PDL BioPharma — Update 17 November 2015

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.

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.

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.

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 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. 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.

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.

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.

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 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.