Description

I am long shares of Enzon Pharmaceuticals (ENZN), a $49mm mkt cap, Icahn Capital controlled NOL vehicle trading at less than 1x ev/'15 ebitda with an unrestricted $100mm+ federal NOL and $29mm in net cash. This idea is limited to personal accounts due to size and ownership stake limitations. 

The company garners the majority of its royalty revenue from PegIntron, a hepatitis C drug marketed by Merck. Additional sources of revenue include royalties from CIMZIA and Sigma Tau Group.

I believe investors are being afforded the current opportunity for three reasons. The first is due to recent excitement/concern around competitor Gilead’s Sovaldi and Harvoni product developments. While Gilead will continue to take share in the US, Europe and Japan, PegIntron is sold in 70 countries worldwide, many of which are undeveloped and very poor. While there is a licensed version of Sovaldi that is sold in poor countries, many of the countries PegIntron sells into are even a step down from that- Africa, Middle East, Asia, etc. Furthermore, it will take time before Gilead can launch Sovaldi in many of these countries with required commercial infrastructure at a price they would be willing to sell it. The cliff in sales has happened for PegIntron- from here on it seems there will be a long tail / steady decline, as detailed in street estimates (see ests tab in model).

Link to model --> https://www.dropbox.com/s/z57uvvx90fk4n3e/ENZN_Final.xlsx?dl=0

Enzon’s next largest royalty stream is CIMZIA (roughly half the “other royalties” bucket), used to treat Crohn’s disease and rheumatoid arthritis. Due to lack of clarity in Enzon’s financials, this royalty stream is also misunderstood by investors, per the below excerpt from a seeking alpha writeup, Warning! Enzon Pharmaceuticals Is Definitely Going To $0, dated Jan. 14, 2014.

The actual text from the financials reads as follows:

Our U.S. rights to receive royalties under our agreement with Nektar relating to CIMZIA, Macugen and OMONTYS expire in 2014. After the expiration of our sublicensed patents, we may be entitled to lesser immunity fees on a country-by-country and product-by-product basis for up to twelve years from the date of first sale of these drugs.

Enzon’s CEO confirmed these “lesser immunity fees” will in fact continue for CIMZIA and noted they are only 20-40% below the current royalty rates.

Furthermore, while the above cited Seeking Alpha author was modeling a decline in ’14, this product is in reality experiencing rapid growth. CIMZIA is marketed by UCB, a multinational biopharmaceutical manufacturing company headquartered in Belgium.

Currently authorized in 54 countries, UCB projects peak CIMZIA sales of more than €1.5bn by 2020 – more than double current levels. People in the U.S. living with psoriatic arthritis or ankylosing spondylitis – almost as many as those living with rheumatoid arthritis - now have access to Cimzia following approval and launch in the U.S. during 4Q13.

The other half of “other royalties” is from Sigma Tau Group, which ends in ’14. Enzon may receive a $7mm milestone payment from Sigma Tau, however I have no view as to the probability and ascribe it no value in my model.

The last reason for the current discount is concern over an ongoing dispute with the IRS, per the company’s latest 10Q:

 The Company has been under an Internal Revenue Service (“IRS”) audit, and although not finalized, on April 23, 2014 received a Notice of Proposed Adjustment from the IRS relating to the disallowance of the write-off of goodwill and other intangible assets in connection with a business that the Company sold in 2010. While the Company disagrees with the proposed adjustment and is currently in discussion with the IRS after providing more facts and information to them, the Company is planning on appealing this adjustment, if needed. If the IRS position is upheld, the result could have a materially adverse effect on the Company’s financial position.

In speaking with the CEO he noted he is confident the company acted appropriately, however he notes the IRS is not under a particularly tight timeframe and the matter is taking longer than necessary to resolve.

Lastly, while the company has previously stated it will distribute cash to shareholders, recent conversations with the interim CEO indicate they could make acquisitions to utilize the NOL, having recently enacted a section 382 poison pill to protect it. Resolving the situation with the IRS could pave the way for the company to make an acquisition and utilize the NOL.

In summary, I believe shares of Enzon Pharma (ENZN) are mispriced and offer attractive risk/reward at current levels. We are buying $0.64/shr of cash for $1.11/shr. This means we're creating the royalty stream and NOL for $0.47/shr. Let's think about the royalty stream as two coupon streams. The first is very short duration - 1 year - and will pay us $0.57/shr by this time next year according to consensus sales estimates for Merck's PegIntron and other royalties. Discounting this at a BBB rate gets us to a bit more than the current share price. This means we are creating the backend coupon for free, in addition to the $100mm NOL. I believe the backend coupon is worth at least $1/shr (conservatively ascribing no value past 2020).

Catalyst

-Cash build

-Company resolves IRS dispute

-Makes acquisition or returns cash to shareholders