Description
Bioveris represents an extremely interesting investment opportunity that has the potential to be worth as much as three times the current price. The market is not properly valuing the $310 to $715 million of NPV that Bioveris is likely owed from Roche, stemming from the 2003 License Agreement where IGEN split, forming BioVeris and folding its ECL (Electrochemiluminescence) business into Roche. At the time, there was a $1.5 Billion payout from Roche that was distributed to shareholders. The market thought that the issue was over and done with, but it certainly is not. This hidden value is worth between $12 and $26 per share.
I’ve written about this company before, but this is a brand new investment thesis, based on new research. I wrote this idea up in 2004 based on the thesis that a significant licensing deal was in the works. This thesis was premised on the fact that the company’s technology had been validated by a $1.5 billion payment by Roche to Bioveris (then IGEN) coupled with an eerily strange silence/lack of management communication with investors that to me, had to have a purpose and did not seem sustainable. A whole new perspective on the company is now warranted as the purpose behind the silence now seems clear.
As with lots of good investment ideas, the information is hiding in plain sight. A careful reading of the December 10Q reveals, in addition to the quarterly recap and rehash of a three year old story, that “[Bioveris] is entitled to 65% of all revenues earned through sales by Roche of products outside the field, all as described in the license agreement. The parties are presently evaluating the nature and amount of such out-of-field sales for 2005 and 2004.”
Going back to the original license agreement which they include in the December 2003 S4 (in excess of 500 pages), the field is defined in section 1.7 as testing human bodily fluids for “physiological or pathological state, a congenital abnormality, safety and compatibility of a treatment or to monitor therapeutic measure.” Uses out of the field are “A) life science research and/or development, including at any pharmaceutical company or biotechnology company, (B) patient self testing use; (C) drug discovery and/or drug development (including at any pharmaceutical company or biotechnology company), including clinical research or determinations in or for clinical trials or in the regulatory approval process for a drug or therapy, or (D) veterinary, food, water, or environmental testing or use.” Thus, any time a Roche Elecsys machine is used for anything outside the royalty free field, Bioveris is entitled to 65% of the revenue.
The latest 10K gives even more color to the story: “We and Roche have engaged a field monitor to review placements and sales of products and services by Roche in 2005. The field monitor has been tasked with preparing a written report, including a list of any sales or placements of products and services that were not within the licensed field and identifying sales or placements of products or services in violation of the license grant. Pursuant to the license agreement, Roche must pay to us, within 30 days after receiving the field monitor’s report, 65% of all undisputed revenues earned through out-of-field sales of products for 2005.” And “Based on its 2005 Annual Report, Roche reported ECL (Elecsys) product sales for the year ending December 31, 2005 of CHF 989 million. For each 1% of Roche’s total sales that were out-of-field during 2005, as determined by the field monitor, there would be approximately a $5.3 million positive impact on our financial position, results of operations and cash flows (using the currency conversion rate of Swiss Francs to U.S. Dollars at June 6, 2006 of 0.8232)”
An important part of this story is that the current wrangling between Bioveris and Roche will not be a repeat of the four year litigation that ended in December of 2003. The December 2003 S4 indicates that the parties agreed that any future disputes about the amounts and the nature of out-of-field sales would be resolved by binding arbitration. Bioveris did not want to repeat the painfully long legal process from its past experience.
It’s hard to conceive of a situation where Roche could stop out of field sales without taking a shotgun to its foot. Over the course of a day, week, month, or year, these machines are used for several purposes. Roche wouldn’t stop selling to reference laboratories so that they could cut their obligation to Bioveris. In what seems as an attempt to absolve themselves of the knowledge that their machines are being used out of field, Roche has sent a letter to their customers informing them that they should not use their machines for out of the field purposes. But the terms of the agreement are for end-use, not intent at sale.
VALUATION
We estimate, from talking to consultants in the diagnostics business, that between 5% and 10% of the ECL business is outside of the royalty free field. That would bring between $26 million and $53 million per year in cash coming to Bioveris for 2005 alone, to continue for as long as Roche is selling machines and assays outside of the field through the life of the patent, (2022) or until there is “complete loss of confidential and proprietary status for all of the Licensed ECL Technology” which could be forever. Let’s assume 20 years of steady payments at a discount rate of 10%. Furthermore, assume that the royalty stream will grow 10% through 2010 and 5% per year thereafter and a tax rate of 30%; that’s between $310 million and $715 million in NPV, or between $12 and $26 per share. If one were to add the $2.50 per share in cash plus prospects for developing a point of care product- one could get to a valuation well north of $30/share.
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RISKS
So why hasn’t the market picked up on this? It’s the typical informational dystopia that we small-cap investors love. Why dig into the K’s and Q’s of a company that looks rudderless, puts out painfully corny calendars at their annual meetings, and won’t talk to their investors? Without hindsight, no sell-side analyst would waste his time covering this company, and nobody on the buy side would dare try to convince their boss that this was worth looking into.
Why has management been so quiet about this? Sun Tzu said: “The victorious strategist only seeks battle after the victory has been won.” It is our speculation that by clamming-up right after the agreement was signed, Bioveris wanted to preserve the integrity of the recorded “out-of-field” Roche ECL business. They could have hammered Roche to stop using their machines in violation of the agreement. Instead they walked away quietly and didn’t breach the topic for two years. All the while they kept one eye over their shoulder, put their case together and pressed Roche only when they were certain that they had a big chunk of change coming their way. That Roche has only just now sent a letter to their customers asking them to stop using the machines for uses out of the field supports the assumption that Bioveris/IGEN has blindsided Roche again.
What makes me nervous about this whole story is that it assumes Roche is incompetent. How could they not know that Bioveris would come knocking to collect? How, after Bioveris fleeced them for $1.5 Billion in 2003, could they get taken for another quarter to half of a billion? Can’t Roche management hear the sound of their own heads rolling when the board sees that there’s more money to pay Bioveris?
Perhaps Roche may offer to buy the rest of the ECL business to stave off the embarrassment of having to shell out cash to Bioveris every year because of something they cannot control. This will certainly be good for shareholders as Bioveris is struggling to bring their point-of–care ECL device to market. And if you read the “Background of the Merger and Related Transactions” you know Bioveris management is capable of getting favorable terms. We can also be comforted by the fact that insiders own about a third of the company, aligning their interests with ours.
The other risk is that they won’t be able to do anything meaningful with the payout. So what if they get $50 Million in cash per year; they posted a net loss of $28 million in 2006 and a stream of consistent losses previous to that. None of their Biodefense, Life Sciences, or Clinical Diagnostics have demonstrated any outward signs of success. They could continue to throw money away, just at a faster pace. I believe, however, that the market will give the company appropriate credit for the annuity stream despite the history of losses, since all of the losses are related to investment in the future.
Catalyst
Settlement of the 2005 payout owed to BioVeris by Roche