Any startup company experiences a blissful moment upon first achieving profitability. It was no different for Ironwood Pharmaceuticals, which broke into the black in this year’s second quarter, except in one respect: The company was formed more than two decades ago.
That’s right. Originally named Microbia, its creation roughly coincided with Bill Clinton’s impeachment. The horror of 9/11 was three years in the future.
Of course, pharmaceutical companies are notoriously late to turn profits, if they ever do. Still, 21 years — the last nine transpiring after Ironwood went public — is a particularly long gestation period. How is it even possible?
“It requires raising a lot of money,” Gina Consylman, a five-year veteran of the company and its CFO since 2017, states matter-of-factly. Ironwood has been kept going by initial rounds of venture capital funding, the 2010 IPO, multiple secondary stock offerings, and a pair of sizable convertible bond issuances.
In this case, a strategic change of direction was also required. At an offsite board meeting in October 2017, the discussion centered on dissatisfaction with lack of movement in Ironwood’s stock price. So a task force, consisting of Consylman and three other management team members, was created.
“We looked at everything: from selling the company, merging with another company, and acquiring inorganic assets to skinnying down the product pipeline,” she recalls.
Paring the pipeline was the ultimate decision, but it wasn’t about abandoning the development of new drugs. Instead, the decision was made to spin off a group of clinical-phase development projects, focused largely on relatively rare diseases, into a new publicly held company.
Ironwood kept its one commercial product, linaclotide — a treatment for irritable bowel syndrome with constipation and chronic idiopathic constipation — that is marketed under the trademarked brand name LINZESS®. It also kept a small handful of clinical-phase drugs that, like linaclotide, target gastrointestinal (GI) conditions.
LINZESS, which hit the market in 2012, was already profitable prior to the spinoff of the new company, Cyclerion Therapeutics. Profits from the GI drug are split 50-50 under a collaboration with a much larger pharma company, Allergan, which augments Ironwood’s relatively small sales force and provides other key commercial services.
The spinoff was executed on April 1 of this year. It’s no coincidence that the quarter that began that day became Ironwood’s first profitable one.
“We had been taking the profits from the collaboration with Allergan and reinvesting them into the pipeline assets that are now with Cyclerion,” Consylman says. “Now we’re able to generate enough profit from LINZESS to support our [remaining] pipeline and still be profitable overall.”
In the second quarter, Ironwood racked up operating income of $18.9 million and net income of $12.3 million, a stark departure from the first quarter’s losses of $50.5 million (operating) and $59.3 million (net).
It’s not that the clinical-phase drugs that went to Cyclerion are without value. Rather, Consylman says that as she and her colleagues went through the process of deciding how to boost shareholder value, they realized that one pool of shareholders was mostly excited about the trajectory of LINZESS and how much cash it was throwing off. “They weren’t so happy about not getting their own cash back,” she says.
Another group of shareholders was more excited about the potential upside of the non-GI assets, which are high-risk but potentially very high-return drugs, notes Consylman.
Ironwood shareholders received one share of Cyclerion common stock for every 10 shares of Ironwood stock held. Given that many shareholders preferred one company over the other, it’s not much of a surprise that they’ve been selling off shares. From the spinoff date until the opening bell on Monday, share prices have sunk by about 20% for Ironwood and 26% for Cyclerion. Consylman acknowledges that there may be more volatility ahead.
Before the IPO, Ironwood faced a weighty tax issue.
One of the many requirements for a tax-free spinoff — where both the parent company and its shareholders are exempt from paying tax on any gain realized from the transaction — is that both the parent and the spun-off entity must be engaged in the active conduct of a trade or business immediately after the distribution of shares.
Historically, the IRS and Treasury Department interpreted that rule as requiring, among other things, that a business have at least a five-year history of collecting revenue. And Cyclerion won’t be generating any revenue for at least a few years.
“The government’s position has limited companies’ ability to spin off early-stage businesses, such as pre-commercial life sciences businesses,” notes Consylman. “We worked with our tax advisers to draft a memo to the IRS explaining why we viewed the [non-GI] assets as a stand-alone business even though they didn’t generate revenue.”
The company’s case was that it often takes seven or more years to bring a drug to market. “It’s not atypical,” she says. “The life sciences industry is different from other industries.”
Fortunately for Ironwood, the IRS announced in September 2018 that it was prepared to issue favorable private letter rulings on spinoffs involving R&D-intensive businesses without a five-year revenue history, while it further studied the issue. Ironwood received such a letter, and KPMG concluded that the spinoff would be tax-free. “It was a huge win for us,” emphasizes Consylman.
If the spinoff had not qualified for tax-free treatment, Ironwood would have recognized a gain reflecting the value of the Cyclerion assets as of the date of the spinoff.
It likely wouldn’t have been a cash event for Ironwood, as the company has about $2.1 billion of net operating loss carryforwards. Of course, though, Consylman is happy that more of the NOLs can now be applied against future profits.
Breaking Up Is Hard to Do
Preparing for the spinoff was a complex undertaking. Consylman notes that she has been with companies that acquired other companies, as well as ones that were acquired.
“This was really different, in that there were critical workstreams that had deadlines,” she says. “When you’re acquiring a company, a lot of the work relates to the integration and the realized synergies. If that activity takes a month or a quarter longer than expected, you can probably still complete it; you might just not save as much money.”
Along with ensuring that the spinoff would be tax-free, the most critical workstream was carving out financial statements for the pipeline programs that were moved to Cyclerion. Ironwood had tracked only direct R&D expenses for those programs, but SEC filings needed to include all of the company’s expenses that supported them.
Another important step was arranging financing for the new company, since it would be running at a loss for years. Consylman closed a direct private placement of $175 million to seed its balance sheet.
Additionally, it was necessary to comb through thousands of contracts to separate out the elements that related to the respective companies. Even real estate was an issue, as Ironwood leased new space so that the companies could be on separate floors of the same building. “Just dividing everything up was a solid year of activity,” the CFO says.
Down With Debt
Four months after the IPO, Consylman completed a restructuring of about $390 million of debt, divided among two buckets. One consisted of $150 million worth of notes that carried an 8.375% interest rate, and they were already amortizing, so Ironwood was paying down principal.
Under the debt restructuring, the company issued new convertible notes carrying interest rates of just 0.75% and 1.5%, and used most of the proceeds to pay down the rest of the outstanding high-interest notes.
Issuing the new notes was a strategic decision. While the company is now profitable, it’s not yet generating what Consylman considers significant cash, so in order to retire the high-interest debt, it needed new financing. In addition to new debt issuance, it considered taking on bank debt.
“It would have been a nice message to say that a bank believed in us and our profitability projections and so gave us a lower interest rate,” Consylman says. “Also, sometimes shareholders react negatively to announcements of [convertible notes], and sure enough ours did.”
“But,” she continues, “we weighed those factors against our strategy and plans over the next several quarters and years. Bank debt comes with covenants, which would have limited our optionality. We think we made the right long-term decision for the business.”
Meanwhile, although Consylman has been with the company for just five years, the company’s financial stakeholders have been waiting much longer for the payoff that should come if the company remains profitable over an extended period.
Asked to comment on that, the CFO says, “People here are very passionate about the science, and about helping patients.”
She adds: “Much of my prior career was at technology companies, and a lot of what I worked on for eight and a half years was improving battery life for cell phones. Now that I’ve transitioned into a life sciences company and had the opportunity to hear what a difference our drug makes for the quality of people’s lives, I can tell you that I would never be able to go back to high tech. This is very meaningful and rewarding.”
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