BOSTON ( TheStreet) -- In early August, with its stock trading stronger than it had in six months, Exelixis ( EXEL) decided to raise money -- a lot of money. A 30 million-share equity offering combined with $250 million in convertible debt raised the biotech company $362 million. The deal also put a break on the upward momentum in Exelixis' stock price. Here to explain why Exelixis trades so poorly since the financing is @ColfaxCapital, an institutional equities trader specializing in biotech and healthcare stocks. (He asked to remain anonymous, hence his Twitter handle.) Colfax explains why investors in the Exelixis financing are profiting handsomely while those trading the stock since have been left holding the bag: For traders and investors who have been wondering why the common equity of Exelixis has been trading so poorly since their most recent financing, one needs to understand a common equity and convertible financing. When the company did the last financing in early August, Exelixis, through their bankers, issued 30 million shares in common equity (+4.5 million shares underwriter allowance) and $250 million in convertible notes (+$37.5 million underwriter allowance.) Common stock was issued at $4.25. The notes are convertible at some point in the future at $5.31. It is very likely that the financing participants took part in both the common equity and the convertible arms. For those who did not participate in the financing, this was a bad deal. It's also a bad deal for anyone who bought Exelixis after the financing. The only shareholders it was good for were the funds who bought both the common equity and the convertible arm of the deal. This deal is very similar to an equity offering with warrants attached. It's just a pig with a different type of lipstick. Warrants are "sweeteners" in financing deals. In the case of the Exelixis financing, the convertible arm was a "sweetener" in lieu of warrants. Why are they called "sweeteners"? Because an investor can use the common equity portion of the deal to finance a portion or all of the warrants/convertible arm. In the case of common equity and warrant deals, you'll often see a fund take down, let's say, 5 million shares of XYZ common stock, and, also be apportioned 0.5 warrants for every common share. Oftentimes, a few weeks later, when the 13F filings come out at the end of the quarter, you'll notice that very same fund owns absolutely no shares of the common stock, despite the stock having barely moved. How is this possible? Because the fund likely used the common shares in a short position to pay for the warrants, making the warrant arm of the trade almost risk-free, or reduce the cost of the warrants greatly. Let's take a closer look at what investors in the Exelixis financing are likely doing: A hedge fund buys Exelixis common stock, in size, at $4.25 per share and has the ability to own more stock at $5.31 per share at some point in the future with the convertible arm. Therefore, any time Exelixis' stock price rises above $4.25 by a reasonable amount, the hedge fund can short the stock and use profits from that short sale to pay for the convertible stock. For instance, days, weeks or months later, if Exelixis' stock is trading at $5.50 and the hedge fund bought 10 million shares in the financing deal, it could short 10 million shares and "arbitrage" the profits.
Since the hedge fund owns 10 million shares at $4.25, it profits from the cost basis of the short versus its long position received in the deal at $4.25. The fund then takes those profits and uses them to pay for the convertible arm in full, or reduces the cost basis of the convertible. Why do this? Easy, it's almost like free money. Furthermore, if an investor thinks Exelixis' cancer drug cabozantinib is going to be a billion-dollar blockbuster drug, then owning the stock at $5.31 -- or lower, cost-basis adjusted -- is a no brainer. And, if investors can get convertible shares for free, it's even better. When a company raises money through an equity sale with warrant or convertible notes as a sweetener, investors who aren't lucky enough to participate should run away from the stock - fast.