ZymoGenetics Takes on First Debt. Deerfield Bets Recothrom Will Pay Dividends

Xconomy Seattle — 

ZymoGenetics is growing up. For the first time, the Seattle-based biotech company has raised capital by borrowing it, instead of following the usual industry playbook—getting it by selling more equity shares to investors.

The latter technique, which creates more supply of available shares and therefore dilutes the value of existing ones, would certainly have raised a ruckus with ZymoGenetics shareholders. The stock (NASDAQ: ZGEN) closed yesterday at $8.42 a share, and has fallen 44 percent from its 52-week high. Another equity sale would’ve likely driven it down more.

“We clearly didn’t want to do that,” said ZymoGenetics president Doug Williams, in an interview. “We feel that Recothrom is going to be a successful product, and because we are a maturing drug company with a marketed product, we can now take on debt as an instrument to fund the company.”

The company said yesterday it agreed to borrow as much as $100 million from Deerfield Management, a leading biotech hedge fund and one of its largest shareholders. It gives ZymoGenetics the flexibility, as Williams puts it, to make strategic withdrawals in $25 million chunks to boost sales of Recothrom, the company’s new drug for surgical bleeding. In exchange, Deerfield gets a 2 percent royalty on sales for every $25 million loan it provides. The company will also have to pay back the borrowed money by June 2013, plus 4.9 percent interest.

ZymoGenetics said earlier this year it would do something to slow the bleeding on its own income statement. The company reported a net loss of $41 million in the first quarter, and had $155 million in cash and investments left at the end of March. To reduce expenses, it cut more than 80 jobs, leaving a payroll of 535 workers. It is also dropping hints about possible partnerships in the works that could bring in new cash.

Without a proven stream of cash flowing in yet from its new product, Deerfield’s bet matters, said Greg Wade, an analyst with Pacific Growth Equities in San Francisco. Recothrom, approved by the FDA in January, still has to pass muster with hospital purchasing committees. That bureaucratic process can take months before the company gets a more specific read on the drug’s sales potential, Williams says. Meanwhile, ZymoGenetics and its partner Bayer have to convince hospitals they should quit using a cheaper competitor, Thrombin-JMI, derived from cow blood and start using the genetically engineered product from ZymoGenetics.

“Deerfield is a highly respected institutional investor, and it speaks to their confidence in ZymoGenetics’ management and product that they’ll put this much money at risk,” says Wade, who owns shares in ZymoGenetics. He added that ZymoGenetics chose the “optimal” way to get capital at a low borrowing cost, while minimizing the dilution of existing shares.

Wade expects Recothrom to generate $23.7 million in sales in 2008, its first year, and $70.9 million in sales next year. That puts Wade in the middle of analyst forecasts for Recothrom sales, which vary from $13 million to $35 million for 2008, said Susan Specht, a company spokeswoman.

It’s still too early to say whether ZymoGenetics can get to the ultimate measure of success for a maturing company: the P-word (profitability). Chief Financial Officer Jim Johnson used the word on a conference call with analysts yesterday, saying it is the company’s goal “in the next few years.” It’s possible that Recothrom sales could push the company into the black, he says, although he didn’t go so far as to predict that one drug alone will do the trick.