Trifecta
Horse betting sits firmly in the camp of gambling, not investing. Returning home from my (infrequent) trips to Santa Anita Racetrack, my lifetime accounts are in the black for entertainment and deep in the red for actual dollars. I'm miserable picking horses even when I make "safe" bets to "show" (the horse has to finish in the top three). But… do I win when I feel really lucky and pick a trifecta - picking the top three horses in a race in the correct order? Also no.
The odds to win a trifecta bet are long, the draw, though, is a much larger payout. Knowing the payout lets you compare it to what you think a horses odds actually are. When investing in stocks, the odds and the payout are both typically shrouded in uncertainty. We have some tools to put a box around them, but, mostly, we only know the payout in hindsight and we can never really get at the odds - even after the fact.
Sometimes, though, situations come up where we do know the payout and can figure out what that means for the odds.
One Horse Race
On June 28, 2023, Sigilon Theraputics agreed to sell itself to Eli Lilly. Sigilon management agreed to the deal after enduring an indignant run from its IPO back in 2020, when biotech stocks were flying high. Price fell 99.1% from its debut until the merger announcement. That stings.
Sigilon is a development-stage biotech company that does… well, LCM is not a biotech expert and the science is admittedly "in development," but they hope to develop off-the-shelf treatments for chronic conditions, like diabetes, lysosomal diseases, and liver diseases.
Eli Lilly had already partnered with Sigilon on its diabetes program, so has an inside look at the lab stuff and is in a much better position than LCM to understand any of it. We'll leave the science there.
Even working in the same lab, though, the Sigilon and Eli Lilly teams had vastly different views of what the company's value. We know that because of what Eli Lilly paid for SGTX: $14.06 plus a handful of paper IOUs or "Contingent Value Rights." Eli lilly only pays the IOUs if Sigilon's treatments do certain things by certain dates. The sides didn't come to couldn’t agree how likely those things are, so punted.
Eli Lilly came to the table with a deal.
Sigilon said "lol, no, we're worth WAY more than that!"
Eli Lilly countered "OK, IF some things work out, we'll pay you more."
Sigilon: (looks at share price, sighs) "Fine."
The Payout
The deal is this: Sigilon shareholders get$14.92 in cash in any case. If doctors deliver an Sigilon treatment to a patient for a clinical trial by July 2027, shareholders get an additional $4.06. If that happens and if Eli Lily submits paperwork to the FDA to get its blessing to sell the therapy to the public by July 2028, shareholders get another $26.39. If those things happen and then Eli Lilly begins marketing an Sigilon therapy by December 2031, shareholders get an additional $81.19.
So, shareholders of Sigilon will get $14.92 when the deal closes and maybe $126.56 by 2031, if their stuff clear all the hurdles.
That's what you get if you "win" the bet. What are the odds? What's the cost?
After Sigilon announced the deal, shares shot up to $22.14 (as of print time). This means the market thinks the deal will close and shareholders will get the $14.92. It also means the market is just about certain that Eli Lilly will dose the first patient by July 2027 and shareholders will get the additional $4.06. That's $18.98 for those keeping score at home.
That leaves an investor today paying $5.98 for a potential payout of $107.58. This pencils out to about a 10-15% chance that Eli Lilly will end up paying those final two IOUs. A 5% range for something is pretty tight for odds served by the market.
In the wild, LCM would expect about 6% of therapies to make it from the earliest stage of development all the way to FDA approval. Sigilon has two therapies in development so, a one in ten chance of anything working out for them seems about right.
Like horse betting, LCM is a dismal judge of science experiments and can't say with much conviction whether Sigilion's therapies offer a better than 10-15% chance of hitting the trifecta and earning all three payments.
What would be enticing to LCM would be if, for some reason, shares fell back towards or below the cash value of the deal. This would leave a negative value for the IOUs and that is a price LCM is always willing to pay. That would be a bargain.