Description

For anyone who has not already done so, I encourage you to read William Thorndike's book, "Outsiders" before reading any further.

Knight Therapeutics (GUD/CN)

*Data is calculated using a share price of $5.05 (CN$) as of 7/21/14. All financials in USD($)

Investment Thesis

Knight Therapeutics is a recently completed spin-off that offers investors the opportunity to acquire an “Outsider” CEO for free.  Taking into account cash on hand and the potential monetization of a Priority Review Voucher, we believe Knight Therapeutics trades at an adjusted EV of just $1.4MM.  The main points of my thesis are as follows:

v  Knight Therapeutics is led by “Outsider” CEO Jonathan Ross Goodman.  Prior to Knight, Mr.Goodman was the CEO of Paladin Labs where the share price under his tenure increased 100x in 19 years.

v  The timing of the Knight Therapeutics spin-off from Paladin has corresponded perfectly with the recent sell-off in biotechnology, allowing investors the opportunity to purchase shares following a 20% correction from the 52-week high.

v  The timing of two subsequent capital raises makes the funds unavailable to screens and standard financial portals.

v  Jonathan Goodman is an owner-operator who is willing to put his money at risk.  Goodman personally committed $65MM into the two offerings and now owns 27% of the shares outstanding.

v  Knight Therapeutics currently owns one of 3 active FDA-granted Priority Review Vouchers (PRV). We believe this asset can be monetized in excess of $100MM+ and is currently misunderstood by Wall Street. (only 4 PRVs have ever been issued)

History & Background

Knight Therapeutics is a spin-off of Paladin Labs. It’s first day of trading began on February 28^th, 2014 following Paladin’s purchase by Endo International. Knight was initially listed on the TSX-Venture exchange and owned in consideration by Paladin shareholders. Since then, Knight has undergone two offerings which have raised $255MM in cash. After the offerings, Knight moved to the TSX exchange where it is now listed under the symbol TSX:GUD.

Knight Therapeutics is a specialty pharma company focused on acquiring and licensing products for under-severed and tertiary markets, particularly Canada.  Furthermore, Knight aims to acquire mature (often times now generic) and under-promoted products from the Big Pharma branded graveyard. These products are then re-focused on sales efforts in specialty markets or against weaker generic counterparts, while requiring little to know R&D risk at the parent level.  According to Knight’s corporate presentation, the criteria for product selection are as follows:

• Late stage development: Product must be in phase II, phase III or approved in a foreign market
• Leverage through existing capabilities: Product must be able to be sold through scalable distribution channels
• Risk of Failure: Agreement must be structured such that failure of the product will not cripple the company
• Financial Return: Risk must be commensurate with reward

Management

Central to our investment is management’s proven history of execution.  Jonathan Goodman is a proven example of what author William Thorndike coined an “Outsider”. In his book Mr.Thorndike highlights the operating and stock-performance differences between typical CEOs and “Outsider” CEOs. While the typical CEO is often judged by their managerial expertise, Mr.Thorndike’s “Outsiders” are better described as Chief Capital Allocators.  By focusing on allocation within their core competencies, these “Outsider” CEOs have proven their ability to repeatedly outperform their peers in shareholder return.

Paladin was started by Mr.Goodman in 1995. During this time, Paladin underwent 18 years of consecutive revenue growth, with revenues growing from $6MM to over $270MM dollars.  Paladin’s strategy to acquire and distribute drugs in Canada and tertiary international markets created scalable process that rewarded investors handsomely. An investor having purchased shares in Paladin under Mr.Goodman’s command would have seen their investment increase roughly 100x in 19 years. 

So why did Mr.Goodman sell Paladin? In August 2011 Mr.Goodman suffered a major brain injury while cycling in Montreal.  Despite wearing a helmet Mr.Goodman went into septic shock and spent the next five weeks in a coma.  Luckily, Mr.Goodman was able to make a full recovery and eventually make his way back to Paladin. However, in his absence the company had grown into something different. He no longer felt the company was his and shopped it to potential suitors.  With Knight Therapeutics Mr.Goodman is driven to prove that he still has what it takes, and is backing his words with his personally money. Quoting Goodman, “Knight won’t rest until it is at least as successful.”

Impavido & Priority Review Voucher

In consideration for its spin-off from Paladin, Knight received the right to take with it one sole asset – Impavido(Miltefosine).  Impavido is a specialty drug used in the treatment of leishmaniasis, a rare tropical disease spread by the bite of the female sand fly. On March 19, 2014 Impavido was granted US FDA approval and is expected to launch later this year.  Knight receives currently a 22.5% gross royalty on sales of Impavido, amounting to roughly $400K per year, to which we believe the US market could provide an additional $200K per year.  These sales are inconsequential to Knight’s long term growth and are not of importance to our thesis.

In 2008, the FDA proposed the creation of a program to incentivize and encourage the development of rare tropical diseases.   This proposal resulted in the government’s creation of the Tropical Disease Priority Review Voucher.  Priority Review Vouchers (PRV) our transferrable vouchers which allow the holder the right to receive priority from the FDA for a drug of their choosing.   This can result in 4-7 months of faster review time, which can equate to a significant sum of money for potential blockbuster drugs. The reasons are threefold:

1. Revenues are received 4-7 months sooner
2. 4-7 months allows for greater market penetration and allows for an increase in total sales prior to generic counterparts entering the market.
3. First entrant market share in the event of two competing drugs racing to the market.

To date four PRVs have been issued by the FDA (Novartis, Janssen, BioMarin, Knight). The Novartis PRV has been used (drug failed), which leaves three remaining.  To our knowledge, Knight is the only holder who is actively marketing and looking to monetize the voucher.  While the lack of history makes PRVs hard to value, independent valuation studies have ranged from $30MM to upwards of $300MM dollars.  To quote one study regarding an independent poll, “responses received from the five ‘large’ companies indicated a willingness to spend an average of $170MM to obtain a voucher.”[1] For our analysis, we believe that the Knight’s Priority Review Voucher can be monetized for $105MM.  At this stage in the spin-off, this represents a large and underappreciated asset to which only active investors are aware.  Any monetization of the asset will serve as an active catalyst.

Offerings and Adjusted EV

Success in specialty pharma is dependent on scale and prudent capital allocation.  With Knight, Mr.Goodman is operating with a drastic head start over his peers and from where he started Paladin.  Since its spin-off, Knight has successfully completed two private placement offerins. The first was completed for $75MM at a price of $3.50, while the second was for $180MM at $5.25 / share.  Both where conducted while Knight was listed on the TSX-venture. Of the $255MM that was raised, Mr.Goodman personally put up $65MM, placing his personal stake at 27% of Knight’s outstanding shares. Furthermore, both of these offering took place after the close of Q1 2014.  To the outside investor this cash has yet to make its way on to screens, and disguises the true enterprise value of the company. Coupled with the potential monetization of the PRV, we believe that Knight Therapeutics is currently trading at a hypothetical enterprise value of close to $0.  At this level an investment in Knight allows us to retain Mr.Goodman’s abilities for little to no premium. To recap:

Enterprise Value

Hypothetical Enterprise Value

Conclusions

An investment in Knight at current levels offers investors the opportunity to acquire Mr.Goodman’s “Outsider”abilities for close to free.  While we do not know what the future has in store for Knight, we believe Mr.Goodman is an excellent jockey with a proven track record.  Accordingly, we recommend for the patient long-term investor to purchases shares and simply forget about them.  

Risks

• Competition amongst specialty pharma drives up valuations and lowers Knight’s ability to make attractive acquisitions
• Knight is unable to monetize the PRV for an attractive amount
• CEO risk

Catalyst