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Seth Klarman’s New Purchase Targacept Is Now a Net-Net

December 21, 2011 | About: TRGT +0%
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gurufocus

gurufocus

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We reported on December 12 that renowned value investor Seth Klarman bought a 16.92% of stake in biotech Targacept (TRGT) after its stock price dropped 60% following a drug trial fail. While the stock was probably cheap then, it is now even cheaper as the stock price dropped another 35% lately. Targacept now has a market cap of $167 million. If we take a look at its balance sheet, as of Sept. 30, 2011, the company has more than $210 million in cash and short-term investments, and almost no debt. With about 33.38 million shares outstanding, the cash per share is about $6.2. This means that Targacept, at its current stock price of $5, is traded 20% below its cash value.

Seth Klarman bought the stock as a cigar butt investment, meaning poor companies at very low prices. With net cash higher than its share price now, the stock is now a Ben Graham net-net. Buying a basket of net-net worked very well for Ben Graham. You can see the current list of Ben Graham net-nets with our Net-Net screener.

Our writer Matt Blecker has done a detailed analysis on Targacept. He concluded that the company will have $8 per share of net cash by the year end, which means that the stock is even cheaper than it looks now.

Will you buy the net-net stock Targacept now at a 30% lower price than Seth Klarman has paid?

For more net-nets, check out our Ben Graham Net-Net screener.

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Comments

yams4112
Yams4112 - 1 year ago
i would like to coin the phrase margin of seth-ty right now.
vgm
Vgm - 1 year ago
Let's see if Klarman buys more. If he does then it really gets interesting at today's price.
tonysf
Tonysf - 1 year ago

A net net is meaningful only when you know either the business will eventually survive or liquidate for higher value. In case for a biotech stock, more expirements will drain all the cash so quickly unless they can get collaboration supports from a big pharma (or selling compounds to them). 200 million of cash really isn't much to develop a couple drug candiates.
Matt Blecker
Matt Blecker premium member - 1 year ago
Excellent point Tonysf. The cash burn rate is a critical part of analyzing a "net net." I feel the risk is worth it with Targacept because they have enough cash to operate for 3 plus years and can always slow the cash burn rate down. They also have many products in trial and do not require an approval to generate additional income, only "milestones." Of course there are risks, but I felt the price reflected the risks involved at $7.50 and even more so at $5.00. Just as investors overreacted on the bullish side at $30, they are on the bearish side at $5.00.

With regard to your statement: "A net net is meaningful only when you know either the business will eventually survive or liquidate for higher value."

If it were certain the business would survive or liquidate for a higher value, Targacept, or any other "net net" for that matter, would probably not be a "net net." A reason many "net nets" arise is because of uncertainty. The major questions with a "net net" are: At what price is the risk of a permanent loss of capital or significant downside over the long-term diminished? And, at what price does the reward amply outweigh the risks involved?
Alex Garcia
Alex Garcia - 1 year ago
"more expirements will drain all the cash so quickly unless they can get collaboration supports from a big pharma"

They have two more tries for TC-5214 to improve phase 3 results. It has also partnered with Astrazeneca (AZN) on two other drugs, so we will see how the relationship goes from here on out.
laddruddell
Laddruddell - 1 year ago
I think there is a good chance that the product portfolio is worthless. It is important to note that this is not a diversified portfolio of products. All of the drug candidates have the same mechanism of action; they target neuronal nicotinic receptors (NNRs). Furthermore, there is no proof that modulating activity of NNRs has any potential to achieve positive medical effects. In fact, they have been researching NNRs for 30 years with no products reaching market to date.

What is more interesting to me is the possibility that shareholders start agitating to have the company shop the portfolio to big pharma to see if they can get anything for it and, potentially, wind down. I am hoping this might happen b/c (1) clearly the market is giving the product portfolio 0 value and (2) their cash burn is way too high given the potential/size of the portfolio if you compare them to similar companies. (For one, management is overpaid; just look at the compensation of the management top 5 or so.)

I don't follow Klarman that closely but my sense is that he is not an activist. Any thoughts on whether he might push to wind this thing down?
Alex Garcia
Alex Garcia - 1 year ago
I doubt he will make any push. The position is only 1% of the Baupost Portfolio. Plus, any activism will not move the needle in terms of returns considering how small the position is.
Matt Blecker
Matt Blecker premium member - 1 year ago

I don't find management to be excessively overpaid given the complexity of biotech research.

Having enough cash for at least 3 years gives the company time to conduct more thorough R & D.

Moving past level 2 trials seems to be the toughest hurdle with most drugs, if you look at eventual approval rates in Phase 1 vs. Phase 3. Other depression drugs such as Pristiq failed several times before approval.

It is also important to note, the firm can generate significant revenues, due to milestones, even if zero drug candiates pass FDA approval.

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