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Riding Convertibles

CuraGen Corp., a biotechnology firm based in New Haven, CT, had been relatively quiet in the public marketplace since its …

CuraGen Corp., a biotechnology firm based in New Haven, CT, had been relatively quiet in the public marketplace since its IPO of 1998——at least, until this past January, when it returned to successfully execute a $150 million convertible bond offering. And, as it turned out, the timing was excellent.

A number of high-tech and biotech companies, such as CuraGen, were rushing to the convertible market at the time, but those who were late getting their act together missed the boat. The red hot convertible market hit the wall when the market began to get messy in March.

“You don’t want to play with market timing,” says CuraGen CEO Jonathan Rothberg. “There was an opportunity to raise money and a convertible is more efficient in terms of time. We might not have completed it if it wasn’t a convertible and we wouldn’t have all that cash in the bank today.”

CuraGen, which uses proprietary genomics-based research tools to develop new drugs for heart disease, cancer, and diabetes, and to improve agricultural seed production, earned $15 million last year. Its convertible offering was a seven-year deal that could be redeemed after Feb. 2, 2003; the coupon was 6 percent and it carried a conversion price of $127.66.

The general market for convertibles, which very simply is a bond that converts into a fixed number of equity shares, had mirrored the ascent of the stock market. In 1995, 108 convertible issues netted proceeds of $14.223 billion. Last year, 143 issues produced a record $39.687 billion. By mid-May 2000 there were already 84 issues with proceeds totaling $27.350 billion, although most of that activity occurred in the first two months. “New issues have really slowed down a lot. It’s all dribs and drabs,” says Jeff Cohen, managing director with Silverado Capital Management, a Saddle Brook, NJ-based convertible arbitrage fund.

While CuraGen certainly benefited from good timing, the decision to go with a convertible bond issuance was intrinsic to corporate strategy. “The convertible allows us to take advantage of the fact that as we progress as a company, we become more valuable and the convertible doesn’t dilute you right away,” says Rothberg.

CuraGen’s strategy has been to develop its technology in the short term, team up with leading pharmaceutical companies (CuraGen boasts alliances with Glaxo Wellcome and Genentech among others) in the medium term, and develop a product portfolio over the long term.

“Over the next seven years our product portfolio will be going through a number of very significant milestones and we expect to have measurable success and increased the value of the company,” says Rothberg. “A convertible is a perfect instrument if you want to bet on your own success over a period of time.” The company expects to reach its first significant milestones over the next three years, coinciding with the call provision.

CuraGen’s story is not unique; for most of last year and the beginning of this year, the convertible market lent itself to growth stories, notes Tom Sugiura, vice president and convertible bond analyst at Bear Stearns. “Those same names that did well in the equity market were the names issuing bonds and there was a great demand for that paper.”

He adds, “the typical story for a non-investment grade company is that you are able to lower your cost of capital by selling this growth story.”

There is, or was, another issue as well. From a corporate finance standpoint, companies like CuraGen may want to add some leverage to their balance sheet and this instrument accomplishes that. For a lot of these growth companies, it is unclear whether or not the high-yield market would allow them to issue straight high-yield debt; but because the growth rate is strong they can issue debt paper through the convertible market, making it an attractive financing alternative.

For CuraGen there were a number of secondary advantages as well:

  •  The opportunity to have a potential premium on the existing stock price was very attractive. The company firmly believes there is a lot of upside movement to its stock and this was the best vehicle to take advantage of that.
  •  There is speed and ease of access to capital that doesn’t necessarily exist with a secondary offering or some other forms of capital raising. With a convertible, the company announces the deal, puts the document together, sells it, closes it, and then files with the SEC.
  • Going with a convertible gave CuraGen a different audience of investors. True, a number of them would have participated in a secondary offering, but a number would not have, so the company reached a broader audience. The convertible certainly fares best in up markets, but since it’s hard to predict swings with precision, it’s an instrument worth looking at, regardless. In fact, Rothberg says, “this is becoming the preferred method of raising capital for leading companies in our industry.”

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