PDL BioPharma An update on several fronts Q315 earnings Pharma & biotech In its Q315 earnings release, PDL announced that Valeant may not have met some of the contractual obligations of its Depomed royalty agreement and PDL is now expecting to begin a royalty audit process by the end of the year. In addition, due to the recall of the Auvi-Q allergy injector on 28 October, there is a question about the Kaleo note, as a long absence from the market could lead to constraints in cash flow from that company. We do not believe any of these issues is major and at this stage are not making any significant changes to our forecasts. More recently, PDL announced that LENSAR, a company that had been put up for sale, was sold, reviving that investment, which had been impaired. 18 November 2015 Price US$3.72 Market cap US$611m Net debt ($m) at end Q315 101.7 Shares in issue 164.2m Free float 92.3 Code PDLI Primary exchange NASDAQ Year end Revenue ($m) PBT* ($m) EPS* ($) 12/14 581.2 501.3 2.04 0.61 1.8 16.4 12/15e 559.0 501.7 1.95 0.59 1.9 15.9 12/16e 206.3 154.6 0.59 0.60 6.3 16.1 12/17e 73.3 18.9 0.07 0.60 53.1 16.1 Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments. DPS ($) P/E (x) Yield (%) Secondary exchange Share price performance N/A Valeant has not been reporting or paying on time Valeant is contractually obliged to report and pay monthly royalties on Glumetza, but appears to have failed to do so. PDL did not receive any payments in Q315, although it did receive payment in late October. In response to this and to other issues (note that Valeant acquired Glumetza via its takeover of Salix, which had been guilty of massive channel stuffing), PDL expects to initiate a royalty audit process by the end of 2015. The timing of its conclusion is unclear. Auvi-Q recalled, but there is an interest reserve Sanofi, which markets and manufactures Auvi-Q, announced its recall due to manufacturing issues, and it is unclear when Auvi-Q will return to the market. The $150m Kaleo note is backed by Auvi-Q royalties from Sanofi, so a long absence from the market could affect cash flow to PDL. However, with a $20m reserve account, interest payments to PDL should be covered through at least Q116. LENSAR sold with ALPHAEON assuming debt LENSAR has been sold to ALPHAEON with ALPHAEON, assuming $42m in debt and issuing PDL $12.5m in company stock. The note will now be functional again, providing PDL with cash flow through Q318. Valuation: $6.30 per basic share We have slightly increased our valuation from $1,024m or $6.20 per basic share to $1,034m or $6.30 per basic share. This increase is due to the inclusion of an additional note deal, the LENSAR acquisition, lower net debt and shares outstanding than we expected, although it was partially mitigated by lower than expected Glumetza royalties in 2015. % 1m 3m 12m Abs (18.8) (38.2) (52.4) Rel (local) (19.5) (36.6) (52.6) 52-week high/low US$8.26 US$3.72 Business description PDL BioPharma has reinvented itself through a two-pronged strategy of investing in royalty streams of marketed and development-stage therapeutics, and providing high-yield debt financing to medical device and diagnostic companies with near-term product launches. Next events Launch of Zalviso in EU Solanezumab Phase III data Analysts H116 Q416/Q117 Maxim Jacobs +1 646 653 7027 Christian Glennie +44 (0)20 3077 5727 healthcare@edisongroup.com Edison profile page PDL BioPharma is a research client of Edison Investment Research Limited
Q315 earnings With the final royalty payments linked to the Queen et al patents coming in Q116, PDL is about to turn a page on a new phase of its existence. In preparation, PDL has been acquiring both royalty and debt-based, income-generating assets, with the hopes of funding both its operations and dividend into the foreseeable future. Valeant s murkiness strikes Glumetza In October 2013, PDL acquired the royalty and milestone rights related to several products (see Exhibit 1) for the treatment of Type II diabetes from Depomed for a total of $240.5m, the largest royalty acquisition deal that PDL has made to date. Exhibit 1: Royalties acquired from Depomed Product Company Royalty rate 2014 sales Glumetza (extended release metformin) Santarus/Salix/Valeant 32% until 2014, 34.5% from 2015, gross $298m margin split post generic intro (~45%) Janumet XR (Januvia + extended release metformin) Merck ~2% $419m Invokana + extended release metformin Jannsen Unknown N/A Jentadueto XR (Tradjenta + extended release metformin) Boehringer Ingelheim Unknown N/A Jardiance + extended release metformin Boehringer Ingelheim Unknown N/A Extended release metformin in Korea and Canada LG Life Sciences and Valeant Unknown Unknown Source: PDL, Wolters Kluwer Currently, the bulk of the Depomed royalties comes from Glumetza, an extended-release metformin, which is the number one metformin on the market today. It had been receiving a 32% royalty until the end of 2014, will receive a 34.5% royalty for 2015 and later and then will split the gross margin once a generic is introduced (we estimate this should effectively translate to a 45% royalty, depending on the final price). In the Q315 earnings release, PDL announced that Valeant may not be meeting its reporting and payment obligations. It is contractually obligated to report and pay monthly royalties on Glumetza, but had failed to do so. PDL received no payments in Q315, although it did receive a net $16.9m payment in late October covering the July to September period. Valeant had also failed to provide timely explanation about the absence of reports on Glumetza sales in July and August. Given this situation and the fact that Glumetza was the subject of massive channel stuffing by Salix, which led to erratic and somewhat unverifiable royalties, PDL expects to initiate a royalty audit process by the end of 2015. It is unclear how long the process will take and whether PDL has in fact been underpaid any royalties. Good outcome for LENSAR following impairment LENSAR is commercialising its laser cataract surgery system in both the US and EU. This is a competitive area where the systems are expensive (~$400,000 per machine) and, based on comments from refractive surgeons, it remains unclear whether it improves outcomes. PDL had previously announced that it had entered into a forbearance agreement with LENSAR following violation of a liquidity covenant. As at the Q315 results, the LENSAR note was considered impaired while PDL funded LENSAR as it negotiated a sale. It is therefore good news that ALPHAEON has agreed to assume the $42m debt to PDL and has issued it with $12.5m in common stock. The note will now be functional again, providing PDL with cash flow through Q318. Auvi-Q recall may put Kaleo cash flow at risk Auvi-Q is an epinephrine product that was developed by Kaleo, but is manufactured and marketed by Sanofi. On 28 October, Sanofi announced that the product was being recalled as a result of inaccurate dosing in some of the units and it is unclear how long Auvi-Q will be off the market. PDL BioPharma 18 November 2015 2
Kaleo currently owes PDL $150m, which is backed by 100% of Auvi-Q s royalties and 10% of Evzio (its naloxone-based product) sales. As part of the agreement with PDL, Auvi-Q created an interest reserve account with $20m of the $150m received from PDL. With this reserve account, PDL s cash flows from Kaleo are likely to be safe through to at least the end of Q116, but an extended market absence could put them at risk. For now we are not changing our forecasts for Kaleo cash flows to PDL. First CareView tranche paid On 29 June 2015, PDL announced a new credit agreement with CareView, a company focused on patient care monitoring. The company s products include virtual bed rails, which can detect if a patient is in danger of falling out of bed, and allow for remote patient monitoring, reducing the cost of having a sitter in the room with high-risk patients. As part of the agreement, PDL agreed to provide two tranches of $20m each based on the achievement of milestones. The first tranche was paid on 7 October after CareView acquired a new revenue-generating product and has a 13.5% coupon. The second tranche will be based on a milestone attained on or before the end of June 2017 and will have a 13% coupon. Each tranche will last for five years. PDL also received a warrant to purchase 4.4m shares of stock at $0.40 per share (approximately 5% warrant coverage), which expires on 26 June 2025. Following the payment of the first tranche, we are now including CareView in our NPV calculation and have increased our forecast accordingly. An additional $4m for Paradigm Spine Paradigm Spine is a spine implant technology company. Its coflex Interlaminar stabilization device is approved in the US and 40 other countries across six continents. Originally it owed PDL $50m at 13% interest, but has just amended the credit agreement so that Paradigm could receive an additional $4m for general purposes and promotional activities. As part of the deal, Paradigm can borrow a second tranche of up to $3m through Q216. Valuation We have slightly increased our valuation from $1,024m or $6.20 per basic share to $1,034m or $6.30 per basic share. This increase is due to the inclusion of the CareView deal in our NPV, an upward adjustment to the value of the LENSAR note following its acquisition and lower net debt than we had estimated for end Q315, as well as fewer shares outstanding, although it was partially mitigated by lower than expected Glumetza royalties in 2015. The company should remain profitable through 2018, although it may have to raise additional capital or cut the dividend to pay off all of the $300m in debt due in that year. It plans to make additional investments over the next few years that will have near-term, income-generating prospects, which should help PDL retain its cash flow-positive qualities. However, there is a question mark over the long-term sustainability of its model, as most of its income-generating deals are set to expire in 2018-19 (and a few are already impaired) and some of the royalty deals may disappoint. However, if solanezumab reaches the market as we expect in 2018, it could be a turning point for PDL s long-term prospects and cash flow position, as it is expected to be a multi-billion product from which PDL would receive 2% royalties. Solanezumab royalties would last 12.5 years and would not be associated with any additional costs. PDL BioPharma 18 November 2015 3
Exhibit 2: PDL valuation Royalty/Note Type Expiration year PDL balance sheet NPV carrying value Queen et al Royalty 2015 N/A $138.4 Depomed Royalty on Glumetza and 2024 $178.2 $261.4 other products VB Royalty on Spine Implant Undisclosed $16.9 $23.6 University of Michigan Royalty on Cerdelga 2022 $71.6 $29.4 Lilly Royalty on solanezumab 2030 N/A $161.4 DirectFlow Note 2018 $51.8 $49.8 Wellstat Note (Impaired) Unknown $50.2 $50.2 Hyperion Note (Impaired) Unknown $1.2 $1.2 Avinger Royalty 2018 N/A $3.7 Lensar Note 2018 $50.3 $58.5 Paradigm Spine Note 2019 $49.9 $55.3 Kaleo Note 2029 $151.5 $155.0 Acelrx Royalty on Zalviso 2027 $65.3 $67.5 Ariad Royalty on Iclusig 2033 $49.9 $80.1 Careview Note 2022 N/A $19.0 Total $1,135 Net Debt (Q315) ($m) ($101.7) Total firm value ($m) $1,034 Total basic shares (m) 164.2 Value per basic share ($) $6.30 Total options 0.8 Total number of shares 165.0 Diluted value per share ($) $6.27 Source: Edison Investment Research, company reports Financials PDL reported $227.5m in cash and cash equivalents in Q315. This decrease was mainly due to the $115m that was invested in the Iclusig and Zalviso royalty streams. With PDL still receiving royalties for the Queen et al patents through 2015 and the beginning of 2016, we expect it to be very profitable and cash flow positive through this period, as it has a low operating cost base. However, in February 2018 it will have $300m in debt due, which will either need to be paid or refinanced. Based on our current projections, PDL may need to make an additional capital raise to pay it off in full or to cut the dividend. PDL BioPharma 18 November 2015 4
Exhibit 3: Financial summary $ 000s 2013 2014 2015e 2016e 2017e Year end 31 December IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 581,225 558,969 206,266 73,265 Cost of Sales 0 0 0 0 Gross Profit 581,225 558,969 206,266 73,265 General & Administrative (34,914) (31,123) (33,612) (36,301) EBITDA 546,311 527,847 172,653 36,964 Operating Profit (before GW and except.) 546,311 527,847 172,653 36,964 Intangible Amortisation 0 0 0 0 Other 0 0 0 0 Exceptionals 0 0 0 0 Operating Profit 546,311 527,847 172,653 36,964 Net Interest (38,896) (26,151) (18,065) (18,023) Other (6,143) 0 0 0 Profit Before Tax (norm) 501,272 501,695 154,588 18,941 Profit Before Tax (FRS 3) 501,272 501,695 154,588 18,941 Tax (179,028) (175,593) (54,106) (6,629) Deferred tax (0) (0) (0) (0) Profit After Tax (norm) 322,244 326,102 100,482 12,312 Profit After Tax (FRS 3) 322,244 326,102 100,482 12,312 Average Number of Shares Outstanding (m) 158.2 167.1 170.4 173.8 EPS - normalised (c) 203.66 195.20 58.97 7.08 EPS - FRS 3 (c) 2.04 1.95 0.59 0.07 Dividend per share (c) 61.1 58.8 60.0 60.0 Gross Margin (%) 100.0 100.0 100.0 100.0 EBITDA Margin (%) 94.0 94.4 83.7 50.5 Operating Margin (before GW and except.) (%) 94.0 94.4 83.7 50.5 BALANCE SHEET Fixed Assets 606,453 705,298 637,793 579,241 Intangible Assets 0 0 0 0 Tangible Assets 62 51 81 111 Royalty rights 259,244 370,256 378,389 341,785 Other 347,147 334,991 259,323 237,345 Current Assets 355,897 286,782 285,725 276,263 Stocks 0 0 0 0 Debtors 300 594 594 594 Cash 291,377 243,691 221,304 218,342 Other 64,220 42,497 63,827 57,327 Current Liabilities (187,983) (36,267) (11,425) (299,384) Creditors (318) (421) (421) (421) Short term borrowings (175,496) (24,842) 0 (287,959) Other (12,169) (11,004) (11,004) (11,004) Long Term Liabilities (313,930) (330,759) (333,582) (48,474) Long term borrowings (276,228) (282,285) (285,108) 0 Other long term liabilities (37,702) (48,474) (48,474) (48,474) Net Assets 460,437 625,055 578,511 507,646 CASH FLOW Operating Cash Flow 292,281 288,284 49,147 (33,855) Net Interest 0 0 0 0 Tax 0 0 0 0 Capex (49) (18) (30) (30) Acquisitions/disposals 21,360 (77,398) 33,735 73,207 Financing 0 0 0 0 Dividends (96,557) (98,307) (102,240) (104,284) Other (159,420) (7,252) 22,000 62,000 Net Cash Flow 57,615 105,308 2,612 (2,962) Opening net debt/(cash) 300,978 160,347 63,436 63,804 HP finance leases initiated 0 0 0 0 Exchange rate movements 0 0 0 0 Other 83,016 (8,397) (2,981) (2,851) Closing net debt/(cash) 160,347 63,436 63,804 69,617 Source: Company accounts, Edison Investment Research PDL BioPharma 18 November 2015 5
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Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE s express written consent. Frankfurt +49 (0)69 78 8076 960 PDL Schumannstrasse BioPharma 34b 18 November 280 High Holborn 2015 245 Park Avenue, 39th Floor Level 25, Aurora Place Level 15, 171 Featherston St 6 60325 Frankfurt Germany London +44 (0)20 3077 5700 London, WC1V 7EE United Kingdom New York +1 646 653 7026 10167, New York US Sydney +61 (0)2 9258 1161 88 Phillip St, Sydney NSW 2000, Australia Wellington +64 (0)48 948 555 Wellington 6011 New Zealand