Description

PDL Biopharma (PDLI - $2.12/sh) is a cash-rich pharma royalty company that is trading at a ~55% discount (~125% upside) to my base case fair value estimate.  On my upside case, the stock would be more than a triple. I believe downside is limited by asset backing (if you take a haircut to all of the asset values you still come up with a price much higher than where this is trading).  But fear not, I’m not going to have a write-up that says my downside case is +60% from here! The real risks are that management destroys value, or that the discount to value never closes or indeed widens. Perhaps the warranted trading value is 70% of my base case liquidation value (of 4.90/sh), or $3.40/sh (for ~60% upside).

Analytically, this is a balance sheet-driven SOTP idea, though the company generates meaningful gross cash flow every year in the form of royalty payments.  To start, let’s take a look at the balance sheet (as of 2Q 2019). The current market cap is $250mm. The liability side of the balance sheet is fairly clean, with just a $150mm convert (carried at $128.5mm) of note.

Liabilities

So at $2.12 per share we are “paying” ~$395mm of EV for this business.  What does that get us?

 Assets

First of all, it gets us $285mm of cash, which puts the remaining EV net of the cash is $110mm.  What are we getting for that $110mm?

We are getting $315mm of royalty rights as carried on the books, $88mm of investment in equity affiliate, two fully-owned companies (Lensar and Noden), and a note receivable of $50mm+ (which, with accrued interest and penalties, could be worth as much as ~$150mm).  On the surface, over $450mm worth of stuff.

Royalty Portfolio

The royalty portfolio, and one royalty stream in particular, is really the key to underwriting the company’s assets.  If we can gain conviction that the royalty portfolio is really worth anywhere near $300mm, then that, combined with the cash, is enough to cover the purchase price – everything else (another couple hundred million worth of various assets) is free.

Of the $315mm worth of royalties, the vast majority, ~$265mm worth (as carried at book) are related to a suite of drugs developed by Depomed (which was later acquired by Assertio).  It is worth noting that Assertio no longer “owns” these drugs – the drugs are marketed by pharma behemoths such as Bausch, Lilly, Merck, and Janssen. Assertio could go bankrupt tomorrow and the royalty streams on these drugs to PDLI wouldn’t change.

The Assertio/Depomed portfolio is a portfolio of Type 2 diabetes drugs – primarily Glumetza.  It is expected to generate on average roughly $50mm of cash flows per year between now and 2026.  The company forecasts revenues on the drugs, and discounts them back using a high discount rate (I have been told 10-20% depending on drug, country, timeframe, etc).  Other investors, such as insurance companies, may use a lower discount rate in underwriting royalty assets, so there is an argument that the company’s marks could understate fair value.  Net, the work I have done here makes me somewhat comfortable in the company’s marks on this asset. At an EV of $115mm, I think there is a decent margin of safety here. 

Note: since this chart was published in May, the company has written down the AcelRX portfolio.  Again, Depmed/Assertio is really what matters.

Investment in Equity Affiliate (EVFM)

In 2Q, the company invested $60mm in publicly-traded EvoFem (EVFM).  They bought 13.33mm share at $4.50, and got 3.33mm warrants to purchase stock at $6.38.  EVFM is trading at around $5.25, which would put the value to PDLI at $70mm (gross of taxes, and ignoring the warrants).  EVFM is a clinical stage biopharma company focused on female reproductive health. 

Notes Receivable – Wellstat

In November 2012, PDLI lent Wellstat Diagnostics $40mm, and in January 2013 (before making a single interest payment!), Wellstat defaulted on the loan.  So PDLI promptly lent Wellstat another $4mm, bringing the total loan principle to $44mm, and after that, PDLI never saw a dime from Wellstat. Fast forward five years (and who knows how many millions spent on litigation), and PDLI is carrying a $50mm+ note receivable from Wellstat on its balance sheet.  While the carrying value is $50mm, the total amount due, after penalty interest and accrued legal fees, is closer to $150mm.

Earlier this month, PDLI won an important decision in NY Supreme Court against Wellstat.  Per the press release on 9/11/2019:

“INCLINE VILLAGE, Nev. (September 11, 2019) - PDL BioPharma, Inc. (“PDL” or the “Company”) (Nasdaq: PDLI) announced that the Supreme Court of New York, County of New York, Commercial Division, issued its decision today in PDL’s previously disclosed litigation related to defaults by Wellstat Diagnostics on loans made to it by the Company. The loans of $44,100,000 were made pursuant to a loan agreement between Wellstat Diagnostics and PDL dated August 2013. Today’s decision resolved a dispute regarding the validity and enforceability of guarantees on the loan made by related entities of Wellstat Diagnostics (the “Wellstat Diagnostics Guarantors”).

“The summary judgment decision holds that the guarantees executed by the Wellstat Diagnostics Guarantors are valid and enforceable, and that the Wellstat Diagnostics Guarantors are liable for the amount owed under the loan agreement. The court ordered a damages inquest before a special referee to calculate the amount owed under the loan agreement between Wellstat Diagnostics and PDL. PDL expects to seek recovery for the full amount due under the terms of the loan, including the principal, accumulated interest, further advances and fees.”

I would not be surprised to see PDLI and Wellstat settle for an amount in between $50mm and $150mm, or even just settle for $50mm, but the odds that this is worth a lot more than zero just went up by quite a bit.

Fully-Owned Companies

PDLI owns Noden and Lensar.  These are two small companies that do in total generate some EBITDA, but are not worth much in the grand scheme of things (I value them together at $30mm).

Noden is a biopharma company that has a portfolio of five hypertension drugs anchored by Tekturna (US) / Rasilez (ROW).  It competes with “first line” treatments for hypertension including ACEs and ARBs (for patients for whom the first line treatments don’t work well).  New generics recently became available. I value this at $20mm.

Lensar is a laser eye surgery device for treating cataracts.  It was acquired when a loan PDLI made was defaulted on and Lensar’s owners handed over the keys.  ~$20mm revenue run-rate. Close to breakeven. PDLI can sell the business and keep the NOLs (as of June 2019).   Comparable Optamedica was purchased by Abbott Optical for $300mm+ when it had $15-20mm of sales, so there could be some optionality here.  I value this at $10mm.

SOTP (vs. $2.15/sh x 114mm shares = $245mm market cap)

Activism, Board & Management

There has been one small activist who has made some noise in this, called Sevensaoi Capital.  Despite not having filed a 13D, they were still successful in getting one board member appointed (Shlomo Yanai, the former CEO and President of Teva Pharmaceutical).  The CEO was also recently changed, and a large buyback implemented, so there is some evidence of change for the better.

You can read the two public Sevensaoi letters here:

April 9, 2018:

https://mma.prnewswire.com/media/664524/SevenSaoi_Capital_Board_Letter.pdf

September 20, 2018:

https://mma.prnewswire.com/media/746872/SevenSaoi_Public_Letter_to_PDL_Board.pdf

I think this is a particularly interesting opportunity for activism:

-          No inside ownership/controlling shareholder (entire management/board combined own 2.7mm shares or 2.2% of the company).

-          Poor stock price performance over any time horizon.

-          Top five shareholders (over 40% of market cap) are all index/quant (Blackrock, Dimensional, Vangaurd, Renaissance, and State Street) – and thus likely to vote with ISS/proxy services.  Add in a few more like Northern Trust, Charles Schwab, Citadel, De Shaw, and you have over 50% of the vote.

-          Cash/asset rich.  You could buy this, liquidate a few things, and get your basis down to zero pretty quickly (and still be left with a few hundred million of interesting assets/call options).

-          Delaware incorporation.

Interestingly, the company exists as it does today thanks to Dan Loeb’s activism on the company back in the 2007 timeframe.  His old letters are always a fun read (though are no longer pertinent):

https://www.sec.gov/Archives/edgar/data/882104/000089914007001037/p3736300c.txt

https://www.sec.gov/Archives/edgar/data/882104/000089914007001301/p3835651c.txt

Buyback

The company had $527mm of cash on the books at YE 2017.   They repurchased $50mm of stock in 2018 and over $70mm in 1H 2019.  They also retired $126mm of converts and made the recent $60 investment in EvoFem (EVFM).

1Q 2018 – 1.4mm shares at 2.97 average ($4mm spent)

2Q 2018 – 6.8mm shares at 2.87 average ($20 spent)

3Q 2018 – None.

On September 21, 2018, the board authorized a new $100mm repurchase program.

4Q 2018 – 8.7mm shares at $2.94 average ($25mm spent)

1Q 2019 – 13mm shares at $3.38 average ($44mm spent)

2Q 2019 – 8mm shares at $3.27 average ($26mm spent)

$4mm remaining on authorization at end of 2Q 2019.  Completed in July.

Buying back stock in the $2-3 range is quite accretive to NAV.  If they bought another $100mm worth of stock at recent levels, my base case NAV would increase to $6.60 from $4.90, bringing base case upside to 200% from 122% (and my 70% of NAV trading bogey to $4.60 for 115% upside).  Of course, they probably wouldn’t be able to buy $100mm of stock at $2.25, but I think it helps frame the current valuation (and even averaging $3/sh on the buyback is still nicely accretive).

Risks

-          Poor future capital allocation that destroys value.  This is my biggest concern with this company. The track record is fairly poor, except for the one home run in Assertio/Depomed.  Time will tell if the new CEO is better.

-          Value of royalty stream is impaired due to competition, generics, change of focus by companies marketing the drugs, etc.

-          EVFM investment is unsuccessful.

-          Negative outcome on Wellstat litigation.

Conclusion

PDLI is a bit of an orphaned company.  It is difficult for generalists to get their hands around.  Management has only seemingly taken actions that benefit shareholders under pressure from activists (but at least they have taken them).  I believe that despite being complicated, trading at 40 or 45c on the dollar is too punitive, and therefore that this presents a good risk/reward at these levels.  

Disclaimer

We have no obligation to update the information contained herein and may buy, cover, or sell shares at any time for any reason. We make no representation or warranties as to the accuracy, completeness or timeliness of the information contained in this presentation. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained in this presentation.  This does not constitute an advertisement or an offer to sell or a solicitation of an offer to buy any securities.

Catalyst

-          Additional buybacks.

-          Successful activism.

-          Sale of any assets (Lensar?), or partial monetization of royalty stream portfolio.

-          Successful outcome/settlement on Wellstat litigation.