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Re Analysis of Targacept Seth Klarman s New Purchase
Posted by: vgm (IP Logged)
Date: March 20, 2012 11:03AM

TRGT: another failed clinical trial. Stock crashes 26%.

Like I said before, predicting the outcome of depression trials is particularly fraught with difficulty.



Guru Discussed: Seth Klarman: Current Portfolio, Stock Picks
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Re Analysis of Targacept Seth Klarman s New Purchase
Posted by: Matt Blecker (IP Logged)
Date: March 20, 2012 01:27PM


VGM,

Very true, but purchasing this stock is not about predicting the outcome of a depression trial, it is about investing in a company selling below liquidation value. The main concern I have with the stock is the cash burn rate as clinical trials are very expensive. However, the firm still has a liquidation value around $6.50 per share. Management is announcing future plans by the end of April.

Since the worst thing possible happened, my worst case scenario above came to fruition. The stock is selling for precisely the scenario I described above if all trials fail. The market is essentially saying the entire pipeline is worthless and only valuing the company based on the liquidation value ended 12/31/12 which is still likely to be approximately $5.50 per share.




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Re Analysis of Targacept Seth Klarman s New Purchase
Posted by: vgm (IP Logged)
Date: March 20, 2012 03:33PM

Matt,

Thanks. Yes, point taken. Your analysis was excellent. However, I was skeptical of your summary:
"In summary, I believe Targacept presents 50% or more upside with minimal downside..."

At the time of writing it was $7.79. It closed today at $5.15.

The problem I saw with this company as an investment was that the margin of safety was already borderline, which, taken together with the downside risk of (what I estimated to be) a low probability of success in the clinic made it, at best, dead money. Like Charlie Munger might have done, I put it on the too-difficult pile.

By contrast, PDLI was a much easier case for me to get comfortable with.



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Re Analysis of Targacept Seth Klarman s New Purchase
Posted by: Matt Blecker (IP Logged)
Date: March 20, 2012 04:16PM


VGM,

While the stock price is down substantially in the short-term that does not necessarily mean there was not a margin of safety in terms of permanent impairment of capital at $7.79.

Using 20/20 hindsight, I wish I would have waited until the second trial was complete. I initially purchased shares slightly below liquidation value at the time around $7.50 and purchased a second batch after the failed second trial at $5.30. So obviously it would be better if my average cost basis were $5.30 instead of $6.40.

Thankfully this was a small piece of my portfolio and not a core position like Microsoft, Apple, Dell, HP, and Intel.

My logic after the first trial was that the company was selling below liquidation value, had 3 plus years of liquidity, a decent pipeline with many products in level 2 trials, still had 3 trials left for TC-5214 and planned to file an application by the end of 2012, as well as many potential milestone and royalty payments. Success in even one of those trials may have created a catalyst, as one successful trial would have likely led to more milestone revenue from AstraZeneca for TC-5214. But you do make a good point that although many phase 3 drugs are sucessful, Depression seems to be a difficult area.

At the time, I saw significant upside (50-100%) with minimal downside with the exception of a worst case scenario in which the downside was approximately 30%. Unfortunately, the ultra-bearish scenario occurred when everything failed.

I still think Targacept remains a hold as long as it is near or below liquidation value and remains a smart purchase as part of a basket of "net-nets."

I would say the lesson I have learned from this purchase, currently down nearly 19%, is that pharma net-nets are tricky and I am much more comfortable purchasing cheaps stocks with strong FCFs/balance sheets or reasonably priced stocks of companies with enduring competitive advantages I feel can continue to grow earnings.

Putting the last paragraph into practice, I have decided to pass on firms such as Aveo and Enzon and instead purchase shares of Dell and Yahoo. We will see how this plays out long-term (3-5 years down the road).




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Re Analysis of Targacept Seth Klarman s New Purchase
Posted by: vgm (IP Logged)
Date: March 20, 2012 05:08PM

Matt,

Again thanks.

You make an excellent point about the inherent difficulty of evaluating pharma net-nets - especially with pending clinical data. That's why for me it went on the too-difficult pile.



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