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The Stocks of Seth Klarman - PDL BioPharma

February 25, 2011 | About:
Josh Zachariah

Josh Zachariah

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The pharmaceutical PDL BioPharma grabbed my attention as it was one of the few stocks that have actually seen a marked drop since Seth Klarman had made a purchase (17% since Q42010). I’ve noticed few stocks that have headed in the downward direction after Klarman had made purchases. In an interview with Gurufocus, Bruce Greenwald commented on Klarman’s purchase:

“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

Josh Zachariah

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 3.5/5 (19 votes)

Comments

random_walker
Random_walker - 3 years ago
Have you calculated the NPV of the royalty stream?

itznuthin1
Itznuthin1 - 3 years ago


Thanks for the write up. I think Pdli looks interesting. Its almost like purchasing an annuity that depreciates in value. I would have to find a way to hedge the position. Seems like there could be some inherent risk in a lawsuit loss. However, a win could be the catalyst to increase shareholder value. Seems like another Klarman equity stub/option play.
rijk40
Rijk40 premium member - 3 years ago


really bad article.....
superguru
Superguru - 3 years ago
PDLI is probably a very very insignificant part of Seth Klarman portfolio. Not even sure why he buys such small positions in such small companies. Does it even impact his returns in any way?

vgm
Vgm - 2 years ago
I realize this is a well worn topic, but I wonder if anyone else listened to Klarman discussing PDL on Youtube. The video is from 2009, a series of seminars which were recorded (see beginning of Seth Klarman 2009 Part III)

http://www.youtube.com/watch?v=VVD_vMwhZBs&feature=related

At that point he says the stock was in the low to mid $6 range, but claimed that it had the prospect of a 30% annualized rate of return and calls it a "remarkable mispricing" of a stock.

Now, we could say yeah that was 2009, but given that he essentially doubled his holdings in 1Q 2011 (when PDLI traded down around $5), and that it trades at $5.80 today, is it possible that his original investment thesis is still valid?

vgm

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