The stock of Exact Sciences (EXAS 0.12%) has tumbled in the past few days. However, there is more going on here than the general market sell-off on fears about the COVID-19 coronavirus outbreak.
With Monday's severe market drop in the background, Exact Sciences forged ahead with a plan to raise more capital by offering debt. An $850 million offering of senior convertible notes was quickly increased to $1 billion. Additionally, the underwriters have an option to purchase up to another $150 million in principal from Exact over the next 30 days.
Let's dig in further to see what this really means.
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Investors are eagerly buying Exact's debt
Debt investors clamored to get a piece of Exact's offering. The notes, due in 2028, carry an interest rate of 0.375%. That marks an exceptionally low cost of capital for an R&D-driven entity such as Exact. So, even with a very low interest rate, investors wanted a piece of the offering.
How do we know this? Six hours after launching the offering, the company and its underwriters increased the offering amount by $150 million and finalized the deal. Weak demand may have meant it took the company one or a few days, rather than hours, to sell the debt.
The institutional investors buying the notes must be confident in Exact's prospects. We know this because their purchases indicate confidence that the company can service the debt, meaning its business will generate enough income to pay the interest. The notes pay interest semi-annually on March 1 and Sept. 1, beginning Sept. 1 of this year. Exact previously provided guidance that 2020 revenue would be in the range of $1.61 billion to $1.65 billion.
The investors who shelled out $1 billion collectively must also be confident that Exact's stock will appreciate enough to trigger the conversion feature. The notes convert into common stock at a ratio of 8.2076 shares of common stock per $1,000 of principal. This equated to an initial conversion price of approximately $121.84. The stock traded at $95.56 when the financing was announced.
Any time after March 31, 2020, and before Sept. 1, 2027, the debt holders may elect to convert into common stock under certain conditions. In one scenario, the stock needs to trade at 130% of the conversion price or higher for 20 days within a 30-day window. The conversion can also be triggered based on certain corporate events, including a fundamental change in the business such as a sale of the company.
Alternatively, investors can trigger a conversion if the price of the debt falls below a certain threshold for five consecutive trading days. The threshold is 98% of the result when the stock price and conversion rate are multiplied. For example, let's say the stock is $95.56 (the price when the notes were priced). Multiply $95.56 times the conversion rate of 8.2067 to get $784.23. Taking 98% of that results in a price of $768.55. Keep in mind, the notes are sold with a value of $1,000, so this is quite a drop in price.
What should investors do?
Take advantage of this buying opportunity. Exact's stock is roughly $20 per share cheaper than last week, when it traded at $102 per share. Who doesn't want a 20% discount? The stock dipped below $80 just before Thanksgiving last year. Risk-tolerant investors who capitalized on those prices could have made a 25% return in three months. Those who continue to own the stock will likely see the stock return to prior levels above $100 per share. Five years from now, long-term biotech investors will look back and see what a gift it was to be able to snap up the stock below $80 or in the low $80s.
Exact completed a $2.8 billion acquisition of Genomic Health last November. This year, we'll see the fruits of that acquisition as well as growth from Exact's own pipeline of products. Importantly, management expects to gain marketing approval this year for their blood-based diagnostic test for hepatocellular carcinoma, the most common form of liver cancer. Thanks to its potential effect on treatment, it earned the FDA's "breakthrough device" designation, which allows for speedier development.
For these reasons and because the strong cash position should weather any hiccups, the stock looks attractive to me at these prices.
