Markets & Finance

PDL's Potent Pick-Me-Up


On balance, the operational diversity, growth, and current valuation of biotech PDL BioPharma (PDLI

; recent price, $30.78) look attractive, and we expect solid upside for the shares. We believe the company carries less risk than most biotechs with similar or smaller market capitalizations due to its more diversified portfolio.

However, we note that the stock could still be highly volatile and downside risk could be strong if results disappoint investors. We find the shares attractive based on our price-earnings (p-e) and net-present-value methodologies. Our recommendation is 5 STARS (strong buy).

PDL, which recently changed its name from Protein Design Labs, markets its own products, derives royalties from several partners, and is involved in research and development through its own efforts and through collaborative arrangements. Of these three operational aspects, we believe that the royalty stream is the most valuable and should remain so in the near term. We think management has also taken steps to strengthen the rest of the company's prospects for the long term.

DEFT MOVE. We believe that some of the company's R&D programs in the recent past were not attractive in relation to their commercial potential and in light of the competitive landscape of approved drugs and compounds that were in development at other companies. However, we believe management refocused its efforts in an effective manner on better programs from a present value standpoint. An additional benefit of this change was the consummation of key development deals with Roche and Biogen Idec (BIIB).

We think the acquisition of ESP Pharma in March, 2005, was a deft move that will eventually lead to solid upside. It has already allowed the company to turn profitable on an ongoing basis for the first time this year. Another potential benefit: increased leverage for potential partnering opportunities -- combining its own compounds with agents from other outfits -- as PDL now has its own sales infrastructure.

Through 2004, PDL was traditionally focused on striking deals for its humanized monoclonal antibody technology and developing its proprietary pipeline. By licensing its technology to other drug developers, we believe the company has built a strong royalty base that we also project to grow nicely over the next several years. Revenues derived from royalties have helped to fund drug development while keeping cash burn at manageable levels relative to other smaller biotech firms.

THE ROCHE CONNECTION. Until the ESP Pharma deal, the company did not market its own products. This acquisition provided it with three modest commercial products and strengthened the pipeline. It also moved PDL into the cardiovascular arena. The company's revenue base was significantly expanded and, we believe, the march to profitability accelerated.

In 2003, the acquisition of EOS Biotechnology brought the experimental antibody M200 into the company's R&D portfolio. In 2004 and 2005, PDL consummated R&D collaborations with Roche Holdings for the development of daclizumab. A development partnership with Biogen Idec ($49.58; 4 STARS, buy) for three PDL agents was formed in 2005. As a result of these acquisitions and R&D deals, PDL's pipeline has improved noticeably over the past three years.

PDL markets three products in the U.S. The company utilizes a hospital-based sales force of over 100 to promote its medications.

BIOTECH NEWCOMERS. Cardene I.V. is approved for the short-term treatment of hypertension when oral therapy is not feasible or desirable. It's the only intravenous calcium channel blocker approved in this indication. Retavase is approved for the management of acute myocardial infarction (heart attack) in order to improve ventricular function, reduce the incidence of congestive heart failure, and reduce mortality associated with heart attack. IV Busulfex is approved as a conditioning agent to be used in combination with cyclophosphamide prior to blood or marrow transplant in patients with chronic myelogenous leukemia.

PDL derives royalties from a number of important biotechnology drugs, including:

Genentech's Avastin. Royalties from this biotech therapy -- currently approved for the first-line treatment of metastatic colorectal cancer -- have the potential to grow significantly for several years, in our view, if Genentech (DNA

; $84.95; 5 STARS) is successful in expanding its use to include additional indications, including the treatment of metastatic breast cancer and non-small cell lung cancer. Avastin is sold by Roche in Europe.

Genentech's Herceptin for the treatment of HER2 positive metastatic breast cancer. Genentech plans to file an sBLA for Herceptin to treat patients with earlier stage breast cancer who are undergoing surgery. Roche also sells Herceptin in Europe.

Xolair, a treatment for moderate to severe asthma in adults and adolescents. This treatment is marketed by Genentech and Novartis (NVS

; $54.28; 4 STARS).

MedImmune's Synagis for the prevention of serious lower respiratory tract disease due to respiratory syncytial virus in pediatric patients.

COMMERCIAL POTENTIAL. PDL also receives royalties from Wyeth (WYE; $49.14; 4 STARS) on sales of Mylotarg for the treatment of acute myeloid leukemia. It also receives royalties from sales of Zenapax (daclizumab) for the prevention of kidney transplant rejection. This therapy is marketed by Roche.

PDL has the potential to start receiving royalties from two additional products in 2006: Genentech's Lucentis for the treatment of age-related macular degeneration (AMD) and multiple sclerosis treatment Tysabri from Biogen Idec and Elan. Of the two, we believe Lucentis has the greater commercial potential, and we expect it to eventually become the AMD market share leader. Tysabri was removed from the U.S. market in February, 2005. However, we expect it to reenter the U.S. market in 2006. While we once thought Tysabri had the potential to reach $1 billion in annual sales in the U.S., we now look for peak sales to eventually hit $300 million.

We think PDL's pipeline has been somewhat overlooked in comparison to the company's royalty prospects. In our view, the two compounds with the most commercial potential are daclizumab and ularitide.

POSITIVE DEAL. In September, 2004, PDL formed an R&D alliance with Roche to develop daclizumab in respiratory diseases, with the lead indication being asthma. PDL received $17.5 million up front and is entitled to up to $187.5 million in milestones. A Phase IIb trial in asthma is planned for 2006. In November 2005, the companies expanded their transplant-development agreement for daclizumab to include long-term maintenance therapy (currently approved as Zenapax for induction therapy in kidney transplant patients). PDL received $10 million up front and is entitled to up to $145 million in milestones. A Phase IIb trial should begin this year.

In August, 2005, the company entered into a development and commercialization collaboration with Biogen Idec covering three PDL drug candidates. PDL received $40 million up front and may receive up to $660 million in development payments and commercialization milestones, contingent upon development success. Additionally, Biogen Idec purchased approximately 4.1 million shares of PDL stock.

We view this deal positively. It should help to accelerate the development of these compounds and also deflect significant costs that would have been incurred if PDL was to develop them independently. Daclizumab is included in this deal for indications other than transplant and respiratory diseases. A Phase II trial of daclizumab is currently ongoing in patients with relapsing multiple sclerosis. The second compound is HuZAF in all indications. A Phase II trial of HuZAF in rheumatoid arthritis is being conducted. The third agent is M200 in all indications.

POSITIVE RESULTS. The M200 agent, acquired as part of EOS Biotechnology, is a monoclonal antibody that targets the integrin a5b1. Inhibition of this integrin may slow the process of angiogenesis (blood vessel growth) that plays a major role in the proliferation of tumors. Phase II trials are ongoing for the treatment of metastatic renal cell carcinoma, metastatic melanoma, and pancreatic cancer. We expect some preliminary findings at this year's annual meeting of the American Society of Clinical Oncology in early June.

Ularitide is being developed independently for the treatment of acute decompensated heart failure. In September, 2005, the company announced positive results from the Sirius II trial. This was a 221 patient Phase II study that showed statistically significant improvements in shortness of breath (dyspnea) score and decrease in pulmonary pressure. The company plans to conduct another Phase II trial in 2006, and possibly a Phase III trial in Europe this year.

PDL is also independently developing Nuvion. A Phase II/III trial in patients with intravenous steroid-refractory ulcerative colitis is ongoing. A Phase III study is also possible by the end of 2006. A Phase IIa trial is being conducted in Crohn's disease, with preliminary results possible in the second quarter of 2006.

PDL ISSUES OPTIONS. Terlipressin is being developed by partner Orphan Therapeutics, and is undergoing Phase III trials for the treatment of type 1 hepatorenal syndrome (HRS), a rare life-threatening kidney disorder. Results are expected this year with a possible New Drug Application submission in early 2007. PDL would market terlipressin.

Our estimates for Standard & Poor's Core Earnings essentially consist of our projections for option costs. Relatively speaking, we do not find PDL's issuance of stock options to be excessive compared to peers in the biotech space. We note that our operating EPS estimates for 2006 and 2007 include our forecasts for option expense. Additionally, we view projected stock option expense as a percentage of overall sales and income as reasonable compared to other biotech players in the small- and mid-cap arena.

While the company was unprofitable in 2005, we anticipate profitability in 2006. Although the p-e of 92.8 times our 2006 EPS estimate of 32 cents is high, the p-e of 35.8 times our 2007 EPS estimate of 83 cents is appropriate, in our view, in light of our projected growth rate. We forecast annualized EPS growth of 34.6% through 2010, using 2006 EPS as the base year for our calculation.

BEST CASE. The p-e to growth (PEG) ratio on 2006 EPS is 2.7 times, while the PEG on our 2007 EPS projection is 1.0 times. This compares favorably to the market-weighted PEG ratio for Standard & Poor's biotech peer group (excluding PDL from the calculations) of 1.6 times 2006 and 1.2 times 2007 EPS estimates. The market-weighted p-e multiples for the peer group stand at 38.8 times for 2006 and 27.3 times for 2007. Our annualized EPS growth rate projection for the biotech peer group is 23.2%.

We think that in a best case scenario, with PDL executing on all cylinders into 2007, the shares could trade in a range within the biotech peer average PEG of 1.4 times to 1.6 times our 2007 estimates.

It is only the first quarter of 2006 and the company is not yet profitable on an ongoing basis, so we assume PDL shares could trade up to a PEG of 1.4 times our 2007 EPS estimate of 83 cents by the first quarter of 2006. This would result in a price of approximately $43. Blending our net present value analysis price with the forward PEG assumption yields our 12-month target price of $40.

POSSIBLE RISKS. We regard the company's corporate governance policies as satisfactory. PDL's board of directors is controlled by a majority of independent outsiders. The compensation committee is comprised solely of independent directors. There is also a committee that oversees corporate governance issues. We look at these points in a positive manner. On the negative side, the firm has adopted stock-based incentive plans without shareholder approval and we think there could be greater transparency regarding specific terms of stock option plans.

Risks to our recommendation and target price, in our view, include clinical development failures, disappointing sales of drugs from which PDL derives royalties, FDA rejection of drugs that PDL could receive future royalties on, potential manufacturing problems by partner Genentech that could hurt PDL's royalty stream, disappointing sales of PDL's own products, and lower than expected earnings or guidance for PDL in 2006.

Analyst DiLorenzo follows shares of biotechnology companies for Standard & Poor's Equity Research Services


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