What Does Third Point See in PDL Biopharma?

Mar.23.07 | About: PDL BioPharma, (PDLI)

PDL Biopharma, Inc. (NASDAQ:PDLI) is a biotech company that has squandered cash on needless acqusitions and undisciplined R&D spending, depressing its stock price. On the upside, however, according to Third Point's filing, the company gets hundreds of millions of dollars in royalties from Genentech's (Private:DNA) Avastin and Herceptin. Specialty pharmaceutical revenues should approximate $200M in 2007 and the Company has other valuable assets: an exciting, albeit slowly-progressing, product pipeline; undisclosed royalties that extend beyond 2014; approximately $430M in net operating loss carry-forwards; real estate and other assets that can be monetized; and a valuable antibody technology platform that should continue to generate new compounds over time.

On March 5th, Third Point, LLC purchased 8.6 million shares in PDL Biopharma. The intent of this transaction is explained in Item 4 of the 13-D as follows:

On March 5, 2007, the Management Company sent a letter to Mark McDade, Chief Executive Officer of the Company, and to the Board of Directors of the Company, expressing disappointment and concern over the Company's high rate of spending and, in the view of the Management Company, the Company's significant underperformance. In the letter, the Management Company urges that the Company cut costs and not pursue additional acquisitions. The Management Company communicated its belief that pipeline development and cash flow generation are not mutually exclusive and that, accordingly, the Company should reduce its spending to focus on essential product development and research. The Management Company has offered to work with management to streamline the Company's cost structure and asset base as soon as possible, in an effort to allow the cash generating ability and value of the Company to be developed and made apparent to shareholders. (Third Point LLC 13-D PDLI)

The letter in the exhibit to this 13-D filing explains why Loeb thinks the shares are undervalued. Third Point feels that the share performance of the company was "particularly troubling" as PDLI has received approximately $400M of royalty revenues over the time period from January 1, 2004 to present (Third Point LLC 13-D PDLI).

Concerningly, the Biotech Index , BTK, has gained 50% over this holding period, while PDLI shares have remained flat. With good fundamentals in the industry, and strong royalty revenues, one must question why the stock hasn't performed. Loeb highlights this in the following paragraph in his letter:

The past three years should have been a golden era for PDLI's shareholders: Genentech's successful development of both Avastin and Herceptin, from which PDLI earns royalties based on its antibody humanization patents, enabled royalty revenues to grow from $52.7M in FY'03 to $184M in FY'06. To review the facts, in February 2004 Avastin was approved for first-line metastatic colorectal cancer.

Subsequently, in March and April 2005 respectively, Avastin was shown to extend survival in first-line non-small cell lung cancer and to improve progression-free survival in first-line metastatic breast cancer. Then, on April 25, 2005, Genetench announced that Herceptin had demonstrated an improvement in disease-free survival in the adjuvant setting for early-stage breast cancer patients. Unfortunately, instead of channeling this royalty stream into earnings generation and expeditious product development, you made what we consider to be an ill-conceived purchase of ESP Pharma for $500M to gain access to products Cardene IV, Retavase and Busulfex. (Third Point LLC 13-D PDLI)

The undervaluation also stems from PDLI management squandering cash. Loeb states that PDLI made "what we consider to be an ill-conceived purchase of ESP Pharma for $500M to gain access to products Cardene IV, Retavase and Busulfex" (Third Point LLC 13-D PDLI). This acquisition was foolish as Cardene, "which represents close to 60% of the combined $165M revenue stream from the three products", will go generic in 2009 (Third Point LLC 13-D PDLI).

Loeb is calling for a cost cutting plan, believing that PDLI "could significantly close the value gap by taking several simple steps," by focusing on "streamlining the cost structure and asset base" at PDLI as soon as practicable (Third Point LLC 13-D PDLI). Loeb also feels that "with some cost-cutting, PDLI will be able to earn $1.00 per share in 2008 and to increase that to $1.50 per share in 2009," while also conducting "PIII trials for Nuvion, develops Daclizumab with BIIB for multiple sclerosis, develops M200 with BIIB for numerous cancers, partners Ularitide, partners Daclizumab for asthma, develops HuLuc63 for multiple myeloma and advances the early stage pipeline" Third Point LLC 13-D PDLI).

Loeb also instructs PDLI's management to not partner Ularitide in exchange for yet another specialty pharmaceutical product, but instead enhance shareholder value by accepting an upfront cash payment. Loeb believes that PDLI "should sell its ESP Pharma assets to a specialty pharmaceutical company and focus PDLI on its core strength of biotechnology product development" (Third Point LLC 13-D PDLI). However Loeb reiterated that he does not feel that the company should sell itself or change management as other frustrated shareholders have called for at this time, and wants to work with management to achieve positive results.

The Bottom Line: Currently, PDLI's shares trade for 20.00. With a forward P/E of 39.68, according to Third Point's estimates of earnings of $1.00 and $1.50 per share in 2008 and 2009 respectively, the stock could be worth $39.68-$59.92.

PDLI 1-yr chart

Disclosure: Author has no position in the above-mentioned securities