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Chris DeMuth Jr. is the founder of Rangeley Capital LLC. Rangeley is an investment firm that focuses on event driven, value-oriented investment opportunities. Rangeley Capital and his value investing forum, Sifting the World (StW), search the world for misplaced bets. Rangeley exploits them for... More
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  • Long Investment Idea For 2014: Genzyme's Contingent Value Right 24 comments
    Dec 23, 2013 12:11 PM | about stocks: SNY

    Genzyme contingent value rights for multiple

    sclerosis drug Lemtrada are trading below any

    possible payout, justifying an investment, writes

    Chris DeMuth Jr. of Rangeley Capital. A

    negative report issued by the FDA ahead of

    an advisory committee meeting last month

    caused the price to drop from $2 to $.50.

    Based on an analysis of the global MS market,

    the drug has a high likelihood of reaching

    the first sales milestone regardless of the upcoming

    FDA decision. This would result in a $2 payout.

    Every year since 2009, we publish one

    of our favorite long investment ideas for

    the coming year. In 2014 our best long

    idea is an investment in the contingent

    value right (NASDAQ:GCVRZ) for the multiple sclerosis

    (NYSE:MS) drug called Lemtrada.

    GCVRZ costs less than 70 cents per

    right today and will ultimately pay out

    between $0 and $13, depending on

    whether or not the FDA clears Lemtrada

    ($1) and whether the drug hits various

    sales milestones (up to an additional

    $12). Lemtrada is already approved in 30

    countries including Europe and Canada.

    Today the price trades below any payout

    from the CVR, so one needs to be able to

    conclude only one of two things in order

    to justify an investment: that the drug will

    be able to generate sufficient sales in the

    countries where it is already approved

    in order to reach the lowest of the sales

    milestones or that the FDA will eventually

    approve the drug.

    In November, FDA staff issued a background

    report on Lemtrada which outlined

    their concerns regarding the structure

    of the Phase III clinical trials and the

    potential for bias in the data. Prior to that,

    most analysts held that the likelihood of

    FDA approval was a near certainty. This

    unexpected report from the FDA caused

    the price of the right to drop from $2 down

    to $.50. On Dec. 27 we will find out if the

    FDA approves, disapproves or delays the

    sale of Lemtrada in the U.S. The market

    tends to dislike binary events, despise

    uncertainty, shy away from discomfort

    and thus misprice securities with these

    characteristics.

    So let's assume for a moment that we

    know the FDA will deny approval. In that

    instance, what is GCVRZ worth? At least

    $2, here's why.

    There are over 2.3 million people in the

    world diagnosed with MS, most of them

    women between the ages of 20 and 50.

    MS is a progressive disorder impacting

    the central nervous system (NYSE:CNS)

    without a known cure. It is an autoimmune

    disease in which cells attack myelin, the

    tissue protecting the nervous system's

    axons. As the inflammatory cells attack

    myelin, the ability of the nerves to conduct

    electrical impulse is disrupted. This results

    in mild to severe disabilities. Most experts

    and most non-experts agree that new

    therapies are needed to disrupt this process

    and Lemtrada is the most promising

    of the potential therapies.

    The drug works by depleting the body's

    disease fighting cells that become misdirected

    and cause harm to one's own body.

    These cells are believed to play a major

    role in multiple sclerosis. Cambridge University

    published a video to describe the

    drug in detail, it can found here.

    The global market for multiple sclerosis

    drugs is approximately $15 billion

    per year growing at a rate of 6 percent

    annually as more people are diagnosed

    and treatment options improve. The first

    sales milestone for GCVRZ, worth $2, will

    be paid if sales for Lemtrada reach $400

    million in annual sales for the total of four

    consecutive quarters, which is less than 3

    percent of the global market share and 6

    percent of market share in Europe. Based

    on our country by country analysis of the

    MS population in the five core European

    countries alone (U.K., France, Germany,

    Spain, and Italy), we believe the likelihood

    of reaching the first sales milestone is

    very high. So we expect to receive a payment

    of $2 per contract in the foreseeable

    future regardless of the FDA's decision. As

    a result of near-term uncertainty around

    the FDA's decision, we do not believe this

    is being accurately priced into the market.

    With full knowledge of the process at the

    FDA, Sanofi has bought these securities

    back in the open market for a price as

    high as $1.75 per share as they ramp for

    the launch of the drug and try to mitigate

    their future liability in this CVR.

    If the FDA approves Lemtrada for treatment

    of multiple sclerosis by April 2014,

    rights holders receive $1. If annual sales

    for Lemtrada hit $400 million on a global

    basis, then rights holders receive another

    $2. Setting aside all other milestones, is

    it worth risking $.70 to likely get $2 to $3

    in the foreseeable future? We believe the

    answer is yes, and this is our best long

    investment idea for 2014.

    - Chris DeMuth, Jr. is the founder and manager

    of Rangeley Capital, which is invested in GCVRZ

    Stocks: SNY
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Comments (24)
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  • Special Situations and Arbs
    , contributor
    Comments (1406) | Send Message
     
    Chris, do you have a Bloomberg TV appearance coming up?
    23 Dec 2013, 04:16 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10652) | Send Message
     
    Author’s reply » SS&A,

     

    I might. They may want to discuss this year's long (GPT) and short (TMF) as well as next year's long (SNY)'s GCVRZ rights and short (IPO). However, my schedule is a bit crammed so we'll see.

     

    -C
    23 Dec 2013, 04:20 PM Reply Like
  • Ruerd Heeg
    , contributor
    Comments (1213) | Send Message
     
    If you could find the time that would be awesome! And I hope it will help the patients as well!
    23 Dec 2013, 04:30 PM Reply Like
  • Mikenaila
    , contributor
    Comments (5) | Send Message
     
    Any idea what time the FDA will announce its decision on Lemtrada?
    26 Dec 2013, 07:04 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10652) | Send Message
     
    Author’s reply » Could be today but probably tomorrow.
    26 Dec 2013, 07:43 AM Reply Like
  • Andrew Williams
    , contributor
    Comments (337) | Send Message
     
    I don't know how they arrive at the final decision. I suppose if it is a vote during market hours, maybe they halt trading?
    26 Dec 2013, 09:37 AM Reply Like
  • Landon R
    , contributor
    Comments (6) | Send Message
     
    Does one need to be an owner prior to the FDA's announcement to be subject to all future payouts?
    26 Dec 2013, 12:05 PM Reply Like
  • ddpddpddp
    , contributor
    Comments (82) | Send Message
     
    Where and how do you trade contingent value rights
    26 Dec 2013, 05:50 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10652) | Send Message
     
    Author’s reply » In my case, via Genzyme getting bought by Sanofi (SNY), but also one can buy and sell them on an exchange via a broker such as Interactive Brokers (IBKR).
    26 Dec 2013, 05:54 PM Reply Like
  • sliman21
    , contributor
    Comments (709) | Send Message
     
    Chris
    Are you still a buyer with FDA news today?
    30 Dec 2013, 09:46 AM Reply Like
  • Out of Ignorance
    , contributor
    Comments (747) | Send Message
     
    DITTO
    30 Dec 2013, 01:30 PM Reply Like
  • bigred2
    , contributor
    Comments (73) | Send Message
     
    It seems that even with a 25% chance of meeting the $400m milestone, the price of the cvr should be in the low $0.40's
    30 Dec 2013, 02:36 PM Reply Like
  • stevenly
    , contributor
    Comments (164) | Send Message
     
    Would like to hear the author's opinion on the fda news as well.
    30 Dec 2013, 08:45 PM Reply Like
  • rauber12
    , contributor
    Comments (2) | Send Message
     
    I am not an expert in pharma / biotech. However, I could well imagine that, in general, the FDA´s decisions are followed by other regulatory bodies. What is the potential negative feedback loop in that the negative decision by the FDA will have a negative impact on the drug´s approval in other markets?
    6 Jan 2014, 08:26 AM Reply Like
  • John Naccarelli
    , contributor
    Comments (303) | Send Message
     
    Chris,
    I reviewed the prospectus from 2011 and (assuming) I read it correctly, the first milestone is the FDA approval by March 31, 2014. If they do not receive that approval - which is likely to be the case - they can exercise that "Failure Purchase" Clause.

     

    Keeping it simple, they will take the average of the preceeding 45 trading days to establish a price. Assuming that this trades sideways for the next few months or even makes it up to .5, there is still some upside (maybe 25%-50%).

     

    Putting all the sales projections and other analysis aside, will Sanofi be motivated to exercise their right in a few months and pay out .35 to .50 cents per right? Will they prefer to wait it out and possibly pay out nothing or even $4. This IMO is the key question to ask myself before diving in ... which I have not done yet because I am doing my own homework too rather than blame others for my laziness.

     

    Anyway Chris, I would really like your feeling and/or answer on this after tracking it for so long and having skin in the game.

     

    John
    6 Jan 2014, 01:08 PM Reply Like
  • bigred2
    , contributor
    Comments (73) | Send Message
     
    I believe that europe, Canada and Australia have completely separate drug approval processes from the FDA approval process in the United States.

     

    With any luck, affluent U.S. MS patients will go to Europe or Canada for treatment. Also people even with median incomes who live near the usa - Canada border will be able to travel to canada for treatment.
    6 Jan 2014, 04:26 PM Reply Like
  • bigred2
    , contributor
    Comments (73) | Send Message
     
    I think that Failure Purchase option is only allowed 3 years after product launch
    6 Jan 2014, 04:36 PM Reply Like
  • jaginger
    , contributor
    Comments (804) | Send Message
     
    KELLY CRITERION - sized positions in GCVRZ at this point are as follows:

     

    If you believe the percentage chance of the first milestone being reached (resulting in a $2 payout) is X, then a full Kelly-sized position in your portfolio would be Y percent of the portfolio. Half-Kelly positioning would (obviously) be Y/2.

     

    X Y Y/2
    18% 0% 0%
    20% 1.5% 0.75%
    25% 7.7% 3.85%
    30% 13.8% 6.90%
    40% 26.0% 13.0%
    50% 38.5% 19.25%
    75% 69.2% 34.6%

     

    Anybody going full-Kelly here?

     

    How about half-Kelly?

     

    I am well below one-tenth Kelly at this point given my assumption (30% chance of payout, which I believe is actually very conservative); but, this certainly argues for a considerably higher position.
    14 Jan 2014, 05:29 PM Reply Like
  • bazooooka
    , contributor
    Comments (3684) | Send Message
     
    Half Kelly at 50% approval seems like fair risk/reward. Still a HEALTHY position though.
    8 Mar 2014, 10:18 PM Reply Like
  • jaginger
    , contributor
    Comments (804) | Send Message
     
    Yes, even half-kelly size is huge here. I doubt anyone has this as 19.25% of their portfolio!
    9 Mar 2014, 10:12 PM Reply Like
  • jhgjhg
    , contributor
    Comments (46) | Send Message
     
    How can you write an article like this and then not follow up with at least a postscript in the comments when the FDA slams the drug?

     

    To me it serves as a timely reminder to anyone who follows pundits' advice on this or any other outlet. When things go badly the pundits are nowhere to be seen (so busy!). You are on your own nursing your losses and wondering why you were stupid enough to follow some idiot on the internet.

     

    Fortunately I didn't buy this one, but I did consider it.

     

    The payout rules are extremely complex (compared to a standard stock purchase) - I have read them several times but am still not exactly sure what needs to happen when. But it seems to me that at least two milestones have now failed, and several others are certain to fail - and yet this is not mentioned in the article.
    8 Mar 2014, 04:05 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10652) | Send Message
     
    Author’s reply » http://bit.ly/LKf6Xb
    8 Mar 2014, 07:08 AM Reply Like
  • Keubiko
    , contributor
    Comments (2891) | Send Message
     
    There is a forum set up that is very active, including meaningful contribution from the author.

     

    I always find it funny when people who have written no articles hand out homework assignments to those that have put in a lot of time and effort to write up ideas.

     

    Regarding complexity it can be your friend. If most people (eg you, per your admission) can't figure something out it provides long and short opportunities for those of us willing and able to put in the elbow grease. People should always do their own work and own their own decisions, or outsource to a pro.
    8 Mar 2014, 09:10 AM Reply Like
  • bazooooka
    , contributor
    Comments (3684) | Send Message
     
    jhg, this might still be a good investment. I suggest DD further if you're interested. However, we won't know for years the final outcome. Too early to pull the ripcord. But those who missed it at 1.50 and 70 cents might want to reconsider now at 35 cents (or not). It won't take much for momentum to swing to black. All this is only my opinion; always do your own DD and own your own risks and rewards.
    8 Mar 2014, 10:22 PM Reply Like
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