Shares fell more than 20% the day after PDL BioPharma (NASDAQ:PDLI) capped a string of disappointing news by announcing last week that it was discontinuing development of lead drug Nuvion.
But what if the fall in share price wasn't justified? What if investors were throwing the proverbial PDL baby out with the bathwater? Of course the Nuvion news was bad, but it needs to be looked at in comparison to the value being placed on PDL shares.
Fortunately, PDL isn't just a normal development-stage drugmaker where we have to pull some numbers out of a hat to get a value for the company. It has several assets that can be monetized -- like the royalty stream it gets on marketed humanized monoclonal antibodies, as well as its marketed drugs and property.
Let's take a look at PDL's key assets and see if we can make a determination on whether shares of PDL are trading at a discount or are wildly overvalued at today's $2.3 billion market capitalization.
Living like a king on royalties
Most people's biggest asset is their home, but the house of PDL relies on the royalty stream that it receives on drugs like Genentech's (NYSE:DNA) Avastin, Elan's (NYSE:ELN) Tysabri, and AstraZeneca's (NYSE:AZN) Synagis.
Last year, PDL generated $184 million of costless revenue from these royalties, and previous guidance for this year was for an expected $220 million to $240 million in royalty revenue.
The key patents covering the technology that allows PDL to collect its royalties on humanized monoclonal antibodies expire in 2014, so it's unlikely PDL will be able to collect these royalties after that.
Let's assume that through 2013, PDL's royalty revenue grows at a 25% compound annual growth rate (CAGR), and that it grows at half that rate for 2014 (to account for the patents expiring in that year). If we apply a 10% discount rate to these royalties, then the cumulative before-tax present value of these royalties is $2.9 billion.
Applying a 40% tax rate to these royalties to account for a blended average of federal and state corporate income tax rates puts their after-tax net present value at $1.8 billion.
A quick comment about some of my assumptions: Projecting a compound growth rate of 25% annually is not unreasonable, considering the 33% sales growth of Avastin last quarter (with possible new label indications in the future), the recent launch of Tysabri, and the potential for new royalty opportunities from the greater than 75 humanized monoclonal antibodies in development.
PDL's other crown jewels
Even after the failure of Nuvion, PDL has other assets besides its royalty stream on which we can place a reasonable price tag.
As was announced last week, PDL has decided to sell off all the assets related to its acquisition of ESP Pharma, including the ESP marketed drugs and pipeline candidate Ularitide. PDL paid $500 million in 2005 to acquire ESP, but the assets are likely not worth that much today; PDL has let the Ularitide patents waste away, and some of the ESP marketed drugs will shortly be facing generic competition.
Now, it's not unreasonable to assume that a potential acquirer like cardiovascular specialist CV Therapeutics (NASDAQ:CVTX) or Gilead Sciences (NASDAQ:GILD), with its fledging hypertension compounds, would be willing to pay somewhere in the range of $300 million for the ESP assets.
As of the beginning of the year, PDL also had about $640 million worth of federal and state net operating loss carry-forwards, which could lower the tax liability of a company that acquires PDL by around $340 million.
At the end of last quarter, PDL had about $320 million in working capital, but about $500 million in convertible debt. Hard assets like its antibody manufacturing plant and headquarters are valued at around $330 million on its balance sheet.
Adding up all these PDL and ESP assets and subtracting for the convertible debt brings an additional $800 million to the fair value of PDL in addition to the $1.8 billion for the royalty stream.
This values the sum of PDL's parts at $2.6 billion ($1.8 billion for the royalties and $800 million for the other net assets). This is already more than $200 million more than its current market capitalization, and we haven't even gotten to potentially the most valuable jewels.
Royal diamonds or cubic zirconia?
The final piece to the PDL puzzle is its own pipeline of drugs in development. You could argue that these early- and mid-stage compounds deserve a value of zero, considering the company's inability to bring drugs to the market on its own in the past six years. Other drugmakers that have partnered with PDL in the past, like Roche and Biogen Idec (NASDAQ:BIIB), would argue otherwise.
Since I've already gotten a fair value that puts shares of PDL undervalued to current share prices, rather than pull some speculative number out of a hat for the value of these pipeline drugs, I'll accept them as simply a bonus to the PDL valuation story if it or Biogen is able to push them through the clinic successfully.
It's worth noting that an alternate explanation for PDL's current valuation could be that the drug pipeline has negative value and the expected growing R&D expenditures are pushing the drugmaker's share price down. This is one of the things that activist hedge fund Third Point reasons may account for PDL's wallowing stock price.
The bottom line
If you believe that majority shareholder Third Point, or whoever is pulling the strings at PDL over the next couple of months, is able to engage in shareholder-friendly activities to realize a fuller value for all of PDL's assets, then shares of the drugmaker are a buy at this point.
As Motley Fool Rule Breakers biotech analyst Charly Travers has stated in the past, before the Nuvion blowup, investors were getting a free call option on PDL's pipeline products. I think this reasoning holds at today's prices.
The bottom line to me is that if the status quo continues at PDL, then shares don't appear very attractive, but if PDL puts a proven shareholder-friendly CEO at its helm or Third Point is successful with its plans to break apart the company, then it's hard to argue PDL is overvalued.
