Description

There are a number of things about Paladin Labs that I don't understand.  I say that freely upfront in case somebody asks me something and I look like the dummy you suspected I am.   However, there are enough positives associated with this stock to make it my largest position at present despite my overriding ignorance.

PLB, simply put, finds and develops drugs for the Canadian market and also invests its cash flow in anywhere they can make a buck (a CAD in this case) in a low risk, high return manner.  The company has an overcapitalized balance sheet, a simply tremendous long-term record of wealth creation, high ROE business model, intelligent management team, and trades for a FCF yield of 11.6%.  Risks include 1) worries about two drugs which have/will have (eventually) generic competition, 2) the unfortunate accident which sidelined the company's dynamic founder, 3) some oddball accounting (to me at least - I'm used to retailers and asset managers and easier stuff than this but I figure that a dummy like me can at least monitor cash levels to make sure everything is a-ok), and 4) all the risks involved with a company that makes acquisitions/other movements with cash a strategic priority.  While they haven't done anything stupid in the past, anything is possible.

all figures CAD

Positives

1 - Strong Balance Sheet.  The easiest thing for me not to screw up.  PLB has 252m on the BS and no debt.  The cap is 882m right now, 621 sans this amount.

2 - Q1 EBITDA, defined by the company, as 18m.  I have tried to understand where they get their EBITDA numbers but it is hard to get a consistent answer but all the analysts basically swallow what the company feeds and any differences between these numbers and others are minor.  However, from the magic of Canadian tax law, another thing that makes me shudder, this company somehow manages to not pay taxes (thanks tax pools) and thus, for at least the next few 3 years, EBITDA is a good proxy for FCF as CapEx is almost non-existent.  I am just taking 18 x 4 as my trailing EBITDA number though again you can get more precise if you want.  TDN shows an estimated 69m for 2012, Paradigm 80m so the number is likely somewhere in between.  

3 - high FCF yield - again, using 72m as FCF by 621 and you get 11.6%.  On a one year forward basis, subtracting EBITDA from the EV gets you to 13%.  In three years, even if EBITDA stays flat, PLB generates 216m or 216/621 or 35% of the current EV.

4 - high ROE business model.  CapEx and PPE is minimal.  This is a business that generates high margins on sales with limited Capital Requirements.

5 - Tremendous record of wealth creation.  Dealing in Canadian drugs where there is no unified authority is a painful process for large pharma companies but a very good business for PLB.   Here is the chart from their website which says many things

Investment Highlights

Strong revenue growth
• 5 year Compounded Annual Growth Rate of 24%
Healthy, robust business
• Generated 67.6 million of EBITDA in 2011 or $3.27 per fully diluted share
Rich, near-term pipeline for growth
• 1 product awaiting regulatory approval
• 3 products pending regulatory submission
• 17 products in phase I, II and III

Financial Data for 10 Years

6 - Intelligent Management Team.  See what they do, not what they say has always been my motto, but PLB talks to talk and walks the walk.  Besides the above array as testament to their skills, there are numerous other examples of what this company does that you can read in the annual circular in SEDAR but my favorite one was here:

On January 11, 2011, the Corporation invested $77,232,000 (£50,000,000) in ProStrakan Group plc ("Prostrakan") through the acquisition by way of assignment of ProStrakan’s existing secured debt facility with the addition of certain conversion rights. On February 21, 2011, in connection with the proposed acquisition of ProStrakan by Kyowa Hakko Kirin Co., Ltd. ("KHK"), the Corporation consented to the repayment of its debt facility subject to closing of the acquisition. On March 31, 2011, at the general meeting of Prostrakan’s shareholders the acquisition of ProStrakan by KHK was approved. On May 17, 2011, the Corporation received gross proceeds of $86,432,000 representing the aggregate of: the principal of the ProStrakan debt facility of $77,232,000, the interest accrued as at May 17, 2011 of $778,000, a break free of $3,089,000, and the outstanding balance of interest payable for the first year of $5,333,000, resulting in an aggregate gain on early redemption of $8,422,000. Moreover, the Corporation has retained the rights to the products it had previously been licensed in connection with the agreement.

Course, there are risks:

1 - the dynamic CEO previous was seriously hurt in a car accident.  His family controls a majority position here, but the bigger concern is how much of PLB's dedication of low risk, high reward capital allocation and business building was directly attributable to Mr Goodman.  I refuse to believe everything was due to one man but it is hard to underestimate how un-nerving this is but his partner and acting CEO Mark Beaudet has so far given investors the same sorts of assurances (thru his public statements and from interviews with others) that he knows the business and will continue with the same culture.

2 - this is a pharma company and there are usual issues with evaluating new drug possibilities and existing drug challenges.  The circular makes this even hard by not breaking out sales by product (IMS data is provided instead) though candidly I'm not going to have the skill set to evaluate if one drug is a threat to another or what not.  There are two significant drugs that face generic competition - PlanB which already has some generic competition but is mostly holding share, and Pennsaid which many thought would have generic competition by now but is expected by Q3.  This will put a damper on growth in EBITDA depending on impact.  There are similar issues/concerns with other drugs.  I am just making the assumption that the business team that built the record above has a handle on these issues.

3 - some oddball accounting.  Again, I'm sure these wouldn't be oddball to smart folks in Canada, but taxes are nil here - always have been - and according to one analyst the company "...aggressively amortizes its product and company acquisitions over a relatively short period of time so depreciation and amortization can be higher than seen in comparable companies."

4 - all the risks you see with a company that makes investments.  PLB is in the midst of a large one - a cash transfer and share issuance and then share acceptance for Litha upon which PLB will have a 45% interest in that company and vastly increase PLB's own look-thru/existing revenue and EBITDA as the company expects to consolidate this portion of Litha's operations inside its financial statements.  This will result in cash going down to  abt 200m (based on Q1 cash) but with, based on 12-11 data provided by PLB, revenue increasing to 255m and 96m in EBITDA (and note this does not give effect to the interest in Litha not owned by Paladin).   Investments in emerging market drug companies are norm here, and it is entirely possible to loans to other companies won't work out and bids for undervalued stocks might not work and a lot of things might not work out. 

It just looks cheap to me.  This is yet another favorite of Jason Doneville of Doneville Kent Asset management, the most Peter Lyncian Canadian investor I've ever seen (though I haven't seen much, but he is a remarkable money manager).  Analysts are currently afraid of the CEO's statement in Q4 that revenue for 2012 would merely be flat with the previous year (which, by the way, PLB did the previous year too and beat it) and refusal to upgrade this forecast despite a jump in Q1 sales.  I just don't think this means anything long-term, and when they close on the Litha deal and if they make more good deals these statements become  a distant memory, though PLB has experienced a good run lately. 

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Catalyst

 - a good deal increasing EBITD even more

 - Goodman ever returning

 - time (I think this is a good business and time will just make it better so to me it is a multi-year holding)

 - from the little I understand, it looks a lot like that pharma company that Sequoia loves so much (Valeant)