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Pay Attention To QLT

Posted: Oct 29, 2009 16:17 PM by Sham Gad

Tickers in this Article: JNJ, NVS, SNY, QLTI

I recently wrote a piece on potential bargains and included global biopharmaceutical company QLT (Nasdaq: QLTI) due to its attractive balance sheet. QLT focuses on diseases of the eye and currently has two marketable products and two products in phase II trials, including a non-invasive product for glaucoma, an eye disease that reportedly affects over 100 million people worldwide.

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Stronger Balance Sheet
This week QLT announced its earnings. On the surface they were terrible, although they matched expectations. QLT earned 4 cents per share from continuing operation and 12 cents from discounting operation. Last year, the comparable numbers were 16 cents and $1.81, respectively.

During the quarter, the company received nearly $50 million in cash as an income tax refund from the Canadian government. So, now its balance sheet has nearly $200 million in cash and no debt. At $3.50 a share with 54 million shares outstanding, the market cap is $187 million. Shareholders' equity is even higher at $335 million. So you are effectively getting the biopharmaceutical today for free.

Cash Is King
Of course, with these types of businesses, getting new products approved is the name of game, so expect some of this cash to be used for those purposes. However, concurrent with the earnings release, management also announced that it will buy back 5% of the shares outstanding. That's an excellent way to create value for shareholders. In the past year, QLT has bought back 20 million shares, or nearly 30% of the company, as shares outstanding have declined from 74 million to 54 million. In the quarter, R&D expense was $7.4 million, so the cash utilization per quarter is not huge relative to QLT's cash balance.

Revenues for QLT now come from a single product, Visudyne, which is marketed by drug giant Novartis (NYSE: NVS). Its second product, Eligard, which was marketed by Sanofi-Aventis (NYSE: SNY), was disposed of and was included in discounted operations for the quarter.

Not An Automatic Home Run
Currently QLT generates around $9 million in revenues per quarter once you take out Eligard sales, a seemingly rich premium for a $200 million company. Clearly, the pristine balance sheet is playing a role in the current share price. So, QLT is not some gem waiting to be discovered. The potential value today rests in the fact that a lot of lucrative options exist for this company. The two products in phase II trials will add value if they are accepted in phase three. Management has demonstrated - so far - prudence with the cash. I wouldn't expect a special cash dividend, but buybacks are essentially the same thing in a different way. The cash certainly creates value in that it provides an anchor to the share price.

Finally, QLT would certainly appeal to a larger pharmaceutical company like the two named above or others, like global Johnson & Johnson (NYSE: JNJ), who could pay double the stock price and still get an excellent deal because of the cash acquired. (For related reading, check out Reading The Balance Sheet.)

A Favorable Risk-Reward Scenario
All of these elements create a situation where it's heads you win big, tails you lose little; a favorable risk-reward scenario as long as management doesn't ruin the balance sheet. That's an unlikely scenario based on its behavior thus far. (For more, see Testing Balance Sheet Strength.)

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By Sham Gad

Sham Gad is the Managing Partner of Gad Partners Fund's, value inspired investment partnerships modeled after the Buffett Partnerships of the 1950's. Previously, Gad ran the Gad Investment Group and delivered annualized returns of 22% from 2002 to 2005. Gad is also the author of "The Business of Value Investing" which will be out in the fall of 2009. Gad earned his MBA at the University of Georgia in May of 2007. Gad runs a value investing blog. He can also be reached by visiting the Gad Partners Funds site. When not writing or analyzing businesses, Gad enjoys hanging out with his wife Maggie, reading, golf, and yoga

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