The combination of a high dividend rate and revenue growth from biotechnology patents is confusing to many potential investors of PDL BioPharma (PDLI). This combination is an apparent contradiction: Stocks typically cannot maintain both a high growth rate and a high dividend yield. This situation is further mirrored in pharmaceutical companies with much larger enterprise values, such as Eli Lilly (LLY), Bristol-Myers Squibb (BMY), Glaxo SmithKline (GSK), and Novartis (NVS) -- all large-cap pharmaceutical companies with dividend yields over 4%.
|Glaxo SmithKline||GSK||$46.50||13.8||4.6%||$128.3 Billion|
|Bristol-Myers Squibb||BMY||$33||15.9||4.1%||$55.4 Billion|
|Eli Lilly & Company||LLY||$46.78||13.0||4.2%||$52.2 Billion|
|Seattle Genetics||SGEN||$27.20||N/A||N/A||$2.9 Billion|
|PDL BioPharma||PDLI||$7.57||5.9||8.0%||$1.2 Billion|
Therefore, it is worth understanding how the current PDLI valuation is justified as it may open the door for additional investment opportunities in the sector. While the "patent cliff" paradox of PDL BioPharma has been discussed on Seeking Alpha, primary source material is always a better source of information.
John P. McLaughlin is the CEO of PDL BioPharma. His impressive executive biography includes stints as a senior executive with Genentech (now a division of Roche) and as a current director of Seattle Genetics (SGEN). He also has significant experience in Washington, D.C., drafting FDA legislation. An interview published Sept. 17 explains the business strategy of his current company:
Question: The bulk of PDL BioPharma's revenues are derived from royalty payments. The company generated more than $200 million in royalty revenue through the first six months of this year. Would you tell us what we should know about the Queen patent expirations that are scheduled for the next three years, and should PDL BioPharma be considered a liquidating asset as some have suggested?
Mr. McLaughlin: It's a good question. The last of the Queen et al. patents expire in December of 2014, but importantly, we'll continue to get paid royalties some period of time after that because royalties will still be due to PDL on product that is made before patent expiration and sold after patent expiration.
But to the point in your question, there is a time when the royalty obligations will expire, and they will no longer have to pay royalties based on the Queen et al. patents.
And so what we have been doing is, at the request of our shareholders, we've been taking some of the money from our royalty income, and using it to try and identify other revenue-generating assets. And what we said to our shareholders is this is an exercise we're going through in 2012 and 2013, and at the end of 2013 and beginning at 2014, we'll step back and say, 'OK, have we identified sufficient revenue-generating assets that it makes sense to continue PDL, or should we simply shut down the company beginning in 2015 and 2016 and distribute the cash that we receive from the current licensees under the Queen et al. patents and get that money out to our shareholders as quickly as possible so that we improve their returns?'
That's the decision we'll probably make in late 2013 or early 2014, so there is a fork in the road for the company at that point in time.
The Q4 2013/Q1 2014 "fork in the road" for PDLI includes upside from existing products already in the market -- the patents may expire, but McLaughlin explains that reducing overhead at that time to zero would create many quarters of expense free royalty income that could be used to pay off existing shareholders in a "special dividend" or the financial equivalent.
The CEO also states in this same interview that further potential upside exists with a yet unproven treatment for Alzheimer's:
We did have the potential for royalties on two Alzheimer's drugs, one being developed by a consortium of Pfizer (PFE) and Johnson & Johnson (JNJ), but it did not work. The other one being developed by Lilly demonstrated some provocative results on secondary end points, and they are actually meeting with the regulators to see what the path forward is on that one.
That is interesting, obviously, because Alzheimer's disease is a high, unmet medical need, but also because we have a know-how royalty that could run from 12.5 years from when it's first commercialized. This could be a blockbuster product if, in fact, the results are real and they can get FDA approval.
Approval will be based on those results or based on those results plus some additional trials. Unlike our Queen et al. patents, which expire at the end of December 2014, that know-how royalty would run, as I say, for 12.5 years from the time of first commercial launch.(emphasis added)
A recent quarterly conference call also provides another potentially significant source of future upside. In response to a question from Roy Buchanan of JMP Securities, McLaughlin states:
The second part is the action in Nevada is -- it's not patent case or a case involving the European patents. It's actually a contract case. So the question is whether or not when Genentech sent that [fax] at the behest of Roche and Novartis challenging the patents, whether that constituted a challenge to our 2003 settlement agreement and a settlement agreement is a contract and that's why I say this is breach of contract case, not a patent case.
And the question is under the settlement agreement, whether or not that fax constitutes a challenge which breaches a settlement agreement and that's what's before the court.
A positive resolution to this lawsuit for PDLI would also further support an enterprise value that has come under challenge from many analysts.
The estimated value of the future monetization of patents embedded in pharmaceutical and biotechnology stocks is a field for significant research and competing interpretations. A close technical and financial analysis is warranted for those companies currently paying high current dividend income with the potential for extreme upside. Investors would be well rewarded in increasing their portfolio exposure to this currently out-of-favor industry for those stocks that have significantly undervalued patent portfolios.