PDL BioPharma: A Genentech / Roche Buyout Candidate?

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 |  Includes: PDLI, RHHBY
by: CVTrader

PDL BioPharma (NASDAQ:PDLI) is a very unique biotech company owns a portfolio of valuable patents that bring in royalties from licensed products. Genentech/Roche (OTCQX:RHHBY) currently has 4 marketed drugs licensing PDLI's technology: Herceptin, Avastin, Lucentis and Xolair. PDLI collects royalties from the total world-wide sales of these successful drugs at rates ranging from 1% to 3%.

PDLI has several ways to enhance shareholder value; paying sizable “special” dividends, seeking new licenses or outright sell of the company. I personally think the last option may be the best for current shareholders, and there is a chance Genentech/Roche may pick this firm up. Here is my analysis why Genentech/Roche should do that.

Genentech/Roche pays PDLI substantial royalties

In the last several years, PDLI derived more than 70% of its revenue from Genentech/Roche products. In 2009 alone, Genentech/Roche paid PDLI more than $220M. Granted, $220M may not be much for a company with annual sale of ~$49B and net income of ~$8B. But still that’s roughly ~3% of its annual net profit which would have a significant impact on its EPS.

In 2009, Genentech/Roche paid ~$2.3B royalty expenses to third parties and the PDLI portion represents ~10%. Genentech/Roche also collected ~1.3B royalty income from other companies licensing its technologies. Buying PDLI would add ~$100M royalties PDLI collects from Elan (NYSE:ELN) and Biogen (NASDAQ:BIIB).

2006

2007

2008

2009

Total Rev($M)

187

225

294

318.2

RHHBY Rev ($M)

160.5

176.4

212.4

227.4

RHHBY/Total %

85%

78%

72%

71%

Click to enlarge

Future Genentech/Roche revenue estimates

Since PDLI's key patents will expire in 2014, it is expected to receive royalties until around 2015-16. In the last five years PDLI’s revenue had a CAGR of ~24%. For my calculation below, with a conservative CAGR of ~12% PDLI will be able to generate revenue of ~$2.7 billion with ~$1.8 billion from Genentech/Roche.

2010

2011

2012

2013

2014

2015

Total Rev ($M)

~350

~380

~420

~460

~510

~560

RHHBY Rev ($M)

~240

~260

~290

~320

~350

~390

Click to enlarge

At time of writing, PDLI has a market cap of ~$700M with ~$500M in net debt. By paying a 50% premium over today’s price, it will cost Genentech/Roche ~1.5 billion, a saving of ~$300 million. Taking into the consideration that PDLI will generate ~$0.9 billion revenue from other licensees in the next 6 years; the real saving for Genentech/Roche would be ~1.2 billion.

Even paying a 100% premium, it would still save Genentech/Roche ~$800 million. That's a good chunk of money for any company.

Advantage of buyout vs. dividend payout to shareholders

As described in my earlier instablog, the total future dividend payout is roughly $8/share. But that will be spread out in the next 5-6 years. A buyout would generate a profit of ~$3-6/share as analyzed above. I certainly think this is the better way to go for current shareholders.

Potential opportunities and risks

PDLI has a highly-profitable business with some substantial upside potentials. The management is actively seeking new licensees, and some current licensees have late-stage product candidate may be approved fairly soon. These include Solanezumab and Bapineuzumab for Alzheimer’s disease developed by Eli Lilly (NYSE:LLY), Johnson & Johnson and Pfizer (JNJ, PFE) respectively.

Management also indicates their willingness to sell the company, which will generate a better return for shareholders. Even without a near-term buyout, it is still a high-income-generating stock for the next 5-6 years. So in my opinion, the downside risk is really limited.

Disclosure: Author holds a long position in PDLI