SCLN On Solid Ground; Stock Cheap, And Large Investors Are Buying
Some notable investors have significantly increased their positions in SciClone Pharmaceuticals (NASDAQ:SCLN) recently, and the stock is expected to work higher on this news plus better visibility on the fundamentals of the business. A schedule 13D filing posted on the SEC website on November 19th revealed that major Chinese private equity fund, GL Capital Group, has been acquiring SCLN on the open market in considerable size. According to the filing (seen here), the group now owns roughly 6% of the company’s outstanding equity, some 3.31M shares, and paid $16.1M to acquire them between October 15th and November 12th. Impressively, GL Capital Group built its entire position in about a month, with nearly half of the position purchased in two days, on November 9th and 12th when the stock swooned due to an earnings miss. Because most of SCLN’s revenues come from sales of Zadaxin in China, we believe the significant vote of confidence from a large and well-connected private equity firm based in China is meaningful (read more). In fact, GL Capital’s founder and CEO, Jeffrey (Zhenfu) Li, was the former President of Novartis’ Chinese Pharmaceutical business, and his deep knowledge of the Chinese pharmaceutical market provides a strong indication that SciClone’s business remains intact and that SCLN shares are on sale.
3Q Shortfall and lowered guidance create buying opportunity. Shares of SCLN fell nearly 20% when the company reported 3Q 2012 earnings that disappointed investors and analysts. Despite the worse-than-expected performance, the company’s lead value driver, Zadaxin (a treatment for hepatitis and cancer) still grew 12% in the quarter vs. the same period last year. SCLN management reduced its annual guidance due to wholesalers shedding excess Zadaxin inventories, slowing demand for the product, and lower Chinese government pricing for Zadaxin. The company expects that the market for thymalfasin (Zadaxin and alternative products) is expected to grow in the 15-20% range, vs. Zadaxin’s mid-20% growth rate in prior years. As a result, it lowered revenue guidance from a range of $165M-$170M to $152M-$157M for 2012. Non-GAAP EPS guidance was also reduced by the company from a range of $0.72-$0.78, to a new range of $0.62-$0.68 for the full year. No guidance was given for 2013 expectations, fueling concerns that there could be another shoe to drop in the coming quarters. Because investors could not get comfortable that all the bad news was in the stock, SCLN tanked to its current “fire sale” price level.
Discounted valuation and growth are what make the shares most attractive. SCLN has always received a discount to its peers because it is a U.S.-based Chinese-focused company, plus investors were discounting the stock in anticipation of a looming one-time price reduction for Zadaxin by the Chinese government. That price reduction has occurred and is now in the company’s guidance. Importantly, at today’s valuation (~4x expected annual cash flow), the shares are trading at less than half the typical multiple on cash flow seen for other specialty pharmaceutical companies. This valuation is unlikely to last, especially since Zadaxin sales (about 80% of total revenues) are expected to keep growing at a rate of 15% or more, hence the likely reason that GL Capital Group has stepped up their equity stake in the open market. SCLN’s decline on the earnings miss and management’s guidance revision has kept fresh money out of the name thus far, however, one has to wonder what GL Capital knows about SCLN and the recovery of its business.
Business conditions appear to have stabilized. The GL Capital purchases of SCLN prompted PropThink to do some further digging, and we were able to reach SciClone’s CEO, Friedhelm Blobel, to find out if the Zadaxin issues were resolved and how the financial picture for the company was shaping up. Importantly, Dr. Blobel, was in Shanghai when he returned our call, and he has been on the ground in China since the 3Q earnings call to ensure that SCLN’s business, particularly the Zadaxin franchise, remains intact. When we asked about his comfort level on the 2012 guidance issued with the 3Q results, Dr. Blobel noted that there has been no change to the new guidance. Importantly, the current guidance implies $40M or more in annual free cash flow, and with SCLN’s enterprise value (EV) at just $151M, the free cash flow yield (an impressive 26.5%) is likely to be attractive to multiple potential investors and perhaps pharmaceutical companies that would like to own the company’s Zadaxin franchise and its Chinese distribution capability. We also asked SCLN’s CEO about wholesaler inventory levels and Zadaxin demand in the context of the company’s recent guidance, which we believe are the biggest investor concerns since the 3Q earnings shortfall. Dr. Blobel stated that there were no surprises since he landed in China relative to the new guidance issued. As a result, we were comforted that the company has a strong handle on its business, and that investors should not expect any further negative surprises from here. In fact, SCLN has a history of under-promising and over-delivering on earnings expectations, so it wouldn’t surprise us to see the company beat estimates when 4Q 2012 results are reported early next year. Given the tough 3Q results and investor trepidation leaving the 3Q earnings call, we believe that an “in-line” quarter is all the company needs to deliver to drive the stock substantially higher by January. We note that SCLN recently raised its authorized share buyback program from $30M to $40M, suggesting that management has confidence in the long-term prospects, and intends to take advantage of the current value in the stock.
Fundamentals and potential buy out are both reasons to own. The significant institutional buying of SCLN and our conversation with management lead us to conclude that SCLN will begin moving higher in the near-term and into 1Q 2013 ahead of 4Q results and next year’s guidance. We find it particularly interesting that GL Capital filed a schedule 13D rather than a 13G. The SEC’s 13G is generally used by funds with a ‘passive’ intent, while managers use the schedule 13D when interested in asserting influence over a company. We also note that the frequency of SCLN purchases by GL Capital in the last 30 or so days suggests there is a major initiative behind the purchases. It all makes sense when one looks back to the article on SCLN published in September by the dealReporter, suggesting there may be parties interested in buying the company. A SLCN takeover bid would be icing on the cake, and not out of the question considering the stock’s discount to its peers and its impressive free cash flow yield. Either way, the strong fundamentals of the business, big investor buying, and the low price of SCLN all suggest that the stock is a good bet moving into the new year.