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Chris DeMuth Jr.
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"It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a misplaced bet - that they can occasionally find one." - Charlie Munger I look... More
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  • A Look At Undervalued Equity Plays 14 comments
    Sep 6, 2013 7:41 PM | about stocks: TMF, GPT

    On September 6, Rangeley Capital Founder and Portfolio manager Chris DeMuth Jr discussed his investment ideas with Deirdre Bolton Bloomberg Television's "Money Moves."

    2013 began with a market that would pay anything for yield and would pay next to nothing for companies without yield. We wanted to capture the difference. Here is how we went about it. First, due to temporary and artificial demand, bonds were terribly expensive.

    Our favorite short idea for the year was a security called the Direxion Daily 20+ Year Treasury Bull 3x Shares, ticker TMF. Rarely do I find a security with more to object to right there in the name: it is bullish on the long bond, leveraged, and traded daily in a manner that locks in buying high and selling low. Due to a structural flaw called the constant leverage trap, it is locked in a frantic self-perpetuating death spiral of trades that degrade its value over time. So, we took the other side of an expensive, leveraged, flawed security.

    Secondly, we sought to buy a security that lacked a yield but had all of the characteristics that would allow it to offer a steady and growing yield by the end of the year. We wanted something that was well managed. We wanted something that was at a size that it could take advantage of business opportunities that its competitors would miss. We wanted something ignored by the markets in large part because of a temporary lack of a dividend.

    We wanted something that had the steady and growing cash flow with which to support a steady and growing dividend. We found it. The company was Gramercy, which currently trades under ticker GPT. By the end of the year, we expect Gramercy to initiate a significant dividend. Management is on track with a business plan that results in a per-share value of over $7 per share. We support the management and their plan - which we call "Plan A". As an alternative, they could liquidate the current book of business or sell to a competitor for a price of around $6 per share if anything goes wrong - "Plan B". Shareholders will insist on one or the other - a dividend or a sale - this year.

    Several years ago, we were shareholders of a company called Genzyme which was purchased at a significant premium by the large French pharma company Sanofi. The purchase price included a right, which is still publicly traded under the ticker GCVRZ. The right is to payments based on a potential FDA approval and subsequent sales of a drug used to fight Multiple Sclerosis. The drug's name is Lemtrada - it is a safe, effective drug that will be widely adopted. Our expectation is that the right holders will receive a payout equal to approximately 50% of the market price by the end of the year based on the potential FDA approval. But here is where it gets interesting. The remaining payments are based on sales of the drug once it is approved. Once the likelihood of these sales are re-rated, we expect the right to trade at or above $2 and that is after a $1 payment for a total value of over a 50% upside in 2013.

    Disclosure: I am long GPT.

    Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital, a partnership that invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our partners, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.

    Stocks: TMF, GPT
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Comments (14)
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  • I own GCVRZ also. The fact that Sanofi was buying in the CVRs speaks volumes. The only lingering concern I had was that the FDA got hit with the sequester and some drug reviews have dragged a bit but I no longer have that concern. I think the market is underestimating Lemtrada's potential. First MS drug to actually improve the condition, not just stabilize patients. Safety isn't an issue as it was on the market as Campath for a long time for a different indication. I agree that $3+ in value is likely with a good shot at $5 over time.
    6 Sep 2013, 08:49 PM Reply Like
  • Author’s reply » Thanks for your very good thoughts on this one. Much appreciated.
    6 Sep 2013, 08:52 PM Reply Like
  • Saw your interview Chris, well done. They don't give you enough time but i guess that is show biz.


    Curious if you have ever looked at SGYP...?


    Best regards,
    6 Sep 2013, 10:58 PM Reply Like
  • Author’s reply » Thanks. As for SGYP, I have looked at it briefly but not focused on it. What is the investment case?
    7 Sep 2013, 06:15 AM Reply Like
  • Please note this commentary is from Red Acre Investments which very succinctly makes a perfect case for SGYP. I agree whole heartedly with his assessment and frankly could not have written a better case, nor quite as eloquent. I did my research independent of Red Acre though our conclusions are very much the same.


    I will say he wrote this back in Dec of 2012. As of today (9/8/2013) I would say a significant catalyst for SGYP would be oddly enough tied to the performance of IRWD (a competitor) and the metrics for their adoption, acceptance and revenue growth by quarter going forward.


    From the Red Acre write up:
    We believe that Synergy Pharmaceuticals' ( stock is poised for a large move in the coming months due to three major company events: initiation of a second Phase III clinical trial of their lead drug, Plecanatide; top-line results from their current Phase IIb/III trial of Plecanatide; and the completion of the merger of Synergy with Callisto Pharmaceuticals (CLSP). Based on the valuations of other biotech companies with drugs in the same therapeutic class as Plecanatide, we believe that SGYP stock is significantly undervalued ahead of these major events as outlined below. The first of these events, the initiation of the company's second Phase III trial, will be announced very soon. (This is in play now)


    About the Drug


    Synergy's lead drug, Plecanatide, is an analog of Uroguanylin (UroG), a natural human hormone that regulates the secretion of fluid into the intestine. Both the natural hormone and the drug activate Guanylate Cyclase-C (GC-C) receptors in the intestinal lining and induce the cells to discharge water into the intestine promoting stool motility which is critical for normal digestion. According to information on the company's website, plecanatide is more potent than natural UroG because it has an 8-fold higher binding to human GC-C receptors. Plecanatide is being developed to treat Chronic Idiopathic Constipation (CIC) and Constipation Predominant Irritable Bowel Syndrome (IBS-C). In September, Ironwood Pharmaceuticals ( received FDA approval for Linzess (linaclotide) which was the first GC-C type drug ever approved for treatment of CIC and IBS-C. Linzess and plecanatide are structurally similar and both drugs act in the gut without being absorbed by the body as verified in clinical trials. According to company estimates, the CIC and IBS-C markets represent a $2 billion annual opportunity.


    IRWD's drug Linzess received FDA approval in September 2012. IRWD currently has 50% of the US rights to the drug with Forest Laboratories ( owning the other 50%. IRWD currently has a market capitalization of $1.2 billion, and Linzess is their only approved drug. IRWD has several drug candidates in much earlier stages of development, so the primary driver of IRWD's value is their approved drug. IRWD has close to 200 million in cash; therefore, net of cash, the market is attributing approximately $1B to IRWD's assets and pipeline.


    Assuming that 80% of IRWD's noncash value comes from their approved drug, the market is attributing a $1.6 billon valuation to Linzess (recall IRWD only owns 50% of the rights to the drug, so we must double the 800M market cap to value the drug properly). This suggests that, should plecanatide be approved after completing clinical trials, the drug should be worth close to $1.6 billion. Since Synergy will have to raise close to $60 million in cash to finish development and get to approval, we expect the share count at approval to be between 85 and 100 million shares, suggesting a valuation of $16 - $19 per share by 2015. The present value of the shares should lie between $11.50 and $14 based on these estimates and a reasonable assumption of discount rates (15%). Based on these (very rough) estimates, SGYP is undervalued by up to 180% if the clinical trials are strongly positive. This undervaluation reflects the significant uncertainty in predicting trial results.


    (At approx. $4.50 a share today 9/8/13, this little gem in my opinion has a strong chance of doubling between now and Q4 2014. My guess is much sooner given it could easily be taken out by a larger pharmaceutical company. In fact $9 is a conservative figure, it could go for $11 or ....) SGYP owns 100% of all the revenue, no partners...


    That is a brief primer on SGYP. I am sure you could through your DD and research draw your conclusions. To me as a spec buy for a micro-cap Biotech, it looks like it has legs.


    Best regards,
    9 Sep 2013, 01:01 AM Reply Like
  • Chris,


    I own GCVRZ, but very little (a little over 1% of portfolio). Although I think the odds of approval are very high I have a hard time committing any more funds since it can go to zero if something goes wrong. How much are you willing to allocate to an investment with this type of risk/reward?




    7 Sep 2013, 11:15 AM Reply Like
  • Author’s reply » I am glad that you own it and hope that it works out well for you (ie for us). You are exactly right that this can go to zero. Few investment ideas have a cleaner route to -100%. How much should you be willing to allocate? However much you are able to lose. From a psychological perspective, it is helpful to have an ability to make up the loss in a relatively quick and simple manner when you take a hit of the kind that this could cause. As for me, I am willing to allocate an amount that would risk about 3% of original capital at risk in an adverse outcome.
    8 Sep 2013, 09:13 AM Reply Like
  • Thanks.
    8 Sep 2013, 12:57 PM Reply Like
  • Chris, do you still like the TMF short?
    11 Sep 2013, 09:34 AM Reply Like
  • Author’s reply » Yes I do. In absolute terms, the US long bond is still expensive (although substantially less expensive than at the beginning of the year).
    11 Sep 2013, 09:44 AM Reply Like
  • Just curious as to why you consider the long bond (I assume you mean the 30-year) to be expensive? Long term average is about 2% real so it's discounting LT inflation in the 1.8% to 2% range which is well above current levels and inline with the Fed's LT target - is your view based on an inflation outlook? Cheers
    11 Sep 2013, 10:23 AM Reply Like
  • Author’s reply » Here are my thoughts on TMF: Incidentally, yes I think that inflation will be worse in the decades to come (despite the little current evidence of it).
    11 Sep 2013, 10:43 AM Reply Like
  • Thanks - the decay on these levered ETFs is pretty sweet. Hard to predict the LT future (ST is tough enough) - I think you are probably referring to the "end game" which like you say may be decades out, and what may ultimately be starting in Japan after a couple of decades. My sense is that the debt in the system will be a boot on the throat of the global economy for many years to come and is ultimately deflationary. Inflation can't really pick up without a wage-price spiral which I don't see given the slack in the system, global supply chains, weakness of unions etc.


    The end game will be interesting. I don't think inflating away the debt is a realistic policy option - the market will react. E.g. If Japan is successful in achieving 2% inflation it means their bonds will probably yield 4% which will bankrupt the country in interest burden - unless of course the BoJ is prepared to buy every single bond out there across the curve and new issues, which would see currency flight and a "boom" moment.


    My ill-timed article on some of my thinking is here:



    I still hold some long bonds in modest size as a counter-weight to some risk and inflation sensitive assets.


    11 Sep 2013, 11:15 AM Reply Like
  • Author’s reply » GCVRZ Forum:
    17 Oct 2013, 05:00 PM Reply Like
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