PDL BioPharma — Update 15 July 2016

Healthcare

PDL BioPharma

Noden deal closes

Business update

Pharma & biotech

15 July 2016

Price	US$3.27
Market cap	US$540m

Net cash ($m) at end Q116		59.8

Shares in issue	165.1m
Free float	92%
Code	PDLI

Primary exchange	NASDAQ
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	4.5	(9.9)	(49.2)
Rel (local)	0.2	(13.3)	(50.5)

52-week high/low

US$6.56

US$2.75

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

Earnings	Q216
Tekturna SEC filing	September 2016

Analysts

Maxim Jacobs	+1 646 653 7027
Nathaniel Calloway	+1 646 653 7036

healthcare@edisongroup.com

Edison profile page

PDL BioPharma is a research client of Edison Investment Research Limited

PDL announced on 6 July 2016 the closing of its equity investment in Noden Pharma, which concurrently acquired the Tekturna pharmaceutical brand from Novartis. Tekturna and Tekturna HCT are blood pressure medications with a combined revenue of $154m in 2015. Noden paid $110m for the brand on closing with an additional $89m due on the first year anniversary. In comparison, PDL made an equity investment of $75m and will provide $32m in a year for an 88% equity stake in Noden. According to management, the total financing needed by Noden is up to $334m and PDL is committed to providing this funding if other sources are unavailable.

Year end	Revenue ($m)	PBT* ($m)	EPS* ($)	DPS ($)	P/E (x)	Yield (%)
12/14	581.2	501.3	2.04	0.61	1.6	18.7
12/15	590.4	530.1	2.04	0.60	1.6	18.3
12/16e	223.3	133.0	0.54	0.20	6.1	6.1
12/17e	196.8	71.4	0.31	0.20	10.5	6.1

Note: *PBT and EPS are normalized, excluding amortization of acquired intangibles, exceptional items and share-based payments.

Total obligation up to $334m

PDL announced that Noden will require $334m financing in total. This includes the upfront fee of $110m, anniversary fees of $89m, $95m in potential milestones, and $40m in working capital. PDL has provided Noden with a $75m initial equity investment and a 60-day bridge loan up to $75m to cover the remaining portion of the upfront payment and the working capital until other financing can be sourced.

Salesforce of approximately 70 contract reps

The company provided additional detail on the Noden commercial organization. Tekturna will be sold with a salesforce of 70 contract representatives. This force exceeds our initial estimates (of 10-20 internal reps), but the lack of overheads may translate to improved scalability and savings over the long run.

PDL confirms that similar transactions are coming

PDL announced that the formation of Noden was part of a strategy to capitalize on the large number of divestitures that are expected from big pharma and specialty pharma companies. PDL intends to opportunistically acquire additional assets in the near future.

Valuation: Increased to $1,119m or $6.78 per share

We have increased our valuation of PDL to $1,119m or $6.78 per basic share (from $1,036m or $6.28) to include value from Noden. We currently value Noden at $259m, which is greater than our previous illustrative valuation of $245m, due to the scalability of the larger-than-expected contract salesforce. This corresponds to $227m for PDL’s equity share (88%), or $158m adjusted for the anniversary payment. This value is partially offset by the $75m purchase costs to PDL. We expect to update our valuation following the SEC filing of Tekturna commercial details and following initial sales reports for the drug following the transition.

PDL acquires Noden, which acquires Tekturna

On 6 July 2016, PDL BioPharma announced that it had completed the acquisition of a majority position (88%) of Noden Pharma DAC. Noden is a company that was recently formed to purchase and commercialize the Tekturna brand (including Tekturna and Tekturna HCT, known as Rasilez and Rasilez HCT outside of the US) from Novartis. The brand sold a combined $154m in 2015. This asset acquisition also closed on 6 July 2016. PDL has transferred its initial payment of $75m to Noden to support the $110m upfront fee for the drug. Noden owes Novartis $89m on the one-year anniversary of the deal and up to $95m in milestones, of which PDL expects to provide $32m and $38m, respectively. These details are consistent with the previous announcement of the deal.

According to the latest announcement, PDL has provided Noden a short-term loan (60 days) of up to $75m to cover costs until Noden can secure debt financing to cover the portion of the Tekturna deal not supported by PDL. Noden will initially be financed with $40m in working capital, bringing the total amount of potential funding requirement to $334m.

PDL also provided more information on the commercial strategy for Tekturna. The selling force will consist of approximately 70 contract representatives. This is more than our initial prediction of 10-20 internal reps; the increase in variable costs associated with more representatives is mitigated by lower fixed costs. The company intends to target both cardiologists and general practitioners, initially targeting high prescribers.

The composition of matter patent for Tekturna expires in 2018 (2020 in Europe). However, we do not expect significant generic competition. The molecule is difficult to manufacture and manufacturing methods are protected until 2021. The Tekturna acquisition includes a transfer of manufacturing know-how from Novartis. We believe that manufacturing provides a barrier too high for generic entry considering the lack of promotion and declining market for the product.

The product transfer in the US will occur over the 90 days following the official closing of the deal (1 July 2016), but may take longer in other countries. The company will also file a special report on Tekturna sales and costs with the SEC by 75 days after the closing date, at which time more detailed information about the operation under Novartis will be released.

PDL also emphasized that Noden (or a similarly structured organization) will serve as a vehicle to acquire additional pharmaceutical products. The company noted that market conditions have created a situation where there are multiple pharmaceutical companies interested in divesting assets.

Valuation

We have increased our valuation of PDL to $1,119m or $6.78 per basic share, from $1,036m or $6.28 per basic share, to include the value of the equity investment in Noden as the acquisition is now completed. We value Noden at $259m based on an NPV analysis, with PDL’s 88% share representing $227m. This is an increase from our initial estimate of $245m ($215m for PDL’s stake). The increase is due to the announcement that Noden will be using a contract salesforce of approximately 70, instead of our estimates of 10-20 in-house salespeople. To reflect this we have increased the cost of selling to 30% (from 10%) in our model, but removed the fixed selling costs. Because our model predicts declining sales, this structure is more affordable at longer time points, hence the increase in valuation.

Accounting for the discounted future payment to Novartis of $89m, the net value of the equity investment of Noden is $158m. We currently predict the maximum amount of milestones payable ($95m) because we do not predict substantial declines in sales or generic entrants. There are two primary risks to this investment: sales risk, due to declining revenue from the product, and financing risk associated with the transaction. We currently model a decline in sales of approximately 10% year-on-year. This decline is slower than the decline in sales reported by Novartis in yearly reports, but is in line with Symphony health data of the past 12 months (8.4%), and we believe that the decline has stabilized. We predict cost of goods at 15%, which is higher than average owing to the difficulty reported in manufacturing the compound.

We predict margins for the product of approximately 50%, but this is in part due to low tax rates from Noden’s Irish domicile (12.5%), and this margin may be negatively affected if PDL is required to repatriate earnings to the US. Noden will require up to $149m in additional financing to make Novartis whole, which it intends to finance via debt. There is a risk, albeit small in our estimation, that the company will not be able to obtain financing with reasonable terms and PDL will be obligated to provide the funds itself. Given that the maximum additional funds needed to complete the transaction are less than 2015 sales of Tekturna, we do not predict substantial difficulty in securing these loans. We will revisit our valuation following these financings or sales reported for the product in future filings (note the SEC filing for Tekturna is due in September 2016).

Exhibit 1: PDL valuation

Royalty/partner/note	Type	Expiration year	PDL balance sheet carrying value ($m)	NPV ($m)
Queen et al	Royalty	2015	N/A	N/A
Depomed	Royalty on Glumetza and other products	2024	$143.9	$209.9
VB	Royalty on Spine Implant	Undisclosed	$17.3	$24.5
University of Michigan	Royalty on Cerdelga	2022	$71.6	$35.5
Lilly	Royalty on solanezumab	2030	N/A	$161.4
Direct Flow	Note (Impaired)	2018	$56.9	$47.7
Wellstat	Note (Impaired)	Unknown	$50.2	$50.2
Hyperion	Note (Impaired)	Unknown	$1.2	$1.2
Avinger	Royalty	2018	$2.3	$3.7
Lensar	Note	2018	$43.9	$56.8
Paradigm Spine	Note	2019	$54.2	$55.2
Kaleo	Note	2029	$146.8	$154.8
AcelRx	Royalty on Zalviso	2027	$69.6	$67.5
Ariad	Royalty on Iclusig	2033	$50.2	$87.1
Careview	Note	2022	$18.7	$20.7
Noden	Equity	N/A	N/A	$158.2

Total				1,135
Net cash/ (debt) (Q116 less Noden acq.) ($m)				(15.2)
Total firm value ($m)				1,119
Total basic shares (m)				165.1
Value per basic share ($)				6.78
Total options				0.1
Total number of shares				165.2
Diluted value per share ($)				6.77

Source: Edison Investment Research, company reports

Financials

We have fully consolidated Noden financials, and we are now including the revenue from Noden in our projections, which corresponds to $69m for H216 and $127m for 2017 (at 100%). This equates to an increase in PDL earnings of $29m and $54m for the two periods, respectively after minority interests ($4m and $7m). The Tekturna acquisition is recorded as a $199m intangible asset CAPEX, with the remainder of the acquisition fee payable on the one-year anniversary ($89m) recorded as restricted cash. We amortize this asset over 15 years. The additional financing for the acquisition and Noden working capital is recorded as $75m in debt in 2016 and $57m in 2017. All of this accounting should be seen as illustrative and we expect to reconcile our forecasts with PDL’s accounting for the acquisition, once it is disclosed.

Exhibit 2: Financial summary

	2014	2015	2016e	2017e
Year end 31 December	US GAAP	US GAAP	US GAAP	US GAAP
PROFIT & LOSS
Revenue	581,225	590,448	223,251	196,831
Cost of Sales	0	0	(10,307)	(19,113)
Gross Profit	581,225	590,448	212,944	177,718
General & Administrative	(34,914)	(36,090)	(59,592)	(80,321)
EBITDA	546,311	550,379	153,352	97,397
Operating Profit (before GW and except.)	546,311	550,379	153,352	97,397
Intangible Amortization	0	0	0	(13,267)
Other	0	(3,979)	0	0
Exceptionals	0	0	0	0
Operating Profit	546,311	550,379	153,352	84,131
Net Interest	(38,896)	(26,691)	(20,330)	(25,960)
Other	(6,143)	6,450	0	0
Profit Before Tax (norm)	501,272	530,138	133,022	71,438
Profit Before Tax (FRS 3)	501,272	530,138	133,022	58,171
Tax	(179,028)	(197,343)	(40,734)	(12,007)
Deferred tax	(0)	(0)	(0)	(0)
Profit After Tax (norm)	322,244	332,795	92,287	59,430
Profit After Tax (FRS 3)	322,244	332,795	92,287	46,164
Minority interest	0	0	(3,968)	(7,358)
Profit After Tax after Minority Interest (FRS 3)	322,244	332,795	88,319	38,805
Average Number of Shares Outstanding (m)	158.2	163.4	164.2	167.5
EPS - normalized (c)	203.66	203.69	53.80	31.10
EPS - FRS 3 (c)	203.66	203.69	53.80	23.17
Dividend per share (c)	61.1	60.2	20.0	20.0

Gross Margin (%)	100.0	100.0	95.4	90.3
EBITDA Margin (%)	94.0	93.2	68.7	49.5
Operating Margin (before GW and except.) (%)	94.0	93.2	68.7	49.5

BALANCE SHEET
Fixed Assets	606,453	733,468	905,359	838,659
Intangible Assets	0	0	199,000	185,733
Tangible Assets	62	31	19	7
Royalty rights	259,244	399,204	383,124	346,521
Other	347,147	334,233	323,216	306,398
Current Assets	355,897	279,731	344,148	404,108
Stocks	0	0	0	0
Debtors	300	0	0	0
Cash	291,377	218,883	228,248	302,323
Other	64,220	60,848	115,900	101,785
Current Liabilities	(187,983)	(36,662)	(117,934)	(283,249)
Creditors	(318)	(394)	(662)	(662)
Short term borrowings	(175,496)	(24,966)	0	(254,315)
Other	(12,169)	(11,302)	(117,272)	(28,272)
Long Term Liabilities	(313,930)	(283,485)	(369,901)	(185,549)
Long term borrowings	(276,228)	(232,835)	(316,352)	(132,000)
Other long term liabilities	(37,702)	(50,650)	(53,549)	(53,549)
Net Assets	460,437	693,052	761,671	773,969
Minority Interests	0	0	(9,000)	(12,840)
Shareholder equity	460,437	693,052	752,671	761,129

CASH FLOW
Operating Cash Flow	292,281	301,465	74,263	544
Net Interest	0	0	0	0
Tax	0	0	0	0
Capex	(49)	(9)	(199,024)*	(24)
Acquisitions/disposals	21,360	(71,593)	10,735	73,207
Financing	0	0	0	0
Dividends	(96,557)	(98,307)	(32,883)	(33,491)
Other	(159,420)	(8,046)	106,273	(23,160)
Net Cash Flow	57,615	123,510	(40,635)	17,076
Opening net debt/(cash)	300,978	160,347	38,918	88,104
HP finance leases initiated	0	0	0	0
Exchange rate movements	0	0	0	0
Other	83,016	-2,081	-8,551	-12,963
Closing net debt/(cash)	160,347	38,918	88,104	83,992

Source: Edison Investment Research, PDL BioPharma reports. Note: FY16 and FY17 estimates include the consolidated financial results of Noden. *FY16e capex relates to the acquisition of intangible (Tekturna brand) from Novartis.

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