Myriad Pharmaceuticals (MYRX)

I am going to be reviewing some of the positions in my portfolio as a way of crystallizing my ideas about when to sell.

First up is Myriad Pharmaceuticals – soon to be renamed Myrexis (where do they come up with these God-awful names?).

Background
The company was spun off from Myriad Genetics (MYGN) on June 30, 2009 with 1 share of MYRX distributed for each 4 shares of MYGN held. MYRX is a cash-burning biopharma company (you can look at the Yahoo finance description of the company if you’re interested) selling below cash value. When I bought into MYRX I thought the situation was a bit like the FACT/PDLI split. That was before FACT received its first acquisition offer, which I had expected or at least hoped for, and before MYRX made an acquisition bid for Javelin Pharmaceuticals (JAV), which I didn’t. Today, I would characterize the MYRX situation differently. FACT/PDLI management demonstrated that they were/are serious about enhancing shareholder value first and foremost. For MYRX management the jury is still out. Initially when MYRX announced its (friendly) acquisition bid for JAV on Dec. 18, 2009, I, and I believe most other post-spin investors, was extremely annoyed; here was a cash flow negative biopharma company buying another cash flow negative biopharma company with nary a significant revenue stream between them. To me this reeked of management entrenchment, with MYRX becoming less attractive to a potential suitor after the merger. More recently, management has been partially redeemed with the April 16 termination of the merger agreement, first because the acquisition price to be paid for JAV ($2.20) is substantially more then the MYRX bid (.282-.3311 shares of MYRX then trading at $5.44 for a value between $1.53 and $1.80 per share), so, in effect, MYRX management appears to have negotiated a ‘good deal’ (or is this just a case of ‘greater fool’?), and secondly because the merger is no longer weighing on the share price (yes, MYRX management does get a bit of credit for not blindly insisting on a higher bid for JAV).

As an aside, I noted in the MYRX shareholder proposal related to the JAV acquisition that talks between the two companies had been going on long before the MYRX spinoff. Somehow, it doesn’t seem quite proper to me that this wasn’t discussed in the spin-off documents; I understand, of course, why it couldn’t be, but it still seems misleading to post spin-off investors. Case for a shareholder lawsuit had the merger gone through? Another instance of poor management judgement in my view.

Management Incentives
One of the things I like to look at in my investment decisions is whether management’s interests are aligned with those of shareholders. Usually a significant ownership by management can assure this. At MYRX the top 5 executives own less than .5% of the outstanding shares. Ugh! That’s not good.  Yet they do have significant ownership of options and restricted stock. According to the merger document 4.5 million MYRX shares were reserved for issuance under restricted stock and option incentive plans (potential dilution of about 15%). Unfortunately I wasn’t able to ascertain the detail of the plan as it wasn’t spelled out clearly (at least to me) who was to get what and when. Looking back at the Form 10 I was also unable to gain clarity from a cursory perusal, my limitation perhaps. I did note the usual acceleration of benefits for top management  in the case of a change in control, but it didn’t seem sufficient incentive for management; the CEO would receive $4 to $6 million in the case of a change in control – only about 4 to 6 times his annual compensation. In sum, I’m not too convinced that management is really incented in my best interest, so I’ll take this into account and look to trade out of this position within the first two years.

Investment Thesis
I bought into this position because 1) it was a spinoff, 2) it was going to have a market cap of about $100 million (generally too small for most money managers to be interested in), 3) it was selling at a significant discount to both book value and cash and 4) it had no debt.

My Cost Basis
I began buying the first day post spin at about $4.00 per share, added another third in September at $4.35 and completed my position in January at around $4.50. Average cost, $4.31 per share. My feeling in January was that the merger would be voted down.

When should I sell?
Generally I will sell out of a position like this when 1) there is a takeover offer, 2) there is a significant negative change in the financial position of the company (like a takeover offer for another company), 3) the stock price rises to 150% of book value within the first year or 125% of book value in the second year, or 4) at the end of the second year unless there is an identifiable catalyst on the horizon.

At spin-off, book value per share (approximately equal to cash per share) was about $7.88 (undiluted). This puts my cost basis at about 55% of spin-off book value. By 12/31/09 the book value had been reduced to $6.99 per share. This implies a reduction in book value of about $.45 per share per quarter. So book value should decrease to $6.09 per share by 6/30/10. Thus if the share price were to increase to $9.15 before the end of the second quarter I would be a seller. Between 6/30/10 and 6/30/11 my sales target will decline to $5.35, assuming the same rate of decline in book value as we saw in the first 2 quarters after the spin-off. At that point, if I still have a position I will likely sell out. This all, assuming no unexpected developments.