Third Point, run by Daniel Loeb, has been pushing for a sale of the company among other things.
A Copy of the Letter:
TO THE DIRECTORS OF PDL BIOPHARMA:
I write to you as cofounder of the Company, inventor of the patents from which PDL derives much of its revenues, a significant shareholder, and a senior executive and Director of PDL for most of its history. I write to you in support of the proposals of Third Point LLC for a new direction at PDL that emphasizes efficiency, focus on product development, and profitability, under the leadership of a new Chief Executive Officer.
PDL's problem is clear, as dramatically illustrated in a graph available at www.FixPDL.com, which compares the performance of PDL's royalty and license revenues with its stock price and the BTK index in the years 2004 -- 2006.The BTK index, which comprises many of PDL's competitors and comparable companies, climbed 43% over that period. PDL's royalty and license income, measured over each 4-quarter interval, grew by about 250%, from about$72 million to $249 million. Yet PDL's stock price fell 15%. Can there be any doubt that if PDL management had simply let more of the dramatic revenue increase reach the bottom line while focusing on timely development of PDL's own products, the result would have been far better? The moderate improvement in PDL's stock price in 2007 is due to the hope for change created by ThirdPoint's activities, and will evaporate if that hope is not fulfilled. The astonishing under performance of PDL relative to competitors and to PDL's own potential can only be a result of a complete breakdown in the strategy of the CEO, Mr. Mark McDade, and of the confidence of the investor community in his ability to lead the Company.
The reasons for the problem are no less clear: lack of focus that has led to critical product development delays, out-of-control spending, and an especially ill-considered acquisition of ESP Pharma. The other Directors at the time of the acquisition will recall how vigorously -- to the point of acrimony -- I opposed it. But it brings me no pleasure now to observe how fully events have justified my protests. The multiple write downs of the acquired products, so far totaling about $90 million, indicates that their sales potential was greatly exaggerated, partly due to apparent channel stuffing by ESP (see the MD&A section of PDL's 2005 Annual Report). In my opinion, this could, should and would have been discovered during due diligence before the acquisition, had PDL's CEO not predetermined that the deal would be consummated. The synergies always touted by the investment bankers in such situations have of course failed to materialize, as PDL has no products of its own to sell. The key product obtained with the acquisition soon faces patent expiration, and PDL has no convincing strategy to avoid loss of most of its sales. The purchase left PDL laden with debt and with diluted shares. Most importantly, the acquisition of two niche non-antibody cardiovascular drugs had absolutely nothing to do with PDL's business of developing novel antibodies to address important medical needs in cancer andautoimmune disease. The result has been complete confusion in the investor community and within PDL itself as to the strategy of the Company.
Meanwhile, development of PDL's key product Nuvion(R), which is critical for the future of the Company, was delayed by about two years. While PDL'sChief Medical Officer apparently took the fall for the delay and left the Company, I am convinced that the root cause for this major failure was the multiple, conflicting demands imposed on the management team and especially the Clinical Department by the CEO. Programs to develop or expand the market for two products obtained with the ESP purchase -- Ularitide and Retavase(R)-- needed to be implemented, doubtless taking vital attention away from PDL'sown products. It is also a reasonable assumption that PDL evaluated many other company and product acquisition opportunities before and after ESP,perhaps some even less sensible, further distracting management attention from the hard but vital mission of the Company to develop new drugs. PDL's lack of focus is undoubtedly a symptom of Mr. McDade's personal lack of focus, as shown by his decision in January 2007 to become Lead Director of Cytokinetics,Inc., in the apparent belief that things are going so swimmingly at PDL that they need only part of his attention!
Despite the slow progress of the company's clinical pipeline and the abandonment of numerous programs -- Terlipressin, daclizumab for asthma and for transplantation, HuZAF -- the company's headcount and R&D and SG&A spending have grown unchecked. Headcount has almost tripled in the 4-1/2years since Mr. McDade became CEO, and R&D spending is up a staggering 350%(from $57.98 million in 2002 to $260.66 million in 2006). The CEO has chosen to emphasize a non-GAAP measure of net income that eliminates depreciation and amortization -- i.e., posits that R&D buildings and acquired products come for free -- apparently to distract attention from the fact that he has no time line for the Company to become GAAP profitable. With so much of PDL's revenues coming from cost-free royalties, I concur with Third Point and many of PDL's other investors that this is unacceptable.
Two particularly dubious decisions made by PDL's CEO have accelerated the loss of investor confidence. First was the announcement on May 2, 2006, that the Company was substantially reducing its guidance for non-GAAP net income(by about 60 - 80%) because of the decision to conduct a large Phase 3clinical trial for Ularitide. It was immediately obvious to observers such as myself that a company having no experience whatever with trials in the cardiovascular field, and which had never conducted a clinical trial involving more than about two hundred patients, couldn't conceivably conduct a trial necessarily involving thousands of heart failure patients, in which safety of the product would be a primary concern. This must have eventually become clear even to PDL's CEO because the Company quietly shelved the whole idea towards the end of 2006 in favor of searching for a partner. However, the damage had already been done: the decision to forgo announced financial targets represented a major breach of faith with PDL's investors, and demonstrated beyond doubt that the Company's appetite for spending was unlimited. PDL's share price fell about 25% the day after the decision was announced, and as much as 40% over the next 3 months. PDL has yet to recover from this collapse, and its CEO never will.
Second, and perhaps even more incomprehensible, is the CEO's decision to abandon PDL's established R&D and office facilities in Fremont, CA, on the east side of the San Francisco Bay, and relocate over 500 employees to new facilities on the Silicon Valley side of the Bay. PDL currently owns two buildings in Fremont which, while lacking architectural pzazz, are of recent vintage and built out only a few years ago to the Company's specifications with state-of-the art research, preclinical and process development facilities. Because the East Bay has not fully revived from the dot-com bust, PDL is literally surrounded with buildings that can be leased at attractive rates and by empty lots on which PDL could construct new buildings when necessary. In contrast, PDL's planned new facility consists of two enormous glass-and-steel structures worth about $200 million -- money that over time will be captured from PDL as lease payments -- and containing about450,000 sq. ft. -- double the floor area of PDL's currently owned and leased Fremont facilities. The new facility has jogging trails by the water,convenient fitness facilities, and many other amenities. Most of PDL's s hareholders shall of course not have a chance to enjoy these amenities, but they will be asked to accept a large write off when PDL sells its existing facilities at a fraction of their cost. Worse, they will need to pay for an extremely expensive build-out of hundreds of thousands of square feet of R&D and office space to replace the space being abandoned, at a cost that will far exceed PDL's entire cash flow for 2007 -- albeit this expense will not be included in PDL's non-GAAP net income, which conveniently excludes depreciation. Moreover, many of PDL's employees have organized their lives to take advantage of the Company's location in the East Bay and will choose not to follow PDL in its peregrinations. The loss of essential staff, added toPDL's already excessive rate of employee turnover and the general disruption caused by a move of this magnitude, will severely hamper the Company during a critical year for its clinical programs. PDL's assertion at its recent Q1conference call that moving to such large and expensive facilities is more cost-effective than simply staying put in the Company-owned R&D buildings, and leasing adjacent office space as needed, is not credible on its face. I call upon the Board of PDL BioPharma to halt this mad enterprise.
I realize there is a natural inclination for a Board faced with a shareholder insurrection to circle the wagons and adopt a defensive posture.Before doing so, I urge the Directors to take a step back and ask yourselves some questions. Has the performance of PDL's stock price over the past three years been satisfactory to you? Has the acquisition of ESP Pharma brought the expected benefits, and has the price been justified by time? Was the delay in developing Nuvion acceptable? Is the approximately $100 million cost of building out PDL's new facilities the best use for that money, and is the build-out coming in within that already huge number? Is the lack of any plan to achieve profitability as conventionally measured, more than 20 years after the founding of PDL, what you expected when hiring Mr. McDade? Has the departure since Mr. McDade arrived of virtually every executive and key person who built PDL, down to the Staff Scientist level and up to the Chairman of the Board, indicative of a well-respected CEO and well-run company? Are you pleased that PDL's under performance has been so glaring as to attract the attention of a major activist hedge fund? Simply put, can things go on this way? Only if the Board can answer in the affirmative to most or all of these questions would the retention of Mr. McDade be justified.
Finally, in the interest of transparency, I want to remind you that I am still a consultant to the Company, and just two weeks ago was pleased to participate in the successful defense of PDL's key humanization patent in Europe. I see no conflict between my roles as consultant and advocate for change at PDL, as I believe that in both roles I am acting in the best interest of the Company, which of course needs to be distinguished from the purely personal interest of Mr. McDade in keeping his job.
Thank you for your attention to my comments.
Cary Queen, Ph.D.