More reverse IPOs on tap?

In a move that could be mimicked by other VC-backed biotech startups, Neuromed Pharmaceuticals Inc. has agreed to merge with publicly traded CombinatoRx Inc. (Nasdaq: CRXX).

“I think you will see more of these,” says Todd Foley, a managing director with MPM Capital, Neuromed’s largest investor. “I think the industry is better served by fewer, stronger companies.”

The deal with CombinatoRx isn’t a typical reverse IPO, “where the public company is a zombie, a shell company with a bunch of cash and not much else,” Foley notes. “It was much more a merger of equals.”

Vancouver-based Neuromed was in a bit of a unique situation. It had fresh capital, having licensed its pain drug Exalgo to a subsidiary of Covidien (NYSE: COV) in June for $15 million in upfront payments, plus $16 million for development costs and up to $40 million more for meeting an approval milestone. But many of Neuromed’s other products were early in development, so it was looking to join forces with a company with products that were farther along, Foley says. That company turned out to be CombinatoRx.

The merger calls for CombinatoRx to issue about 36 million new common shares to Neuromed stockholders with each party owning about half of the combined company, which will be called CombinatoRx. But ownership will change based on the outcome of an FDA review of Exalgo. For example, if the drug is approved by Dec. 31, pre-merger Neuromed shareholders will own 70% of the combined company, but if approval is not received by Dec. 31, 2010, then pre-merger CombinatoRx shareholders will own 70% of the combined company.

We’re not doing this to get some liquidity and get some pennies from our investment. We’re doing this to build a strong company for the longer haul.

Todd Foley

The deal, which is expected to close during the fourth quarter, values Neuromed at about $29 million based on CombinatoRx’s closing price of 83 cents on July 6.

Foley takes the low valuation in stride. “We’re not doing this to get some liquidity and get some pennies from investment,” he says. “We’re doing this to build a strong company for the longer haul.”

He notes that if MPM didn’t have any confidence in Neuromed, it probably would have urged the company to sell Exalgo rather than license the drug and then just shut down the remaining company. “We decided to essentially double down on the Neuromed team and their discovery programs, and we found some good assets at an attractive price in CombinatoRx,” he says.

MPM has invested about $35 million in Neuromed, which has raised a total of about $143 million over seven rounds since 1997, according to Thomson Reuters (publisher of PE Week). Most recently, the company raised $43.2 million in August 2007 from MPM, Business Development Bank of Canda, GrowthWorks, NDI Capital, RBC Capital Partners, Richardson Capital and Royal Bank of Canada Pension Fund.

As for when an actual liquidity event will occur, that’s anyone’s guess, Foley says. CombinatoRx has said it has “sufficient cash” to continue operations into 2012. That should give the combined company plenty of time to execute on milestones and new products and push up its stock price. At less than $1 per share, it has plenty of upside potential. —Lawrence Aragon