Intriguing Patent Litigation Situation ($FNCH)

A highly impactful verdict arrives tomorrow—deciding the fate of this Net-Net.

Aug 08, 2024

Because this is a time sensitive matter, this is substantially shorter than most of my posts. For more background, one can see my IdeaBrunch interview, where I initially discuss this situation. I was not a shareholder then, but I have recently purchased a small position going into this week’s jury trial.

Background

There's an interesting situation brewing at Finch Therapeutics ($FNCH). This article provides a solid summary of the case. The gist is that Finch holds several key patents regarding Fecal Matter Transplant technology. FMT is a game-changing technology for those suffering from gut issues like persistent C-diff infections—a $1b+/year market.

The FMT methods addressed in these patents were largely developed and patented by Australian doctor Thomas Borody, who holds numerous patents across FMT. In 2015, Borody apparently transferred ownership of these patents to Finch. Knowing this and anticipating legal action against its drug Rebyota—which utilizes technology covered by Finch’s patents—Ferring preemptively took Finch to court. Their goal is to 1) assert no infringement due to “prior art” and 2) more broadly make the case that Finch does not, in fact, own these patents. Finch is arguing the opposite, and likely seeking remedy, e.g. a royalty on Ferring’s Rebyota sales.

Catalyst

A verdict should be out tomorrow which, if positive for Finch could result in a settlement that may be several times the company’s (admittedly tiny and illiquid) market cap. More discussion on that later. However, one must note that, if Finch loses, it will likely spend all of its cash on legal fees, and be a zero.

Interesting Recent Developments.

I first mentioned this idea on the excellent @ideabrunch, where I said one should wait until delisting as there would be lots of forced selling. It has since traded up into trial from .8s to ~$3 today. I wasn't a shareholder at that point. However I recently went long in small size. Why?

Ferring, has engaged in some sordid behavior in this trial, and the judge is quite displeased:
1. https://ipde.com/blog/2024/08/02/to-say-that-the-court-is-troubled-by-the-occurrences-to-date-would-be-an-extreme-understatement/
Additionally, Ferring recently forfeited its argument that Finch does not own these patents.
1. They now—importantly—stipulate that Finch owns the key Borody patents.
  1. When I'd at first talked w/ lawyers about this case, they mentioned that this was a major risk to Finch’s argument, so this development seems important.
    1. https://ecf.ded.uscourts.gov/doc1/04316504160
Generally it seems that Finch has a better case from my reading, but there is still the “prior art” matter that the jury must rule on. If Ferring can make the case that Finch’s patents shouldn’t have been granted in the first place, they may protect themselves from Finch’s claims of infringement.

Caveat Emptor

However, that doesn't mean Finch will win. This is still a jury trial. Finch will have to prove that their patents should not be considered prior art, and that they have been damaged by Ferring’s actions.

What if Finch Wins?

Finch definitely has more cash on hand than market cap (~$5m); probably $15m+ if I calculate burn correctly. W/ no business activities, this trial is basically the sole factor in its future as a company
Ferring's drug Rebyota—which I can't find sales info on—has a close comp in Seres. Seres has sold over $40m of FMT drug Vowst last year and is at $50m+ run rate.
Ferring prices it's drug at ~$9k/dose and I assume its sales are around the same—or higher. Rebyota is a 1-time rectal dose. Vowst is 4 capsules taken once daily for 3 consecutive days. Both are highly efficacious.
It has been alleged by Finch’s expert witness that, in this scenario, royalties could amount to 30% of revenues. However this is of course a contentious point.
That's about $22.5m potentially in arrears, not counting any go-forward royalties (once again, major assumption that Rebyota is similar to Seres' drug).
Obviously returns could be quite good for Finch shareholders in this scenario considering it is a $5m cap!
Finch could also use this as a precedent to settle with other FMT companies like Seres potentially

Valuing Rebyota Another Way

I have not found much definitive information on Rebyota sales. However Seres recently sold Vowst to Nestle for $175m. Additionally another $75m should be coming in 2025 per the PR, w/ additional milestone payments up to $275m. Also keep in mind that Nestle has invested several hundred million in Seres to date already.

If Rebyota is worth a similar amount to Ferring, one can imagine that Finch has a strong case to allege a larger settlement. This excellent article offers a comparison of the two drugs and may help investors think about the pros and cons—and therefore potential success—of each.

Update: See the following language from the JMOL just submitted by Finch:

Finch are seeking $50m+ a 30% running royalty.

Risk Factors

If Ferring proves some or all of Finch’s patents are invalid under “prior art”, Finch has a diminished case.
Finch management, in the case of a loss, probably end up burning all/most of the cash on legal fees and it's a donut
Even in a win, payments may encourage management to pursue drug development, and burn all the winnings
It's not clear necessarily how shareholders would have cash returned to them...
Finch might roll the cash into new litigation w/ Seres etc.

Also, I want to note that Finch just submitted a Judgement As Matter of Law (JMOL). This is a request that essentially says the evidence is so overwhelmingly in their favor, that this case should not even go to trial.

Here’s a link.

A JMOL can be submitted after the opponent’s closing arguments (as it appears to have been in this case based on it arriving on PACER before any jury decision) or after a verdict. The judge may deny this request, but it is notable that it was just submitted. My reading is that Finch is fairly confident.

Summary

As I mentioned, I am long, so I am biased. This situation is not for the faint of heart. It's an extremely risky binary. I've spent $100 on PACER documents alone and talked to several lawyers. If you haven't done this, best to not touch. However it is an interesting opportunity, and the sort of thing large funds can't touch due to illiquidity.

A Note on Trading Dynamics

I think it might be worthwhile to watch from the sidelines, and see if liquidity improves. I recall Eiger, which was initially illiquid at around $2.5, but was still a compelling r/r at $7.5 when it became far more liquid post sales of its assets (and even had a VIC post written about it). The situation is different, but the trading dynamics may be comparable and allow for entry.

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