announced it was "exploring strategic options to enhance shareholder value". The situation didn't improve , losses continued and the share price began to fall. As November rolled around the Chpt 11 proceedings were announced and the bottom fell out of the stock.
Nuvectra's stock was de-listed from the Nasdaq and it began trading on the OTC markets under the ticker NVTRQ (the Q denotes that the firm has entered bankruptcy proceedings).
Some readers will be aware that in virtually all bankruptcies the common becomes worthless since it sits at the bottom of the cap stack. There is rarely anything left for shareholders once the secured/unsecured creditors, lawyers and bankers have received their portion of the liquidated assets.
And yet, NVTRQ hasn't gone to zero, volume has dropped off since the heavy selling on the bankruptcy announcement subsided. The share price has been bouncing around between the $0.10-0.20 range and shares are still being traded. Why?
Me and a fellow investor have been looking through the Q tickers for the last few months and NVTRQ came on the radar, we didn't dig too deep and moved onto the next one. A few weeks passed and I was contacted by another investor who had examined the bankruptcy in closer detail uncovering some interesting things. At this point I 'd like to extend my thanks to @FBuschek for all his work on NVTRQ. I recommend you all follow him on twitter and ask him to start a value blog! :)
For those of you who don't know, the public can pull up the court docket for a bankruptcy and read through the filings. You can find the docket for the NVTRQ case here.
Okay, here's where it gets interesting.
Rather than opting for a Chpt. 7 bankruptcy where the company is shut down and all the assets are sold off Nuvectra has gone down the Chpt. 11 route instead.
Chpt. 11 gives a company time to reorganize it's business affairs and restructure it's debts. It can opt to sell some of its assets or the whole company as a going concern. As part of the bankruptcy Nuvectra is legally obliged to file a monthly financial report.
Let's take a look at the balance from the most recent report which you can find here.
As you can see , according to the last available filing NVTRQ had total assets of $32,457,881 and total liabilities of $21,794,196.
BV stands at $10,663,685 vs a Market Cap of $3.22 Mil.
Now obviously the argument can correctly be made that certain assets must be heavily marked down in a bankruptcy since it is a distressed situation. This is correct but in this instance it is not the focus. This investment thesis hinges upon something else.
What the balance sheet doesn't capture is the potential value of Nuvectra's I.P. pertaining to it's two products, the FDA approved Algovita and pre FDA approved Virtis.
An FDA decision for Virtis is due in H1 2020 so it's value is limited at the present time.
Algovita is an FDA/CE approved product which has been implanted into 5,000 patients, prior to bankruptcy it achieved annual revenue of $25 Mil in FY 2017 and $47 Mil in FY 2018. What would a potential bidder pay for that?
1x, 2x, 3x or 4x Rev?
To further bolster the case for the value of Algovita on Dec 31st it received another FDA approval ;
"On December 31, 2019, the U.S. Food and Drug Administration (the “FDA”) granted full-body magnetic resonance (MR)-conditional approval for the Company’s Algovita® spinal cord stimulation product. The approval was granted following the FDA’s 180-day review process with respect to the Company’s previously announced regulatory submission in June 2019."
Prior to the bankruptcy Nuvectra had racked up an accumulated deficit of around $150 Mil. If the company sells some of it's assets such as Algovita and continues as a going concern it will have a sizable amount of NOL carry-forwards to utilize too.
The plot thickens!
Nuvectra is now moving forward with a stalking horse bid process.
For those who don't know, a stalking horse bid process involves a bidder being selected, they are then invited to table an initial bid which acts as a price floor for an asset or group of assets to be auctioned off. As part of the deal, if the primary bidder is outbid they get a compensation fee, usually around 3% of the transaction cost.
The latest 8-K notes the following;
"The Company may select a Qualified Bid as a “stalking horse” bid. The Order provides that if a stalking horse bidder executes a purchase agreement on or before February 7, 2020, the stalking horse bidder is entitled to receive deal protections consisting of (i) reimbursement of reasonable out-of-pocket expenses, subject to an aggregate cap of $250,000, and (ii) payment of a break-up fee equal to 3.0% of the cash purchase price set forth in the stalking horse bidder’s Qualified Bid."
The stalking horse bid process is good for the bankruptcy estate and the creditors as it ensures that the assets aren't just sold off at fire-sale prices.
Prior to the Bankruptcy there were around 45 potential bidders who had expressed an interest when Nuvectra announced it was exploring strategic alternatives in August 2019.
Post bankruptcy this number has increased to around 60 interested parties;
Whilst I was finishing my buying spree news came through that the court had approved the sale and stalking horse bidding process. Here's the timeline for the sale.
The Order approving the bid and auction procedures also notes the following;
The important part in the above except is "the sale of Assets free and clear of all liens, claims, and encumbrances..."
So, things are moving fast here.
Feb 7th is the deadline for selecting the Stalking Horse Bidder.
Feb 24th is the deadline by which all bidders have to submit a bid.
An auction is held on the 27th and the whole deal closes by March 19th assuming no objections.
There's the possibility of some 'cure costs' depending on how the executory contract plays out. The bidder can choose to buy certain assets or just buy NVTRQ outright as a going concern. The break down for the possible cure costs can be seen here. If the buyer just keeps all the contracts in place then the cure costs are minimal, those that aren't retained by the buyer must be 'cured' by the debtor.
The largest portion of the $2.86 Mil pertains to the employment contracts of the CEO and CFO, around $2.18 Mil. If they are kept on cure costs are negligible. Assuming NVTRQ fetches a decent price for it's assets then it's no major issue if it ends up on the hook for all the costs.
The other costs to consider are those of the lawyers and bankers overseeing the proceedings. You'll see them listed on the balance sheet in the post-petition liabilities section and labelled 'professional fees'. The above report is on an accrual basis so those aren't the final costs.
Below is the professional fee budget schedule. Bear in mind this is a just a projection though, the fees can and commonly do overrun this. Thus far there's an overrun of around $200k which is negligible. The total projected cost is around 3.5 Mil but given the overrun I'd add another $1 Mil to that.
This investment doesn't succeed or fail based on professional fees and cure costs though, it's all about the I.P. for the two products.
I have no idea how to value this as it all comes down to what a bidder is willing to pay for Algovita, Vertis or the whole business.
Maybe it's $25 Mil, maybe $50 Mil, maybe even $100 Mil. Your guess is as good as mine.
Medtronic, Stryker, Abbott and the other big players have a lot of cash to deploy. If a bidding war gets underway then the sky is the limit.
One thing I'm pretty sure of is that it is probably going to be a lot more than the current market cap of $3.22 Mil. I can't say for sure though.
What are the risks here?
The first one is the fact that you're reading a blog post about a bankruptcy case written by some random guy on the internet, I'm not a bankruptcy lawyer, I've never taken any law classes, I'm just a guy who's read through the court docket, checked the financials and looked up the definition of some legal terms.
Don't invest based on what I'm saying, I could be dead wrong here.
The second risk is that a deal gets done but the winning bid isn't large enough to cover the liabilities and costs, the common ends up with nothing.
The third risk is that the deal plays out but somehow the common gets screwed in the process. Maybe insiders cut a deal that massively dilutes minority shareholders, there's always a chance.
The fourth risk is that the deal ends up falling through, NVTRQ has to honor all it's liabilities to it's creditors including any lawyers/bankers fees and the rest. It moves into Chpt. 7 and sells off it's remaining assets at fire-sale prices. The common is left with nothing.
And so it is. To the moon, to zero, or somewhere in between.
Let's find out which.
David J. Flood
UK based Value Investor.
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