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Did This High Dividend Stock Just Lower the Bar?

With all of the producing drugs comprising PDL BioPharma's (Nasdaq: PDLI  ) portfolio, it's perhaps a bit surprising that the biotech won't be enjoying as great an increase in its royalty stream in the third quarter as it enjoyed in the second. PDL said it expects royalties to rise 2% year over year in the September quarter, but below the 3% increase it saw last time out. Not that the market seems to mind: Its stock is up 7% since announcing the expected royalty stream.

When companies forecast lower sales or profits, their stocks usually take a hit. It's not always easy to tell whether it's having a fire sale or burning down. Maybe it is time to get out -- or maybe it's time to buy more!

Here investors have clearly said it's time to scoop up more, but don't blindly follow them: You still need to do some research. We need to use the announcement as a jumping off point for additional research.

PDL BioPharma snapshot

Market Cap $1.1 billion
Revenues (TTM) $360 million
1-Year Stock Return 55.5%
Return on Investment 169.3%
Estimated 5-Year EPS Growth 15.5%
Dividend and Yield $0.60/7.5%
Recent Price $7.99
CAPS Rating (out of 5) ****

Source: TTM = trailing 12 months.

A blockbuster in the making
Revenues for PDL are by and large generated from just a handful of drugs covered by its patents. Roche pays for cancer therapy Heceptin and Avastin, and recently added Perjeta to the mix, a metastatic breast cancer treatment that could be a $1 billion blockbuster. Novartis licenses macular degeneration therapy Lucentis and Xolair, which is also paid for by Roche. And Elan (NYSE: ELN  ) and Biogen Idec pay royalties for Tysabri.

All of these drugs have recorded strong sales in recent quarters, and Perjeta holds particular promise because Roche has set a price for it that's rich. At $5,900 a month for treatment, it's not a cheap cocktail. Although it's not uncommon for biotechs and even big pharmas like Johnson & Johnson (NYSE: NYSE: JNJ) and Bristol-Myers Squibb (NYSE: BMY  ) to price their therapies at seemingly exorbitant rates, there is the risk of a backlash. Dendreon (Nasdaq: DNDN  ) was excoriated for its $90,000 tab on Provenge, and KV Pharmaceuticals was ostracized and ultimately bankrupted for the $1,500 fee it placed on Makena.

Push off the cliff
The big risk with investing here is that the company's patent protection on most of these drugs starts peeling away over the next two years -- by 2014, it has none. As PDL noted on the conference, without the patent revenues, the biotech "will likely cease to operate," let alone pay dividends.

Of course, they don't intend to let that happen. In July, the company provided Merus Labs with a $35 million loan and a $20 million line of credit to get the rights to Emselex and Enablex, two extended-release tablets sold in Europe and Canada. It's this sort of deal-making that PDL hopes will become the model for extending its lease on life (and on paying its high-yielding dividend).

Earlier this summer, I rated PDL to outperform the market indexes on Motley Fool CAPS, the 180,000 member-driven investor community on the belief of the strength of its drug portfolio and management's ability to continuing driving value for shareholders. It's also a means of holding myself accountable for the CAPScalls I make here, and so far it's paid off as the stock has risen 24% compared to the S&P 500 rising just 9%.

Yet it can't be denied that the new business model for the biopharmaceutical holds a lot of risk, and the dividend, which currently yields 7.8%, is in danger. If PDL can continue finding enough small biotechs looking for cash for their drugs, it may be able to pull off a huge surprise and send its shares higher, but the path is fraught with hazards, and the stock should only occupy a small portion of an otherwise well-diversified portfolio.

Cheap by almost any measure
At less than five times earnings estimates and just a fraction of its expected growth rate, PDL is discounted more than virtually every other biotech out there, particularly because it has a strong lineup of current performers. No doubt the looming patent cliff for it weighs heavily on its valuation.

Tell me in the comments box below if you think PDL BioPharma will be able to successfully transform its business and continue offering investors a high yielding dividend.

Looking under rocks
If you understand the risks of biotech investing, but realize the profit potential still inherent in the space, make sure to check out the Motley Fool's in-depth coverage of Arena Pharmaceuticals in this brand new premium research report. Complete with a year's worth of updates, this report will give you the investing edge you need, along with a full year of updates on how this biotech will change the debate on obesity drugs. Click here to get your copy.

Fool contributor Rich Duprey holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Dendreon and Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of and creating a diagonal call position in Johnson & Johnson. The Motley Fool has a disclosure policy.
We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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