Description

A long position in BIOV has an excellent risk/reward profile at the current time. issambres839 wrote up IGEN in September 2003, advocating for the value to remain in the soon-to-be spun-off BIOV. Much, if not all of his argument for being long BIOV still holds true. I believe the current stock has $2 of downside and over $10 of upside.

BIOV is effectively a spinoff from IGEN International. BIOV was spun off shortly before Roche acquired IGEN for $1.2 billion in cash in January of 2004. To understand BIOV it is very important to understand the history of IGEN and its great past success.

IGEN innovated and patented a technology called ECL or electrochemical luminescence which was licensed to Roche (more accurately to a company acquired by Roche) in the early 1990s. Around ECL technology, Roche built a recurring $500 million per year diagnostic business which has been marketed to the clinical reference lab market. The initial deal between IGEN and its licensee was that IGEN was paid an upfront license payment of $80 million and Roche and its predecessor spent in excess of $200 million in developing specific diagnostic tests around the ECL technology. IGEN was entitled to receive 9% royalties on sales. Roche under-payed on the royalties and IGEN sued Roche. IGEN ultimately won the lawsuit and gained the right to take back the technology from Roche. Since such a meaningful business around the ECL technology, Roche was in a terrible position and had little negotiating leverage.

Roche paid IGEN $1.2 billion in cash in exchange for a perpetual, royalty-free license to the ECL technology. So IGEN shareholders received the cash and one share of BIOV for every IGEN share. Ownership of the ECL technology remained with BIOV. In addition, BIOV has a perpetual, royalty-free license to all diagnostic tests built by Roche around the ECL technology. As a part of the settlement agreement, BIOV purchased a license to Roche’s PCR technology for use in conjunction with ECL.

VALUATION
With 27 million shares outstanding trading near $6 per share the company has a $180 million market cap. With over $100 million in cash (or roughly $4/share), and $50 million in value from the paid up PCR license purchased less than a year ago, the stock market is placing zero value on the $25 million in annual bio-defense business and zero value on the prospects for a licensing deal. I believe that BIOV represents a compelling speculation, even as the company has been burning between $4- $5 million per quarter.

Clearly, the event that will serve to unlock substantial value will be yet another licensing deal for the point of care market to a large diagnostics company. The following wording was found in the 10Qs for both June and September:


“We expect our available cash to be sufficient to fund our operations for at least one year, but we cannot predict how long our available cash will be sufficient to fund our operations thereafter. In this regard, we expect that we will from time to time have discussions with third parties, including multinational corporations, regarding various business arrangements including distribution, marketing, research and development, joint venture and other business agreements, which could provide for substantial up-front fees or payments.”

At the annual meeting management stated that they are still pursuing a point of care (POC) deal and speak with their banker, Lehman, regularly. However, no more detail was forthcoming.

WHY IS THE STOCK SO CHEAP?
1. As is the case in many spinoffs, what is spun off is not well understood. In this case, management has been incommunicado with the exception of the annual meeting and its quarterly filings for about a year. No conversations with existing or prospective investors, no company visits etc. In my opinion, if there were no POC deal in the pipeline, management would be more communicative as there would be little reason to be quiet. Counter-intuitively, the silence is a message in itself.

2. Importantly, even as many investors in IGEN recorded large gains, the tax treatment for the BIOV spin-off was such that whatever price it traded at on the first day post-spin-off represents the tax basis of the investor. In this case, BIOV traded at an average price of $17/share on the first day post spin-off. I believe that after year-end 2004, the selling pressure will abate.

3. Another factor which has led to the bad performance of the stock since the spin-off has been the closure of the relationship between BIOV and the son of BIOV’s CEO. Many accuse the CEO of self dealing at worst and of poor judgement at best. However, the key takeaway, in my opinion, is that the relationship is terminated and will not be an obstacle in any licensing deal for BIOV.

4. No point of care deal has happened yet. Some investors believe that if a deal were to have happened it should have happened by now. I believe this argument has little merit. The CEO is extremely patient and has proven that he will not expedite the process if it means harming the interests of the long term shareholders.

CONCLUSION
It is simply too quick to forget the current management team’s past record of generating fabulous returns for shareholders. There are very understandable reasons why the stock has floundered since the spin-off. However, I believe an alternative perception of the facts presents an extremely interesting speculation, with $2 of downside over the next year and open-ended upside potential in the event of licensing deal is signed. I believe the stock could double from this level on the first day of trading if a meaningful license deal were to be inked, and, depending on the terms of any such deal, continue to rise after that.

Risk
The biggest risk is that the inference of value from Roche paying $1.2 billion for a non-exclusive license for ECL technology is incorrect; that no meaningful partner emerges for point of care and BIOV simply flounders along and gradually burns up its cash.

Catalyst

Point of care deal
Year end tax selling abates