Liposome Contingent Value Righ LCVRZ
March 17, 2001 - 7:27pm EST by
2001 2002
Price: 0.10 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 0 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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I think that LCVRZ is a buy because it is an orphaned security that will allow you to create a stub with a 50%+ probability of paying off 15-1.

Origin of CVRs: LCVRZ came into being when Elan purchased Lipsome, which was in the process of developing a drug which is now called Myocet (used to be called Evacet). At the time of the merger, the regulatory approvals had not been completed for the drug. In the merger talks between Elan and Liposome, they compromised on how to value this opportunity by issuing to Liposome shareholders a contingent value right based upon the outcome of this drug.

Description of CVRs: There are two milestone payments associated with the CVRs. The first milestone is for obtaining marketing approval for the drug in the EU and negotiating pricing with the UK and Germany. Elan announced that they will meet the first milestone and will pay it within 10 days of the end of the 1st quarter (3 weeks from now). Elan has announced that they will be paying 1.12 per CVR. That leaves a stub of 6 cents. The second milestone is for achieving sales of at least $10.5 million in the EU and Canada in any quarter before the end of 2002 and will pay 97c. That would be a 15x return on your investment.

Descrption of Myocet: Without getting technical, Myocet (liposome encapsulated doxorubicin citrate complex) is a drug that can be used in combination with cyclophosphamide for first line treatment of metastatic breast cancer. Breast Cancer as you know is a large potential market. Elan will begin marketing Myocet in 2Q01. There are currently two drugs that address similar needs. The European sales of these two drugs is on the order of $400 million annually. Analysts are projecting sales of Myocet of $20 million in 2000 growing to over $100 million in a few years. 10 million in quarterly sales is very achievable.

Risk Reward: The clear uncertainty is whether or not you will hit the second milestone by 2002. I would conservatively assign a 50%+ probability to this figure based upon the size of the market and sales forecasts. If you think about it $10 million a quarter just isn't that much for a relatively decent sized drug. This probably will never be a blockbuster, but all we need is 10.5 million in sales in one quarter before 2002. Given that they will be starting in 2Q01 and will probably ramp into their sales, that estimate alone probably implies $10 million of sales by the 4th quarter. The good news is that we got plenty of time in case these forecasts prove optimistic. For a 15x potential return, I would take this bet again and again.

Why this opportunity exists: This is an orphaned security…there are no natural holders for these rights. They were created in the merger and the risk arbs probably valued them at zero and have happily blown them out long ago. One might look at this opportunity and say that the risk reward is so favorable that I must be missing something. Could well be, however if you look at the trading history of these securities they have consistently traded well below fair value. As an example, they got the regulatory approval for Myocet in mid 2000, but had yet to have negotiated the prices in the UK and Germany. From my understanding of the process, this is a lay up. Once the scientists approve the drug, agreeing on the price with the state health plans of the UK and Germany is not something that blows a drug. For many months you could have picked up these rights between 60-80c, even though it was nearly certain to make the first milestone (not to mention a good change on the second). In addition, for structural reasons stub securities tend to trade cheap as well. When I look at them I always charge myself an interest cost for the large sums you need to put to use to create the stub. I have always felt that these opportunities are best captured by investors with access to marginal capital. Given the short time period to create this particular stub, it doesn't make a big difference. Some people stay away from these opportunities because you need to use a lot of capital to take your position, but I have found that these can be some of the most attractive opportunities. Keep in mind the success that we had with the Key 3 Media stub opportunity. That was a similar situation where there was a 10x return in a short period of time. I believe it was the best idea of last year.


Payment of $1.12 in 3 weeks.
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