Thursday, June 08, 2006
Western Prospector presents a uniquely compelling value proposition amongst uranium juniors with known reserves. The recent weakness in commodity stocks combined with legal and political problems specific to
WNP’s core asset, Gurvanbulag was extensively developed by the Soviets for two decades, brought into pre-feasibility in the 80s and subsequently abandoned with the withdrawal of Russian personnel after glasnost in 1989-1991. With a historically measured resource of 50M pounds and management’s stated objective of bringing that number to 100M pursuant to this year’s exploration program, a conceptual mine at Gurvanbulag alone could be worth a billion dollars. Sweetening the deal is the blue sky potential of the enormous -1,900 km²- Saddle Hills property. Indeed, the basin was only sparsely explored by the Soviets who lacked a clear geological model and worked with outdated technology. It is conceivable then that the currently known deposits only represent part of a much vaster system; and such a view certainly finds support in the strong drill results generated by WNP’s exploration work to date.
To get a sense of uranium’s fundamentals, I urge you to look at hkup881’s write-up on Strathmore Minerals dated
In the last year alone, spot and long-term prices have more than doubled and hundreds of stocks have reinvented themselves as uranium plays. As of this writing, non-producing juniors alone boast a combined market cap north of $10B, up from maybe a half billion bucks just two years ago; this is a lot for a boutique industry. How did it happen? First, uranium stocks with actual production and/or established reserves are very few and far in between – after two decades of severe drought in exploration and mining the industry has had to virtually start from scratch. Second this formidable expansion has largely been fuelled by retail investors throwing their money at early stage exploration plays, completely blind to the fact that the bull will be most likely dead by the time the projects actually get going. Needless to say, the uranium frenzy has also made it difficult to find reasonable, let alone value propositions. This is why we consider WNP as a phenomenal opportunity; not only is it dirt cheap relative to peers, but it is also one of the most active explorers out there, with $20M in drilling budgeted for this year alone.
Turning to valuation; as of the day of this writing WNP boasts a market cap of $90M, zero debt and working capital of approximately $35M. Its Enterprise Value (Market Cap - Cash) per Pound of Uranium is hence ($90M-$35M)/55M = $1 per lb. Let us see how this compares to competitors:
Aurora Energy Resource ____________$6.73
CanAlaska Ventures _______________$4.89
Energy Metals Corp. _______________$1.93
High Plains Uranium _______________$5.32
Laramide Resources Ltd. ____________$8.99
Mega Uranium ___________________$19.15
Paladin Resources _________________$12.12
Pitchstone Exploration Ltd ___________$11.61
Quincy Energy ____________________$1.02
Santoy Resources __________________$3.58
SXR Uranium One _________________$6.53
Tournigan Gold ___________________$4.98
Triex Minerals ____________________$5.94
UEX Corp. UEX ___________________$29.80
Uranium Power Corp. _______________$6.95
Western Prospector ______________$1.00
Of course not all pounds are made equal and while pays to be sceptical with respect to any multiples methodology – which for all intents and purposes ignore future discoveries – we believe that WNP is amongst the top juniors not only in size but also in quality of its assets. The company is a fast mover and is generating results. WNP expects to integrate the underground work into a pre-feasibility study in H2 2006 and ultimately begin production by 2009. By the end of 2006, management believes that it should be able to bring its resource base at 100 million lbs U3O8. In the meantime, an independent resource calculation is slated to be completed in June and is expected to confirm historical grades and tonnage as well as upgrade the resources to a higher level of confidence (to the “Measured and Indicated” category). Success in this area is likely to be received positively by the market which tends to value higher confidence resources much more heftily. Additionally it is likely that the independent resource calculation will increase overall tonnage as actual grades have been higher than reported by the Soviets.
During the late 1970s and 1980s, the Russian invested millions of dollars in the region, basically setting up the Saddle Hills area as a major uranium mining centre. Historical work on Saddle Hills by the Soviets discovered 4 uranium deposits: Dornod, Mardaigol, Khavar and Gurvanbulag. Dornod was the first to be brought to production, in 1987, because it was considered a better prospect for open-pit mining due to its low-depth mineralization -currently the bigger part of the 40M pound deposit is owned by Khan Resources. Gurvanbulag however was the largest and most extensively developed of the four, and had undergone extensive pre-production development. Three shafts (one concrete-lined) were driven into the ground and a considerable 15 kilometers of tunneling was completed for underground drilling. The Soviet geologists worked up a resource estimate on these deposits: 23 million pounds of U3O8 grading 0.245% in the “C1” category (the Russian equivalent of Measured and Indicated), as well as 32.9 million pounds grading 0.14% in the “C2” (Inferred) category. With the goal of confirming and upgrading the Soviet resources, WNP has completed over 118 drill holes to date, representing 100,000 feet of drilling. Some 40 holes were drilled in Block 6 to verify “C2” inferred resource, yielding on average twice the grades indicated by the Soviets. Additionally, the drilling program has defined previously unrecognized trends of higher grade uranium mineralization (including 2.12% U3O8 over 7.1 metres) in elongate zones within the main “C1” Gurvanbulag deposit. The geometry of these recently recognized higher grade feeder zones not only provides WNP with opportunity for redefining higher grade core zones but also suggests geologic potential for extending the reported mineralization beyond the limits originally defined by historic drilling. Based on the drilling performed to date, WNP is currently carrying out an independent resource calculation expected in the next few weeks which will doubtlessly confirm -and perhaps even increase- the historically defined resources.
The Soviets, who were primarily interested in getting ore out of the ground as quickly as possible, performed little exploration on the remainder of the Basin. In addition to drilling at Gurvanbulag and the immediate vicinity, Western Prospector during 2005, has defined 15 additional high-potential uranium targets. Because last year’s exploration program was focused on confirming historic resources, only three of these targets have received any drilling, with two intersecting some encouraging results: the Southwest and Mardaigol-Tsever zones have demonstrated similar geological characteristics to Gurvanbulag. Furthermore, the Soviets, lacking a clear geological model, focused over 95% of the historic drilling on delineating stratabound mineralization within a depth of 200 m and overlooking vertically controlled structures. Very few deep holes were completed to test other known mineralized horizons at Gurvanbulag or anywhere else for that matter and even fewer holes were designed to test vertical structures. WNP’s 2006 drill program is trying to expand the known boundaries of the deposits and work to date has intersected strong results at deeper horizons as well as suggested that there is the opportunity for definition of near-surface uranium mineralization. The point is
On the permitting front, a Mongolian company has been hired as lead consultant and baseline studies are ongoing. Permit applications for water discharge from the underground have been cleared and de-watering of the underground workings is scheduled to commence this month. Given the existing infrastructure (including the concrete lined Main shaft) Gurvanbulag will likely be developed as an underground mine utilizing a combination of inclined room and pillar and cut and fill mining. In addition, there appears to be potential for open-pitable resources. We have worked out a DCF model for Gurvanbulag based on comments by WNP management and conservative cost assumption.
Mine Life (years) ___________________________13
Daily Throughput (tpd) ____________________2 000
Total Lbs Produced ___________________50 000 000
Average Ore Grade Processed (% Uranium) _____0.262%
LOM recovery ____________________________92%
Average mining cost per tonne _______________$30.00
Average mining cost per tonne _______________$19.00
Average G&A cost per tonne _________________$4.00
Average annual production (lbs uranium) _____3 800 000
Average cash cost per pound ________________$ 10.50
Current U Price (lb)_________________________ $46
Initial Capital Cost __________________$200 000 000
Sustaining Capital Cost per annum _________$2 000 000
Working Capital ______________________$5 000 000
Tax Rate ________________________________30%
Royalty ________________________________ 2.5%
Discount Rate _____________________________10%
DCF NPV (50 M pounds) ______________$380,000,000
DCF NPV (100M Pounds) _____________$800,000,000
Providing additional upside potential, the company holds a number of coal licences and applications in three areas of Mongolia. About 125 km east of
Despite the wealth of positive data coming from WNP’s exploration programmes, shareholders have endured a 70% decline this year following the initiation of a lawsuit by Maximum Ventures in early March and, more recently, an uninspiring Windfall Tax on gold and copper enacted by
In short Berluschi/Maximum are alleging the existence of a verbal partnership with Ken de Graaf and privately owned Brant Enterprises (which sold WNP the Saddle Hills licenses) whereby De Graaf was to act as agent and trustee for Maximum Ventures. The agent-principal relationship would in turn mean that Maximum had a right of first refusal with respect to any properties sold by Brant Enterprises, including those held today by WNP. Ken de Graaf is VP Exploration for WNP and is a highly respected and influential man in
The political situation in
We also have no doubts that despite the current instability in
Saturday, March 25, 2006
According to Warren Buffet, investing is like a baseball game with no called strikes, you can just wait for the perfect pitch. Another way of seeing this is that 90% of all investments are valued in a reasonable range 90% of the time and the best investments are those rare occurrences when valuation is at extremes. You just got to sit tight and wait for that cheap stock or bond to come down your way. Truly exceptional returns however are earned not only when an individual security is cheap relative to its peers but when the market it lies in is highly discounted as well. Of course, the broader your investment horizon is, the more likely you are to spot these six-sigma events.
Unfortunately most investors’ perspective is limited to what’s going on in
For those who like to walk off the beaten path, I have an international speculation to suggest: buying real estate in
Thursday, March 24, 2005
Uranium: The Next Hot Thing
It may come as a surprise to you that the name of the almighty American dollar came out of a 19th century Uranium mine in
In the 60s-70s nuclear energy went through a phase of e growth as both the western and eastern world were discovering the technology’s potential. Then two incidents happened: Three Miles Island (79)’s meltdown and
Today, there are about 1200 reactors of various kinds and sizes in the world, and about 445 large commercial reactors in operation. Worldwide, they will require about 180 million pounds of uranium ore each year yet, surprisingly, mining only supplies about 92 million pounds a year. What is even more astounding is that this massive shortfall has persisted for over two decades now. How did that come to be? One has to understand here that natural resources take a long time to bring from discovery into production; the Uranium production timeframe has historically been about ten years, five to map out the deposits, three to obtain permits, two to build facilities and troubleshoot. When the energetic potential of Uranium was discovered, first for the use in atomic in the 50s and then for generating electricity in the 70s, demand for it quite literally exploded on both occasions. This led to a rush in exploration and massive capital flows to expand capacity. Unfortunately for those producers, as you got closer to the end of the 10 year production window all the added capacity came online at the same time and the market collapsed. This is typical of all commodities, they are very cyclical in nature, capacity is never commensurate with demand and vice versa, like a dog chasing its tail the process of reaching market equilibrium is bound to fail! In the case of Uranium this problem was compounded by government intervention that guaranteed floor prices for a certain time; furthermore uranium exploration is notoriously easy since the deposits emit radiation that penetrates through many feet of rock and can be detected by handheld radiation counters. Consequently prices per pound dropped from a peak in 1953 of $75 (per pound in inflation adjusted US dollars) to a trough in 1969 at around $25 and then up to a new peak of 110$ in 1976; it stands at 22$ today which significantly below production costs. Another consequence was a massive build-up of inventories, i.e. Uranium that no one needed nor wanted, to be more specific all 200,000 tonnes of excess Uranium were produced from 1970-1984 in the U.S. and Russia. This stockpile, along with huge amounts of highly enriched uranium from de-commissioned nuclear weapons are what’s been providing half the world’s supply of Uranium for twenty years now. However, today every indicator seems to suggest that these supplies are running out. For instance, the Clinton administration sold its last remaining stockpiles when USEC (NYSE:USU) was IPO’d; the only government with potentially large remaining stockpiles is Russia, yet the country is currently embarking on a reactor program of their own and would prefer to conserve supplies. Furthermore, the renewed military focus will likely mean limited sales of weapon grade materials. Finally, a more potent indicator is that utilities have been drawing down their internal stocks of uranium. For most of the last 25 years, utilities have kept about 2 years worth of supply on hand. This peaked at almost 5 years worth in the late seventies and now is at about six months to a year worth. Once this is depleted, without foreign selling, Uranium spot prices should respond strongly. I think it is reasonable here to envisage a scenario where Uranium prices will triple or even quadruple in the next two years. Uranium has been ignored by the broad market for long enough because it is just such an obscure story, but I think this is also about to change. Fortunately as Canadian investors we are fortunate to be the largest Uranium producer in the World, the million dollar question is in which nest to put your eggs in?
Tuesday, March 01, 2005
Arbitrage Opportunity: EDV.TO
I originally discovered this stock through a write up on VIC, here's a sumamry of what they do:
"EDV acquires investments through private placements by junior mining companies. These may be in the form of equity, bridge loans, secured loans, unsecured loans, convertible debentures, warrants and options, royalties, net profit interests and other hybrid instruments. In exchange for these high risk capital commitments, EDV receives very favorable pricing. EDV especially likes situations where new capital is critical to a transformation such as arrival of a new management team or a significant corporate development (e.g. acquisition/development of a major new asset). EDV seeks to obtain a 30% or better internal rate of return on transactions, based on reasonable projections.
EDV normally holds about 20-25 small positions. EDV’s objective is to continually realize gains and recycle capital into new favorably priced private placements. If the original investment thesis was correct then the investee company should have some clear benefit from use of the capital and the market for its public securities should improve allowing EDV to distribute its equity at a profit. Obviously there will be a great variation in individual returns with some investees thriving while others fail completely.
The exceptional success of some early investments allowed the portfolio to evolve with a second component of “core merchant banking investments.” EDV holds larger longer-term investments in these companies and seeks representation on the Board of Directors. An experienced Endeavour executive can provide critical guidance to small companies with high potential. It also ensures that Endeavour has a deep familiarity with the fundamental value of each investment."
Here's a link to the write-up, I suggest you read it:
Basically EDV is a cheap way to go long on metals and mining since the stock is selling at about a 30% discount from its Net Asset Value, or the value of the investments it holds in its portfolio. The discount to NAV might partly be explained by the hefty fees paid to EDV's investment advisors (or portfolio managers if you will) Endeavour Financial. In 2004, the fee was $3M on assets of $75M and in 2003 the fee was $4M on assets of $45M. The fee is two-tiered: 1) an investment advisory fee, calculated as 2% on the first $50 million of net assets, 1.5% on the next $50 million of net assets, and 1% on net assets in excess of $100 million, payable as to 1/12th monthly. 2) The investment advisor also receives an annualized performance fee of 20% of the Corporation’s net income from operations in excess of a 15% return on the weighted average Shareholders’ Equity during the fiscal period. Notice that this fee structure is a lot like a hedge fund, although this alone is no guarentee that the advisory services add any value to EDV, it is nevertheless an indicator that EDV believes that this is the case. Indeed two distinguishing traits of Endeavour Financial compared to your typical mutual fund managers are 1) They invest a lot in private opportunities, hence acting a lot more like a VC firm, with an intimate (EDV sits on the board of 40% of its invetsments) and specific knowledge of the junior mining industry and 2) an active investment approach with a high turnover of assets (in 2004 EDV sold $44M worth of its portfolio and invested $55M worth in new opportunities).
Ok now that I've set the context EDV sits in, let me explain why I believe there might be a short-term opportunity here with a potential upside of 10-15% to be earned in just a few days (I've been long this stock for a while but intend to doubel my position this week - you can play it however you want, short term trade or long term)
The company publishes its Net Asset Value (NAV) on its website every month (7-14 days from end of month) and I believe that EDV will report an increase in NAV in the range of 20-25% for February, something that EDV's stock has failed to discount (at least entierly) since its stock is up only 10% since the beginning of the month. Furthermore considering EDV's high volatility I believe a small position could be established at 3.45 -3.50$ (5% below current levels) within the week.
How exactly do I know that? Well as might be expected, EDV's share price will be strongly correlated to the performance of its investments; furthermore the market's expectations as to its "present" and future performance will stick closely to that of the sector of investments it is weighted in. Originally EDV was strongly invested in Gold and other precious metals, and EDV's performance in 2003 mirrored closely that of the Phily Gold and Silver Index ^XAU
To this day EDV is strongly weighted in Gold and Precious Metals stock (in their 2004 annual report they again provide the XAU index as a backdrop for analysis), however in 2004 EDV has likely diversified its holdings to include more base/industrial metals and mining stocks, as evidenced by their annual reports for the last 2 years (I included excerpts at the end of the write up). Furthermore I do not believe that the ^XAU index ever was an appropriate framework for EDV since the latter has a strong focus on junior mining companies, which are inherently more risky and hence offer better returns on a sector bull market than their XAU counterparts. I believe that a better framework is the S&P/TSX CANADIAN MINING INDEX, ^GSPTTMN, although EDV's portfolio is only 20% weighted in North American stocks, I believe that the smaller and more diversified nature of ^GSPTTMN's components more closely reflects EDV's current portfolio. This is evidenced by the close correlation of EDV to that index in the past 2 years:
In February the ^GSPTTMN index has rallied 25% (mainly because of a broad rally in industrial metals while the gold index has only rallied 8%, mirroring EDV's roughly 10% appreciation sicne February)
To be more specific I've extracted EDV's Core Merchant Banking Positions from their 2004 annual and included a $2,5M position in AV.V announced in January:Here is the Performance for the month of February
February January December 12Months Jan03-04:
BGO.TO: 5% 0% (13%) 68%
BGC.TO: 50% (13%) (10%) 150%
CMM.V: 15% (13%) (4%) 10%
NNO.TO 8% 14% 1% 27%
SLW.TO 25% (8%) (1%)
WRM.TO 4% 6% 0% 20%
Average Return 19% (2.5%) (4.5%) 50%
EDV NAV: ? (0.005%) (2.5%) 0%
^GSPTTMN 24% 1% 2% 25%
I do not know to what extent these positions are representative of EDV's portfolio because the weights of these investmenst arent provided. However I note that 4 of the 6 were also mentionned as core merchant banking positions in 2003 (hence 2 positions were initiated sometime in 2004, these are CMM.V and SLW.TO ), 75% of the 2003 portfolio was turned over in 2004 and two major positions were shed at some point during the year GGG.TO (down 40%) and OXS.L (down 20%).You can draw your own conclusions from the relative performance of the portfolio to that of EDV's NAV. However I believe that the portfolio as it was announced in the annual report which came out last month could be very relavant as it is up to date and could make up 50-60% of the publicly traded securities which are used in the NAV calculation
I intend to buy 2000 more shares at 3.45 in the next 7 days hence doubling up my position.
Also the chairman purchased 20,000 shares in the open market at 3.40$ on February 11th, he had no holdings previously.
Excerpts from Annual Reports:
As we projected a rise in the price of gold it
led us to focus on gold-related transactions
when we implemented our business plan.
Subsequently, we expanded our focus as we
recognized the early resurgence in a
broadening metals and mining cycle. Indeed,
2004 was a remarkable year: gold and
copper traded at 16-year highs, and the
prices of energy-related commodities such
as coal, uranium, and oil and gas, climbed
Even though this positive environment has
improved access to capital for the junior
and intermediate mining companies that
make up our primary client and investment
base, successful financings still require
intelligent sponsorship and guidance. Our
merchant banking strategy to provide
intellectual capital in addition to financial
capital is therefore increasingly relevant.
Our view is that strong, positive forces will
continue driving the natural resources
sector, sustaining and possibly increasing
high commodity prices. We see the sector’s
favourable economic drivers creating
opportunities in a broader range of minerals
and in energy, and we are confident that
Endeavour Mining’s core strengths are well
suited to capitalizing on these emerging
Endeavour Mining will remain focused on
metals and mining. But, we are well
positioned to apply our business approach
and investment strategies to other facets of
the natural resources sector, which also
depend on capital markets for growth. Our
growing reputation as a capable investor and
our international network across financial
markets provide us with an expanding flow
of transactions. All indicators suggest that
the time is right for us to evolve our growth
strategy by deploying our investment capital
base into other natural resource sectors
while continuing to be highly selective in our
During fiscal 2004, several of our merchant
banking investments matured, and certain of
these holdings were realized, in whole or in
part. We nonetheless retain core merchant
banking positions in Bema Gold, Bolivar
Gold, Century Mining, Northern Orion,
Silver Wheaton and Wheaton River
Minerals, among others.
During the year, we broadened our
investment capital base by adding a number
of special situations in coal, platinum and oil
and gas to our predominately metals-based
core positions. When originating
transactions, we target investment
opportunities where we can capitalize on
the unique strengths of our professional
staff and its ability to create value.
Now, we believe that the economic
fundamentals bode well for a broad set of
commodities, with particularly attractive
opportunities in the base metals sector.
Our investment focus already reflects these
evolving trends while we remain positioned
to take advantage of continued strong gold
Looking ahead, we see strong, positive
forces driving the mining sector. The
long-term picture is naturally less
predictable. We will use our experience in
managing financial risks and our intimate
industry knowledge to continue to
intelligently position Endeavour ahead of
major market trends.
Thursday, February 17, 2005
Biovail: A Cheap Way to Cash In On Your Parents Getting Old
Shares of Biovail have fallen 70% in the past 18 months, as the company’s aggressive marketing practices, its accounting for acquisitions and its use of off-balance sheet financing were called into question. These questions famously culminated in accusations that the company overstated the value of Wellbutrin XL that was lost in a traffic on October 1, 2003. (An informal SEC inquiry is ongoing.)
Yet amid this backdrop of seemingly endless bad news, Biovail has made progress on a number of fronts, including improved financial disclosure (putting questions surrounding aggressive accounting practices behind the company) and the recent arrival of a new management team, including Chief Executive Dr. Douglas Squires and Chief Financial Officer Charles Rowland. We expect the management team to set a new tone at Biovail, establishing improved financial controls (eg, better quarterly reporting procedures) and enhanced disclosure of both the company’s pipeline and its financial results. Prior CEO Eugene Melnyk remains as Chairman (and still holds 15% of outstanding shares), focusing primarily on Biovail’s long-term vision and corporate governance issues.
The opportunity here arises from excessively low expectations for the current outlook of Biovail evidenced by a steep discount compared to specialty pharmas and even generics (BVF 11X 05 EPS vs. 18.5X for Generics and 20X for Specialty Pharmas), a valuation that in our opinion fails to account for a very strong pipeline, overlooked by investors due to disclosure issues that should be cleared up in the near term. We are not advocating that Biovail merits a valuation equal to that of specialty pharma competitors or fast growing generics as BVF is plagued with significant issues relating to generic exposure (as will be explained below, patent protection for formulations is inherently more vulnerable to challenge than are the underlying compounds, with average exclusivity duration of 13 years vs. 5 for reformulations) which, combined with uninspiring sales growth of promoted products as well as declining prescription trends among the company’s legacy and generic franchises cast a shadow over the long term growth prospects of the company. However we believe that investors are ignoring certain significant catalysts that should provide a large upside during the next few moths: a likely change in market strategy culminating in the restructuring of an unbecoming sales force ($128 million in expenses or roughly $0.81 per share), improved disclosure of an underappreciated pipeline and final FDA approval and launch of Ralivia ER and ODT (06Q1).
I. LIKELY CHANGE IN STRATEGY
Biovail’s recent investment to realign and expand its
Out of 05E sales of 200M (Gross Margin of 75%) for promoted products, about $135M will be spent for sales reps ($170,000 x 600 reps and an annual A&P budget of roughly $35 million or 15% of estimated 2005 promoted sales); this can be compared to a typical out-licensing with 25% Royalties, Gross Margins of 70% yielding 35M EBITDA vs. 15M for the self promoted . Equivalent profits would be reached when sales are at 250M and a larger sales force would most likely be able to grow topline more significantly, although the ing question remains whether any major player would be willing to take on these weak franchises. In our opinion eliminating the sales force entirely would be a suboptimal outcome, the marketing expertise and improved economics (i.e., retain higher proportion of net sales) could be favourably used for future product launches when third party licensing options are limited. Although the operational risk associated with a large fixed cost is not to be neglected. One option would be to more fully leverage the sales force though acquisitions or in-licensing third party products, although opportunities currently seem scarce given the fierce demand from multiple players looking to bolster their product lines. Furthermore this does not address the issue of Biovail’s current sales force is simply inadequate to effectively compete in large markets, especially those where primary care physicians write the majority of prescriptions. We believe the most sensible solution, and the one Biovail is likely to adopt is to downsize in order to focus exclusively on the specialist physician population (essentially keeping only its two specialty sales forces while laying off the remaining 75% of sales reps). We note that this approach should free up $75M in EBITDA while only affecting topline minimally. We believe Biovail recognizes that its current sales force is underutilized and will seek ways to address this issue in the near term. In fact Biovail recently cancelled its annual company-wide sales meeting planned for mid-January in Las Vegas and we believe the cancellation may reflect a willingness by management to solidify their long-term strategic direction (and the sales force’s place within it) prior to rolling out the 2005 marketing plan to their reps.
II. YOUR MONEY’S WORTH
The beauty of BVF at current levels is that you’re getting the pipeline basically for free. Indeed a sum of the parts analysis yields a value for Biovail’s existing product lines (excluding Ralivia and Glumetza) at approximately $2,500 million or $16 per share (net of estimated net debt of $385). Let’s look at the components of BVF’s business:
1) Wellburtin XL (37% of sales)
On November 17th the company announced that two competitors Anchen Pharmaceuticals and Abrika Pharmaceuticals have filed ANDAs with the FDA seeking approval of their generic equivalents to Wellbutrin XL, Biovail’s fastest growing product. 2004). The market reaction to the filing was severe, with Biovail’s shares falling close to 14% in the two days following the announcement. Biovail recently filed patent infringement suits against both companies, effectively prohibiting the FDA from approving the generic applications for a period of 30 months, provided a district court does not rule in favor of the generic companies prior to expiration of the 30-month stay. While the threat of generic competition for Wellburtin XL has been a ing problem since the product’s launch a year and a half ago, the speed with which this challenge has emerged has certainly come as a surprise. Furthermore it seems that most investors now expect that XL will be facing generic competition as early as 2007, a widely held belief that we find highly unrealistic. A more educated call we believe is for generic XL in 2009 or earliest 2008. Indeed Wellbutrin XL is known for being a very difficult molecule to formulate; Glaxo reportedly worked on a new once-daily formulation for nearly a decade before licensing Biovail’s once-daily version. The manufacturing complexity and technical challenges associated with the formulation enabled Biovail to extract a high royalty rate which may be greater than 35% at the top tier. We are, therefore, doubtful that Anchen in only 13 months has been able to replicate Wellbutrin’s pharmacokinetic profile without infringing on the company’s intellectual property position. Furthermore, generic companies, and in particular Andrx, appear to have historically rushed some applications in the race to be the first filer. For generic companies the first filer position is important because it provides the first generic on the market with 180 days of market exclusivity. Moreover, no other generic can be cleared for launch until the first filer has been on the market for 180 days. Also first filers have sometimes monetized the exclusivity period by allowing another generic companies to launch ahead of them in exchange for royalty payments
Based on a May 2008 generic launch assumption, a –2.0% terminal growth rate, 9.8% discount rate (BVF's WACC) and a 10% long-term tax-rate, we estimate the value of Biovail’s interest in Wellbutrin XL at approximately $1000 million or $6.30 per share. This assumes XL worldwide commercialization starting in 2007.
2) Promoted Products (19% Sales)
In general, we view the overall growth potential of these assets as modest. We note that Cardizem LA ($60M in rev) is competing for market share within a highly genericized segment (once-daily diltiazem) of a slow-growing class (calcium channel blockers), limiting the product’s long-term growth prospects in our view. Although the angiotensin II receptor blocker (ARB) class is one of the fastest growing segments within the hypertension market, we believe a weak competitive profile and limited reimbursement have limited Teveten’s ($20M in rev) penetration. We expect Zovirax ($65M in rev) sales to rebound in 2005 as wholesaler inventory issues are resolved, but expect the contribution from this franchise to decline over time due to continued weakness in the topical herpes market.
Based on assumptions of 5% growth through 2010, a 2% terminal growth rate and a 9.8% discount rate, we estimate the current value of Biovail’s promoted products at approximately $450 M or $3.00 per share. We have allocated all the costs associated with the sales force as it stands today to this estimate. It should be noted that there is potentially some upside here for Teveten if Biovail is able to differentiate its product based on the results of the recent MOSES study (Morbidity and Mortality After Stroke) which have showed that Teveten significantly reduces total mortality and total cardiovascular and cerebrovascular events, as well as the recurrence of stroke and associated disease. Biovail is currently working with Solvay to gain access to the data and hopes to have it available for medical marketing by its sales representatives in the first quarter of 2005.
2) Generics (17%)
We are forecasting revenue of $109.9 million from Biovail’s generic franchise in 2005, down nearly 20% versus our 2004 estimate of $136.9 million. Typical of generic products, we expect continued erosion in prescription trends for this franchise over time and have forecast a 9.5% compound annual decline in generic revenue through 2010 (versus our 2004 forecast). Based on our current sales forecast, a –6.5% terminal growth rate and a 9.8% discount rate, we arrive at a DCF valuation for the generic franchise of $470 million or $3.00 per share. Our valuation implies a 2004E revenue multiple of approximately 3.3x, in-line with the current generic average of approximately 3.4x. Note that as part of a recently renegotiated agreement with Teva, the latter secured an option on an additional bioequivalent product under development by Biovail and development rights to two extended-release generic products. We have not factored into our forecast any additional product sales, milestone payments or royalties associated with these products under the revised Teva agreement.
3) Legacy Products (15%)
Given that most products in this category face generic competition, we anticipate continued erosion in this product franchise over time (we are forecasting a 10% compound annual decline in legacy revenue through 2010). While we have not allocated any sales or promotional costs to this franchise, we have accounted for the tax benefit associated with $20 million in annual amortization costs and approximately $36 million in long-term obligations (2005-2007) associated with the Vasotec and Ativan acquisitions. Utilizing these assumptions, together with a –6.5% terminal growth rate and 9.8% discount rate, we arrive at a DCF value of $320.0 million, or $2,00 per share. Our valuation implies a revenue multiple of approximately 2.6x our estimated 2004 revenue forecast for this franchise.
In addition to the launch of Tiazac XC (Cardizem LA) in early 2005, we expect Biovail to launch both Glumetza and Wellbutrin XL into the Canadian market within the next 24 months. Although the possibility of near-term generic competition for Tiazac remains a risk to our Canadian forecast (a trial is anticipated in the second half of 2005), we expect new product launches to fuel strong growth from BPC through 2010 (we are forecasting a compound annual growth rate of approximately 9%). Similar to our valuation of the
Sum of the Parts = 6.30 + 3.00 + 2.00 + 4.50 = 15.8$/Share
EV/EBITDA(04) = (2718.9 – 385)/355 = 6.5
EV/FCF(04) = 2335/220 = 10.5
P/E(05) = 17.1/1.6 = 10.6
III. Ralivia ER and ODT
A total of 13.0 million prescriptions were written for tramadol in 2004, up 13.4% versus 2003. Although several generic formulations of tramadol are currently available, we believe a once-daily formulation represents an important improvement over current formulations that require dosing three to four times daily. In addition to convenience, a once-daily formulation may alleviate some of the side-effects associated with tramadol treatment, including nausea, vomiting, headache and sleepiness. Immediate release formulations of tramadol currently require extensive titration regimens to alleviate these effects. We also note that a renewed promotional focus behind a once-daily formulation combined with the recent resurfacing of concerns surrounding COX-2 inhibitors may serve to accelerate the growth of the current tramadol prescription market.
We expect Ralivia ER to capture close to 50% of total baseline tramadol prescriptions within 24 months of launch. While there is a possibility that initial conversion rates exceed our estimates (our conversion forecast falls below that observed for both the Wellbutrin SR / XL and Adderall / XR conversions), we have tempered our expectations relative to historical analogs given that Biovail has not yet secured a strong marketing partner for Ralivia. Clearly, failing to secure an agreement or out-licensing the marketing rights to a company without a strong primary care sales force (as Glaxo is for Wellburtin) would adversely impact our estimates for this opportunity.
We believe peak end-user Ralivia sales could reach $500 million by 2009 before growth is moderated by the presence of additional once-daily competition within the
IV. A STRONG PIPELINE
Biovail has historically provided limited detail surrounding the progress and potential clinical merits of its pipeline candidates. It is hence admittedly difficult to quantify the market opportunity for these product candidates without an understanding of the potential advantages (e.g. improved efficacy, easier titration, improved side-effects) relative to existing formulations. Evaluating the future cash flows of a pipeline is inherently an arbitrary exercise, and it is here exacerbated by a lack of material information. However we believe the opportunity here is such that even assuming more than half of the pipeline does not bear fruit the pipeline is still worth 8-10$ per share.
One proxy for pipeline strength are historical R&D spending trends compared to competitors. Note that Biovail had in the past pursued a very aggressive acquisition strategy, avidly buying off various assets as well as delivery technologies.
5 Year Cumulative R&D (Includes acquired R&D net of 5-year amortization) – Note that these are very rough figures
Biovail (Market Cap = $2.5B): 275M (5-year R&D) + 325M (Acquired R&D) = $575 M
Ivax (Market Cap = $3.6B) : 390 + 25 = 415M
Teva Pharmaceuticals (15B): 675 + 100 = 775M
Barr Pharmaceuticals ($4B): $450M
Watson Pharmaceuticals ($3B): $450M
Mylan Pharma ($4.5B) : $360 + 25 = 385M
Andrx Group ($1.6B) : $225M
Eon Labs ($2.3B) : $75M
Alcon ($24B) : $1.5B
Cephalon ($2.7B): $700M
Endo Pharmaceuticals ($2.7B) : $200M
Medicis Pharmaceuticals ($1.9B): $250M
MGI Pharma ($1.6B): $200M
Biovail R&D acquisitions history:
Ativan_ line extension products in pre-clinical phases of development: $40M
Athpharma cardiovascular assets: Bisochron and Isochron (Phase III) and Hepacol I and Hepacol II (pre-clinical) : 45M
Pharma Tech assets acquisition: $80M
Intelligent Polymers: $210M
Acquisition of Fuisz assets (17 under development + delivery technologies): $150M
Right now Biovail has 25 products under development (excluding Ralivia), with a combined target market of roughly $25B (targeted legacy products generated on average $1B of Rev for 2004). Although we would argue that reformulations of existing products carry significantly less risk than new chemical entities, the risk of failure for these products is clearly non-zero. We believe it is a reasonable (if not conservative) assumption, given the company’s historical focus on novel reformulations of existing legacy products – and having looked at a sample of Biovail’s portfolio, that Biovail will be first to file on 10-12 of its pipeline within the next 2-3 years. Assuming 5 year protection from generic competition, peak conversion of 12.5%, ASP discounts of 20%, royalty rates averaging 25%, Gross Margins of 75%, and assuming all R&D is allocated to the pipeline, a DCF for 10 of 25 yields 8-10$ per share.
Adding up all components: 15.9$ (base business) + 2$ (Ralivia) + 8$ = 26$
A 50% upside from current levels.
V. KEY RISKS
i) Generic Competition for Wellburtin XL before 2008.
However we note that protection from generic competition may extend well beyond this rough three-year estimate if the generic companies are found guilty of infringement, a likely scenario here given the complexity of Wellburtin XL. Our sense is that the more likely first generic here will be Eon Labs and/or IMPAX labs in 2008-2009.
ii) Canadian Operations Likely Under Pressure
iii) Paragraph IV Certification Against Cardizem LA
iv) Investigation Risk
- Announcement of a change in market strategy and the downsizing of an expensive sales force
- FDA approval and launch of a potential blockbuster: Ralivia ER and ODT
- Improved disclosure of an underappreciated pipeline
SAUDI’S OIL – THE DAWN OF AN ENERGY CRISIS
I recently stumbled upon an interesting article in the widely read business weekly Barron’s (you can find this marvellous source of business and investment news at the lovely Bronfman library) about the world’s largest private energy banker and oil guru Matt Simmons and his claim that Saudi Arabia’s declared reserves are largely a deception. Upon reading the piece and then consulting Simmons & Company International’s website www.simmonsco-intl.com I became fascinated with the oil problematic with which the commodities market seems to have been struggling as prices and volume have surged over the past 16 months (go to www.nymex.com and look at oil futures trading over the last 12 months, observe that WTI crude prices are up 70% over last year but more importantly notice the extreme volatility of price swings). Simply stated, the concern about the most relevant commodity in the world is that global production might reach its zenith in the very near term while demand is growing at phenomenal rates; case at point China and
You might ask where Saudi comes in this picture? As a lot of you may know, Saudi and more generally OPEC have acted as gatekeepers for global oil prices since the US’s Texas Railroad Commission relegated that role in 1972 (US oil production peaked in 1970), performing a price setting function by controlling the supply side of the market (for those of you who were sleeping in ManEc that’s what’s called a cartel). Saudi alone makes up 15% of world production and purportedly owns 30% of worldwide reserves, present and future or in oil lingo proven and probable. Perhaps even more importantly,
Matt Simmons - and this is a belief widely held amongst many oil aficionados – however holds a very grim opinion of OPEC’s ability to continue to provide cheap oil abundantly. In fact he contends that Saudi has perpetrated the largest deception of the 20st by hugely overstating its oil reserves and the cost of bringing new wells on-line. Simmons advocates that behind its veil of opaque and deceptive disclosure - the oil industry is owned exclusively by the state-run company Armaco - Saudi’s been hiding the fact that its major oil wells are actually running out, only maintaining current levels of production through water infusion, which, while improving flow rates, also leaves behind huge amounts of contaminated oil recoverable only at very high costs. He further questions the ability of advanced extraction technology to recover oil above and beyond the normally perceived limit, citing that second and third generation wells merely accelerate the depletion rate but fail to deal with left over oil. Finally Simmons discusses the poor quality of new projects, citing the fact that about only a quarter of Saudi Ariabia's 85 fields have been produced while so much effort has been spent on mature, or perhaps dying fields like Ghawar, which casts doubt on the feasibility of other fields.