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Is Enzon dead money?

March 5, 2013

As I was reading through this year’s Berkshire Hathaway Annual Report I came across a section that reminded me of my relationship with one of my portfolio holdings; Buffet on the failure of business managers.

“The usual cause of failure is that they start with the answer they want and then work backwards to find a supporting rationale. Of course, the process is subconscious; that’s what makes it so dangerous.

Your chairman has not been free of this sin. In Berkshire’s 1986 annual report, I described how twenty years of management effort and capital improvements in our original textile business were an exercise in futility. I wanted the business to succeed and wished my way into a series of bad decisions. (I even bought another New England textile company.) But wishing makes dreams come true only in Disney movies; it’s poison in business.”

This seems to sum up what I’ve been doing with Enzon. The original investment thesis was based on 1) a large cash holding and 2) the realization of value from a potentially valuable drug pipeline. Well, the cash holding has dwindled and the pipeline doesn’t look all that valuable anymore. The shares are down from a high of $11-$12 two years ago to a recent $4.17, though you have to remember in that management returned $2 per share to shareholders last December. So despite having a pedigree crew of investors (Baupost) and activists (Icahn) on board (and I mean that literally as Icahn’s representatives are on the Board), there hasn’t been any monetization of the company’s drug pipeline up to this point. So, is my original investment thesis still remotely intact? I think I owe myself an objective review.

First, a little bit of a refresher. I’ll just cut and paste here from a recent 8k.

“Enzon Pharmaceuticals, Inc. is a biotechnology company dedicated to the research and development of innovative therapeutics for patients with high unmet medical need. Enzon’s drug-development programs utilize two platforms: Customized PEGylation Linker Technology (Customized Linker Technology®) and third-generation mRNA-targeting agents utilizing the Locked Nucleic Acid (LNA) technology. Enzon currently has three compounds in human clinical development and multiple novel mRNA antagonists in preclinical research. Enzon receives royalty revenues from licensing arrangements with other companies related to sales of products developed using its proprietary Customized Linker Technology.”

In 2010 the company was dramatically transformed when it sold its manufacturing and production arm, leaving only its R&D efforts, a bunch of cash and a product royalty stream. Then in 2011 things changed again, as they are wont to do when there is a cash hoard sitting on the balance sheet, when Icahn became actively involved. The company’s focus shifted, R&D staff was slashed, the then-president left (or was shown the door) and there appeared to be a movement toward value realization. But here we are 18 months later and little has actually happened. Yes, there has been a further expense squeeze and more executive management has been cut, but there is still no sight of an endgame. This past December the company announced that Lazard had been retained as a financial advisor for a review of the possible sale of part or all of the company. Since then there has been no further shareholder communications outside of a couple of required 8-Ks relating to severance for the few remaining executive officers. I don’t have any way of speculating on timeframe but it continues to look like a sale/liquidation; we just don’t know when.  But if we are close to a sale or perhaps a liquidation of the company what can common shareholders own expect to receive? That, after all, is the $64,000 question!

There are three components of value at Enzon: Cash, the PEGINTRON royalty payments and the drug pipeline. Let me be candid; I have no way of valuing Enzon’s drug pipeline. Let’s just assume this is upside and look at the other 2.

Net Cash and Marketable Securities
As of September 31, 2012 the company had $280 million in current assets (mostly cash and marketable securities) offset by $124 million in current liabilities (primarily 4% convertible notes due 6/1/13) for a net position of $156 million. In addition the company had $10 million in long-term marketable securities. In December, $90 million of the cash was returned to shareholders (45.2 million shares x $2 per share) leaving $66 million in net current assets and LT marketable securities. I’m going to assume there has not been much change in the cash and marketable security balances since then as the company had positive net cash operating results in the 3rd quarter, and presumably so in the 4th.

According to this blog (mind you from 2011) the value of the PEGINTRON royalty stream was around $277.5 million. The blogger based this on a 2007 transaction reported in the 2008 10K whereby 25% of the PEGINTRON royalty stream was sold for $92.5 million. However, it really seems to me that even if we accept the transaction value as indicative of the value of the royalty stream remaining with Enzon in 2007, we would have to adjust for both the present value of that valuation today as well as all royalty payments that have subsequently been received. When I do that (in my back-of-the envelope way, mind you) I come up with a MAXIMUM value at year-end 2012 for Enzon’s Pegintron royalty stream of under $60 million. On reflection, however, that seems a bit low given that in both 2010 and 2011 Enzon received about $40 million per year in royalty payments. The question really is how long will the royalty stream last? I don’t have a good answer. I read in one 10K that Pegintron was approved by the FDA in 2004. Usually the patent is applied for and granted significantly before FDA approval, sometimes as many as 10 years before. But lets assume it was 6 to 8 years before. That would mean the patent will expire sometime between 2016 and 2018, given that patent life is 20 years. Under these assumptions there may be between 3 and 6 years of royalties left. At current levels this could indicate a value of $110-215 million for all future royalties.

Total value of Enzon Pharmaceuticals

($ in millions except per share)

Total value Per Share
High Low High Low
Cash and Mkt. securities $66 $66 $1.46 $1.46
PEGINTRON royalty $215 $110 $4.76 $2.43
    subtotal $281 $176 $6.22 $3.89
Drug pipeline ? ? ? ?

In sum, I still believe there is more value in ENZN shares than Mr. Market is currently reflecting, though nowhere near what I expected when I originally purchased. Moreover, it appears to me the endgame should take place in the next 12 months. (But I’ve said that before!)

At this point, however, I do have to conclude that my original thesis was far too optimistic and depended too much on the presence of activists and  ‘super’ investors.


PS. Sorry for those who were sent an unfinished draft of the above post… I might say it was due to ‘technical difficulties’, but I think you are all smart enough to know that it was simply my technical incompetence!

  1. juan permalink

    Thanks for this post.
    I still hold on to my Enzon shares as well, and have a similar valuation range.

  2. ruinius permalink

    Hey there,

    This is my first time leaving a comment but I have been reading your blog for a while. Great work!
    I couldn’t help leaving a comment, because I have been pondering the same questions… so just to share some notes:

    1) There is actually a really nice table in the 10-K with the expiration dates…

    2) PEGINTRON is ~80% of the future royalties… but they also have some other stuff. Originally Hematide provided some upside in royalties but just got recalled for safety concerns…

    3) I am not sure what the value of the pipeline assets are either… but this is actually not hard to figure out with a few calls to oncologists. All the clinical data is public already. I just don’t have anyone on hand to call or want to pay ~$500 to an expert network

    4) One thought though – for my analysis, I placed the value of pipeline assets at ~$250m (typical value for an oncology phIII product). When I did that, the convertible debt participated in the upside, so there is reason to wait until 6/1/2013 for the debt to mature before transacting. What do you think?

    At the end of the day, everything hinges on 3), which is not out of reach at all… I do it all the time for my work… just can’t justify $500 for my puny portfolio…

  3. Yes, how stupid of me. The patent expirations are laid out clearly in the 10-K as you noted. So my low estimate of the value of the PEGINTRON royalty stream seems more appropriate. Thus, as you state, Enzon’s total liquidation value is very dependent on the value of the drug pipeline. I think you are also spot on that timing of the expiration of the 4% convertible notes (June 2013) may be the reason for the delay in liquidation. If so, it would imply that the per share value of Enzon is greater than the conversion price of the notes ($9.55, I believe). This, of course, would be good news for current holders of the common.

    Thanks for your comments and corrections.

    • Patrick permalink

      The recent 10-K for 2012 has an update on the conversion price of the notes…

      As of December 31, 2012, the principal amount of our 4% convertible notes outstanding was $115.8 million. After giving effect to a required adjustment to the conversion price of our 4% convertible notes resulting from the December 2012 special cash dividend, our 4% convertible notes are currently convertible at the option of the holder into shares of our common stock at a conversion price of $6.76 per share. At December 31, 2012, the potential dilutive effect of conversion of the 4% convertible notes was 17.1 million shares using the conversion price of $6.76 per share or 147.8211 shares per $1,000 principal amount of notes.

      • Thanks Patrick. I’m still hoping that the reason for the delay in liquidating the company is to avoid the convertible note dilution; management first pays off the convertible note in June before announcing a sale of the remaining assets. This would imply that the value of the company is more than $6.76 per share. But perhaps this is only wishful thinking.

  4. ruinius permalink

    Got interested and actually did more research…

    Read through some academic paper for the pipeline assets. The most important one, PEG-SN38 might not be worth anything. The drug showed promise in PhII trials… the problem is Nektar has a SLIGHTLY better one in the same category that is 6 months ahead in R&D. Just wanted to share the thoughts.

    The value of PhI assets are anyone’s guess still.

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