Description

SWKH is a cash-generating portfolio of pharma royalties and structured credits trading at origination value with a roughly 13% projected yield and a free biotech company embedded in it.  The board of directors already has a committee in place to evaluate strategic alternatives, so I expect the value to be unlocked in short order.  This is very illiquid, so likely mostly a PA opportunity.

SWK Holdings has been written up numerous times on VIC.  It’s a long story, but I will do my best to summarize.  Essentially this was a public shell that had $37 million in cash and huge NOLs (like $450 million) with the majority expiring in 2021.  Carlson Capital owned 27% of the company and brought in some people to buy life sciences royalties and make specialty loans in that segment with the cash on the balance sheet in 2012.  In fall 2014 they did a rights offering and Carlson put more money in the company while preserving the NOLs and bringing its ownership just above 71%.  They hit some bumps early on with non-performing loans but since Winston Black was put in place as CEO the portfolio seems to have low double-digit returns on originated positions.  The thing is, the NOLs basically all expire this year and Carlson seems tired of having its capital tied up in such an illiquid stock, so now it is time to do something.

The company has persistently traded at a discount to book value.  It has tried to remedy this by up-listing to the NASDAQ from the OTCBB and doing some roadshows.  In 2019 it bought Enteris BioPharma so it now has an operating business too.  Not much has worked.  The primary business remains this finance portfolio which has a net tangible book value of $16.31 per share.  The current yield on the portfolio is ~13%.  Since Winston Black became CEO in 2015 this book has compounded around 7% despite public company costs, and the occasional non-performing loan, etc.  I’d imagine the actual cash on cash return of the book has been low double digit.

Royalty Pharma (RPRX) – a much bigger player in the royalty finance business that has leverage on its portfolio recently went public and trades at nearly 3.0x book, so there is clearly some appetite for this kind of business at a larger scale.

Clearly frustrated, Carlson put in a non-binding offer to buy out the existing book of finance receivables at 94% of book value ($193 million) on April 5th, 2021 (with proceeds to be distributed to shareholders and Enteris remaining public), but an independent committee of the board rejected it and couldn’t reach an agreement after “subsequent enhancements to the proposal that we (Carlson) thought significantly enhanced SWK stockholder value.” 

Because they couldn’t come to terms, SWKH has formed a strategic review committee to evaluate third party strategic alternatives (with support from Carlson and one of their employees on the board and committee).  Carlson said, “However, as it is clear that the proposed transaction is not proceeding, the formation of this Strategic Review Committee to pursue and evaluate third-party strategic alternatives has the full support of Carlson Capital, and we look forward to working together and seeking to deliver enhanced value to SWK's stockholders as expeditiously as possible.”  Carlson is ready to get out.

In a low interest rate environment, given the consistent track record and low correlation to other assets and solid cash flow generation, I think third parties might find the royalty/finance portfolio attractive.  With respect to Enteris, SWKH basically paid north of $30 million for it when considering milestone payments and as they have hit numerous milestones since then the company is probably worth quite a bit more than that.  If the Cara Therapeutics drug gets approved (it is entering a phase 3 trial this year) and Enteris starts generating royalties, it will be worth a whole lot more.  The street has this drug potentially doing $500 million per year at peak and SWK is entitled to half of the low single digit royalty.  And it should be noted that Enteris’s technology is really a system that takes injectable peptides and turns them into orals that could be applied to a lot of injectable only peptide drugs.  They have a couple older injectable drugs that they themselves are turning into orals and are in clinical trials with.  Additionally, Enteris recently finished building out a 30,000 square foot manufacturing facility that allows them to provide full contract development and manufacturing (CDMO) services.  This is a good little business that the SWK team rightly purchased at a good price even though it wasn’t in their traditional wheelhouse.

So, basically you have an opportunity to buy a solid yielding portfolio of pharma royalties/structured credits at origination value and you get Enteris for free.  You have a majority owner who seems to be motivated to get their money back and a strategic committee that is working on a plan to maximize the value to shareholders in the near-term.  Worst case I think they could put the portfolio into runoff and pay out the proceeds to shareholders while leaving Enteris as a public company on its own once the portfolio runs off.  I think the returns from here in that scenario would be very acceptable.  Carlson already tried to make a “screw the minority shareholders” bid, and the board rejected it, so I feel like the take under scenario is off the table.  Basically, I think you are looking at getting a relative safe and uncorrelated double digit return from here with the immediate catalyst of the strategic review committee potentially doing a transaction in the near-term.

Catalyst

The strategic review committee completes its work and does a transaction to unlock value for shareholders and get Carlson out.