Biotechnology stocks like Ocugen (NASDAQ:OCGN) are among the market’s riskiest plays. Add in a $31 million market capitalization and potentially significant cash burn, and Ocugen stock self-evidently is not for risk-averse investors.

That said, for investors who understand the potential downside, there is an intriguing story here. The reverse merger that brought Ocugen to the public markets led to huge losses — but some investors are buying the dip. A partnership with a respected Asian biotechnology company offers some validation to the pipeline, and a key product is progressing through Phase III trials.

It’s worth emphasizing: Ocugen stock is a play with enormous risk. As with many biotech stocks, the most likely outcome is for the company to fail, and for shareholders to wind up with zero. But the allure of the space is that when a company wins, its shareholders win big. And it’s at least possible that OCGN could wind up being a winner.

Ocugen’s Path to the Public Markets

Ocugen came to the market via what was essentially a reverse merger with Histogenics Corporation, a deal that closed at the end of September. Histogenics itself highlights the risks involved in small-cap biotech. In 2018, its NeoCart biologic failed to meet the primary endpoint of its own Phase III trial. Shares fell 72% on the news, and kept falling after Histogenics decided to suspend development of the product in December 2018.

The Ocugen deal is a way to salvage some limited value. Ocugen sold $25 million of stock in a private placement before the merger. Histogenics shareholders then received about 14% of the company, according to the merger prospectus. The combined company has an agreement to sell the rights to NeoCart to privately held Medavate, leaving it reliant on Ocugen’s pipeline.

So far, that merger hasn’t worked out for Histogenics’ former shareholders. Shares declined 85% in three sessions around the closing of the merger, which also included a 1-for-60 reverse stock split. The newly renamed Ocugen stock kept declining through year-end, but has managed to stage a bit of a rally in 2020, gaining 15% year-to-date.

The Balance Sheet

For investors new to the story, there are some positives when it comes to OCGN stock. First, the balance sheet is in at least decent shape. The $25 million private placement executed before the merger brought in much-needed cash. The sale of NeoCart, which still is pending, can bring in another $8 million, based on the current agreement.

To be sure, current cash isn’t enough. According to the prospectus, the combined company posted an operating loss of roughly $30 million in 2018. Without NeoCart, that burn likely comes down. But the sale of NeoCart appears to not yet have closed after its deadline was extended to allow Medavate to secure financing. It’s certainly possible the deal will fall through, leaving Ocugen with just the $15.8 million in cash with which it closed the third quarter, according to its 10-Q.

Still, Ocugen’s balance sheet isn’t as dire as its share price might suggest. And a partnership with China’s CanSino Biologics (OTCMKTS:CASBF) should help the company develop its pipeline. CanSinoBio is a legitimate player in the industry; the company’s market cap is near $2 billion after a nice rally in recent weeks. CanSinoBio will be able to fund much of the development of OCU300, Ocugen’s flagship product that targets oGVHD (ocular graft versus host disease), a common complication of bone marrow transplants.

The Case for Ocugen Stock

That product drives the current bull case for Ocugen stock. OCU300 already has received an “orphan drug” designation from the U.S. Food & Drug Administration for oGVHD; there is no currently approved treatment in the U.S. The generic form of brimonidine, the active ingredient, is not approved for the condition, according to Ocugen’s most recent presentation.

If OCU300 is approved, there’s a reasonably large market. Ocugen estimates the drug could have as many as 63,000 potential patients. Pricing likely would be favorable, given the lack of alternative treatments. CanSinoBio will receive some of the profits, but Ocugen still would skyrocket with FDA approval and ensuing revenue — and there are more products in the pipeline. The company has a gene therapy platform as well as two preclinical compounds that aim to treat retinal diseases.

The broad point here is that, even with a ~$30 million market capitalization (based on updated share count information disclosed in an 8-K filing on Dec. 9), this is a company with a legitimate opportunity. Its top officers have experience at Pfizer (NYSE:PFE) and other well-respected pharmaceutical and biotechnology companies. The reverse merger with Histogenics was a disappointment, but the purchase price for the NeoCart intellectual property suggests that company had little chance of survival on its own.

Big Winners Elsewhere

Biotech companies have emerged from similar levels to become huge winners, as evidenced simply by looking at some of the best biotech stocks for 2019.

Axsome Therapeutics (NASDAQ:AXSM) had an equity value below $75 million in March 2017; it’s now worth over $3 billion after rising over 1,000% last year. The market capitalization of Relmada Therapeutics (NASDAQ:RLMD) went from under $10 million at the end of 2017 to over $500 million at the moment. Cassava Sciences (NASDAQ:SAVA) has soared 454% in just the last three months.

Ocugen isn’t a promotional, fly-by-night penny stock. There’s an opportunity here. That doesn’t mean success is guaranteed. It has real management. It has real products. And while Ocugen will need more capital at some point, the company at least has time to push OCU300 forward and get its story out to investors.

What Goes Wrong

So, what goes wrong? The short answer is: everything. Most biotech companies have intriguing stories on paper; Ocugen is no different. But realizing value in practice usually is a difficult endeavor.

From a near-term standpoint, there are two key risks. The first is that Ocugen is facing potential delisting from the NASDAQ given that its share price still sits well below $1. Ocugen does have at least 180 days to cure that problem, but the simplest answer is for the company to execute a reverse stock split. Those reverse splits generally are poorly received by the market, even if in theory they should have little to no practical impact on trading.

The second is that the balance sheet still needs some help. The CanSinoBio partnership does help, but Ocugen still has a long way to go with OCU300. The company initiated its Phase 3 trial of OCU300 back in July 2018. It announced on Dec. 9 of last year — 17 months later — that it was 50% through enrollment. That’s not a new problem: a previous Phase 1/2 study, according to the prospectus, was “discontinued early due to slow enrollment.” The company noted that additional trials may be required as well.

From a broader perspective, the risk is the same as it is across biotech: most candidates fail. Even before that point, the most promising candidates generally can find funding. Ocugen had to go an unusual route to go public. Even though Ocugen did raise $25 million in a private placement, the story behind OCU300 clearly was not enough to support an initial public offering on its own.

A Nano-Cap Biotech

A $30 million market capitalization doesn’t mean Ocugen has no chance. But it does mean something. It means that institutional investors focused on the sector largely have passed on the pipeline. It means that raising capital will be more difficult going forward.

In other words, it means that even by biotech standards OCGN stock is an enormously risky play. The odds of Ocugen stock winding up at zero are material. The chances of anything more are small — but the rewards could be huge.

Investors need to understand the risk profile here. But if they do, Ocugen stock at the least looks like an intriguing bet.

As of this writing, Vince Martin has no positions in any securities mentioned.