Less dividend equals more deals

PDL provided an update on operations and earnings for Q216 on 4 August 2016. Concurrent with the report, PDL announced that it was eliminating its dividend. The dividend was $0.05 in Q116 and Q216 and prior to this had been $0.15 per quarter. This development is not particularly surprising considering the reduction in cash flow from the Queen at al. patents. In addition, the current financial environment for pharma and biotech is particularly difficult through traditional avenues, and this should increase the attractiveness of alternative financing like that offered by PDL. The recent equity transaction with Noden Pharma will provide a new platform for investment, which is also attractive considering the large number of products expected to be divested from larger pharmaceutical companies. The company’s capital is likely more valuable being leveraged for additional deals rather than dividend payments, at least for the near term. We estimate that the elimination of the dividend, if continued, will release cash of over $80m through 2018, based on previous rates.

The company reported $14.2m in royalty revenue from the Queen et al. royalty stream. This revenue is based on the sales of Tysabri over Q116. The royalty agreements for the other Queen et al. products have stopped, but the royalties for Tysabri are tied to product manufactured during 2014. Biogen continues to draw down this inventory, which will likely provide additional revenue. The Tysabri royalty for Q216 is similar to Q116, suggesting the same volume of product bearing the royalty was sold, and therefore this revenue stream will likely continue, at least to some degree, into Q3. We do not include this revenue in our forecasts and valuation due to lack of insight into these inventory levels.

PDL reported revenue loss from royalty rights of $855k for the quarter, which reflects a write-down on the fair value of the rights of $15.5m offset by $14.7m in cash proceeds. The majority of the write-down can be attributed to a $7.6m change in the fair value of the University of Michigan royalties and a $7.4m change in the value of the Depomed royalties.

The University of Michigan royalties pay a small percentage (estimated at 2-3%) on the sales of Cerdelga, which is marketed by Sanofi for the treatment of Gaucher disease. The write-down is the result of a delay in pricing and reimbursement decisions in Europe and Japan, which constituted a significant portion of predicted revenues. Sanofi reported €49m in sales for the drug in the first half, an 88% increase over H115. Based on this growth rate and no expansion into new territories, we predict €124m ($138m) in sales for 2016. As a consequence, we have reduced our valuation for the University of Michigan royalty to $29.7m (from $35.5m).

The write-down for the Depomed royalty is due to lower than expected Glumetza sales. Unfortunately, Valeant (which markets the drug) does not release any details regarding sales or pricing of the product, but according to a third-party source, low sales were predominantly due to a decrease in the gross/net ratio because of pricing pressure associated with the recent launch of generic versions of the drug. This marks the second quarter in a row in which these assets have been reduced in value by the company, following the $48m write-down in Q1 citing other effects of the generic launch. However, our valuation for the Depomed royalty has increased to $211.7m (from $209.9m) because the recent approval of Jentadueto XR, which is also covered under the agreement, has offset adjustments to Glumetza sales, which were conservative on our part. This approval directly contributed $6m to the royalty cash proceeds for the quarter from the approval milestone.

PDL announced on the earnings call that it has initiated a new royalty agreement associated with Kybella, a treatment for double chin that was developed by Kythera and subsequently purchased by Allergan. The company purchased a royalty in the low single digits from an inventor of the therapy in return for $9.5m upfront and $1m in sales milestones. We currently model sales in the range of $450m for the drug before generic entry in 2028. With an assumed 1% royalty rate, this corresponds to an NPV of $12.7m, which is now included in our valuation.

The company recently announced that as part of its agreement with ARIAD, the company provided the second tranche of $50m to ARIAD on 28 July 2016. Under the agreement, the royalty to PDL will increase to 5% (from 2.5%). These developments were previously accounted for in our valuation of the ARIAD deal and our financial projections.

PDL also provided an update of the Wellstat Diagnostics liquidation proceedings. The company had previously petitioned the supreme court of New York to provide a summary judgement against Wellstat for the $117.5m legally owed to the company. This motion was granted, and the company is now pursuing a writ of attachment that would hold Wellstat officers liable in the case that Wellstat’s assets are insufficient. Despite this, PDL maintains that Wellstat’s assets exceed the carrying value of the note ($50.2m).

We have increased our valuation to $1,133m or $6.84 per basic share, from $1,119m or $6.78. This adjustment is based on a number of positive and negative factors. Our valuation of the Depomed royalty assets has increased from $209.9m to $211.7m despite the Glumetza write-down due to the offsetting effect of Jentadueto XR approval. University of Michigan royalty rights have been reduced to $29.7m from $35.5m, based on the Cerdelga regulatory issues in Europe and Japan. The value of the Direct Flow note has increased slightly to $48.1m from $47.7m because of $1.5m in additional financing issued to the company. We have added the Kybella royalty stream deal to the model with a value of $12.7m. Finally, the net debt position has improved to $11.1m from our $15.2m estimate at the closing of the Noden deal in July 2016 (note: we include both a $75m COD and the cost of the Noden transaction in this calculation). We expect to further update our valuation with the release of detailed Tekturna financials in September 2016, and following any additional transactions.

PDL reported revenue of $21.0m for the quarter, which corresponds to $36.6m in cash generated from operations (offset by the non-cash write-downs). Spending was $9.9m for the quarter in line with Q1 ($9.8m). We expect spending to increase significantly in Q3 to account for the fully incorporated Noden financials associated with a salesforce and other overheads. We forecast spending of approximately $20m for Q316 and Q416, but this should be more than compensated by predicted sales in the range of $34m per quarter, if Tekturna remains on the same sales trajectory. The drug had sales of $154m in 2015 and $73m for H116. Earnings for Q216 were $4.1m, which is substantially lower than previous quarters ($55.8m for Q116) due to the Queen et al. royalty stream reduction.

The company ended the quarter with $116m in unrestricted cash and $106m in restricted cash to finance the Noden/Tekturna deal. The company also placed $75m in a long-term certificate of deposit, presumably to serve as collateral for the remaining portion of the Tekturna acquisition cost due to Novartis in July 2017. We do not expect PDL to need additional financing in the future, and we believe that it will not need to refinance its current outstanding debt of $233m in convertible notes (4% due 1 February 2018, $9.17 conversion price). We expect an aggregate $132m in additional debt to be issued to Noden to complete the Tekturna transaction based on PDL’s guidance. However, should Noden fail to secure this financing, PDL is obligated to provide the cash itself. Based on the recent announcement suspending dividends, we do not include any in our forecasts, although the company may decide to reinstate them at any point if financial conditions change.