I posted a couple comments on my last Facet Biotech post to highlight Facet's Q1 10Q and conference call transcript. After reading the transcript I've decided to dig a little deeper. Most of the time when I'm investing it feels like me against the amorphous market and I'm OK with that, as on average I win that game. Investing in Facet feels different. It feels like I'm up against Seth Klarman and Robert Chapman, even though they are currently both on my side, or so I assume from their holdings. I feel totally outclassed and so all I can do is dig deeper, as I know at some point we'll be on opposite sides.
In the conference call Q&A Chapman asks what feels like a scripted question. Here is the exchange:
Gentlemen, could you give us your perspective on the cash that was placed into Facet at the time of the spin-off as compared to the future expenses and liabilities that were quite predictable given the structure of the lease and the plans for expanding the pipeline per se? Is it fair to say that as in investor of Facet that one should look at the cash as in some way or form being pre-dedicated or pre-committed to future expenses and not really reflective of free cash that will be available for any kind of distribution?
This is Andrew. I’ll take that question. In terms of the deliberations of the Board with the man
ement team in considering the capitalization levels for Facet, I think it is fair to say that certainly both the assets and liabilities that were being assigned to Facet—and the biggest of those liabilities clearly being the lease obligation—were part and parcel into consideration with the determination of the overall capitalization level of Facet. That level was—the funding was to appropriately capitalize Facet in light of those assets and liabilities to execute on its strategy going forward and was not to capitalize at that level to presume an immediate distribution of a portion of that down to the stockholders in the Company.
The reason I ask that, I’ve seen an analysis that seems relatively prudent or well thought through that essentially that when looking at the essential market cap and the enterprise value of the Company that to sort of reduce the market cap by the cash to evaluate the enterprise value is misleading because the cash essentially has been earmarked as part of the business plan, which as a new Company, the Company intends to implement. And instead, the enterprise value of the Company can be simply thought of as if the cash and liabilities were matched off. Does that sound reasonable to you?
Andrew Guggenhime Yes. It does.
So time to dig into the 10Q for more details. Rather than start with the leases I'll feign interest in the long term prospects of Facet. First up, the pipeline.
Volociximab is listed as Phase 1/2. That means is it is in safety trials and you you can't test oncology compounds on healthy volunteers. As they're testing on real patients there will also be efficacy results. For simplicity I'm calling it P1.
For more information on the pipeline, it's time to open to open up the annual 10K filing. I'll summarize, but those interested in more details should open up the 10K and scroll to page four.
- The SELECT Daclizumab P2 trial commenced Q1 2008 and is currently being expanded from 300 to 600 subjects and the primary endpoint is being changed to annualized relapse rate. Both the FDA and EMA have agreed that only one additional registration-enabling study is required. That is likely to commence in 1H 2010. Biogen (BIIB) and Facet share the trail costs and commercialization.
- I see little point in diving too deep into the P1 and preclinical compounds. They're monoclonal antibodies. Volociximab has phase 1-2 and phase 1 clinical trials in ovarian cancer and non-small cell lung cancer (NSCLC), respectively. Elotuzumab is being evaluated in three phase 1 trials in patients with multiple myeloma. An IND for PDL192 was filed in the second quarter of 2008 and a phase 1 dose escalation program in solid tumors has been initiated. BMS has option on PDL241 upon completion of preclinical studies, expected in the second half of 2009.
Anyone still with me? Stick around as now it's time to look at the fascinating subject of leases.
I just re-read Chapman's questions. Far be it for the slightly dyslexic me to jeer at an investing wordsmith superstar, whose silvery tongue on his famous 13Ds has made his name familiar to mere wannabes like me. But come on, how complex does Bob need to make a simple question? Perhaps asking "Do you need your cash to support the development of your pipeline?" would simply have been too dull and made his question transparently worthless, though that was the crux of his question. Anyone with an iota of biotechnology investing acumen, actually almost anyone, could answer that question. Drug development costs a shirt load, Facet's most advanced compound is still in phase 2, so their 'spare' $300M odd is not going to cut it. They need their cash for their business.
Actually, I'd wager Facet will raise more cash prior to any commercialization of any current compound. So why did he ask it? Perhaps Chapman is somehow being disingenuous with his questions, or is pushing another barrow or maybe simply wanted to point out the obvious to someone. As I'm outclassed I have no idea what game he might be playing, so I'll simply continue to play my own game.
For those who need to know things in more detail than "shirt load" I'll add: Facet have stated their cash burn for 2009 will be approximately $95 to $100 million. At that rate they'll run out of cash in around three years, which even with everything going well is before Daclizumab will come to market. Don't forget the probability of Daclizumab making it to market is probably 50% or lower. Also keep in mind they'll raise cash before they become paupers, let's say early 2012 at the latest.
To quote from my first writeup on Facet.
PDL set Facet up with $405 million for the clinical development of daclizumab, volociximab, elotuzumab and PDL192, the research and development of pre-clinical programs, working capital, and general corporate purposes.
I bought in with a double in mind. I’ve had a good look at their pipeline since posting and I did not buy for the pipeline. Their lead compound is for MS which is a notoriously hard to crack. The rest of the pipeline are early stage cancer compounds, which aren’t worth much. Who doesn't have some early stage cancer compounds lying around!
I did not buy for a cash handout, I bought with the belief that Facet was worth more than the market was currently pricing it at. It's up 53% since then and I comfortable holding for more upside.
Facet are valued at less than their cash and they have a drug pipeline of value. They are burning cash, but have enough to survive for three to four years. I really not sure how additional thinking could add value to that simple picture.
But anyway, how about those leases.
Scroll down to page 21 of the 10Q. Total contractual obligations $233,711k. Ooh ah! Scary stuff. That's most of their free cash. Or at least that's what I think Chapman and the CFO wanted us to believe. In reality $155,091k of that is over five years out, so we can forget about it. Only $78,620k is due within five years, or around $16 million a year in contractual costs. Ummm hello. Didn't the CFO say "and the biggest of those liabilities clearly being the lease obligation".
With an annual cash burn of $100M he has the audacity to say $16M is their largest liability. I think even my eight year old knows that 16 is clearly not a big slice of 100. In fact, lease payments are only $13.5M a year, the remainder is contract manufacture and other. The largest liability is the CFO's, other executives and employees salaries. I suspect the main reason the board do not want Wong or anyone else talking about winding up the company is their own vested interest in continuing their own large pay packets and option grants.
If a Phase 3 study for Daclizumab eventuates that will cost in the order of $70 million. Now that is a very rough number and I would have said $35 million, except for this comment by the CFO in the conference call
I think it’s fair to say based generally on phase 3 programs in the MS space that even our portion of an aggregate phase 3 study would be in excess of the $30 million milestone payment."
At any rate the P3 won't be a big cash drain as costs are shared with Biogen. However, I must add that $70 million figure is very expensive. Unfortunately if that is what they think it will cost that is how much it will cost. US based biotech firms have no idea on how to economise, after all it's not like it's their money.
What's the point of all of this, besides questioning a famous investor's motives and verbosity, and Facet's board and management's incentives? As I said I have not invested with a cash return in mind. However, putting aside all other considerations, there is no doubt that the best possible outcome for me would be to wind Facet up right now. Sack everyone, sell the assets, pay the costs to break the leases etc and divvy up the cash. Each share should net over $15. That's a bird in the hand I'd be happy to take, though of course it's not in my hand and it wouldn't really be fair play old chap.
Disclosure: Long Facet and Biogen.