Digging the depths of the valuation tables around Vancouver yields no end of small promotional mining companies, burning through a cash pile in a furious chase to make their one big strike. You may pay less than face value for their mostly liquid assets, but money drains quickly from a hole in the bottom of those cash flow statements.
In the midst of such company, trading at 89% of its net cash balance, is local pharmaceutical player QLT Inc. (QLTI, Financial).  QLT, which originally stood for Quadra Logic Technologies, had a glorious bubble-era run as one of Canada’s premier names in biotechnology. Humbled by a history of promises never delivered and abandoned by institutional investors who at one point propelled the company to multiples of 20X book and 200X revenue, QLT now soldiers on at the depths of the valuation tables. A cigar butt, by the standard of investing guru Benjamin Graham. But does this cigar butt have legs?
Company Background:
Founded in 1981, the company’s aim was to develop photo-sensitizers, which are drugs that interact with light in order to fight disease. Most of the applications for photo-sensitizers are related to vision and ocular health.Â
QLT did not generate any revenue until 1994, living on serial rounds of funding and research grants. In the late 1990’s the company developed two products: Photofrin (a niche cancer therapy that was sold off in 2000) and Visudyne, a drug which treats age-related macular degeneration and therefore can help prevent the onset of blindness.Â
Revenues from Visudyne exploded to $150M following its FDA approval in the year 2000. Times being what they were at the turn of the century, this rapid success was greeted with some excitement from investors.Ă‚ QLT shares soared from below $10 in 1998 to well over $100 in late 2000.
However, despite the addition of revenue from a second product (Eligard) growth soon slowed and competitors such as Pfizer and Genentech began entering the market with superior therapies.Ă‚ In 2002, founder Dr. Julia Levy departed and handed the reins to managers who have tried, so far in vain, to transform the company into a multi-product pharmaceutical enterprise.
The market, ecstatic about QLT ten years ago has turned rather sour towards the company’s prospects. A recently lost royalty claim lawsuit case cost the company $130M in cash, which was the final blow for many holders who capitulated. The stock chart tells the story, whereby $100 invested in QLT in the year 2000 is worth less than $3 today.
Company Strategy:
In recent years QLT has focussed its efforts on two fronts. First it has made attempts to extend the product lifecycle of Visudyne by attempting to support the case for combination therapies. There is a possibility that overall patient outcomes are improved using use eye-drop administered Visudyne alongside injected drugs like Genentech’s Lucentis.
Secondly it has pursued a gradually winnowing list of new therapies designed to add a second major product line to replace Visudyne. The current hope is in the development of “punctal plugs,” which is really a drug delivery system. Punctal plugs are inserted into the tear ducts and provide a more even dosage of drugs to the eye than eyedrops. While a recent trial of this therapy disappointed in clinical studies, QLT researchers have gone back to fine tune their method and further developments are expected in July.
Truth be told, neither of the company’s strategies is bearing much fruit at the moment. Visudyne revenues continue to wane, declining to $20M in Q1 from $24M in Q4 2008. Punctal plugs, on the other hand, have shown a tendency to become dislodged and fall out without the patient’s notice.
Investment Thesis:
Bad news notwithstanding, investing in QLT at the moment appears to be a wager with limited downside and at least moderately appealing upside.Ă‚ Protecting the downside is a strong liquidation value that may be as high as $5 per share.
Cash value of US$130 Million gives us a starting point for liquidation of more than C$ 2.75 per outstanding share. QLT also has a couple of cash generating businesses. Visudyne and out-licensed Eligard still contribute about $100M of revenue per year. While fading, this stream of revenue may continue for some time. Assuming $200M of revenue will ultimately come from these drugs at a 60% gross margin yields $120M in gross value, or $80M NPV after tax, or about C$ 1.70 per share. Other net financial and real assets on QLT’s balance sheet, may be worth $10 Million or another C$ 0.20 per share.
Table 1. QLT Liquidation Value Estimate
Against this liquidation value we have a continuing burn of spending on development, as management tries to extend the company’s life and their own jobs. I would estimate the loss in value at between $40-$50 Million per year. So today’s $220 Million liquidation value should become $175 one year hence, all else remaining equal.
Liquidation value of course needs a liquidator, and this may be the flaw in the analysis above. Ideally an industry player with synergies is waiting in the wings ready to strike.Ă‚ I know of no such suitor however.Ă‚ The most likely activist shareholder appears to be a Danish hedge fund, Nordic Biotech Advisors, which owns 17% of outstanding shares and must be thinking about the best way to exit this position.
Beyond liquidation there is a potential upside. Somewhere in the great mass of accumulated research and experience of QLT, may lie a potentially significant therapy which could represent the next leap forward in treating ocular disease. I am in no position to guess as to what that therapy might be, but I’m inclined to believe that over $200M of R&D spend since 2004 hasn’t been completely without consequence. But we should take this intangible value for free.
Summary and Target:
Unless something changes for the better, QLT’s value will diminishes as time goes on. In normal markets such a cigar butt opportunity has proven to be much less attractive than buying a solid growth company and having time on your side. However, these are clearly not normal times. In this prolonged global recession where almost every business is shrinking, the deep cash resources and embedded future options of QLT are an attraction. The alternative for equity investors are businesses priced off EBITDA, which has shown a nasty tendency of late to decline or even to disappear.
Still, one needs to approach QLT with a considerable margin of safety.Ă‚ If liquidation value one year out is estimated at $175M or C$3.75 per share, then a target entry point might be $1.80-$2.00 and a target exit point might be $3.00.
This is indeed a cigar butt and the legs have yet to show themselves. Legs may appear in the form of new commercial therapies rising from the murky mists of the company’s research laboratories. Legs may also arise from the careful consideration of a trade buyer, able to leverage QLT’s knowledge over a broader product portfolio. However for our purposes we need to buy the butt for half price and hope the legs materialize for free.
Geoff Castle
marketdepth.typepad.com
In the midst of such company, trading at 89% of its net cash balance, is local pharmaceutical player QLT Inc. (QLTI, Financial).  QLT, which originally stood for Quadra Logic Technologies, had a glorious bubble-era run as one of Canada’s premier names in biotechnology. Humbled by a history of promises never delivered and abandoned by institutional investors who at one point propelled the company to multiples of 20X book and 200X revenue, QLT now soldiers on at the depths of the valuation tables. A cigar butt, by the standard of investing guru Benjamin Graham. But does this cigar butt have legs?
Company Background:
Founded in 1981, the company’s aim was to develop photo-sensitizers, which are drugs that interact with light in order to fight disease. Most of the applications for photo-sensitizers are related to vision and ocular health.Â
QLT did not generate any revenue until 1994, living on serial rounds of funding and research grants. In the late 1990’s the company developed two products: Photofrin (a niche cancer therapy that was sold off in 2000) and Visudyne, a drug which treats age-related macular degeneration and therefore can help prevent the onset of blindness.Â
Revenues from Visudyne exploded to $150M following its FDA approval in the year 2000. Times being what they were at the turn of the century, this rapid success was greeted with some excitement from investors.Ă‚ QLT shares soared from below $10 in 1998 to well over $100 in late 2000.
However, despite the addition of revenue from a second product (Eligard) growth soon slowed and competitors such as Pfizer and Genentech began entering the market with superior therapies.Ă‚ In 2002, founder Dr. Julia Levy departed and handed the reins to managers who have tried, so far in vain, to transform the company into a multi-product pharmaceutical enterprise.
The market, ecstatic about QLT ten years ago has turned rather sour towards the company’s prospects. A recently lost royalty claim lawsuit case cost the company $130M in cash, which was the final blow for many holders who capitulated. The stock chart tells the story, whereby $100 invested in QLT in the year 2000 is worth less than $3 today.
Company Strategy:
In recent years QLT has focussed its efforts on two fronts. First it has made attempts to extend the product lifecycle of Visudyne by attempting to support the case for combination therapies. There is a possibility that overall patient outcomes are improved using use eye-drop administered Visudyne alongside injected drugs like Genentech’s Lucentis.
Secondly it has pursued a gradually winnowing list of new therapies designed to add a second major product line to replace Visudyne. The current hope is in the development of “punctal plugs,” which is really a drug delivery system. Punctal plugs are inserted into the tear ducts and provide a more even dosage of drugs to the eye than eyedrops. While a recent trial of this therapy disappointed in clinical studies, QLT researchers have gone back to fine tune their method and further developments are expected in July.
Truth be told, neither of the company’s strategies is bearing much fruit at the moment. Visudyne revenues continue to wane, declining to $20M in Q1 from $24M in Q4 2008. Punctal plugs, on the other hand, have shown a tendency to become dislodged and fall out without the patient’s notice.
Investment Thesis:
Bad news notwithstanding, investing in QLT at the moment appears to be a wager with limited downside and at least moderately appealing upside.Ă‚ Protecting the downside is a strong liquidation value that may be as high as $5 per share.
Cash value of US$130 Million gives us a starting point for liquidation of more than C$ 2.75 per outstanding share. QLT also has a couple of cash generating businesses. Visudyne and out-licensed Eligard still contribute about $100M of revenue per year. While fading, this stream of revenue may continue for some time. Assuming $200M of revenue will ultimately come from these drugs at a 60% gross margin yields $120M in gross value, or $80M NPV after tax, or about C$ 1.70 per share. Other net financial and real assets on QLT’s balance sheet, may be worth $10 Million or another C$ 0.20 per share.
| $ US Million | C$ per share | |
|---|---|---|
| Cash | 130 | 2.75 |
| NPV of Product Revenue | 80 | 1.70 |
| Other net assets | 10 | 0.20 |
| Total | 220 | $4.65 |
Against this liquidation value we have a continuing burn of spending on development, as management tries to extend the company’s life and their own jobs. I would estimate the loss in value at between $40-$50 Million per year. So today’s $220 Million liquidation value should become $175 one year hence, all else remaining equal.
Liquidation value of course needs a liquidator, and this may be the flaw in the analysis above. Ideally an industry player with synergies is waiting in the wings ready to strike.Ă‚ I know of no such suitor however.Ă‚ The most likely activist shareholder appears to be a Danish hedge fund, Nordic Biotech Advisors, which owns 17% of outstanding shares and must be thinking about the best way to exit this position.
Beyond liquidation there is a potential upside. Somewhere in the great mass of accumulated research and experience of QLT, may lie a potentially significant therapy which could represent the next leap forward in treating ocular disease. I am in no position to guess as to what that therapy might be, but I’m inclined to believe that over $200M of R&D spend since 2004 hasn’t been completely without consequence. But we should take this intangible value for free.
Summary and Target:
Unless something changes for the better, QLT’s value will diminishes as time goes on. In normal markets such a cigar butt opportunity has proven to be much less attractive than buying a solid growth company and having time on your side. However, these are clearly not normal times. In this prolonged global recession where almost every business is shrinking, the deep cash resources and embedded future options of QLT are an attraction. The alternative for equity investors are businesses priced off EBITDA, which has shown a nasty tendency of late to decline or even to disappear.
Still, one needs to approach QLT with a considerable margin of safety.Ă‚ If liquidation value one year out is estimated at $175M or C$3.75 per share, then a target entry point might be $1.80-$2.00 and a target exit point might be $3.00.
This is indeed a cigar butt and the legs have yet to show themselves. Legs may appear in the form of new commercial therapies rising from the murky mists of the company’s research laboratories. Legs may also arise from the careful consideration of a trade buyer, able to leverage QLT’s knowledge over a broader product portfolio. However for our purposes we need to buy the butt for half price and hope the legs materialize for free.
Geoff Castle
marketdepth.typepad.com
