Description

DESCRIPTION

Maxygen (MAXY) is a rare biotech value investment where you don't take clinical risk, you have much asset optionality, and you have a solid downside protection from a large cash position and a management team committed to returning value to shareholders.  I expect the Board to return cash to shareholders through a combination of special dividends, return of capital and stock buybacks as MAXY monetizes assets.

BRIEF HISTORY

Historically, MAXY was a biotechnology company that engaged in the discovery and development of improved next-generation protein pharmaceuticals for the treatment of disease and serious medical conditions.  Now, however, MAXY is in the process of becoming an asset holding company whose stated purpose is to maximize value for shareholders by managing and monetizing its assets at the appropriate time.  After failing to sell the company in its entirety through an exhaustive process led by Lazard over the last few years, MAXY has largely ceased all clinical development activities and taken steps to reduce cash burn by selling pipeline products, monetizing various investments and creating structures that protect shareholders from clinical risk downside. MAXY has a market cap of $184 million, an enterprise value of $44 million, and five interesting assets that have very compelling option value.

EFFORTS TO MONETIZE ASSETS & RETURN VALUE TO SHAREHOLDERS

In 2006 MAXY had two partnered clinical assets fail in development and their partner Roche cancelled the programs. On the back of this, beginning in October 2006, the Board retained Lazard to explore strategic options. Lazard approached over 50 parties and could not sell the company, largely because MAXY owned a diverse collection of assets that were not appealing to one individual buyer.  Additionally, the sale process was impeded when Amgen (large cap biotech company) had intellectual property (IP) issued that conflicted with one of MAXY's most promising pipeline products, MAXY-G34, leading to potential partners and investors questioning if they could bring the drug to market. As a result, the Board refocused its efforts to realize value through asset sales, licenses and strategic partnerships.  In 2008 and 2009, MAXY entered into a number of transactions to effectuate said goal. Specifically, MAXY did the following:

1. July 2008: sold hematology assets to Bayer Healthcare LLC for a $90 million upfront payment and a potential milestone of up to $30 million based on MAXY VII initiating a Phase 2 clinical trial and satisfying certain intellectual property conditions;
2. September 2008: signed a license agreement with Astellas (Japanese big pharma) for its autoimmune asset MAXY-4 in exchange for a $10 million upfront payment, future contingent milestones, low double digit royalties and $10 million of committed funding for the program;
3. May 2009: granted Cangene Corporation (biological biodefence company) a license for MAXY-G34 for the treatment of acute radiation syndrome (ARS) for a nominal upfront payment and up to a $30 million contingent license fee payable upon successful government contracting. MAXY retained rights to use MAXY-G34 for all other medical conditions;
4. July 2009: created Perseid JV with Astellas. MAXY contributed its rights under the MAXY-4 license agreement, various preclinical/early stage assets and $10 million for an 83% ownership stake; Astellas contributed $10 million for a 17% ownership stake. Astellas has a call right with a three year, escalating prespecified purchase price ranging from $53-123 million for which it can buy the JV from MAXY. Deal transferred most employees to Perseid. Note that Astellas paid a $5mm milestone to Perseid recently, validating the progress being made on Perseid's compounds.
5. Reduced headcount to 10, and reduced annual burn to $5-10 million per year going forward (will be somewhat offset by Codexis royalties going forward). MAXY also ceased all expenditures on clinical development for all remaining pipeline products, including MAXY-G34, until a partner is secured to fund development. MAXY's CEO, CFO and head of business development all resigned as the final part of the transition.
6. December 2009: new management team completed a Dutch tender offer for 18.5% of the outstanding shares @ $5.30/share, for a total cost of $38.9 million. MAXY also announced it will consider additional means for returning value to shareholders.

HOW DID WE GET HERE?

The Street didn't much care for MAXY's transformation. Indeed, all analysts dropped coverage over the past 18 months and the shareholder base has largely turned over.  It also hasn't helped that new management recently stopped hosting earnings conference calls.  That said, the new management team is taking the right steps to drive value.

VALUATION

Traditional metrics do not apply here as MAXY has historically burned cash. I focus the valuation on the potential to realize cash proceeds from asset sales, etc.

Pro forma for the Dutch Tender offer, 2010's estimated cash burn and 2009 transaction success bonuses, MAXY has 31.1 million shares outstanding, approximately $140 million of unrestricted cash and no debt; MAXY's PF EV is approximately $44 million.  The stock is currently trading @ $5.93/share and the Dutch Tender cleared at $5.30. I see the Dutch clearing price as close to the downside here with upside to come from any of the following key assets:

1. 21.4% ownership of Codexis. Codexis a "biocatalyst" company that recently filed for up to a $100 million IPO. If successful, the listing will put a public mark on MAXY's ownership. The biocatalyst sector is "hot" right now (see Novozymes) with multiple applications in pharmaceuticals, biofuels, water treatment, and chemicals. The company has LTM sales of $77 million, growing 84% YoY (much of those sales though are product development related; LTM product sales were $20m and grew 24% YoY.) Based on the Series F round led by Shell Oil in March 2009, the EV of Codexis is $307 million, which implies MAXY's stake is worth $53 million, or $1.70 per share to MAXY (assuming a 20% private to public firm discount). This valuation implies a forward revenue multiple of 1.9x, relatively in-line with early launch stage technology companies. I estimate the low end of the valuation range for Codexis as $160 million, based on the valuation the company used when valuing stock options in August 2009. Using a 30% private to public firm discount, I estimate the low end value to MAXY is $24 million/$0.77 per share. Additionally, the private to public discount should substantially narrow post the Codexis IPO, implying additional upside.
2. MAXY-G34: MAXY-G34 is worth at least $25 million, and potentially upwards of over a $100 million, or $0.80/share to $3+/share based on biotechnology product comps. Analysts' estimates for peak sales for MAXY-G34 reached $1+ billion. Currently, the market assumes its value is zero, which is incorrect (see the value MAXY received from Bayer as validation of G34 valuation range; IP discussion and drug overview below).
3. 83% ownership of Perseid: Perseid is worth $59 million today based on Astellas' $10 million investment for a 17% stake in the JV, implying MAXY's share is worth approximately $1.27/share (adjusted for employee option pool). Based on the prespecified call prices of $53-123 million, a 50-80% chance that Astellas actually exercises the call by 2012 and a 20% discount rate, Perseid is worth $0.20/share to $1.14/share to MAXY. Note funded early stage biotechnology companies typically trade with EVs of $50-$100 million; many of these comps do not have a big pharma partner already signed like Astellas.
4. $30 million milestone payment. Bayer bought MAXY's hematology assets for $90 million, which indicates Bayer felt strongly about the program as this program is early stage/finishing Phase 1 testing. The milestone is worth $0.08/share to $0.28/share to MAXY (assigning a 15%-50% probability of success, and 20% discount rate).

 THE VERDICT

The sum of the parts valuation yields an EV of in the range of $6/share to $10.20/share. My price target is $8-8.50/share based on the higher end estimate of the Codexis valuation and Bayer milestone, mid-range value on Perseid and the lower end of MAXY-G34.  Basically, for the stock to work, you only need a few of the above to work out.  

$ in mm except per share amounts

--Additional Upside Options--
In this presentation, I do not ascribe any value to MAXY's royalties from Codexis on biofuel-related projects/programs, nor do I give them credit for the platform technology or vaccine platform the company still wholly owns. Note that MAXY's platform technologies are valuable, having created 3 private spin outs, two of which MAXY previously monetized for $81.8 million in 2004 and 2006 (3^rd is Codexis).  I also excluded any value to related to the up to $30 million Cangene contingent license fee (see below). Lastly, I do not factor MAXY's $30 million in NOLs into the analysis. Suffice it to say that there is much optionality in this name with limited downside.

ALTERNATIVE CASH USE RISK

In my conversation with Jim Sulat MAXY's CEO he highlighted the strategy: (1) extract value from assets/portfolio, (2) minimize the impact of taxes, (3) return money to shareholders, and (4) redeploy cash "sensibly". This last comment is concerning as it begs the question how far they will progress with items 1-3.  Mr. Sulat suggests that they may "lower-risk" investments to make and notes that MAXY has successfully invested in programs heretofore. He did say they will not be acquiring some platform technology and adding new employees to develop any such investments. The company is only in the conceptual stage. I will be monitoring progress here very carefully as this is the primary risk to the story. Unfortunately, it is very hard to handicap this scenario though company has been very upfront regarding its primary intensions to harvest portfolio assets and return value to shareholders.

CODEXIS CONSIDERATIONS

While Codexis is still burning cash, it has completed a few financings since 2005, which provide for some ballpark valuation guidelines. Key customers Pfizer and Shell have invested in the company.

*Not adjusted for cash at closing

While it is nearly impossible to predict how Codexis' IPO will be received, certainly a road show will be good for MAXY.  The lead managers of the IPO are Credit Suisse and Goldman Sachs, so the execution should be good.  MAXY is Codexis' largest shareholder and the road show will be free publicity for the stock. Note that Codexis tried to go public last year prior to the market fall out and understandably pulled the IPO. I don't think this will taint the IPO as Shell stepped up post-IPO cancellation to lead the Series F in March 2009, a strong testament to their commitment and excitement in the technology. They recently have filed a few amendments to the S-1 so it seems they are making progress with the SEC.  Top Codexis shareholders below:

Lastly, on February 1, 2010, Shell signed a non-binding memorandum of understanding with Cosan S.A., with the intention of forming a joint venture in Brazil for the production of ethanol, sugar and power, and the supply, distribution and retail of transportation fuels. According to the announcement, Shell would contribute to the joint venture Shell's equity interest in Codexis. Per the amended S-1 filed 2/26/10, the estimated fair value of Codexi's common stock increased to $7.28/share ($1.41/share to MAXY including 20% public/private discount.)

MAXY G-34 CONSIDERATIONS

AMGN's Neulasta franchise does over $3 billion in sales per annum, thus AMGN is very keen on protecting it from a 'biobetter' competitor. MAXY-G34 is differentiated from AMGN's products by the amino acid sequence, the type of post-translational PEG linkage, the site of PEGylation, and the number of PEGylated amino acids. Based on head to head Phase 2 studies, MAXY-G34 potentially has both a better efficacy and safety profile vs. AMGN's product - a homerun combination that lead analysts (back when they covered the stock) to model over $1 billion in peak sales for the product. The FDA has also given MAXY guidance on a registration path forward, which is a nice have prior to entering Phase 3 (final phase) trials.  (As an aside, these drugs treat chemotherapy-induced neutropenia. Neutropenia is a dangerous condition marked by low white blood cell counts.)

Based on the chemical and structural differences, the USPTO (patent office) granted MAXY three patents covering MAXY-G34.  Note that AMGN's existing IP estate did not conflict with MAXY's patents at the time they were issued. However, on June 3, 2008 the USPTO issued AMGN patent 7'381'804, which contains claims for certain analogs of GCSF, conflicting with MAXY's IP. MAXY filed a protest with the USPTO and the USPTO has agreed to reexamine AMGN's patent. Given MAXY's preexisting intellectual property, it is highly likely the USPTO reverses the AMGN patent, or severely restricts its claims, as the issuance appears to be a mistake/oversight by the USPTO (not the first time this has happened). MAXY and the Street, through consultations with IP lawyers, strongly believe that MAXY will prevail. If and when it does, it will be a powerful catalyst for MAXY. However, it may take another 18 months to resolve,  and the outcome is far from certain.

What this means is that despite potentially better efficacy and safety, and longer patent coverage (AMGN's products lose their patent coverage in the 2013-15 time frame vs. MAXY's out to 2021+), no potential partner will likely touch this situation until the USPTO resolves the situation.  Regardless, MAXY is continuing its partnering discussions and reports continued large pharma interest.

MANAGEMENT COMPENSATION AND OWNERSHIP

Nothing stands out here as the company has a standard equity incentive plan for a biotechnology company. MAXY did implement a few special incentives for the recently departed management team prior to consummating the various strategic transactions, which have been paid out. I expect the Board to review and update the equity incentive program in the near future. The Chairman, CEO and COO own 1.9%, 0.25% and 2.2%, respectively. The recently departed CEO, CFO and head of business development own 10%.

CANGENE CONTINGENT LICENSE FEE

Cangene is one of Canada's largest biopharmaceutical companies that focuses in the biodefence industry. Concurrent with licensing MAXY-G34 for ARS, Cangene submitted a bid to develop MAXY-G34 for treating ARS under a request for proposal (RFP) issued March 13, 2009 by the Biomedical Advanced Research and Development Authority (BARDA) within the U.S. Department of Health and Human Services.  BARDA's RFP solicitation is entitled Advanced Development of Therapeutics for Treating Neutropenia Resulting from Acute Exposure to Ionizing Radiation (think Bioshield).  Cangene has successfully contracted with the US government on biodefence therapeutics in the past.

If Cangene is awarded a government development contract that meets certain Cangene criteria, Cangene would exercise its option for an initial license and pay Maxygen a $12.5 million licensing fee. Maxygen would also be entitled to additional licensing fees based upon a percentage of Cangene's net contract revenues under the development contract.  Cangene also has the right to acquire a fully paid automatic grant of the initial license and the subsequent license for a one-time payment to Maxygen of $30 million. The $12.5-$30 million payments represent $0.40 to $0.96/share upside (not risk adjusted) for MAXY. On Cangene's December 15, 2009 earnings call, they noted that they were continuing to receive numerous questions on the RFP proposal from BARDA and would update the situation as soon as practicable.  An announcement could come any day, but may also be substantially delayed.

RISKS

1. Codexis IPO fails. Mitigant: Shell led the last financing round with post-money EV of $307mm in March 2009, which provides a decent floor value for the technology. Company has revenues and is growing.

2. Management determines to invest in some outside technology that is value destroying. Mitigant: It is very tough to handicap this though the company has been very upfront regarding its primary intensions to harvest portfolio assets and return value to shareholders. 

3. MAXY-G34 is never heard from again. Mitigant: patent office agreed to take another look at AMGN's patent that was recently issued. I expect a resolution here in the next 18 months

4. Lack of catalysts: we are trading near cash, see limited downside from here based on asset value.

5. Management does not host conference calls anymore. Mitigant: one of the reasons for the opportunity - no one follows the company. Management is focused on delivering value for shareholders.

DISCLOSURE: We and our affiliates are long Maxygen (MAXY), and may acquire additional shares or sell some or all of our shares, at any time. We have no obligation to inform anybody of any changes in our views of MAXY. This is not a recommendation to buy or sell shares.

Catalyst

1. IPO of Codexis (road show)

2. Any other shareholder friendly activities such as a special dividend (being contemplated by management)

3. Resolution of MAXY-G34 IP situation and partnership

4.  Perseid pipeline progress, particularly with respect to MAXY-4

5. Bayer $30 million milestone payment

6. Cangene progress with the ARS BARDA bid