The Stocks of Seth Klarman - PDL BioPharma
“The problem with pharmaceutical companies is that they have these very stable cash stream from their portfolios of their existing paths of drugs. And then they give away a huge percentage of it in the research and development process looking for new drugs to replace the old ones that are coming off path. So really, if you can’t trust the management to be a good manager of the money, normal pharmaceutical companies are very risky companies. PDLI split off their royalties on the existing drug from the new drug R&D activity. And was interested in buying at a reasonably good price from the annuities stream from the existing drugs, so it is not a normal pharmaceutical.”
PDLI is not a normal pharmaceutical at all. This stock is a unique situation and is better characterized as a bond that will mature in 2014. Of course in this case the coupon payments are uncertain. The company derives royalties for its antibodies from various biotech firms, with Genentech being the largest. Most of the royalties will expire in 2013 and 2014 leaving the company with few if any revenue streams afterwards. The revenues PDL will earn in the next 3-4 years depend on how successful the drugs Genentech sells as PDL receives up to 3% of the sales.
Even more important is litigation the company presently has with Genentech. PDL is specifying damages of up to $1 billion for Genentech’s beach of a royalty contract. The context of the case is a dispute in which PDL believes it is entitled to certain royalties for drugs sold on an international basis which Genentech denies. Though the $1 billion is the high estimate for damages, divided 139 million ways, it would be a very handsome payment to shareholders given its shares are trading around $5.
However, a recent lawsuit went awry with the biotech company MedImmune. PDL sued MedImmune also for patent infringement, but the judge ruled against PDL and PDL has since settled with MedImmune for a sum of $92.5 million.
There is a certain amount of risk in this stock and a good deal of it hinges on the success of this lawsuit. Klarman is known for his bold and seemingly unorthodox moves that are event contingent. Early last year he held “way out of the money” put options on bonds as a form of insurance against rising rates. If rates were to reach 5-7% then nothing would be made on the hedge. If rates were to reach double digits the put would be 10-20 times as valuable. Likewise if rates were drop, the put would be worth less though he didn’t mention that.
This investment looks similar. If the lawsuit is a success the stock could potentially be twice as valuable. If not, the company will continue to milk its existing royalties until they disintegrate in 2014. In the meantime the company has been paying fat dividends. In 2010 it paid $1 in dividends or an effective dividend yield of 20% on today’s price. Again keep in the mind the company is in somewhat of a liquidation mode and these outsized dividends should not be expected for the foreseeable future.
Another unusual element about the company is that the book value of has dipped below 0. After paying a large $6.85 dividend in 2008 the capital of the firm was severely depleted as this dividend was not financed by free cash flows.
PDL has its 4th quarter conference call on Monday and I’ll be sure to post an update on any developments.
Disclosure: Recently Long in PDLI