Description

Knight Therapeutics (GUD/CN)

*Based on 5.25$ share price as of March 25, 2024.                                                                                                            All financials in CAD ($)

Knight Therapeutics, founded in 2014 and based in Montreal, is a specialty pharmaceutical company with operations in Canada and Latin America. The company is currently led by Jonathan Goodman's protege, Samira Sakhia, and Goodman himself, who was the CEO prior to transitioning to the role of Executive Chairman in 2021. Before founding Knight, Goodman served as the founder and CEO of Paladin Labs, a company operating under the same business model as Knight and where he orchestrated an impressive 100-fold increase in the company's stock over his 19-year tenure. Unlike traditional pharmaceutical companies, Knight performs no clinical research activities since it does not develop innovative products internally. Instead, the company acquires, in-licenses, markets, and distributes pharmaceutical specialty products on behalf of Big Pharma or Biotech partners through its local operations in 11 countries, including Brazil (49%), Colombia (13%), Argentina (11%), and Canada (12%).

With revenue growing by more than 20% annually to $328M since its transformative acquisition in 2019, Knight has emerged as the biggest specialty pharmaceutical player in LATAM. It is the sole significant players in region to sustain global industry standards, making it the preferred choice for pharmaceutical companies seeking a Pan-American (Ex-US) commercial solution. Accordingly, Knight has struck dozens of deals over the years, building a diverse portfolio of over 100 branded products sourced from more than 20 partners, including names like Gilead and AstraZeneca but also smaller biotech companies.

Large companies opt to partner with Knight because the consolidation within the pharmaceutical industry over the last decades means that Big Pharma needed more and more substantial opportunities to move the needle. As LATAM represents only 6% of the global market and has a very high degree of regulatory complexity requiring extensive local expertise, the region is just not significant enough for these companies to invest. In the case of biotech, they usually opt to sell their rights in LATAM as they prioritize larger markets and use these licensing deals as a non-dilutive way of raising capital. In addition, Knight collaborates closely with its partners long before any sales are generated, especially for late-stage deals, owing to the extensive process of bringing innovative products to market, which is essentially why companies choose to do business with Knight in the first place.

For late-stage products, once Knight's partners complete clinical trials, Knight is responsible for obtaining regulatory approval, typically taking 1-3 years. Subsequently, efforts to secure reimbursement and educate practitioners about the product usages typically take another 1-3 years. Finally, Knight launches, or re-launches in the case of underpromoted products, with sales usually reaching their peak after 3-5 years depending on the product complexity. Successful launches typically rely on three key pillars: (1) stimulating demand among physicians using a "pull-through" marketing approach, (2) focusing on product fields where a small number of practitioners drive most prescriptions as to reduce sales efforts, and (3) securing patient reimbursement through negotiations with insurance companies and health organizations.

Moreover, Knight's success hinges on its licensing playbook, which mirrors Paladin's approach, and involves both in-licensing late-stage innovative products and acquiring or in-licensing underpromoted products already available on the market. Its framework explicitly states that deals for late-stage products require higher expected returns and must demonstrate superior safety, efficacy, or pharmaco-economic value compared to existing offerings. Products should also align with Knight's sales strategy and complement its portfolio, or either be viable on a standalone basis or a foundation for expansion. The length of its in-licensing agreement varies from a 5-year sales period to perpetual, typically involving royalties and milestone payments once certain targets are achieved. Finally, Knight sometimes offers upfront cash payments but aims to minimize them to mitigate the financial impact of product failures.

History 2014-2019

Knight's history began on the same day its founder Jonathan Goodman sold Paladin Labs to Endo Pharmaceuticals for $3.2Bn. Originally a division of his father’s company Pharmasciences, one of Canada's top three drug manufacturers, Paladin saw remarkable growth under Goodman's leadership. At only 26, he took Paladin public only to witness its share price surge from $1.50 to $150 over 19 years preceding the company’s sale. Similar to Knight, the company focused on commercialization, overseeing regulatory processes, product launches, and distribution, while outsourcing R&D and manufacturing to mitigate clinical and manufacturing risks. Goodman's rationale for this strategy at the time stemmed from his observation that Big Pharma and biotech showed little interest in investing in Canada due to its smaller and more regulated nature, resulting in poorly commercialized products. Recognizing this gap, Paladin capitalized on in-licensing and acquiring late-stage and underpromoted products in Canada, experiencing record sales and profitability for 19 years in a row without ever taking on debt, and record revenue of $270M and EBITDA of $87.4M in the year prior to its acquisition.

Amid a booming pharma industry where companies like Endo made debt-fueled acquisitions, Goodman skillfully negotiated with its acquirer to spin off a newborn entity named Knight Therapeutics as part of the Paladin transaction. Included in Knight’s spinoff were assets such as an FDA priority review voucher (PRV), which expedites the review process for blockbuster drugs, as well as global rights to a drug named Impivado, $1M in cash, and even Paladin’s office furniture. Then, Jonathan successfully raised over $685M between 2014 and 2016, participating in every round and bringing his ownership stake to approximately 22.5% today. Moreover, shortly after the spinoff, he sold the PRV to Gilead for $125M, nearly doubling the $67.5M the other PRV sold for that same year, showcasing Goodman's prowess in deal-making. Armed with these resources to embark on a new venture, Jonathan's intent from the outset was to replicate Paladin’s playbook with the only difference being that it would seek to profit from market inefficiencies worldwide, not just in Canada.

As part of replicating the Paladin playbook, Knight also began offering loans to life science companies at mid-teens rates, on a fully secured basis. This approach had proven highly successful at Paladin for strengthening industry relationships and securing distribution rights. Given that Knight had a substantial cash reserve to deploy, this strategy was an ideal fit. Consequently, Knight utilized a portion of the cash it raised to provide over $150M in loans to partners over the years. Additionally, the company invested more than $157M through life sciences venture funds to enhance its access to innovative pharmaceutical products being developed within the funds’ ventures.

Despite a promising start and Jonathan cautioning investors that the strategy would require time to play out, expectations for Knight ended up being far ahead of the reality that unfolded. By 2017, TTM revenue stood at a modest $8M, with few deals closed. Several factors were affecting the deal flow, including heightened competition and stricter reimbursement criteria in the Canadian market. Additionally, the low-interest-rate environment weakened biotech financing need and boosted deal valuation, while Knight's limited salesforce, which Jonathan was hesitant to build without securing deals first, also contributed by its lack of appeal to potential partners.

Still, Goodman stayed patient, refusing to pursue deals simply for the sake of it. As a result, investors’ impatience started pilling up and Knight's stock peaked in 2017 at ~$11 and gradually declined to ~$7.50 by 2019. At $7.50, or $1Bn in market cap given a ~142M share count vs today’s 101.2M, the stock was effectively trading at par with its book value, which included more than $960M in cash and investments. In addition, the company had already generated cumulative net income of over $230M from its loan and funds’ investments as well as the PRV sale.  

2019 – Now

It was only in late 2019 that Knight finally announced its all-cash $418M (EV) acquisition of Grupo BioToscana (GBT), marking its foray into the LATAM region. At the time of the acquisition, GBT boasted a robust TTM EBITDA of $49M representing a margin of 18%, and revenue growth of over 20% in the prior five years, making the 8.5x EBITDA and 12x P/E paid fairly conservative. Additionally, GBT's presence in 10 countries and focus on promoting specialty pharmaceuticals provided Knight with a significant sales platform in the rapidly expanding Latin American market.

The acquisition also included GBT's manufacturing segment of branded generic drugs (BGx), which enjoy substantial popularity in LATAM. Consumers in the region often harbor concerns about off-market and unregulated products, prompting them to prefer branded generics over plain generics. The segment is non-core to Knight strategy as Knight doesn’t aim to produce anything internally, although it diversifies its offering. Initially, BGx represented 28% of sales, but now only accounts for 16%, as Knight's innovative portfolio experienced faster growth and BGx is a though field to compete in. Sales of BGx fluctuate depending on the timing and Knight's capabilities to launch products first, as well as its competitors' ability to introduce alternatives swiftly. Despite the segment being run for profit over growth, Knight has invested $20M in 2023, representing a $5.1M increase from 2022, for the development of very-low risk generics in order to address the segment's current lumpiness. The impact of these investments through product launches is expected to materialize starting in the latter half of 2024.

Meanwhile, Knight's negotiating power significantly strengthened as it was now able to offer package-deals for 11 countries instead of just Canada. As can be seen from the P&L presented below, reported sales have grown by over 18% since the acquisition. Regarding future sales, Knight launched 5 products in the last 12 months, which should contribute to further growth for the next 3-4 years. In addition, the company has deployed more than $270M across 11 agreements for 13 products since GBT, representing $110-$140M in additional sales embedded in the current pipeline which should also be unlocked gradually over the next 5-6 years.

Valuation

Yet, even as Knight is now generating adj. EBITDA of $64M, FCF of around $54M, and did spend more than $230M in buyback to reduce its share count by ~42% since 2019, the company valuation has never been that low, with a market cap of only ~$530M compared to its 2017’s peak valuation of ~1.3Bn.

Along with cash and marketable securities of $162M, Knight also holds its loan and biotech fund portfolio currently worth a combined $128M, as well as $45.5M in long-term receivables essentially consisting of cash wired to the IRA following a tax dispute that is expected to be resolved with Knight getting its money back. Considering these financial assets that will eventually be converted into cash, and the minimal $62M in debt that serves as a currency hedge for its operations in LATAM, Knight's reported EV of $430M translates to an adjusted EV of only $256M. This observation suggests that this business, which could be very reasonably expected to growth by at least 10% per year over the next five years, is trading for around 4x EBITDA and 4.75x FCF. For comparison, Paladin was valued at approximately ~12-13x EBITDA in the years prior to its acquisition. Consequently, by assuming an EBITDA multiple ranging from 10-12x and taking the $64M in EBITDA it generated last year, Knight current value based on non-adjusted EV would be $640M to $768M, representing a potential upside of ~50% to ~80%. On an adjusted EV basis, the upside would be ranging from ~150% to ~200%.

Regarding the investment downside, Knight P/B has hovered around 0.7x for the last 3 years. When one considers the liquid nature of the assets and that most assets most have been bought in the last five years at very good prices, it does not seem farfetched at all to believe that the current ~50% discount to NAV represents very good downside protection.

Potential Causes & Catalysts

Below are several factors, beyond the pre-GBT era where investors lost patience, that might be influencing the current subdued market sentiment towards the stock, which all seems temporary in nature, along with explanation for how these factors could become catalysts for the stock.

1. -      Knight acquired the rights of Exelon’s in 2021, a product for the symptomatic treatment of Alzheimer's disease that is commercialized since 1997 and present in ~90 countries. The product rights were bought for $218M or 8.7x EBITDA, and in 2021 it generated approximately $60M in sales across Canada & LATAM, with two-thirds coming from Brazil and Colombia. Where it gets interesting is that Exelon was bought in USD. Thus, it required the related intangibles to revalued from USD to CAD at the time of the deal, and subject to periodic adjustments based on currency movements. With the USD appreciating against the CAD in 2023, it led to an impairment charge of $9.2M, effectively degrading the reported number despite having nothing to do with the true underlying performance of the business.
2. -      In 2011, Jonathan had a near-fatal cycling accident, causing him to be absent for a year while at Paladin. Investors became concerned about Jonathan's ability to execute successfully following the accident, especially as they grew impatient during the pre-GBT period. This concern resurfaced once again in 2021 when Jonathan transitioned from CEO to Executive Chairman, stating his intention to focus solely on the firm's dealmaking activities and forego the day-to-day operation. Although Jonathan said in the past that he experienced some energy loss and mild short-term memory issues in the years following the accident, it occurred 13 years ago, and market fears look way overdone. During this time, Jonathan successfully sold his former company, established a new one, and executed numerous multimillion-dollar transactions. Moreover, the new CEO and prior CFO, Samira Sakhia, is known for her high energy, ability to execute, and strong determination. Samira, who has an ownership stake of approximately $6M in Knight, representing probably the majority of her net worth, has also been Jonathan's protégé for the past 20 years, serving as CFO at Paladin before joining Knight in 2015. Therefore, I don’t think there should be any sort of discount because it.
3. -      While valid arguments exist for intangible amortization, especially when judging capital allocation rather than operating performance, Knight huge intangibles amortization make its operation appear unjustifiably unprofitable. Notably, as a way of maximizing tax efficiency, Knight opts to amortize its intangibles (consisting of license-related milestone payments and acquired product rights) on 3 to 10-year schedule despite licensing terms ranging from 5 years to perpetuity. Concerning Exelon’s right, representing roughly half of Knight’s $290M total intangibles value, its lifespan almost certainly exceeds 10 years, being owned by Knight, mature, off-patent and commercialized since 1997. Alternatively, excluding GBT’s acquisition, Knight has invested $286M ($28.6M/year) in products since 2014 and reported $45M in amortization of intangibles for 2023, down from $51.7M in 2022. This means that it amortized almost 200% of what it normally spent on product deals each year. Absent of significant transaction involving upfront or milestone payments, annual expenses are expected to continue decreasing, as seen in 2023 versus 2022, potentially revealing the business's true earning power overtime.
4. -      Knight used to have more than 20% of its sales from its Argentina’s subsidiary that has experienced hyperinflation in recent years, causing lower reported sales than what the market anticipated. More specifically, using constant-currency results and by removing the impact of IAS 29’s hyperinflationary accounting adjustment, sales would have been $305M in 2022 and $343M in 2023, compared with the reported $294M in 2022 and $328M in 2023. For illustrative purpose, the “2023 Adjusted” column in the P&L presented above is the company’s performance once these factors are removed. Hence, investors certainly have gotten irritated to see Knight sales and operations being troubled by hyperinflation, but now that Argentina seems on the path to recovery, this currency headwinds should dissipate in the coming quarters.
5. -      Finally, even though Knight's investments in life sciences funds have generated $128M in distribution since 2014, including $70M in realized gain, and the remaining invested portion is currently valued at more than $113M, they only resulted in two small licensing opportunities. In addition, they have been subject to cumulative markdowns of more than $30M in the last 2 years, which has once again fueled market negative sentiment. Being primarily focused on improving its product pipeline rather than investing profits, Knight announced that it would cease injecting further capital in the strategy a while ago and will let the remaining invested capital gradually mature over the next 5 years. 

Conclusion

In conclusion, despite Knight stock stagnating over the past three years, the company has undergone significant improvements since the GBT acquisition. Although these advancements haven't always been fully reflected in the P&L, the positive developments in Argentina, coupled with the other catalysts mentioned, may lead Knight to achieving its first year of positive reported operating profits as shown in the P&L above. Furthermore, with financing becoming scarce in the biotech sector due to higher interest rates, there's an increasing likelihood that Goodman will intensify deal activities, a setup he has been waiting for eagerly. When coupled with the lowest level of optimism ever, offering significant downside protection, chances are that Knight could be re-rated to something closer to its true market value, offering investors with up to 200% in upside based on what seems like conservative assumptions.  

Catalyst

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