Salomon analyst likes PDLI

By Ronda Fears

Nashville, Tenn., March 26 - With the rebound in Protein Design Labs Inc. shares since they sank on news that a new drug failed to meet its expectations, Salomon Smith Barney analyst Stuart Novick likes the 5.5% convertible due 2007 (CCC) in the biotech space among similar credits.

"All in, the PDLI 5.5s look attractive to us when compared to the handful of other CCC-ish rated, moderately high premium, coupon paying convertible bonds that mature in the five year time frame or sooner," Novick said in a report Tuesday.

"Indeed, only the Getty Imaging 5% bonds of 2007 look comparable at roughly 7.9% up 93%, although that company's cash position is far less hefty than PDLI's. Millennium Pharmaceuticals, meanwhile, tendered for its 4.5% bonds. Affymetrix 5% of '06 is confronting a potential slowdown in its core gene chip array business, while Rescare 6% of '04 is presently in violation of its bank debt covenants. And we've previously discussed the high cash burn rate at Sepracor, whose 5.75% bonds of 2006 fit the 75%-100% conversion premium parameter."

Shares of Protein Design U-turned to a 20% gain after initially falling 20% when the release of clinical data showed that its drug Zenapax failed to slow the recurrence of psoriasis.

"The price rise didn't seem to make sense, but several equity analysts said that the outcome, while a negative, removed some near term uncertainty from the PDLI story," Novick said.

Red ink is likely to persist out to 2006, however, and Novick said Protein Design's bottom line will probably dip back below break even this year, winding up with a per share loss of $0.19.

Given the Zenapax setback, Novick now expects the deficit situation at PDLI to grow over the next few years, peaking at a net loss of $35 million in 2005, or about 38c per share basis, and reversing direction in 2006 when for a small loss of about $3 million, or 3c per share.

All told, net losses through 2006 would total about $110 million to $115 million, the analyst said, and toss in capital spending of about $10 million per year, versus $8.7 million in 2001, and cash usage out to 2006 should come in around $160 million to $170 million.

"That's a lot, but the company's cash balance is substantial," Novick said.

At the end of 2001, PDLI had cash plus marketable securities of over $650 million. The sum is largely the result of a $366 million secondary stock issue in 2000, along with the $150 million convertible that year.

Keeping in mind the outlook for spending at the company over the next several years, and the fact that the convert represents the only significant piece of debt on the balance sheet, Novick said he believes the cash will be sufficient to retire the convertible bonds at maturity in February 2007, if need be.

The issue has call protection for almost another year, the analyst added.

"While the shares are currently well below their $37.75 conversion price, they were as high as $45.50 during the past 12 months," Novick said.

"Therefore, we couldn't definitively rule out the possibility of a call next February despite the fact that our 12-month price target for the stock is just $25. Even if the shares were to reach that target price, the converts should return about 25% in the coming year."

Protein Design Labs 5.5% due 2007 (CCC)

Convertible Price: 86.50

Common Price: $17.25

Current Yield: 6.36%

Yield-To-Maturity: 8.97%

Conversion Premium: 89.30%

Investment Premium: 22.00%

Breakeven: 7.42 years

Conversion Price: $37.75

Conversoin Ratio: 26. 49

Call: Feb. 15, 2003 at 102.75%

Fair Value: 74.44

Delta: 40.2%

Spread: 900 bps

Investment Value: 70.93

Option Value: 9.54

Volatility: 60.0%

Upside/Downside: 24%/5%

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