Laughing Water Capital - Avid Bioservices: A Few Years Away From Large, Relatively Sticky FCF

seekingalpha04-21

Avid recently experienced one of the worst "own goals" that I have ever seen in public markets, but despite this blunder and resultant stock pullback, the long-term thesis is very much intact.Avid is ...

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Avid Bioservices (AVID)  Avid is our disposable biologic drug substance CDMO. Like Lifecore, Avid is set to benefit from tremendous operating leverage tied to filling recently installed capacity. However, Avid recently experienced one of the worst \"own goals\" that I have ever seen in public markets. Despite this blunder and resultant stock pullback, the long-term thesis is very much intact. As for the details of this own goal, in March of 2021 Avid issued a ~$144M 1.25% convertible bond under SEC Rule 144A, which restricted the sale of these privately placed securities to qualified institutional investors until such time as the company removed the restrictive 144A legend that governed the bonds. The company agreed to remove this legend by March 17, 2022. There was nothing unusual about this arrangement at all - many securities come to market under 144A restrictions, and removing the legend is typically as easy as the company sending an email to the transfer agent and asking that the 144A legend be removed. However, in the case of Avid, they forgot to send that email, and the legend was not removed. The market, the company's CFO, the company's banker, the company's legal advisor, and unfortunately yours truly were all blissfully unaware of this oversight until early last month when someone who had purchased more than 25% of the bond (probably around 80 cents on the dollar) notified the company that their failure to remove the 144A legend constituted an event of default under the bond's indenture, and they were demanding immediate repayment. This forced Avid to pursue an emergency financing in the form of a new $160M 7% convert that matures in 2029. Most unfortunate is that the conversion price of the new bond is $9.89, vs. $21.21 for the old bond, and thus comes with significantly more dilution than I earlier anticipated. There is a lot to unpack there, and none of it is good, and there is plenty of blame to go around on how this could have happened. From my perspective, removing a 144A legend is so routine that it is not something I have ever seen on any investor's diligence checklist (although I have added it to mine). Before this event I would have no sooner asked a CFO if he had scrubbed his company's bonds than I would have asked him if he washes his hands after going to the bathroom, or if he looks both ways before crossing the street. These are things that one just expects to be done, especially when there is a CFO, internal legal, external legal, and the bankers who structured and sold the bond all involved. Not to mention that I have been told that for the original convert Avid used documents that were \"off the shelf\" from Morgan Stanley, and these documents did not allow for a cure period. If a cure period would have been specified, Avid could have simply scrubbed the bonds when they realized their mistake, and paid some sort of penalty rather than having to resort to an emergency financing. I assure you that Morgan Stanley has since updated their boilerplate in this regard. In any case, this event does not affect the normalized revenue generating capacity of Avid, but it does affect free cash flow conversion and per share value as interest payments and future diluted share count have both gone up. It is impossible to say precisely how much per share value was destroyed by this blunder, however, because the original bonds would have had to have been refinanced at some point in the first half of 2025 anyway. In my blue sky scenario, I envisioned the business quickly inflecting before then in such a way that would have allowed the company to refinance with bank debt and pay off the 2026 convertible bonds with zero dilution. A lot of things would have had to go right for that scenario, but management did express confidence that this was within the realm of possibility. However, more realistically I had my doubts and was already factoring in some additional dilution before the emergency convert, so the true delta in share count and interest rate are likely not as bad as the headline. In any case, Avid is still on their way to filling up their $400M in revenue capacity, and they will still likely achieve low 30% EBITDA margins when they do. Assuming conversion of the debt, free cash flow will be the same as I originally envisioned, but it will now be split over ~80M shares rather than ~70M shares. The net of this is that 2 months ago I would have said that I thought Avid was a few years away from being worth something like $30-33 dollars, and now I think it is a few years away from being worth something like $25-28 dollars. In sum, the upside here has been truncated. At the same time, based on the recent industry developments laid out above, my confidence in Avid's ability to quickly fill their facilities has gone up. Either way, with shares presently around $7, I think there is plenty of upside left.   Disclaimer This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private offering memorandum (\"CPOM\") / confidential explanatory memorandum (\"CEM\"), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the CPOM/CEM, the CPOM/CEM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, Laughing Water Capital, LP , Laughing Water Capital II LP and LW Capital Management, LLC make no express warranty as to the completeness or accuracy, nor can they accept responsibility for errors appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The portfolio is under the sole trading authority of the general partner/investment manager. A portion of the trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. The portfolio is concentrated, which leads to increased volatility. An investor should not make an investment, unless it is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward-looking statements and are based upon certain assumptions. Other events which were not taken into account may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of LW Capital Management, LLC. The information in this material is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Laughing Water Capital LP and Laughing Water Capital II LP, which are subject to change and which Laughing Water Capital LP and Laughing Water Capital II LP do not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. The fund/partnership is not registered under the investment company act of 1940, as amended, in reliance on an exemption there under. Interests in the fund/partnership have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws. The S&P 500 and Russell 2000 are indices of US equities. They are included for informational purposes only and may not be representative of the type of investments made by the fund.  Click to enlarge   Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2429938508"}