Seth Klarman re-opened his position with PDL BioPharma (PDLI) in recently reported filings. Klarman’s hedge fund, The Baupost Group, had previously owned the stock in 2008 and the first half of 2009 before selling out in Q3 2009. He again bought 4% of the company in Q4 2010 at prices similar to what shares are currently trading at. PDL is a unique stock, and Klarman is a unique hedge fund manager, so let me give you a little more background on each.
Seth Klarman ranks as one of the greatest investors in the world. Through The Baupost Group he’s returned nearly 20% annually since its inception in 1983. This despite his propensity to hold very large cash positions. At any given time Klarman holds a small amount of the fund’s assets in equities. At the end of 2010, he reported $1.7 billion of stock holdings out of his $7 billion fund. This is why a large purchase in a stock like PDL is noticeable.
At this point in its life, PDL is essentially a royalty and patent defending company. Their assets consist of antibody humanization patents and royalty assets containing its Queen et al. patents and licensing agreements. The Queen et al. patents are seven patents they own and license to various biotech and pharmaceutical companies. Income derived from these activities is returned to its shareholders. This is why they’re able to function with fewer than 10 employees. Products include Herceptin, Avastin, Lucentis, and others. The expiration of the Queen et al. patents is coming in 2013 and 2014, so the company is a bit like an annuity with depreciating assets. The biggest threat for them is legal challenges by its so-called partners, and there is some litigation currently taking place.
PDL’s cash position is at $248 million. On the debt side, they currently have a $134 million balance on 2% convertible senior notes due in February 2012 with a conversion rate price of $7.11 per share. They also have $180 million of 2.875% convertible senior notes due in February 2015 at the same conversion price, and $204 million of a 10.25% note associated with Genentech royalties. The latter note is expected to be paid off on September 2012.
As you would expect with a special situation investment like this, PDL vigorously defends its patents. There are two main legal matters to highlight. The first involves communications received from Genentech regarding Avastin, Herceptin, Lucentis and Xolair. Without going into too many legal details, PDL took the offensive and sued Genentech asserting a violation of their 2003 agreement which limits Genentech’s ability to challenge the validity of PDL’s patent rights. A court case is currently pending, but if PDL were to win, there would be a substantial windfall for shareholders potentially on the order of $1 billion. I won’t speculate on the chances of success, but I will say that PDL’s aggressive response should limit any future communications from Genentech, which would be a positive for PDL.
The other legal matter to note involves MedImmune and the sales of Synagis. PDL did not receive any royalties for Synagis in 2010. MedImmune asserted that they should recoup royalties of up to $280 million paid to PDL. The judge has ruled that recoupment is not appropriate, but it’s possible this issue could be revisited. Additionally, MedImmune is not obligated to pay PDL royalties for Synagis in the future. These decisions may be appealed but, again, PDL is not factoring in future Synagis royalty payments at this time.
How do investors make money? The company returns money to shareholders through dividends and convertible note buybacks. They should be announcing their dividend policy for 2011 soon. In 2010, they issued two $0.50 per share dividends, one on April 1 and one on October 1. At least one analyst has suggested the 2011 dividends will total $0.50 per share via two payments, but we’ll have to wait for their announcement.
PDL is certainly a special situation, but at these prices, shares provide a nice return if investors understand the story. There also is the potential of a payoff with the Genentech dispute. My advice is to watch the story closely. Seth Klarman has followed this company for years, and his decision to buy back into it suggests both safety and potentially significant appreciation.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PDLI over the next 72 hours.