CloudBreak Pharma Files for Hong Kong IPO Amid $1.4B Losses and Over $1B in Financial Liabilities: Will Secondary Market Investors Become the Bagholders?

Stock trading depends onGolden Qilin Analyst Report, authoritative, professional, timely, comprehensive, helping you explore potential thematic opportunities!

Source: Sina Finance Listed Company Research Institute

Author: Tianli

On November 30, the Hong Kong Stock Exchange (HKEX) website disclosed the listing application submitted by CLOUDBREAK PHARMA INC. ("Cloudbreak Pharma") to the HKEX. The company's listing materials have been officially accepted, with UBS Group, CCB International, and Huatai International acting as joint sponsors.

Public information shows that Cloudbreak Pharma is a clinical-stage ophthalmic biotechnology company driven by innovation, dedicated to developing novel and differentiated therapies. However, after reviewing the company's prospectus, many hidden concerns have been found.

Firstly, the company is a "triple-negative company" with no products, no revenue, and no profit. Moreover, due to the issuance of a large number of convertible and redeemable preferred shares to strategic investors, the company's high financial liabilities have led to years of losses. After going public, it may remain in a long-term loss state, potentially maximizing the interests of primary market investors while possibly harming those of secondary market investors. Secondly, the company has transferred the domestic rights of its core product to its shareholder Grand Pharmaceutical but has not disclosed the upfront payment or sales royalties. The actual benefits the company will gain after the product’s market launch remain to be evaluated.

　　High Financial LiabilitiesAccumulated Losses Exceed 1.1 Billion, Strategic Investors Win Big as Secondary Market Takes Over

Cloudbreak Pharma was established in November 2020. Due to the lack of commercialized products, the company has been in continuous losses since its inception. The prospectus shows that Cloudbreak Pharma incurred losses of $35.4 million, $66.8 million, and $56.3 million in 2021, 2022, and the first half of 2023, respectively, equivalent to approximately RMB 252 million, RMB 476 million, and RMB 401 million. The total accumulated losses over three years have exceeded RMB 1.1 billion.

The reasons for the continuous losses, which show a further expanding trend, lie in two aspects: on one hand, the company's R&D expenses have been continuously increasing; on the other hand, the company has a large amount of financial liabilities resulting from the Series C strategic investment. According to the prospectus, in 2021, 2022, and the first half of 2023, the fair value changes of Cloudbreak Pharma's financial liabilities and derivative financial instruments recorded at fair value through profit or loss were losses of $26 million, $45.3 million, and $42.1 million respectively, totaling approximately RMB 809 million.

The so-called conversion right refers to the unconditional conversion of preferred shares into common shares after the company goes public. The redemption right, on the other hand, refers to the company's obligation to redeem the relevant preferred shares at an agreed price if it fails to go public within a certain period.

In the financial statements, although convertible and redeemable preferred shares are classified as preferred shares, they are accounted for as liabilities measured at fair value. This means that as the company grows, the valuation of the relevant preferred shares increases, which will be reflected in the income statement as an increase in losses due to the rise in fair value.

For Cloudbreak Pharma, although convertible and redeemable preferred shares have the right to receive dividends prior to common shares, the company is not obligated to pay dividends due to its current loss-making status. If a successful IPO provides an exit strategy, the obligation for repurchase also becomes irrelevant. For primary market investors, convertible and redeemable preferred shares offer guaranteed returns while holding the potential for excess profits post-IPO.

However, for secondary investors, the loss caused by the increase in the fair value of convertible redeemable preferred shares is reflected in retained earnings, but the premium portion converted into common stock is reflected in additional paid-in capital and will not offset accumulated losses. The premise for a company to distribute dividends to secondary market investors is that retained earnings must be positive, meaning there are no accumulated losses, and additional paid-in capital cannot be used for dividend distribution. Therefore, companies with substantial financial liabilities find it difficult to provide investment returns to secondary market investors through dividend distributions.

Moreover, from a valuation perspective, after the C-round financing, the valuation of Cloudbreak Pharma has increased from US$163 million in July 2020 to US$469 million in November 2021, nearly tripling in less than a year and a half.

Due to the particularity of the innovative drug industry, some companies have not yet achieved profitability, so the commonly used price-to-earnings ratio valuation method presents distortion. The price-to-research ratio, introduced in this context as a key quantitative valuation indicator, emphasizes R&D investment and technological innovation capabilities. It overcomes the limitations and inapplicability of traditional valuation metrics such as "price-to-earnings ratio and discounted cash flow models" when comparing innovation and enterprises, and can serve as a reference for valuing related companies.

Based on the pre-IPO valuation estimate of Cloudbreak Pharma, the company's price-to-research ratio is 55.18, significantly higher than the valuation level of unprofitable companies in the Hang Seng Innovative Drug Index. Wind data shows that the average latest price-to-research ratio of 13 unprofitable innovative drug companies listed on the Hong Kong Stock Exchange is 43.15, with a median of 26.08. Considering the often substantial premium space in new stock IPOs, secondary market investors also face high risks in gaining capital appreciation through stock premiums.

　　Why Does the Contract Avoid Discussing the Transfer of Core Product Rights to Shareholders?

From the perspective of products, Cloudbreak Pharma currently has only one new drug in its R&D pipeline that has passed clinical Phase II, which is in the "valley of death" stage of new drug development — CBT-001 for the treatment of pterygium. Currently, there are no approved drug treatments available globally for pterygium, and if CBT-001 successfully comes to market, it may become a "first-in-class" drug.

It is worth noting that, as the core product closest to commercialization and with the most potential, part of the rights to CBT-001 have been transferred to Grand Pharmaceutical.

The prospectus shows that on April 13, 2020, Cloudbreak Pharma entered into an exclusive commercialization license agreement with Grand Pharmaceutical, granting Grand Pharmaceutical the rights to manufacture and commercialize CBT-001 in mainland China, Hong Kong, Macao, and Taiwan. Cloudbreak Pharma will receive upfront payments, priority purchase right payments, and milestone payments totaling up to RMB 59.5 million. Cloudbreak Pharma retains the commercialization rights outside of Greater China as well as the rights for research and development and self-nomination applications.

Generally speaking, relevant licensing agreements should include upfront payments and subsequent profit-sharing arrangements. Since upfront payments are mostly one-time and non-refundable, the amount of the upfront payment relatively accurately reflects the value assessment of the pipeline by the related companies. The sharing ratio directly impacts the evaluation of the company’s future revenue and profit generation capabilities.

For example, Envonliumab, the world’s first and only subcutaneously injectable PD-L1 antibody, was independently developed by Alphamab Oncology. It was later introduced to 3D Medicines and Simcere Pharmaceutical for collaboration. The sales plan is as follows: Alphamab Oncology sells the drug to Simcere Pharmaceutical at an ex-factory price after adding a certain percentage markup. After completing commercial sales, Simcere extracts a sales share from the revenue, and the remaining pre-tax profit is equally divided between 3D Medicines and Alphamab Oncology.

What is quite puzzling is that the CBT-001 collaboration authorization, as the only non-government-subsidized revenue item in Cloudbreak Pharma's past history, did not disclose the amount of the upfront payment received or the revenue-sharing ratio for future product commercialization.

In fact, Grand Pharmaceutical is not only the company's sole collaborative customer but also its shareholder. According to the prospectus, Grand Diamond (a wholly-owned subsidiary of Grand Pharmaceutical Group) and CNCB Grand Healthcare Investment Fund LP (a fund indirectly invested in and managed by an associate of the controlling shareholder of Grand Pharmaceutical Group) are Series B and Series C investors of Cloudbreak Pharma, respectively. Together, they hold 4.52% of the company's equity.

Moreover, Design Time, which holds 3.2% of the company's equity, is indirectly wholly owned by CCB International (Holdings) Limited, the joint sponsor of Cloudbreak Pharma's IPO. Skketch Shine, holding 6.39% of the company’s equity, is a member company of CDH Investments Group. CDH Giant Health I Limited, under this company, is a major shareholder of Grand Pharmaceutical with more than 10% stake. The frequent appearance of the "Grand Pharmaceutical Group" among shareholders, coupled with the core product licensing agreement avoiding mention of upfront payments and sales royalties—can Cloudbreak Pharma’s commercialization journey proceed smoothly? We will continue to monitor.

Editorial Responsibility: Company Observation