PDL Biopharma: liquidation in the final innings

PDL Biopharma (NASDAQ:PDLI) announced at the end of 2019, after a strategic review, that the company would cease making investments and pursue a strategy of monetizing their existing assets. This year the company has made a huge amount of progress. They completed two separate spin-offs, sold another operating division, reached a big settlement on some outstanding notes and sold a small part of their royalty portfolio. If every company could be as quick in implementing a liquidating as PDLI I would be a happy camper. PDL Biopharma is now about to enter the final phase of its liquidation process, and will file a certificate of dissolution with the state of Delaware on January 4, 2021 after which the stock will cease to trade.

Thanks to the flurry of transactions done this year the company is now a greatly simplified entity, and yesterday they published for the first time a balance sheet under liquidation basis of accounting. Because of this all costs that are expected to be incurred during the liquidation are added as a liability on the balance sheet, making it easy to estimate the total amount of liquidation distributions we can roughly expect. As you can see below the company has, proforma for the Lensar spinoff that occured after the end of the quarter, net assets in liquidation of $382.3 million.

With 114.2 million shares outstanding this translates to $3.35/share while the stock is currently trading around $2.35 which implies a potential upside of more than 40%. Of course, just by looking at the balance sheet above you know that most of the value resides in assets that are less certain than cold hard cash and we have to account for the fact that the remainder of the liquidation could take a significant amount of time. But at the same time, I don’t you don’t need to do a deep analysis to know that with a spread of more than 40% between net assets and price any potential return will most likely be pretty okay. Unless, of course, you believe the value of the assets on the balance sheet are all wildly overstated and deserve a huge haircut. I don’t think that they do, but some of the receivables certainly carry credit risk and might not be paid in full. I will breakdown the remaining assets below:

  • Receivables from asset sales
    These are the receivables from the sale of the Noden operating subsidiary. It was sold for up to $52.83 million, of which $12.2 million was paid at closing. The remainder will be paid in the next three years in quarterly installments, and there are two additional contingent payments of $3.25 million in total, and a small VAT reimbursement receivable. The carrying value on the balance sheet is slightly lower, but not by much, than the sum of all possible payments.
  • Notes receivable
    These notes are the ones involved in the settlement mentioned in the introduction. PDLI loaned out money on a secured basis to Wellstat, but they defaulted. After a bunch of legal proceedings they reached a settlement under which Wellstat would pay $7.5 million at signing and either $5 million in February 2021 and $55 million in July 2021, or $67.5 million in July 2021. Obviously there are some risks here giving the background of litigation, but paying $7.5 million shows a decent commitment to the settlement in my book. The carrying value on the balance is also discounted compared to minimum of $60 million outstanding.
  • Royalty assets
    With a value of $227 million they are by far the biggest asset, and will for a large part determine the outcome of this liquidation. The company is looking to sell the royalties, but if its unable to find a buyer that is willing to pay a good price they are considering putting it in a liquidation trust and let the cash flow to shareholders. I’m perfectly fine with that. The royalties are generating solid cash flows, $17.6 million in the last three months, and $42.6 million in the last nine months. Because almost all royalties are from a single drug (Glumetza) the stream of cash is not the most stable. It is declining as well because of competition from multiple generics that have been on the market for some years. But just based on historical cash flows the valuation seems to be in the right ballpark, and it is certainly not going to be a zero. They will generate some solid cash flows.
  • Income tax receivable
    This is a “little” present from the Trump administration. These are mostly losses that they can now carry back to previous years when they were a significant tax payer. While I can imagine that it will take some time before they get this money from the IRS, I think this should be a low risk asset that will almost certainly payout.

The liability side of the balance sheet does not need a whole lot of discussion. The only item that could perhaps generate a windfall profit, but also could turn out to be more costly, are the uncertain tax positions. The company is under audit for the tax years 2009 through 2015 by the California Franchise Tax Board and for the 2016 tax year by the IRS. In September the company reduced the carrying amount of the uncertain tax positions by $4.4 million, so that shows that there is the possibility for (hopefully, positive) surprises there.

Given that the last payments from the Noden sale will not be received before the end of 2023 it is clear that this liquidation will take time to complete. Additionally, the Wellstat notes will only be paid halfway in 2021, it will take time to get the tax receivable, and it will take time to sell the royalty portfolio. To get an idea what kind of impact the timing of these cash flows will have on the eventual internal rate of return that investors can expect I created the following simplistic cash flow model. There are some small assets that I ignore, and the timing of these cash flows are not necessarily the timings you should expect as an investor in the stock.

Simplistic cash flow model PDLI liquidation

You might have noticed that there is $83 million of cash on the balance sheet. I have made the conservative assumption that this whole amount will be fully reserved to pay for the known liabilities, and not used for an initial liquidation distribution. Since the total liabilities are $106.5 million I have also adjusted the cash flow from the Wellstat payments downwards by $15 million, adding a few million as a reserve for unknown liabilities as well (common in a liquidation). The $5 million liability “cost to sell assets” has been deducted from the potential proceeds from the royalty portfolio sale.

As you can see, this simplistic model throws out a more than satisfactory 27% IRR. You can recreate it and play around with some assumption, but you will see that there is quite some room for bad news before returns turn negative. Reduce the Wellstat payment by $45 million and the IRR is still 14.5%. Set all the Noden payments to zero? 17.5%. A 50% (!!!) haircut on the royalty portfolio? Still a 1% positive return.

Conclusion

PDL Biopharma is at the moment one of the idea’s I’m most enthusiastic about. I think it is easy to see how this liquidation can generate great returns while multiple things most go horribly wrong before you start losing money. That’s the kind of bet I like to make. But perhaps I’m missing something, and in that case I would love to hear from you!

Disclosure

Author is long PDLI

34 thoughts on “PDL Biopharma: liquidation in the final innings

  1. bp

    I really appreciate the post. I think this is a great opportunity as well. I wonder if the company will be buying shares with the remaining repurchase authorization? The stock did seem to sell off in the last 10/15 minutes as the market rallied.

    Reply
      1. bp

        They discontinued the 10b5-1 plan, I believe the share repurchase authorization remains intact. So they could potentially do open market purchases or I guess, maybe another 10b5-1 plan?

        Reply
        1. Alpha Vulture Post author

          Ah right, I guess theoretically they could do that. But in practice I don’t think they will buy a single share. With all the sale discussions they are having they have presumably material inside information, so there cannot be much of a trading window for them. Especially since the stock will cease to trade at the end of the year.

          Reply
  2. Riley

    Good risk reward!

    I’ve never owned or dealt with something like this before.

    Referring to the quote below… the stock ceases to trade, but distributions from the liquidations continue to flow into the account you own PDLI in… or, how does it work exactly?

    “PDL Biopharma is now about the enter the final phase of its liquidation process, and will file a certificate of dissolution with the state of Delaware on January 4, 2021 after which the stock will cease to trade.”

    Thanks.

    Reply
    1. Alpha Vulture Post author

      I’m not a tax expert, but assuming that you are from the US, in general liquidation distributions first reduce the cost basis of your position till it reaches zero and any income after that is treated as capital gains.

      Reply
  3. VB320

    Hi, on the Glumetza/Assertio royalties:
    – Anyone with a good view on what means the part (b) in this statement (from the filings) regarding the agreement termination?
    The Assertio Royalty Agreement terminates on the third anniversary following the date upon which the later of the following occurs: (a) October 25, 2021, or (b) at such time as no royalty payments remain payable under any license agreement and each of the license agreements has expired by its terms

    – When did the price cut on Glumetza take place, and what was its amplitude? Royalties are down 27% TYD, but a much more impressive -58% YoY in Q3…

    Reply
    1. Alpha Vulture Post author

      The quote describes basically that the royalty agreement can only be terminated three years after no royalty payments remain payable, and no matter what, not before Oct 25, 2021 + 3 years. So no worries that these terminate anytime soon, that would be the case if the language would be “following the date upon which the EARLIER of the following occurs”

      About Glumetza, from the Q4 2019 conference call:

      Bausch Health markets Glumetza, our single largest royalty contributor. In the second half of 2019, they signaled an accelerated shift in channel mix that was expected to result in a substantial decline in net selling prices that would impact the run rate for Glumetza net sales in the fourth quarter and beyond, and in turn, PDL revenues from these assets.

      Reply
    1. Alpha Vulture Post author

      Sloppy work from me!

      But shouldn’t impact things too much. Average strike is $2.62/share. Will be adjusted downwards to account for the Lensar spinoff, but shouldn’t cause to much dilution given that the exercise of the options will also generate cash.

      Reply
      1. value investor wannabe

        The Q3, 2020 earnings call transcript states that they will only start with distributions upon completion of the Safe Harbor procedures, which will take between 12 to 18 months.

        As they will file their Certificate of Dissolution on January 4th, 2021, I don’t think shareholders should expect any distribution before January 4th, 2021 to July 4th, 2021.

        I think there is a low chance of loosing money on this and the IRR is really dependable on the date and size of the first distribution.

        All in all a very interesting risk-reward situation. Thanks for the write-up!

        Reply
        1. value investor wannabe

          What I forgot to ask is: “How do you view the credit worthiness of Wellstat Diagnostics”?

          I cannot find a lot of info on this company and it is thus very difficult to handicap the value of the receivable.

          Reply
  4. Dave

    Any idea why there is a discrepancy between the “ Condensed Royalty Asset Data” on the presentation and income statement?

    Reply
  5. Dave

    Cash royalties are $25.6m for the 3 months ended 9/30/19 but the income statement only shows 15.38m. Same thing with 2020 (I know the time frame are a bit different).

    Reply
  6. Cole

    The royalty sale they did (VB/AcelRX/Kybella) was on the books for $27M and they sold for $4M. Maybe I’m reading too much into that, but concerning given the remaining royalties (Assertio/U-M) are roughly equal on going concern and liquidation basis.

    They had a revenue forecast in 2019 for each royalty through 2026. Applying 20% discount rate (SKW’s stated undiscounted hurdle in IR pres) to the remining royalties, I get in the ballpark of their liquidation value.

    Curious if you have other ways your sense checking that royalty valuation? The investment really hinges on that and tax rebate and agree with you a nice cushion before you start to lose money.

    Reply
    1. Alpha Vulture Post author

      I’m not sure those other royalties are comparable, and I think PDLI was very motivated to sell them because they were partly responsible for the large tax receivables that are now on the balance sheet. Especially AcelRx turned out to be a big loser that they paid too much for.

      But no, I don’t have any special insight in Assertio/VB. But just based on the cash flows that have been generated so far, it looks pretty reasonable to me. They generated $10 million in the past two months. They don’t have to keep that up for very long before you get a meaningful portion of the book value converted to cash.

      Reply
      1. Robert

        Royalty fair value is definitely the crux of value here. Even if you give their stated royalty asset a 25% haircut, you’re at a ~13% upside from today’s share price. I think it’s still a pretty good risk/reward. I’d be interested to see how they actually got to the $277m figure for the royalties on the books.

        Reply
        1. Alpha Vulture Post author

          They have never been willing to share their assumptions, but according to them realized cash flows matched more or less predicated cash flows reasonable well so far.

          But we do know for sure that these cash flows are discounted with a decent discount rate. In the latest 10-Q we can see that the value of the rights increased by $14 million because they switched to liquidation accounting, and now the estimated cash flows till the date the expect to sell the royalties are undiscounted. I would guess that they probably expect to sell in 12 to 18 months, and since TTM of cash flow is ~around $50 million (and I assume they have modelled some decrease in cash flow) you are probably looking at a decent double digit discount rate given the $14 million jump in book value.

          Reply
  7. Derek

    Thanks for the write-up; how does your cash flow estimates reconcile with the statement “Before distributions, PDL will follow Safe Harbor Procedures to potentially reduce the liability of stockholders and Directors from future claims…Safe Harbor Procedures generally require 12-18 months to complete, but may take longer”

    Reply
  8. Dave

    Engine capital (the activist) just sold out their position. They purchased shares at roughly today’s price after accounting for the spinoff. What do you think?

    Reply
  9. Pingback: PDL Biopharama Liquidation (NASDAQ:PDLI) | Pyrrhus Value

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