Description

National Patent Development (NPDV) was created when GP Strategies (GPX) decided that its collection of non-core assets depressed the multiple on its core corporate training business. So GPX decided to package and spin off portfolio in the form of NPDV, completing the separation in Nov. 2004 at $1 per share. The long idea is NPDV. I currently do not have a strong view on GPX.

While the stock has appreciated to $2.60, I will argue that the risk/reward is more compelling now then at $1 given how little we knew then, and the positive developments since the spin-off. Effectively it was a flier in November and is now an investment.

Traditional analysis of the financial statements is virtually useless. This is purely a sum-of-the parts analysis and the operating businesses that are consolidated onto NPDV books provide virtually none of that value. So now I’ll go through the array of assets.

I split the assets into two buckets: 1) the first consists of two assets plus a litigation claim that provide huge upside, 2) the second is a bunch of other junk that provides downside protection should the three assets in bucket #1 disappoint.

Bucket #1:

(1) NPDV owns approximately 18% of Valera Pharmaceuticals (formerly Hydro Med Sciences), which has filed its preliminary S1 to go public this fall under ticker VLRX. The company makes a drug delivery device in the form of an implant used to treat meta-static prostate and other cancers which have reached a terminal stage and aren’t responding well to chemotherapy. This is a $1.3bn market currently controlled by Astra Zeneca, Bayer, Sanofi and Abbott. The competitors’ implants are paired with cancer drugs like lupron while Valera’s implant mechanism is paired with histerelin, which has been shown equivalent efficacy but with fewer problems regarding elevated testosterone levels. Both histerelin and lupron are off-patent while the device was approved by the FDA in late 2004 and obviously is patent protected. The drug is basically just a sell through.

Valera’s implant is unique in that it releases the drug over the course of 12 months. The only other 12 month implant is sold by Bayer and it is paired only with lupron. Bayer’s product is also larger and less flexible, which can cause discomfort. The others competitors' implants have durations of only 3 to 6 months. Since the FDA approval in November, Valera sold 2,200 units at a $2,500 ASP in the two month stub period. While annualizing this number to $33mm sales is very conservative given the market size and resulting ramp that is expected, I expect that the ASP will come down some, so $33mm is probably a decent starting point. Prior to filing its S1, the company estimated the sales potential at $100mm. Gross margin is estimated to be 80%. The company is expected to be cash flow positive by Q3 of 2005. This is after both R&D and the cost of patient recruitment for clinical trials to use a similar implant for the treatment of both excess hormones in kids and gigantism. Both are small markets but there are currently no comparable implant options for these two patient populations, leaving potential for strong market share. The bottom line is that it is hard to argue that this company deserves a valuation anything below $200mm. As a frame of reference, the last private round valuation, which was pre FDA approval, was $68mm. I used $200mm as the downside case and $250mm as the upside case. This results in a gross valuation to NPDV of $33 to $41mm.

(2) In 1998, GPX bought a business called Learning Technologies from EDS, which had in turn bought it from WorldCom. GPX claims that the financials and projections with which it underwrote the acquisition were fraudulent and filed suit in January of 2001 for actual damages of $117mm plus punitive damages and interest (the interest alone totals nearly $30mm). GPX lost nearly the damages amount since the acquisition and struggled for 5 years to stave off bankruptcy. Of course fraud cases are very hard to prove but there is a key factor here that makes me more confident than would normally be the case. The judge decided to send a portion of the case to binding arbitration to test the merits of several of the claims. GPX was seeking $18mm (consisting of $12mm damages and $6mm interest) and, under the arbitration structure, successfully was awarded and has received the full amount. NPDV only received $5mm of this settlement but the split between GPX and NPDV on any additional awards from the suit is now 50/50 once GPX receives $15mm net of legal fees and GPX only has $1.3mm more to go. So post arbitration, that brings the damages sought to about $100mm, again excluding interest and punitive damages.

With the arbitration completed, the case went back to the courts. At that point EDS filed a slew of motions to dismiss, but the NY Supreme Court granted only one of them, and it appears to be a relatively minor component of the overall case (though I'm still working through this issue). That’s the last motion EDS is likely able to make before trial, which commences Nov 1. For the downside case, I assume that the award/settlement is zero and for the upside case $150mm. This number includes interest and any punitive damages. The lawyers will receive 20% of the proceeds. The resulting range in gross values to NPDV is $0 to $59mm.

(3) The last piece of Bucket #1 is 980 acres in Pawling, NY along Whaley Lake that NPDV owns with no mortgage. I'm told by New Yorkers that it is beautiful and it looks pretty nice on Google Maps, which is a great way to waste time. A four year old appraisal pegged the value at $8mm and I believe that based on the current zoning and access, it’s probably worth more like $25 or $30 to Toll or another builder. The real upside case, which I’m not in this analysis, comes from the simple real estate math I walked through with a local real estate broker. He expects zoning for 4 acre lots, which is obviously big and hampers value by lower the number of lots/units developed. Assuming $200,000 for a beautiful 4 acre lot and 245 lots (980/4) gives a value of $49mm. Given The issue is that the land is pledged as collateral against a note that Gabelli holds. What’s goofy is that the note is the obligation of GPX, not NPDV. When NPDV was spun out it got the land along with its pledge, and GPX kept the note to Gabelli. Not a smart, clean or fair way to do it without a doubt, particularly since there is no compensation paid by GPX to NPDV for the pledge of its asset. The note matures in 3 years and I don’t think it can be redeemed early. Ultimately the land is worth what it’s worth regardless of the pledge. For the downside case I used $12mm (one way to look at this is 10% appreciation per year on the four year old appraisal at $8mm) and for the upside case $25mm. By way of reference, NPDV’s carrying value for the property is $2.5mm.

So adding up the three pieces of Bucket 1 gives a range of gross values of $45mm to $121mm. Tax consequences of the gains estimated in Bucket 1 are unclear. NPDV currently has $4.6mm in NOL and is losing money due to the businesses within Bucket 2 discussed below. Incorporating the tax basis for each property, the NOLS and a 30% tax rate (which incorporates the ongoing operating losses of the company) the range of net value for NPVD $34mm to $87mm. Admittedly a wide range, but that's mainly because in the downside scenario I assume they win nothing in the EDS suit.

Bucket 2:

The company owns 64% of Five Star (FSPX), a regional home decorating and hardware distribution business. Though not a good business, the company is breaking even. I assume that FSPX equity is worth zero but that the $2.8mm intercompany 8% cash pay note owed to NPDV is money good.

NPDV owns 2% of Millenium Cell (MCEL), which is developing an alternative energy source based on boron chemistry, whatever that means. It might be worthless, but the market cap is $80mm. I take a 20% haircut giving a net value of $1.6mm.

The company owns 100% of an optical plastics business called MXL. MXL did $1mm in annual cash flow three years ago but is now losing a small amount of money. There is no cash drain on NPDV because MXL has its own bank line. They've replaced management and are attempting to turn it around. MXL did $1.8mm sales last quarter. My downside case uses zero and upside case uses 0.5x sales or approximately $4mm.

Stripping away the businesses consolidated in the NPDV financials (FSPX and MXL), you can calculate that the corporate level cash is approximately $5mm after the receipt of the arbitration proceeds and the annual burn, again at the corporate level, is $1mm. The lawyers in the EDS suit are paid almost entirely on a contingency basis. I'm including $3mm of net cash in the valuation. I think the implied two year burn ($5mm cash today minus $1mm burn per year for two years) is realistic.

Adding up the three pieces of Bucket 2 gives a range of $7mm to $11mm depending on what you assume MXL is worth.

Bucket 1 plus Bucket 2:

Downside $53mm, upside $136mm on a gross basis; downside $42mm, upside $104mm on net of tax basis. I know the spread is incredibly wide, but again the idea is that the downside scenario assumes that they get zero in the lawsuit, Valera is only a $200mm company and the real estate is worth $12 versus an appraised value of $8mm four years ago.

Based on a share count of 18.9mm including all outstanding options, that gives a share price range of $2.21 (16% downside) to $5.50 (125% upside)..

Risks:

1) The Valera IPO could be delayed either due to the market environment or some unforseen problem with their implant.
2) Fraud lawsuits are hard to win and EDS may not be willing to settle. Also, the NPDV and GPX management teams take this lawsuit personally given that it nearly bankrupted the company and therefore are less likely to settle even if the offer is attractive.
3) Management, which really at this point has no ongoing role to manage anything other than a lawsuit, may decide to try to rebuild some sort of operating business once Valera and the EDS suit play out. However, the board, which includes 14% owner Bedford Oak (Harvey Eisen) and 8% owner Equity Group (Sam Zell's investment group) clearly will push management to wind the company down once things play out either positively or negatively.

Catalyst

1) Valera has filed it's S1 to go public and hopefully it will be completed this fall.
2) EDS lawsuit starts Nov 1.
3) A prime piece of real estate does sit not undeveloped long in this market, Gabelli note or no Gabelli note.