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Value Investing In Canada: The Good, The Bad & The Ugly

A specialty pharmaceuticals company based in Montréal, Québec, Knight Therapeutics comes across as a carbon copy of Jonathan Goodman’s first venture, Paladin Labs, listed at $1.50 a share in 1995 and sold to Endo nineteen years later for $151 a share.

As part of the deal, Knight was spun-off from Paladin with a royalty stream from sales of Impavido — a drug for treating a rare parasitic infection — outside of the United States, in addition of a FDA priority review voucher later sold to Gilead for $140 million.

It then went on to raise $685 million — the latest round at a richer valuation than today’s stock price — and pocket $179 million in profits through several astute transactions.

The son of pharmacist turned successful entrepreneur Morris Goodman, Jonathan grew up reading prescriptions and trade press from breakfast to bedtime. And it shows, as the man lives and breathes the pharma business.

When the time came to strike out on his own, he devised a colorless but highly opportunistic business model in licensing niche, late-stage or underexploited products in markets overlooked — because deemed too small — by big pharma.

This now field-tested playbook consists in identifying unaddressed needs in the attractive specialty pharmacy segment, searching for the right target to licence on the right terms NPV-wise, before sifting through the arcane approval and marketing process.

In short: being rational, sweating the small stuff and grinding it out — the kind of endeavors that should appeal to old-fashioned value investors. Though simple in theory, in practice it seems that within the pharma business — and money management likewise — the basic concept of working hard yields an appreciable competitive advantage by itself. So why go without?

Knight also runs a portfolio of debt and equity securities in selected funds and companies. Beyond being — most likely — sound investments, these deals satisfy a strategic purpose, for they offer a perfect leeway to secure profitable licensing rights out of the group of investees.

A straight shooter armed with little patience to suffer fools and reckless speculators, Goodman keeps demonstrating outstanding skills in capital allocation. His various sermons about patience, prudence, shunning leverage and waiting for the right valuations — ideally when an urgent seller unloads good assets in distress — read like value porn and flow through the way business is conducted at Knight.

You don’t have to swing at everything — you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, “Swing, you bum!”.

Yet investors have manifested fatigue over waiting for large acquisitions, so many bailed out. Goodman — the chief shareholder — said a myriad of times that he was running the company “for his grandchildren” and that he wasn’t keen on laying down cash in a sellers’ market, but his plea fell on deaf ears in a world feverishly oriented towards excitement and fast money.

As a consequence, the recent sell-off offered placid investors the opportunity to hop in alongside a phenomenal entrepreneur in a burgeoning business at roughly book value — or even slightly less once adjusted.

Should the Paladin-like call option fail to happen, the fortress balance sheet — made of $979 million in cash, cash equivalents and securities, for only $13 million in liabilities — provides a compelling margin of safety.

(Long GUD at an average price of CAD $7.9 a share.)

Enter the bad and the ugly in the same glory of the past: BlackBerry, whose management keeps bombarding investors and the press alike with a deluge of triumphant but groundless — if not outright misleading — communications.

Beyond headlines, the dreadful reality is that the turnaround in hardware failed while the push into software has yet to return any profit. In addition, despite management’s best efforts, monetization of patents persists elusive.

At $13 a share, adjusted for potential dilution and net cash position, the company trades for $6 billion. What do we get for that price? Let’s unroll a basic sum-of-the-parts to figure it out.

The hardware revenue now comes close to nil — $62 million for the first nine months of 2017, versus $5 billion five years ago — so let us count this segment for zero.

Meanwhile, the patent portfolio value is likely eroding at a fast clip. Excluding remarkable one-time wins such as the Qualcomm case, the segment nevertheless delivered $127 million in revenue last year, and $138 million for the first nine months of 2017.

On a hopeful basis of $150 million in revenue per year and a profit margin of 50% — typical of the licensing business — we could assign a no less hopeful multiple of ten to this bottom line, and thus value the intellectual property at $750 million — admittedly not watchmaker’s work, but better being roughly right than precisely wrong.

(For the anecdote, in late 2014 yours truly valued the whole intellectual property portfolio for roughly $2 billion on a private market basis.)

BlackBerry’s mobile management solution leads a sluggish $4 billion market — laboriously growing by 10 to 15% per year — in which nobody makes money. Indeed, competition is fierce and revenue per user tiny, so profit margins aren’t exactly where you’d expect them to be when you hear the magic word “software”.

However, the business may hold value for larger players such as Microsoft or SAP, should one of them be determined to scale it up as part of a comprehensive service offering. Assigning a reasonable multiple of two times revenue — which is what BlackBerry paid to acquire its former competitor Good Technologies, then in deep financial distress despite being the market leader — the mobile management business would be worth $700 million, more or less its reproduction value following the streak of acquisitions it took to build it up.

We’re still $4.5 billion short of current market valuation, and thus left to assume that QNX — allegedly the crown jewel among BlackBerry’s assets — has seen its value grow twenty-three-fold since its acquisition from Harman for $200 million in 2010.

Installed in 60 million vehicles, QNX generates $150 million in revenue per year — a stagnant performance since 2015. So we’re talking about a pitiful $2.5 per unit. Should we accept to drink management’s Kool-Aid and bet on the prospect that QNX is going to take over the buzzy “connected car” market, we might equally acknowledge that a growing, promising software venture can be valued between five and ten times revenue. So QNX would have to bring in $400 to $800 million to warrant its current valuation.

That won’t happen unless the base of installed vehicles or revenue per unit expand dramatically. Not to cut the ground from under dreamers’ feet, but if there’s money to be made in this market, BlackBerry won’t be alone in trying to seize the opportunity. A formidable competition is already lining up — Google, Apple, Baidu, etc. — with flows of capital and capabilities that already dwarf the Waterloo-based company.

BlackBerry also owns a bunch of other miscellaneous assets — Messenger, Radar, Certicom, Paratek, a stake in NantWorks, etc. — but since none of these yield any profit, better to count them as a whole for zero. In that respect, according to the prudent hypotheses laid down above — workable at will — an investment at this price entails highly confident expectations about QNX’s prospects.

On a side note, extra caution should be exercised towards the uber-promotional communications released week in, week out. As my mentor used to say back in the days, with so much time being spent on television, one has to wonder where John Chen still finds the time to run his company.

(No position.)

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