Author: Cheng Yuan
Covestor model: Value with Catalyst
Disclosures: Long ENZN
The model portfolio continued to underperform both benchmark indexes by a substantial margin in June.
Reading International was the largest contributor to the underperformance this month. Coincidentally, my June commentary highlighted some of the positive developments shared by Reading management during the annual shareholders meeting. During the last week of June, Mark Cuban’s continued disposition of shares may have had a hand in the sharp drop in Reading’s stock that week. Whatever the reason Cuban sold, the weaker hands on the table may have followed suit. Despite the market sell-off, I continue to believe the Reading story has not changed and intend to hold on to my shares.
Enzon Pharmaceuticals (NASDAQ: ENZN)
In my April commentary, I wrote “I am hopeful that management has been busy executing on its $200mm share repurchase which, if completed, ought to reduce shares outstanding by approximately 30%.” From the 2011 Q1 10-Q report, Enzon reported “During the three months ended March 31, 2011, the Company repurchased and retired 3,853,073 shares at a cost of $41.5 million, or an average cost per share of approximately $10.77. There is $158.5mm left in the share repurchase program. The precipitous drop of the stock following the announcement that Enzon would discontinue its lead PEG-SN38 clinical program in metastatic colorectal carcinoma may present another opportunity for the company to exercise its share repurchase program.
In the meantime, Enzon has switched its focus to its PEG-SN38 clinical program in metastatic breast carcinoma, which is currently enrolling patients in Phase II. In addition to its PEG-SN38 compound, Enzon has begun Phase I studies on three of its four mRNA antagonists namely Hypoxia-Inducible Factor-1α (HIF-1α), Survivin and AR mRNA which are all targeted for solid tumors and pediatric acute lymphoblastic leukemia (ALL).
While the royalties from Pegintron, which comprises the majority of Enzon’s revenue, has dwindled quarter to quarter, there is at least renewed hope of potential new stream of royalties on the horizon. Sales of CIMZIA, used for treatment of Chron’s disease and rheumatoid arthritis, has begun to pick up. UCB Pharma which markets CIMZIA is expecting sales to peak at EUR1.5B by 2020. CIMZIA generated EUR198mm in 2010 and 2011 Q1 sales has already outpaced sales from the same quarter last year by 97%. In May, UCB announced its intention to pit CIMZIA against Humira, Abbott Laboratories’ blockbuster drug for rheumatoid arthritis that generated sales of $6.5B in 2010.
But CIMZIA is not the only potential royalty stream replacement that Enzon could bank on. Following the sale of the Specialty Pharmaceutical operations to Sigma-Tau, Sigma-Tau has taken on the responsibility of manufacturing Oncaspar’s main ingredient L-asparaginase. In April, Sigma-Tau announced the approval from FDA to manufacture L-asparaginase. Enzon received a $5mm milestone payment as a result of this and will receive additional royalty payments based on sales above a 2009 baseline for all four products that were part of the Specialty Pharma operations. The other products are Adagen for the treatment of combined immunodeficiency disease, Sylatron for treatment of melanoma and Peginesatide for the treatment of anemia in chronic kidney failure. Sylatron, which is marketed by Merck, was recently approved by FDA in March. On May 3, 2011, Affymax together with Takeda Pharmaceuticals announced their submission of New Drug Application (NDA) for Peginesatide for the treatment of anemia in chronic kidney failure.
Enzon’s most valuable asset besides its cash hoard and equivalents of approximately $5/share net of liabilities is its PEGINTRON royalty stream. Enzon’s PEGINTRON royalty stream can be estimated based on an implied value suggested by a quote from its 2008 10-K: "In August 2007, we monetized 25% of our future royalties from the sales of PEG-INTRON for $92.5 million in gross proceeds." This puts approximately $6.85/share on the value of PEGINTRON royalty stream. At the current market price of a little over $10/share, the market is ascribing no value to the CIMZIA royalty stream, the potential royalty streams from the Sigma-Tau suite of products, the potential of the PEG-SN38 compound and the mRNA antagonists.
Most research biotechnology companies burn cash in their quest for the next blockbuster drug. Enzon has plenty of cash on hand, at least one promising royalty stream to fund its research activities and an activist installed board and management who have their interests aligned with shareholders.
With current market volatility, I think it’s wise to consider some sort of tail risk protection. James Montier of GMO covered the different strategies better than I can. So, I’ll simply link to his timely market commentary “A Value Investor's Perspective on Tail Risk Protection: An Ode to the Joy of Cash" and try my best not to quote an excerpt out of context for those of you who have less time on your hands:
“When considering tail risk protection, investors must start by defining the tail risk they are seeking to protect themselves against. This sounds obvious, but often seems to get scant attention in the tail risk discussion. Once you have identified the risk, you can start to think about how you would like to protect yourself against that risk. In many situations, cash is a severely underappreciated tail risk hedge. The hardest element of tail risk protection is likely to be timing. It is clear that a permanent allocation is likely to do more harm than good in many situations.”
I’d define my tail risk as a the risk of a systemic drawdown event much like 2008, though perhaps not as severe. I consider cash to be an easy and safe way to hedge against this risk - hence my current holding of almost 30% cash. As highlighted above, the timing is likely the hardest element to get right. I’ve missed more than one opportunity in the past and fully expect to continue to miss more opportunities in the future. I’d like to think that I’m seeking tail risk protection because of fear, not greed. Time will tell if I got it right.
"Selling Citigroup stock, still bullish on Enzon – Cheng Yuan (C, ENZN)" Cheng Yuan. http://investing.covestor.com/2011/04/selling-citi-stock-still-bullish-on-enzon-cheng-yuan-c-enzn
"Reading International’s underappreciated value – Cheng Yuan (RDI)" Cheng Yuan. http://investing.covestor.com/2011/06/reading-internationals-underappreciated-value-cheng-yuan-rdi
Enzon 2011 Q1 10-Q Report, May 3, 2011. http://sec.gov/Archives/edgar/data/727510/000093041311003746/c65595_10-q.htm
UCB Q1 2011 Corporate Presentation, Slide 7, May 2011. http://www.ucb.com/_up/ucb_com_investors/documents/1105%20-%20IR%20corporate%20presentation%20Q1-2011.pdf
“UCB To Test Arthritis Drug Cimzia Against Abbott's Humira”, Sten Stovall, Dow Jones Newswire, May 25, 2011. http://online.wsj.com/article/BT-CO-20110525-703549.htm
“Sigma-Tau Pharmaceuticals Announces Approval for New Manufacturing Process for ONCASPAR® (Pegaspargase) Primary Ingredient”, Company Press Release, April 18, 2011. http://www.prnewswire.com/news-releases/sigma-tau-pharmaceuticals-announces-approval-for-new-manufacturing-process-for-oncaspar-pegaspargase-primary-ingredient-120055504.html
“FDA Approves Sylatron for Melanoma Treatment”, MedScape, April 4, 2011. http://www.medscape.com/viewarticle/740196
“Affymax and Takeda Announce the Submission of a New Drug Application for Peginesatide for the Treatment of Anemia Associated with Chronic Renal Failure in Patients on Dialysis”, Company Press Release, May 31, 2011.http://www.investors.affymax.com/releasedetail.cfm?ReleaseID=581773
“A Value Investor's Perspective on Tail Risk Protection: An Ode to the Joy of Cash”, James Montier, GMO, June 27, 2011. https://www.gmo.com/America/Research/General/