Description

Usually market operators are left with the painful choice of being either “value” or “growth” investors. Acacia (Nasdaq: ACTG) is instead one of those rare opportunities to gain exposure to some extremely popular segments, genomic sequencing and cancer immunotherapy, for pennies on the dollar. 

Acacia Research Corporation is a $350m company investing in intellectual property (a so-called “patent troll”) with a strong relationship with Starboard Value, a well-known activist investor. The Company is trading at $8, 1.5x book value, but this is a misleading measure: Acacia may be worth north of $15/share and most of this additional value is easily identifiable, nearly certain, highly liquid and on its way to be unlocked by upcoming catalysts. 

The not-so-hidden treasure hiding on Acacia’s balance sheet is a distressed portfolio acquired last year from UK fund Woodford for $284m: Acacia bought itself a stake in the “crown jewels” of the UK biotech industry at bargain prices. This portfolio is now carried on Acacia’s books either at cost or at valuations far below market value. 

Acacia’ assets are simple: they consist of a portfolio of public companies, some minority stakes in a number of private companies and cash. Since the its last earnings report, Acacia’s holdings in public companies have doubled in value and are now worth around $100m. In its private portfolio, composed of four distinct assets, the situation is more extreme: investments are currently booked at costs or at inadequate valuations. 

Three private investments, Immunocore, AMO Pharma and Viamet, are booked at a combined $31m on Acacia’s balance sheet, while their true market value may exceed $277m, let’s see why:

First, Immunocore just had a successful IPO and Acacia’s 5% stake is now worth $89m. Second, AMO Pharma recently received a tradable voucher (PRV) from the FDA valued around $100m: it follows that Acacia’s 18% stake must be worth at least $18m. Third, Viamet shows up on another public company’s balance sheet implying a $600m valuation which translates into $170m for Acacia’s 26% stake. So that’s already $277m of value booked at $31m. 

The most extreme source of upside is Acacia’s 6% stake in Oxford Nanopore (“Nanopore”), arguably the market leader in the most advanced class of DNA sequencing currently under development. 

On Acacia’s balance sheet, the Nanopore stake is carried at only $108m, but what is its true value? 

For comparison, the only other serious player in 3G genomics is Pacific Biosciences, a US public company which historically has traded at a strong discount to Nanopore’s private value: its stock price has recently skyrocketed to a $10b market cap. Nanopore has recently expressed its intention to go public: should its IPO confirm its historical premium to PACB of 137%, the implied market cap would be around $23b, a $1.4b value for Acacia’s stake (13x its book value). We spoke to several industry experts and they claim that Nanopore premium is justified by superior technology, lower barriers to entry and higher scalability. 

On the liability side, Acacia faces almost certainly a sizeable dilution due to preferred shares and warrants issued for the benefit of Starboard, which has a right to convert as much as 100m share at $5.25 (or less if Acacia issues certain convertible notes). We have modeled the cost of such derivatives under various scenarios and, though they significantly limit any upside, they do not affect our investment case significantly. 

Our base case values Acacia’s Nanopore stake at $1b. Adding the rest of the assets we reach $1.5b. Starboard’s warrants would increase outstanding shares to 150m, but would bring in some $525m of cash to Acacia (as exercising warrants requires cash), increasing total assets to $2b or $13.3/share. Considering Acacia/Starboard’s now proven skill in sourcing profitable transactions (they also sourced the Veriton deal recently with staggering gains), there is no reason that the stock shouldn’t trade at a modest 30% premium to book value, implying a fair value of $17 and a 116% upside to current stock price.

For completeness, we calculated a bear case assuming Nanocore’s IPO loses all of its historical premium to Pacific with Acacia trading at only book value: price would be around $10 implying still a 25% upside. If Nanocore historical premium is confirmed in the IPO, Acacia’s fair value, including a 1.4x book value, would be around 21.5, a 162% gain from current price.

The chart shows Pacific Bioscience’s market cap vs. implied valuation of Nanopore in private founding rounds. Given PACB current market cap, Nanopore should be worth around $23b if its historical premium were confirmed.

Catalyst

Oxford Nanopore, the "crown jewel" of Acacia's portfolio holdings, has expressed its intention to IPO in the near future. This represents the strongest catalyst for price appreciation.