Third Harmonic Bio (THRD) Stock: A Rabbit Out Of The Hat?

Introduction

The new year is upon us, and change is abound in the air. Unfortunately, Third Harmonic Bio (NASDAQ:THRD) faces serious challenges from 2022. Three weeks after its only clinical asset failed in phase 1 testing, Third Harmonic remains conspicuously quiet.

Third Harmonic Bio is a biopharmaceutical company with no clinical pipeline. Their main clinical asset was a novel oral KIT inhibitor, THB-001, and it was shelved after a dangerous elevation in liver enzymes was detected in a phase 1b chronic inducible urticaria trial. Although asymptomatic, liver transaminitis was detected in two of the five study participants — prompting Third Harmonic to discontinue its only clinical trial. (Third Harmonic’s intentions to evaluate THB-001 as a treatment for asthma have also been scrubbed from its web page.)

Down by over 75% from the initial public offering price, important questions linger in the air: where does Third Harmonic go from here? Should shareholders cut their losses? Is it actually a deep-value buy with shares trading at a negative enterprise value?

Pulling A Rabbit Out Of The Hat

To put it simply, Third Harmonic appears to be at a dead end. Although the equity seems to be trading at a favorable and risk-buffered valuation (the cash value per share exceeds the price the common stock trades at), the value within the company is locked away. I believe that only returning the cash either through a special dividend or chapter seven bankruptcy would actually unlock the value existing as cash on the balance sheet.

Instead of directly creating shareholder value by simply returning their cash hoard, Third Harmonic has signaled that they will go back to the drawing board and painstakingly find a new KIT inhibitor. Consequently, Third Harmonic is now a preclinical biotech company. Existing cash on the balance sheet will be used on a second gamble after the first one failed. By stating their intention of selecting a new KIT inhibitor as a clinical candidate, the management team is signaling that they will try to pull a rabbit out of the hat; this move will be costly.

Moreover, Third Harmonic’s silence creates uncertainty. Almost a month after they discontinued their clinical trial, there has been no corporate update regarding the plan going forward. No plan to cut costs has been put forward. In fat, a quick glance at their LinkedIn shows that their current employee headcount is 26, which shows that their initial plan to double their headcount from 14 by the end 2022 was fulfilled. Unfortunately, this expansion in headcount, and thus cost, does not harmonize well with the discontinuation of THB-001. Given that Third Harmonic is not conducting any clinical trials and has no approved products to manage, the expansion seems mistimed.

From a purely financial perspective, the extra costs associated with the increased headcount is buffered out by Third Harmonic’s large cash pile — one which insulates them from short-term pressure and provides a moat for shareholders. But this one-dimensional perspective could ensnarl existing shareholders and lead prospective investors into a value-trap.

The Financials

It is true that Third Harmonic trades at only ~$4.15 a share, giving it a mere market capitalization of $168 million at the time of writing. As of their latest 10-Q, Third Harmonic has about $299.5 million in cash and cash equivalents on hand. With no debt on the books, the current market capitalization gives Third Harmonic a negative enterprise value of ~$131 million.

Essentially, what this means is that the net cash position within the company exceeds the public valuation of the common stock. Dividing up the total cash position by the current shares outstanding shows that each share of Third Harmonic actually holds $7.38 in cash and cash equivalents — which is nearly double the current share price. The sheer size of this difference obfuscates the larger picture; it presents an illusion of deep value.

However large this discrepancy may be, it does not change the financial fundamentals. Third Harmonic has no immediate means to generate revenue and is years away from the prospect. From start to finish, it typically takes around ten years of regulatory testing and at least two billion in spending to get a drug approved. Moreover, there is a huge risk of any clinical candidate flunking out during clinical testing at any moment. And clearly, Third Harmonic is not immune to failure.

Taking a longer-term perspective makes Third Harmonic’s cash pile seem tiny. According to their last earnings report, they believe that they only have enough cash runway to sustain operations through 2025. What happens after 2025? How does Third Harmonic expect to finance itself? Will they borrow funds in a high-interest rate backdrop, or will they have secondary equity offerings that dilute the existing shareholders? With the stock trading at a negative enterprise valuation, how does Third Harmonic expect to negotiate any dilutive equity financing from a position of strength?

I think that these are important questions to ask. Last quarter, Third Harmonic burned through ~$8.5 million. Over the past three quarters, the cash burn came in at ~$21.1 million. Without any cost-cutting measures, and with much more preclinical and clinical testing ahead, Third Harmonic will likely see its burn rate accelerate down the line. Slowly, their cash moat will erode, increasing the risk of any dilutive or debt-based financing.

Risks

Selling now comes with its own risks too. Namely, there is a chance that the management team will decide to cease operations and directly return the cash on their balance sheet to shareholders. Another possibility is that another larger biotech buys out Third Harmonic completely. Both of these outcomes are possible, but unlikely, in my view.

The former outcome is unlikely because management has already issued guidance that they are working on identifying another KIT inhibitor as a clinical candidate. The clinical pipeline page on their website confirms this, noting a “KIT Inhibitor” program in place with two focuses: dermatology and respiratory therapeutic areas.

It’s more likely that Third Harmonic sells itself completely to a larger company, giving the existing team a means to exit with grace. But this outcome is still dubious, in my view. The unfortunate truth is that Third Harmonic has no clinical pipeline — what would a larger company be paying for? Any hope of a corporate strategic review resulting in the sale of the company is purely speculative.

However, one specific tidbit substantiating this speculation worth noting is that the one job opening on Third Harmonic’s LinkedIn is a director-level position for legal “contracts administration.” Contracts administration revolves around the planning, negotiations and execution of any legal agreements with third parties. Extensive responsibilities for the position are listed, which include drafting, reviewing, and negotiating contracts involving “confidentiality” and “material transfer,” among other aspects. A speculative interpretation of this job posting suggests that Third Harmonic is seeking a favorable deal with an external partner to allay their lack of options. Possible M&A activity, a new clinical candidate being acquired or an outside external investment could all be positive catalysts which send the stock price upward.

Conclusion

Yes, Third Harmonic Bio is trading significantly below its cash per share at a negative enterprise value. And no, that does not make it a good investment or suggest the downside of this price entry is limited.

Such a low valuation obscures the gravity of the situation. Third Harmonic’s only clinical candidate was scrapped after serious safety flags — sending the company back to the preclinical stage. My principal worry now is that shareholders are possibly locked into a years-long effort to pull a rabbit out of the hat.

How successful any new KIT inhibitor will be remains to be seen. What is certain, however, is that there is only enough cash in the bank to sustain operations until 2025. Shadowing the company is the threat of financing — either debt-based or equity-based — under unfavorable circumstances (rising rate environment coupled with a negative enterprise valuation.) Unless anything changes in the near term, it makes no sense to lock up your capital on a ship with no clear direction.

For those reasons, I believe that the stock is a sell — even at this price.