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.
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.
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!
Author is long PDLI