Description

We previously wrote up PDLI in 2019, which was a cash-rich pharma royalty company Sum-Of-The-Parts story. Its value was ultimately unlocked for a solid return. We think this situation rhymes with that one to a certain extent, although this is a much simpler idea with fewer moving pieces. While Vanda has been discussed on Twitter and shows up on the Magic Formula Investing screen, it has not been written up on VIC.

Vanda’s market cap is $245mm ($4.25/sh), and the company has net cash of $489mm ($8.50/sh).

Usually ~50-cent dollars in busted biotech land have large cash burn rates and much less scale. That is not the case here.

A few ways of putting the valuation in context

• Vanda could distribute $6.50 per share and still keep over $100mm around for a rainy day.

• The stock is assuming the core business is worth nothing and that Vanda lights $250 million on fire. Sure, they could do some bad M&A, but this seems egregious.

• The stock is trading at about 10x pre-tax interest income generated by having the cash in T Bills.

Overview

A quick overview of the company. VNDA has two drugs that have been commercialized: Hetlioz for various sleep disorders ($150mm of 2022 revenue) and Fanapt for schizophrenia ($100mm of 2022 revenue). Vanda also has a clinical development pipeline of additional drugs for additional indications.

Hetlioz went off patent last December (we comment further on this below).

Annualzed 1H 2023 revenues were $220mm. COGS were ~$20mm, SG&A $120mm, and R&D $70mm. In other words, operating income was roughly breakeven, but after adding back interest income at 5% (short-term T-bills), the company is not burning cash and should indeed be generating around $25mm of interest income per year.

Ultimately, this is a “pile of cash trading at half of its value” thesis. We don’t have a strong view on the rate of decline of Hetlioz or on Fanapt or on the development pipeline. We believe the commercialized products and the development pipeline likely have value to someone. If these products were put under a larger company’s umbrella and R&D reduced, there would at the very least be a nice profit tail for several years.

The key to our analysis is to answer questions like: “How do we get paid?”  “Will this be a value trap?” and “Will the management squander a few hundred million of value?”

Why so cheap?

We don’t believe Vanda’s long-term history since its IPO in 2006 is too pertinent today (but here’s a taste: wild swings in the share price, lots of equity issuance, negative cumulative earnings). As for the near 60% stock decline in the last year, there were two primary drivers.

1. December 2022. Vanda loses a patent lawsuit on its largest drug (Hetlioz, accounting for 60% of VNDA’s sales), which allowed for generic competition. Stock falls from ~$11 to $7.

2. September 2023 – Vanda is removed from S&P 600 small cap index. Stock falls from ~$6 (in August) to the low-mid $4s.

This second point is important. The shareholder base was/is very heavily skewed to index funds (and quants). As of the most recent filings:

• Blackrock owned 18% of the shares (now down to 12%, which is still surprisingly high, as per a recent 13G).

• Vanguard and State Street each owned 7%.

• RenTec, GS, and Dimensional each owned 3-5%.

At least half of the shares were/are owned by non-fundamental or quantitative investors. We think the majority of the recent selling has been by these non-fundamental investors as the stock left the index. The biotech index (XBI) has also been very weak and is not far above its 5-year lows (including covid lows), which may account for additional selling pressure.

The value here is self-evident.  Let’s examine the risks and what could go wrong.

Risks / Things to Note

• We believe the single biggest risk is that the company engages in bad M&A.

• Corporate governance is weak.

  • The lead independent director is 81 and has been on the board since 2005.

  • There is a staggered board.

  • Board members are paid ~$300k each.

  • Three of the CEO’s children are employed by the company.

• There is a lot of ongoing litigation, including numerous lawsuits the company filed against the FDA and the federal government. Let’s just say the “Legal Matters” notes in the Ks and Qs are quite extensive.

Low Shareholder Alignment

Inside ownership is fairly low, with the CEO owning only 4.5% and all directors and officers as a group only owning 7.7%.

Conclusion

These types of cigar-butt 50-cent dollars can be hit or miss (probably more typically miss than hit). That said, we think the scale makes this more attractive than many such situations.  This is not a $20mm market cap with $40mm of NAV and $3mm per year in cash burn. Half a billion of cash and $25mm/yr in interest income is substantial. And there is obviously a huge amount of G&A and R&D which could be cut if need be. Even if tens of millions of dollars of value are destroyed, there is still a lot of upside.

Bottom line, we think this is juicy enough that it will not be ignored and left to trade at these kind of deep discounts for too long. 

Catalyst

• Overhang from index removal getting lifted.
• More investors becoming aware of the company.
• Potentially dividends or share buybacks.