PDL Biopharama Liquidation (NASDAQ:PDLI)

Post inspire by Alpha Vulture Here. At the end of 2019, the company announced a strategic review and ultimately decided to cease making investments and monetize it’s existing assets. They’ve done a series of transactions this year, including spinning off LENSAR, Evofem, and sold off some of it’s royalty portfolio. The company will file a certificate of dissolution with Delaware State on 1/4/2021 after which the stock will cease to trade (including OTC). It will wind down the remainder of the company over the next 2-4 years.  

The company published a balance sheet on a liquidation basis recently (cash proceeds, net of projected cost to sell). This is roughly what you’re getting: 

  1. Cash/AR – 23% of assets
  2. Receivables from Asset Sales – 7.5% of assets
    1. PDLI sold Noden to PE firm CAT Capital with payment deferred over two years: $12.2M upfront cash payment; $33M in 12 equal quarterly installments through 10/2023; $3.9M quarterly installments in 2023; and $2.5M contingent payment if a binding transaction is reached within one year (details undisclosed?) for a total of $39M of value.
    2. There may be some slight counter-party risk here, but absent reviewing the definitive agreement, I view this as low risk and can be taken at face value
  3. Notes receivable – 9.9% of assets 
    1. This is a messy litigation that’s been going on for years based on a loan they made to Wellstat. The punchline is they reached a settlement on the loan with Wellstat who will pay $7.5M upfront plus either (1) $5.0 million by February 10, 2021 and $55.0 million by July 26, 2021 or (2) $67.5 million by July  26,2021  
    2. There is clearly credit risk here, and it’s difficult to really diligence. The $7.5M upfront payment is a strong signal intend to fully pay this though.
  4. Royalty assets – $231.7M – 43% of assets 
    1. 90% of the value here is in five Type II diabetes drugs. They’ve had the royalty stream since 2013 and there’s been four different generics launched between 2013-2017 which has put downward pricing on sales. You can see trend where cash flow declined from $98M in 2017 to almost half that in 2020 (estimate). Generics have been an issue for a while now — this is not a new issue and presumably management has a view on further degradation in coming up with their value
    1. I don’t have the slightest expertise in valuing a drug royalty. Sense checking management’s valuation, though, you can discount the cash flows they laid out in a Aug 2019 IP at 20% (500 bps premium to stated undiscounted cost of capital of SWK holdings who acquired the other royalties earlier in the year) and get ~$220M valuation, which roughly aligns with mgmt’s liquidation value 
    2. If they’re unable to sell these, they’re still throwing off ~$50M a year of cash flow that management has said they’d be willing to put in a liquidating trust and just make distributions. If M&A/financing freezes up for some reason, it’s not a huge risk
    3. The one thing that gives me pause is the other three drugs sold earlier in the year had a book value of $27M and were ultimately sold for $4M. That’s a huge spread. There may be mitigating factors here: management was in a rush to get these off the books; Assentio was a huge dud (so why didn’t they mark down book before selling?) but it’s still concerning
  5. Income tax receivable – $77M 15%
    1. This is a legacy of the CAREs act where NOLs incurred in 2018-2020 can be carried back for a tax refund. Assuming management are not total idiots, I’m assuming they’ve had a tax advisor vet this before publishing the balance sheet. I view this as lower risk 

Liabilities are relatively straight forward and I burdened with another 10M of misc. expenses.  The “uncertain tax position” is the only question mark. The company settled an IRS audit for the tax year 2016 and currently has an audit from the California Franchise Tax Board for 2009-2015 which they are accruing for. There a could be a surprise to the upside here, but who knows.    

So adding this all up I’m paying $2.38/share versus $3.25 of distributions (adjusted for options and small reserve for other expenses) for a total of 1.36x MOIC . Thinking in MOIC terms only, a lot has to be wrong for you to lose money here. The thesis really hinges on what you believe about royalty assets and the Wellstat note. If they sell (or prices drop) by 25% for royalties and the Note Receivable is a zero , then you break even, which feels like a healthy margin of saftey.

On an IRR basis  timing obviously matters. This will take at least through 2023 based on Evofem payments. Below I’ve laid out a rough estimate on distributions. This is on a distribution basis rather than the actual cash inflows/outflows (my understanding is they won’t make distributions for at least 12-18 months based on safe harbor provisions). At the end of the day this is not much more scientific than MOIC^(1/n)-1,but timing is important enough to be precise. I get ~17% IRR. I think this is likely to be conservative; Management has no incentive to do anything other than sandbag this range. The uncertain tax provisions if added back get’s you another 400bps.

Thinking through a few scenarios (same timing as above), I still think it’s generally attractive returns to the downside. For a 10% cost of capital, You need to believe there is a ~70% chance of case #2 where the notes are 60 cents on the dollar and the royalties at 80 cents on the dollar to miss the benchmark. That feels excessive. The disaster scenario just feels draconian and even then it’s just dead money.

Framing this another way, there is a collection of uncorrelated assets that each have a different risk profile. Cash and AR = no risk. Asset sale and income tax refund, I don’t think risky so 3% for some time value. Note receivable some clear credit risk so let’s say 12%. Royalty assets I think (?) trade at 15%-20% unlevered, so let’s make it 20% to be safe. Weighted by assets, you need ~11% for this to be correctly priced. The IRR I’ve laid out is ~17%. That feels decent relative to the risk. I could get cute and add an illiquidy premium of 600bps, but I don’t work for Houlihan Lokey valuing portfolios so I’ll refrain.

So risking capital for 17-20% return that’s difficult to lose money feels like a good bet. This is one of those turn your brain off, and be ok with 70% of the knowledge necessary rather than trying to diligence it to the basis point.

One of the other reasons I like this is it’s relatively insulated from the overall market. The Luby’s liquidation is attractive on an upside basis (or was) but they have no access to capital if something goes wrong. If you think their assets are undervalued, you could be right, but a 08-09 freeze up probably cause a serious impairment of capital (they have no access to capital anyway). With PDLI, it’s a self-contained little box. No one wants to buy the royalties? That’s fine, we’ll just distribute the distributions (I doubt diabetes is cyclical…). Credit freezes up? That’s fine there is plenty of cash to fund liabilities.  

Conclusion: Long at $2.38/share