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Animal health company Kindred Biosciences (KIN) surged 14.45% higher last Friday on decent volume after billionaire Seth A. Klarman (founder of the Baupost Group) disclosed a 17.93% passive stake in the company via a 13G filing. This translated to roughly 2.9 M shares. Currently, this position in KIN is worth about $34 M.

The actual transaction took place on December 31, 2013, when the stock was trading at $11.17 per share. Based on this, we can also say that the initial investment was $32.4 M. Based on this, we say that Baupost is already up 5% on the position.

BMO Capital Markets and Guggenheim Securities were the lead underwriters for the Kindred IPO, which took place in December 2013. 7.5 M shares of stock (~46% of equity) were sold at an IPO price of $7.00 per share, which raised $52.5 M for the company (before factoring in discounts and fees).

Seth Klarman / Baupost

Seth is a very famous fund manager that is known for his emphasis on risk management. His investment management company, Baupost, had total assets of $29.4 B in 2012. That is huge, but even more impressive is the performance of Baupost since inception. According to this WSJ article, he managed to generate ~19% in average annual returns since inception (1983). In the last 10 years, he has been generating ~17% in average annual returns. So statistically speaking, Seth is one of the best investors of all time.

Baupost is considered fairly conservative, which makes a 17.9% acquisition of a micro-cap like Kindred a very rare event. Rarer still when you consider Seth Klarman's view of a general "lack of opportunity" in the current market.

Dirt-Cheap Trials & Higher Success Rates

As we pointed out in the last article, animal pharmaceutical developers have lower barriers to entry and significantly reduced expenses during the clinical development stage. Generally speaking, an animal drug can be put through its clinical trials for about $3 or 4 M. This is nothing compared to the cost of human clinical trials, which drives the cost of standard drug development up into the $750 M - $1 B range.

It is also much easier to obtain regulatory approval for animal drugs, as one might expect. Approving a new drug for a certain patient population exposes the FDA to the risk of unexpected deaths and/or adverse side effects. Drug-induced patient deaths result in drug recalls and media outrages that severely damage the FDA's reputation.

That type of risk exists for animal pharmaceuticals, although deaths and adverse effects are not nearly as damaging to the FDA. Dangerous animal drugs would be given a black box warning instead.

Animal drug developers also enjoy independence from the reimbursement policies of health insurance entities.

Qualified Management Team

By filing via 13G, Seth/Baupost is claiming that they do not intend to exert control over the company despite a >5% stake in Kindred equity. To us, this implies that they see the company as an investment opportunity that does not require shareholder intervention.

We think that the Kindred management team is very strong, which explains why the company is generating so much interest at such an early stage. The CEO and CSO are affiliated with some of the most successful drugs ever made.

- CEO Richard Chin, MD has been involved in the development of some HUGE drugs including: Lucentis, Xolair, Tysabri, and Rituxan.

- CSO Kevin Schultz, PhD developed Frontline Plus, a mega-blockbuster animal drug. Frontline Plus can really be considered "the Lipitor of animal health". Kevin also developed Oncept, Previcox, and Gastrogard.

Pipeline, & Market

The company's pipeline contains three compounds that are scheduled to file their NADAs (the animal equivalent of an NDA) at some point in 2014. These include:

CereKin - a chewable beef-flavored formulation of diacerein, which inhibits interleukin-1 beta. The active ingredient in this product treats osteoarthritis pain and inflammation in humans, and data suggests similar efficacy in canines. Has an advantage over NSAIDS due to certain safety concerns.

There are ~80 M dogs with owners in the US. Osteoarthritis is very common in dogs, especially if they are old (10 years+). If we estimate that ~15 M dogs have osteoarthritis and that half are being treated for it, we have a patient population of ~7.5 M. If the medication costs $150/year, a $1.13 B market is created.

AtoKin - a high-dose chewable beef-flavored formulation of fexofenadine - a potent antihistamine that is approved for use in humans. This drug will be used in dogs with atopic dermatitis - a common allergic skin disease.

Based on the 80 M dog estimate, we can estimate canine atopic dermatitis incidence at ~8 M. It could be more apparent to dog owners, so assuming a treatment rate of 75% and a $150/year price we get a $900 M market.

SentiKin/KIND-009 - This is a non-NSAID, non-opioid formulation of flupirtine for post-operative pain in both dogs and cats. This analgesic is also used in humans, and also has some advantages over NSAIDS.

There are probably 180 M cats and dogs belonging to owners in the US. Assuming that there are 15 M surgeries per year (disease-related plus neutering), and assuming a $100 price per procedure, we get a $1.5 B market.

10 products exist in total (5 small molecules and 5 biologics), although the focus is currently on the three that could see approval within the next year. Collectively, they target ~$3-4 B in potential annual revenues.

Kindred Financial Info

Estimated Cash (NOW)

$50 M

Cash Before IPO (June 30th, 2013)

$3 M

Convertible Preferred Stock

$3.5 M

R&D Expense per quarter

$220,000

General & Admin Expense per quarter

$90,000

Total Expense per quarter

$310,000

See S-1 filing here

Risks

Know that Kindred is still a developmental pharmaceutical company that is exposed to development-related and regulatory risk. It will continue to use money for administration and R&D until one or more of its products is approved and put onto the market. Then it will be able to generate income for shareholders.

Source: Baupost Group Acquires Huge Stake In Kindred Biosciences