AOL in the news
The debate heats up about our largest holding. Barron's Alan Abelson, usually a contrarian indicator for this portfolio, over the weekend cited a hedge fund buddy for his positive view on the shares. In response, the stock jumped yesterday over 6%.
It hasn't been pretty for AOL Time Warner. The company has warned on earnings twice over the last six months. Its stock is down 32% for the year, and 77% from its all-time high closing price of $94. On the one hand, David Gardner is glad Robert Pittmann has returned as COO, thinks the company still has potential and doesn't find the kind of changes in the business that would support the stock's decline of late. Finance professor and Fool community member Mark Hirschey (mhirschey) argues that for value investors, AOL Time Warner is an excellent buy at current prices. Others are not convinced. In yesterday's provocative In My Opinion, ChrisMcAdams asks the reasonable question, what's happened to the alleged $285 billion in value in the merger of America Online with Time Warner?
The company is one of those in the portfolio I know the least, and I'm following these discussions -- as I hope you are -- to learn more.
There's been one substantial development since we recounted part of our Foolish meeting with Human Genome Sciences (HGS) execs last week, and it trumps the rest of our visit in importance. The company yesterday announced the very important news that it was dropping development of Mirostipen for chemotherapy and radiation-induced blood cell deficiency. It plans to reallocate resources toward another more promising drug for the same condition, Albugranin, which uses HGS's albumin fusion technology. HGS said it intends to file an IND (investigational new drug applications to the FDA to begin human trials) for Albugranin "within the next several weeks."
While it's certainly rational to move development dollars to the best future product, the move leaves the company's repifermin for chronic venous ulcers as HGS's only in-house Phase 2 drug. Repifermin has struck out so far in testing for its other two conditions, showing safety, but insignificant efficacy. That means HGS has only one current drug-hopeful to navigate several years of Phase 3 trials, possibly receive FDA approval, and generate substantial drug revenues. (Another HGS Phase 2 drug, VEGF-2, is being developed by privately-held partner Vascular Genetics.) SteveMRach shows why this is so disappointing, and he thinks the stock would be even lower were it not primarily for HGS's cash and year 2000 acquisition of Principia and its albumin fusion technology.
The cash is indeed comforting, but only to a point. HGS may have $1.69 billion in cash, but it has pledged $500 million for its facilities' construction bank loan ($114 million is now restricted but will grow to $500 million) and could have to pay up to $500 million in convertible debt due in 2007 and convertible at stock prices of $56.25 and $109.50. To be conservative, that leaves $700 million not only to fuel repifermin to hoped-for success, but to support the company for the 8 to 10 years or so until any of its Phase 1 hopefuls bears fruit.
HGS shareholders should keep one thing in mind. If repifermin does move to Phase 3 testing for chronic venous ulcers -- a huge worldwide market in which repifermin appears to have no significant competition -- HGS and GlaxoSmithKline (NYSE: GSK) split development costs as well as future profits. This would leave more of the $700 million for other drugs in the pipeline.
It's all about leverage
To achieve its ambition of being a fully integrated drug maker, HGS needs the power to form partnerships with large partners on favorable terms. It won't deliver meaningful returns to shareholders through 10%-20% royalties on sales of drugs it licenses to partners. Four things provide leverage to demand better deals: big drug makers' desperation for product drugs to fill their weakening development pipelines, promising drug candidates to dangle in front of them, and enough cash and manufacturing capacity not to be so desperate as to have to strike deals at any cost.
HGS has cash and is building some critical manufacturing capacity, but the company has already partnered for its Phase 2 hopefuls, repifermin and VEGF-2. Without Mirostipen, HGS is left to pursue deals for its Phase 1 candidates further. If I were a large partner, I'd let HGS spend its money and come in at Phase 2 when it's in a weaker position to try to secure a better deal. With a stock price a little over three times its cash minus the full future $500 million in restricted cash and the full $500 million in convertible debt, and less than 1.5 times its cash without those subtractions, it's possible that the market accurately perceives HGS's reduced leverage.
Things looked better for the company last week, that's certain. We'll watch closely to see how its talented management responds to this latest challenge.
Until next week, Fool on! Portfolio returns are below. Starting next week, thanks to folks at the Rule Breaker - Strategies discussion board, we hope to have the S&P 500 benchmark including dividend reinvestment.
Rule Breaker Portfolio Returns as of 4/15/02 Market Close:
RB Port S&P 500 Nasdaq Week -0.23% -2.04% -1.80% Month -4.72% -3.92% -4.96% Year* -16.24% -3.98% -10.08% CAGR** since 8/4/94 26.32% 12.07% 12.26%
*We plan to add $25,000 in April: $12,500 for the quarter and $12,500 that
we didn't deposit in Jan.
**Compound Annual Growth Rate using Internal Rate of Return. This
performance measure accounts for the periodic deposits. Total return
wouldn't be meaningful, because we started adding cash to the portfolio in
July 2001. In a total return calculation, or (Current Value - All Cash
Deposited)/All Cash Deposited, cash added shows up as returns.