What Does Klarman see in Facet Biotech?
Just the FACTs Seth, Just the FACTs
Set Klarman of Baupost Group
I originally disagreed with this Seeking Alpha article which claimed Facet Biotech Inc (FACT) was a current Seth Klarman favorite. However, upon more research it appears Klarman, the founder of Baupost Group, does indeed see value in this biotech spin-off from PDL BioPharma Inc, PDLI. In my defense it was difficult to give credibility to a writer who said Klarman wrote Benjamin Graham’s fundamental investing classic
Security Analysis. Plus, first appearances made it easy to conclude that Baupost Group simply inherited the Facet shares when it was spun-off from their major holding of PDLI.
According to Baupost Group’s year end filing they held 2,772,092 shares or 11.6% of Facet. They received those shares when FACT was spun-off from PDL, in which Baupost owns 14,363,749 shares, up slightly from the 13,860,460 shares they owned at the end of Q3 2008 and on the December 3 record date when one share of Facet was granted for every 5 PDLI shares.
I had assumed Klarman would quickly sell his holding in Facet for two reasons. In his ironically over valued classic Margin of Safety he highlighted the initial downwards share price path of spin-offs due to institutional selling creating a temporary supply-demand imbalance. I also thought he might be a tad gun shy of speculative biotech after his recent ACUS debacle. However, according to this recent filing Klarman has indeed upped his stake to 3,985,567 shares or 16.68% of Facet. He appears to have focused on buying after the institutional selling forced the share price significantly under the cash backing. While Graham extolled the virtues of net nets, in Facet’s case selling for less than their cash, that is generally a poor measure for a cash burning biotech. So is Klarman attracted by the current undervalued stock or does he see value in Facet’s pipeline?
PDL set Facet up with $405 million for the clinical development of daclizumab, volociximab, elotuzumab and PDL192, the research and development of pre-clinical programs, working capital, and general corporate purposes.
This analysis of Facet by WdiJohns at UpDown.com includes a good summation of spin-offs.
A spin-off is essentially the formation and forced distribution of shares of a side company (which, in many cases, could not be sold) onto uninterested, indifferent shareholders of the parent company. Most of these shareholders are institutions who, for various reasons, cannot hold the spin-off’s shares even if they wanted to. This results in mass selling pressure due to a supply-side imbalance; and whenever indiscriminate (regardless of price or investment merit) selling takes place opportunities for value investors may materialize.
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Here’s the calculation using Facet’s Sept 30th, 2008 pro-forma balance sheet: (Current Assets = $420,000,000) – (Total Liabilities = $102,218,000) = $317,782,000/(Shares Outstanding = 24,000,000) = $13.24. $13.24 represents the approximate per share liquidation value of Facet, this does not include the $124,500,000 in plant, property and equipment, net, or other long-term assets, and $405 of that $420 million is cash. The approximate margin of safety of an investment in Facet Biotech at $8.09 is $13.24/$6.42 = 51%.
As the above analysis highlighted Facet is selling at a significant discount to it’s cash backing. With the current price of $6.56, the only downside appears to be from further institutional selling. Looking at the chart and volume it appears most of the selling was completed by the end of January.
On Jan 7 Facet announced they had restructured the company and cash burn for 2009 would be $110M. In this presentation Facet maintains they can fund business operations for four years. That gives them enough time to progress their clinical trials with an outside chance of success. The presentation provides an excellent overview for anyone looking to dig deeper into what Klarman may see.
Pipeline Update and Why FACT was spun-off
The company’s current clinical-stage programs consist of daclizumab for the treatment of multiple sclerosis, currently in a second phase 2 trial and for which the company has presented positive data from a placebo-controlled phase 2 clinical trial; volociximab, currently in phase 1/2 studies in ovarian and non-small cell lung cancer; elotuzumab, which is in three phase 1 studies in patients with multiple myeloma; and PDL192, which is in a phase 1 study in various solid tumors. Facet Biotech is developing daclizumab and volociximab in collaboration with Biogen Idec Inc. and elotuzumab in collaboration with Bristol-Myers Squibb Company.
As PDL’s chairman Brad Goodwin said
The spin-off of our biotechnology operations [Facet] from our royalty assets will enable investors to invest in and realize the benefits of each asset fully and independently. The spin-off will better allow PDL to return the value of the royalty assets to its stockholders, and enable Facet, the new biotechnology company, to create value by investing in disciplined R&D activities to improve patients’ lives and create value for stockholders.
Baupost’s stake in PDLI made sense to me as an investment in a royalty stream. I didn’t think Klarman would be interested in the R&D of Facet, but now my interest is peaked and at the current price there appears to be little downside.
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