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PDL BioPharma (PDLI)

March 23, 2011

I have been watching PDLI for a while now (though I do have to disclose that I purchased some for my income account several years ago at a slightly higher cost basis than today). January’s unfavorable court ruling followed by the February announcement of a cash settlement with MedImmune ($92.5 million to be paid by PDLI this year and next) recently led to an interesting opportunity, with the share price falling under $5. Since then, the 1st quarter revenue guidance announcement in early March has revived the share price somewhat and it now trades in the mid $5 range.

I know. I know. In the last post I wrote about how I wanted to sell off some orphan positions and increase my cash because I really didn’t like the market at this level and here I go making another investment. But bear with me. The price was right and Baupost Group’s latest 13F showed Klarman once again taking a position in PDLI in 4Q 2010 at levels above the February price dip. [PDLI traded down to $5.15 in October and November 2010 but was generally trading at $5.50 or above] Klarman re-entered PDLI after selling out his position in Q3 2009 at a significantly higher price (somewhere between $7.75 and $9.25, but of course there have been subsequent dividends and distributions). I view this as a liquidation play, as I intend to hold it for 3 or 4 years as it gradually liquidates, not a capital gains play. From this perspective I really don’s care how Mr. Market values the shares over this timeframe, except of course if he is willing to overpay me to buy them back, giving me an IRR of 40% or more during the next couple of years (say by offering $7 a share in the next 12 months or so).

Besides the Klarman seal of approval why does PDLI look attractive? The cash flows from current royalties don’t seem to provide much upside potential. I’ve included a very over-the-top projection of cash flows from current royalty streams which you can view here (PDLI proj). It shows an IRR of around 14%. But there may be more to it than meets the eye. The PDLI ‘Queen’ patent technologies are being used in a number of new medicines under development (see the March 8 investor presentation via Edgar for details). These new medicines could boost PDLI income significantly above projections for royalties on currently manufactured medicines. Furthermore, the ‘Queen’ patent royalties may continue longer than one might initially anticipate; a chart prepared for investors in the March 8 presentation shows royalties continuing for up to 30 months after patent expiration because royalty payments must be made on medicines produced during the patent lifetime, not just sold during this period. My aforementioned simple model reflects royalties through 2015 only, that is, 24 months from the beginning of patent expiration in 2013, which is probably a conservative extimate. As an added kicker, PDLI has filed a $1.9 billion lawsuit against Genentech (Roche) based on a letter received from them last August questioning the validity of the ‘Queen’ patents in Europe. If there is any positive outcome here it could provide a bit of additional gravy. 

The general characteristics of this situation are also attractive. The company’s market presence is small with a market cap of around $750 million. There are no assets outside of the revenue stream from the patents.  The company is basically in liquidation. There is imperfect clarity about future cash flows as they are dependent on 3rd party sales of medicines as well as where the medicines are produced. Any analysis is kind of like a crossstick puzzle. In sum, this isn’t a traditional investment opportunityand thus the number of potential investors is somewhat circumscribed. To-date PDLI management (although, unfortunately, not large shareholders) has done an admirable job of capital allocation and maximizing shareholder value. This, combined with the company’s finite life, leads me to conclude that there is actually a very low probability of loss on PDLI shares if purchased south of $5 and one is willing to hold 4 to 5 years. With my current less than rosy market view this is just the kind of investment I’ve been looking for.


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