March 15, 2011 - 6:47pm EST by
2011 2012
Price: 5.47 EPS $1.64 $1.97
Shares Out. (in M): 140 P/E 3.34x 2.78x
Market Cap (in $M): 764 P/FCF 3.34x 2.78x
Net Debt (in $M): 348 EBIT 380 437
TEV ($): 1,112 TEV/EBIT 2.93x 2.54x

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PDL BioPharma, Inc.

Nasdaq: PDLI

While very few things are presently undervalued, I believe PDLI presents pronounced asymmetry. It would appear that the chance of ultimate loss is exceedingly low, while numerous potential catalysts exist to provide a great return.  PDLI can simply be viewed as an annuity, although a misunderstood one in my opinion.  


From the company's most recent form 10-K:

"We were organized as a Delawarecorporation in 1986 under the name Protein Design Labs, Inc. In 2006, we changed our name to PDL BioPharma, Inc. Our business is the management of our antibody humanization patents and royalty assets which consist of our Queen et al. patents and license agreements with leading pharmaceutical and biotechnology companies pursuant to which we have licensed certain rights under our Queen et al. patents. We receive royalties based on these license agreements on sales of a number of humanized antibody products marketed today and also may receive royalty payments on additional humanized antibody products launched before final patent expiry in 2014. Under our licensing agreements, we are entitled to receive a flat-rate or tiered royalty based upon our licensees' net sales of covered antibodies. 

Until December 2008, our business included a biotechnology operation which was focused on the discovery and development of novel antibodies which we spun-off (the Spin-Off) as Facet Biotech Corporation (Facet). From March 2005 until March 2008, we also had commercial and manufacturing operations which we partially divested in 2006 and fully divested in 2008." 

Following the Facet Spin-Off, the company relocated to Nevada to avoid state income tax in California.  PDLI currently has a total of eight full-time employees and one part-time employee.  

Note that after paying special dividends during 2008 ($4.25 per share), 2009 (total of $2.67 per share), and 2010 ($1.00 per share, the board adopted a regular dividend policy of $0.15 per quarter, or $0.60 per share annually, in February 2011.

A Very Quick Overview of Antibody Humanization Technology
The following information has been reproduced from March 2011 Company Overview which is available at www.pdl.com:

Antibody Humanization Technology

  • Antibodies are naturally produced by humans to fight foreign substances, such as bacteria and viruses
  • In the 1980's, scientists began creating antibodies in non-human immune systems, such as those of mice, that could target specific sites on cells to fight various human diseases
  • However, mouse derived antibodies are recognized by the human body as foreign substances and may be rejected by the human immune system
  • PDL's technology allows for the "humanization" of mouse derived antibodies by moving the important binding regions from the mouse antibody onto a human framework
  • PDL's humanization technology is important because the humanized antibodies retain the binding and activity levels from the original mouse antibody
  • PDL's technology has been incorporated into antibodies to treat cancer, eye diseases, arthritis, multiple sclerosis and other health conditions with aggregate annual sales of almost $20 billion

Resolved Litigation

The following is taken directly from the company's Febraury 28, 2011 press release announcing fourth quarter and full year results:

Settlement with MedImmune

As previously announced, PDL entered into a settlement agreement with MedImmune resolving all legal disputes between the companies, including those relating to MedImmune's product Synagis, and PDL's patents known as the Queen et al. patents. Under the settlement agreement, PDL paid MedImmune $65.0 million on February 15, 2011 and will pay an additional $27.5 million by February 10, 2012, for a total of $92.5 million. No further payments will be owed by MedImmune to PDL under its license to the Queen et al. patents as a result of past or future Synagis sales and MedImmune agreed to cease any support, financialor otherwise, of any party involved in the appeal proceeding before the EPO relating to the opposition against PDL's European Patent No. 0 451 216B (the '216B Patent) including the opposition owned by BioTransplant Incorporated (BioTransplant).

Settlement with UCB

Also in February 2011, PDL reached a settlement agreement with UCB Pharma S.A. (UCB) that resolves all legal disputes between the companies. Under the agreement, PDL provided UCB a covenant not to sue UCB for any royalties regarding UCB's Cimzia(R) product under the Queen et al. patents in return for a lump sum payment of $10 million, to be recognized as revenue in the first quarter of 2011. In addition, UCB agreed to terminate pending patent interference proceedings before the U.S. Patent and Trademark office (PTO) involving PDL's U.S. Patent No. 5,585,089 patent (the '089 Patent) and the '370 Patent in PDL'sfavor. UCB also agreed to formally withdraw its opposition appeal challenging the validity of the '216B.

Settlement with Novartis

On February 25, 2011, PDL reached a settlement with Novartis. Under the settlement agreement, PDL agreed to dismiss its claims against Novartis in its action in Nevada state court which also includes Genentech, Inc. (Genentech) and F. Hoffman LaRoche Ltd (Roche). Novartis agreed to withdraw its opposition appeal in the EPO challenging the validity of the '216B Patent. The settlement does not affect PDL's claims against Genentech and Roche in the Nevada state court action. Under the settlement agreement with Novartis, PDL will pay Novartis an amount based on net sales of Lucentis during calendar year 2011 and beyond. The Company does not currently expect such amount to materially impact our total annual revenues.

Acquisition of BioTransplant

On February 8, 2011, the United States Bankruptcy Court for the District of Massachusetts issued an order approving the acquisition of BioTransplant by PDL's wholly owned subsidiary, BTI Acquisitions I, Inc. for $415,000. In February 2011, PDL instructed BioTransplant's representative before the EPO to formally withdraw its opposition appeal challenging the validity of the '216B Patent. PDL believes that BioTransplant's activities before the EPO, including payment of counsel fees, were financially supported by MedImmune. By virtue of PDL's acquisition of BioTransplant and settlement of all disputes with MedImmune, including their financial support of BioTransplant's appeal in the opposition proceeding, PDL was able to ensure that BioTransplant's opposition and appeal would be withdrawn in accordance with the governing rules of practice before the EPO.

Termination of European Opposition to '216B Patent

Pursuant to PDL's settlements with UCB, MedImmune and Novartis, and as a result of PDL's acquisition of BioTransplant and subsequent withdrawal of BioTransplant's appeal, all of the active appellants in the EPO opposition have formally withdrawn their participation in the appeal proceeding. Accordingly, the EPO has canceledthe appeal proceeding and terminated the opposition proceeding in its entirety, with the result that the 2007 EPO decision upholds the claims of PDL's '216B Patent as valid, which will become the final decision of the EPO. In the year ended December 31, 2010, approximately 35 percent of PDL's revenues were derived from sales of products that were made in Europe and sold outside of the United States.

Following the above resolutions, the company'sonly material outstanding litigation is a law suit filed by PDLI in the state of Nevada against Genentech and Roche, which is briefly referenced above under "Settlement with Novartis".  This case will be addressed in greater detail below.


PDLI's Current License Agreements and Royalties

As of December 31, 2010, the company has the following license agreements in place: 


Product Names

Genentech, Inc.








Elan Corporation


Wyeth Pharmaceuticals, Inc.


Chugai Pharmaceutical Co., Ltd.

Actemra / RoActemra

During the year ended December 31, 2010, Genenetch (Roche) accounted for 85% of revenues and Elan accounted for 10%.  Note that MedImmune, discussed above under "Recently Resolved Litigation", accounted for no royalties during 2010. For a better understanding of the Genentech/Roche products, as well as Elan's Tysabri, please refer to their latest respective annual reports. 

Note that the products listed, excluding those of Chugai Pharmaceuticals (which is a majority-owned subsidiary), amounted to roughly 38% of Roche's total 2010 sales.

In June 2010, after adverse results from a clinical trial, Pfizer discontinued "commercial availability" of Mylotarg.   


Genentech/Roche Royalties

PDLI's master patent license agreement with Genentech provides for a tiered royalty structure for any royalty-bearing products manufactured orsold in the United States.  For those products both made andsold outside of the United States, PDLI receives a flat 3.0%.  The following table describes the applicable royalty rates for Genentech's U.S.-based sales: 

Aggregate Net Sales

Royalty Rate

  Net sales up to $1.5 billion


  Net sales between $1.5 billion and $2.5 billion


  Net sales between $2.5 billion and $4.0 billion


  Net sales exceeding $4.0 billion


Note that the average royalty rate on all Genentech/Roche products was 1.9% in 2010, compared to 1.7% in 2009.  The average royalty rate is expected to increase in future periods as Genentech is expected to begin manufacturing a greater share of their products abroad. Noteworthy are two plants, one in Singapore and one in the European Union, that will begin manufacturing and supplying Lucentis in 2011 and 2012.  For those products ultimately sold in the United States, the above tiering will continue to apply. That said, a great deal of Lucentis sold internationally was previously manufactured in San Francisco. Such international sales, if no longer produced with the US, would be subject to the 3% flat royalty rate.  It is my understanding that by 2012, all Lucentis will be manufactured ex-U.S.


PDLI's Outstanding Debt

PDLI had the following debt outstanding as of December 30, 2010.  Note that the table reflects expected maturities related to the issue labeled "Non-recourse":


2012 Notes

2015 Notes

































2012 and 2015 Convertible Notes

Both issues are convertible at a conversion rate of 144.474 per $1,000, or $6.92 per share.  Neither issue is puttable.  The 2012 Notes are currently redeemable at 100.29% of par.  The 2015 Notes do not become redeemable until August 15, 2014, at which time they can be called at 100% of par.

Non-recourse Notes: The "Securitization Transaction"

From the most recent PDLI 10-K:

"In November 2009, we completed a $300 million securitization transaction in which we monetized 60% of the net present value of the estimated five year royalties from sales of Genentech products (the Genentech Royalties) including Avastin®, Herceptin®, Lucentis®, Xolair®and future products, if any, under which Genentech may take a license under our related agreements with Genentech. The QHP PhaRMA Senior Secured Notes due 2015 (the Non-recourse Notes) bear interest at 10.25% per annum and were issued in a non-registered offering by QHP, a Delawarelimited liability company, and a newly formed, wholly-owned subsidiary of PDL. Concurrent with the securitization transaction and pursuant to the terms of a purchase and sale agreement, we sold, transferred, conveyed, assigned, contributed and granted to QHP, certain rights under our non-exclusive license agreements with Genentech including the right to receive the Genentech Royalties in exchange for QHP'sproceeds from the Non-recourse Notes issuance. Once all obligations on the Non-recourse Notes have been paid in full, including all other sums payable under the indenture, the indenture shall cease to be of further effect and all of the security interests in the collateral shall terminate, including the pledge by PDL to the trustee of its equity interest in QHP. At such point, there will be no further restrictions on the Genentech Royalties and PDL shall be free to either keep them in QHP, transfer them back to PDL or to further dispose or monetize them."

As you can see from the above table, the company expects the QHP issuance to be completely repaid in 2012.  Management has stated that they will not pursue future securitizations.  
PDLI's Balance Sheets and Adjusted YE 2010 Balance Sheet
The following adjusted balance sheet should assist the reader in following our later forecasts, as we transition from accrual to a cash-based approach:

Consolidated Balance Sheets





(In thousands, except per share data)















Current assets:





  Cash and cash equivalents





  Short-term investments





  Receivables from licenses





  Deferred tax assets





  Foreign currency hedge





  Prepaid and other current assets





    Total current assets





Property and equipment, net





Long-term investments





Long-term deferred tax assets





Other assets





    Total assets










Liabilities and Stockholders' Deficit:





Current liabilities:





  Accounts payable





  Accrued legal settlement





  Accrued liabilities





  Deferred revenue





  Current portion of convertible notes payable





  2012 Notes





  2015 Notes





  Current portion of non-recourse notes payable





    Total current liabilities





Convertible notes payable





  2012 Notes 





  2015 Notes





Non-recourse notes payable





Long-term deferred revenue





Other long-term liabilities





    Total liabilities





Stockholders' Deficit:





  Preferred stock





  Common stock





  Additionalpaid-in capital





  Accumulated other comprehensive income





  Retained earnings/Accumulated deficit





   Total stockholders' deficit





    Total liabilities and stockholders' deficit






The "2010 Adjusted" column has been adjusted to reflect the following items:

  • Cash and cash equivalents has been adjusted to reflect the 12/31/2010 balance less $65MM paid to MedImmune plus $10MM received (or to be received)from UCB Pharma S.A.  Cash has been further reduced by $20,952 to account for the Q1 2011 dividend.
  • Prepaid and other current assets have been reduced by $3.362MM in "Non-recourse Notes issuance costs"
  • PP&E has been assumed worthless
  • Other assets have been reduced to $0, as all "Other assets"are issuance costs
  • Acrrued legal settlement of $27.5MM due MedImmune by February 2012 has been brought up from Otherlong-term liabilities
  • Other long-term liabilies have been reduced by the $27.5MM moved to"Accrued legal settlement" and also the $10.7MM Facet lease guaranty. While I would have excluded the lease guaranty regardless, note that Facet was acquired by Abbott in April 2010.
  • Retained earnings/accumulated deficit has been adjusted to balance
Miscellaneous Items and Inputs for Scenarios That Follow
  • Aside from the $92.5 million legal settlement with MedImmune expensed during 2010, the other rather extraordinary item was "Legal Fees" which increased to $29.3 million, from $10.9 million in 2009.  During the company's most recent earnings conference call, the CFO stated that "in 2010 our total legal expenses were $29.3 million, of which almost 90% of that was due to these legal issues that we've now resolved."  Thus going forward from 2010 we have modeled "Legal fees" flat at $2.9 million per year.
  • Also within SG&A we have held "Insurance expense" flat at $793,000, "Stock-based Compensation" flat at $662,000, assumed $0 depreciation as PP&E was assumed worthless and "Other" was fixed at the 2010 and 2009 average of roughly $2.6 million.
  • There seems to be a misconception in "the market" about PDLI's patent expirations in 2014, and how this effects the company thereafter, with most market participants apparently making the assumption that revenues will stop on January 1, 2015. While the Queen et al. patents do face final expiration in December 2014 (Herceptin in mid-2014), products manufactured prior to expiration, but sold thereafter will still provide royalty payments to PDLI. At the Cowen and Company Health Care Conference on March 8, 2011 (playback can be accessed here -   http://www.wsw.com/webcast/cowen3/register.aspx?conf=cowen3&page=pdli&url=http%3A//www.wsw.com/webcast/cowen3/pdli/) - an extremely important point is made about "inventory" levels and production time.  The speaker indicates that inventory levels of closer to two years would likely be the normal level, but that inventory at 12 months supply would have PDLI receiving royalties through the first quarter of 2016.
  • Royalties are received one quarter in arrears, typically in the second month of each quarter.  Royalty receipts are typically highest in the first and second quarters, as this corresponds to higher sales by licensees in Fall and Winter.
  • I have excluded any potential dilution from employee options, which is consistent with the past few years and seems most likely given outstanding options and related exercise price.
  • Given the conversion rate and resulting price, I have assumed that the 2012 Converts are redeemed in cash in 2012 and that the 2015 Converts are converted into 40 million common shares in mid-2014 at a price of $4.50. Thus the share count is approximately 180 million at 3/31/2016.
  • I have assumed that the company operates until March 31, 2016, at which time it is liquidated.  Given management's commentary on their hope to purchase new roalty assets, such an assumption obviouslyseems somewhat counterintuitive. Given that management is only contemplating "approved products" I do not find this risk substantial enough to derail the following hypothetical valuations. If anything, I believe such a purchase has a high likelihood of being value enhancing via a higher "yield" on what I have assumed below to be excess cash.
  • Marginal tax rate of 35%.
  • Dividends of $0.15 per quarter are paid between now and December 2015.  Therefore the valuation excludes the dividend already declared in Q1 2011 as does return data ($ and %).
  • No milestone payments received.
  • Note that while Compensation expense and Professionalfees are arbitrarily adjusted in what follows, the impact between 15% or 20% is immaterial.
  • While we live in a chaotic world, the below assumes linearity. 

All of the above hold throughout the three outcomes addressed.

"Worst-Case" Scenario Valuation
 While there are far worse scenarios which could be entertained, the following represents my worst-case scenario.  I find this scenario extremely unlikely, especially given Q1 royalty revenue guidance provided by the company of $73 million.  Here are the assumptions:
  1. Revenue remains flat at 2010 level through the first quarter of 2016
  2. Compensation expense grows at 20% annually
  3. Professional fees grow at 20% annually
  4. Yield on cash (previous year's balance) equates to 0.25%.

After receiving $2.85 per share in dividends, book value at 3/31/2016 is $2.39.  Sum equals $5.24.  This would represent a 4.21% overall loss or CAGR of negative 1.11%.

Better Scenario
  1. Revenue grows at 15% per year from 2010 level through the first quarter of 2016, ramping up beyond 2011 as Genentech manufacturing moves away from US
  2. Compensation expense grows at 15% annually
  3. Professional fees grow at 15% annually
  4. Yield on cash (previous year's balance) equates to 0.50%

After receiving the same $2.85 per share in cumulative dividends, book value increases to $6.27.  Sum equals $9.12.  This outcome would represent a 66.73% gain or CAGR of 12.71%.


Upside Scenario Basis

Genentech/Roche Lawsuit

From the most recent PDLI 10-K:

"Genentech / Roche Matter

Communications with Genentech regarding European SPCs

In August 2010, we received a letter from Genentech, sent on behalf of Roche and Novartis, asserting that Avastin®, Herceptin®, Lucentis® and Xolair®(the Genentech Products) do not infringe the supplementary protection certificates (SPCs) granted to PDL by various countries in Europe for each of the Genentech Products and seeking a response from PDL to these assertions. Genentech did not state what actions, if any, it intends to take with respect to its assertions. PDL's SPCs were granted by the relevant national patent offices in Europe and specifically cover the Genentech Products. The SPCs covering the Genentech Products effectively extend our European patent protection for the '216B Patent generally until December 2014, except that the SPCs for Herceptin will generally expire in July 2014.

Genentech's letter does not suggest that the Genentech Products do not infringe PDL's U.S. patents to the extent that such Genentech Products are made, used or sold in the United States (U.S.-based Sales). Genentech's quarterly royalty payments received in August and November of 2010 after receipt of the letter included royalties generated on all worldwide sales of the Genentech Products.

If Genentech is successful in asserting this position, then under the terms of our license agreements with Genentech, it would not owe us royalties on sales of the Genentech Products that are both manufactured and sold outside of the United States. Royalties on sale of the Genentech Products that are made and sold outside of the United States (ex-U.S.-based Manufacturing and Sales) accounted for approximately 35% of our royalty revenues for the year ended December 31, 2010. Based on announcements by Roche regarding moving more manufacturing outside of the United States, this amount will increase in the future.

We believe that the SPCs are enforceable against the Genentech Products, that Genentech's letter violates the terms of the 2003 settlement agreement and that Genentech owes us royalties on sales of the Genentech Products on a worldwide basis. We intend to vigorously assert our SPC-based patent rights."

See above under "Termination of European Opposition to '216B Patent"

"Nevada Litigation with Genentech, Roche and Novartis in Nevada State Court

In August 2010, we filed a complaint in the Second Judicial District of Nevada, Washoe County, naming Genentech, Roche and Novartis as defendants. We intend to enforce our rights under our 2003 settlement agreement with Genentech and are seeking an order from the court declaring that Genentech is obligated to pay royalties to us on ex-U.S.-based Manufacturing and Sales of the Genentech Products.

The 2003 settlement agreement was entered into as part of a definitive agreement resolving intellectual property disputes between the two companies at that time. The agreement limits Genentech's ability to challenge infringement of our patent rights and waives Genentech's right to challenge the validity of our patent rights. Certain breaches of the 2003 settlement agreement as alleged by our complaint require Genentech to pay us liquidated and other damages of potentially greater than one billion dollars. This amount includes a retroactive royalty rate of 3.75% on past U.S.-based Sales of the Genentech Products and interest, among other items. We may also be entitled to either terminate our license agreements with Genentech or be paid a flat royalty of 3.75% on future U.S.-based Sales of the Genentech Products.

On February 25, 2011, we reached a settlement with Novartis under which, among other things, PDL agreed to dismiss its claims against Novartis in its action in Nevada state court against Genentech, Roche and Novartis. Genentech and Roche continue to be parties to the Nevada suit. The outcome of this litigation is uncertain and we may not be successful in our allegations. For further information, see "Item 3-Legal Proceedings.""

Essentially, PDLI is accussing Genentech/Roche of breach of contract. During the most recent conference call the PDLI CEO said the following:

"So in the Genentech dispute so far, the issue is whether or not they breached the settlement agreement.  They have sent us a fax (yes, the letter was a fax) questioning whether or not they infringe in Europe and we have responded that we believe that you can't raise that question in the context of an SPC without actually challenging the underlying lenity of the patents.

And that's the advice we got from all our foreign councils but the only real, the only legaldispute in terms of a court action between the parties right now is PDL suit in the State of Nevada for breech of the 2003 settlement agreement which is really a contractual dispute.  And at this point it doesn't have any patent claims and I don't know that I can envision the means where patent claims would be brought to bear in that.  If at some point they took some other actions that could happen, but I don't know that I can specualte as to what they may or may not be doing at this point."

A little later in the call -

"In fact because the SPC describes the product specifically, it calls the product actually by its generic name, that you can't challange an SPC in terms of infringement, the only challanges is in terms of validity and that is a breach of the 2003 settlement agreement. And as I discussed in response to your earlier question, there are penalties for violating that."

I have no idea if this situation eventually adds value to PDLI or not.  I initially looked to dismiss it because, as my thinking went, "it is just a fax".  Upon further reflection, and knowing that Roche purchased Genentech and may have acted in haste, I cannot rule out something positive resulting.  Regardless, downside to PDLI does not currently exist.

Additional Products

While I am unable to go into detail in this space, I believe there to be a high likelihood that PDLI's royalty stream is much larger in two to three years, as numerous potential products sit in Phase II and III FDA trials.  Take a look at the pipeline data on Roche's website.  Also, see slide 15 of the March 2011 Company Overview - http://pdl.com/wp-content/uploads/2010/07/Company-Overview-March-2011.pdf.  Also have a look at slides 25 and 26 of the same presentation.

Upside-Scenario Valuation

  1. Revenue grows at 20% annually from 2010 level through March 31, 2016, as new products are introduced following FDA approval
  2. Compensation expense grows at 15% annually
  3. Professional expenses grow at 15% annually
  4. Excess cash earns 1%
  5. $500 million judgment/settlement with Roche/Genentech received in 2013.  Note that for every $100 million received, book value per share would increase by roughly $0.37 per share.  
Same $2.85 in dividends are received through December 31, 2015.  At March 31, 2016 book value is $11.75.  Sum equates to $14.60, or 166.91% above today's closing price of $5.47.  CAGR would be 24.46%.

While this scenario is quite optimistic, it is not difficult to see that should a few things go in PDLI's favor, considerable value could be realized.

  • Further litigation - I am not quite sure how likely this risk is, but it must always be acknowledged
  • Misallocation of capital - As mentioned briefly above, management has mentioned a number of times the intent to purchase currently marketed royalty assets.  Assuming the price paid is right, I am not sure this strikes me as much of a risk as an opportunity. A 10% yield on excess cash, if the ideal home could be located, would add roughly $1 per share above.
  • Cancer and macular degeneration cease to be a problem - cross your fingers

While any of the above assumptions might be questioned, it is hard to see how PDLI does not represent an asymmetric opportunity.  A favorable developmentin the Genentech/Roche matter, future products being marketed by licensees, potential milestone payments (which I did not incorporate into the above), etc. could contribute materially to the value shareholders realize over time.  The great thing about PDLI is that the chance of ultimate loss appears extremely low and an owner is paid just shy of 11% currently to see if a few things work out. 

Note that should inventory levels be at a "more normal" 24 month level when the Queen et al. patents expire, the royalty stream would likely continue for another maybe 12 months, adding considerable upside to all scenarios presented.


Disclaimer: Funds we (me, myself, and I) manage own shares of PDLI.  We may buy or sell PDLI without informing the VIC community.  Do your own research.


Aside from a favorable Genentech/Roche ruling or additional products being approved and launched by current (or new) licensees, I do not see a near term catalyst. Therefore, patience is likely required. A nearly 11% dividend yield should help one wait for the business to simply perform. 
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