PDL Just Got Riskier

PDL could get an added boost from royalties received from Tysabri, the multiple sclerosis drug developed by Elan (ELN) and Biogen Idec (BIIB). Tysabri was taken off the market in 2005 after it was linked to a potentially deadly infection of the brain called PML, but it was recently reapproved.

Most observers in the medical industry expect the reintroduction of Tysabri to progress slowly at first, but, considering the superior efficacy of the drug, if no more cases of PML are reported it could eventually become the blockbuster that was originally envisioned. PDL is certainly hoping for that scenario, considering it receives royalty payments on Tysabri.

PDL also could be poised for some upside owing to Genentech's Lucentis, a therapy for wet age-related macular degeneration, a disease that causes blindness. Currently, PDL hasn't been advised if it will indeed receive royalties on the drug, and Genentech has been known to play hardball when it comes to payments. Still, most industry watchers expect PDL to ultimately collect royalties on Lucentis, which isn't included in the company's guidance.

If you're looking for a pure royalty play, PDL isn't a bad one, considering its attachment to several blockbusters and the potential of Tysabri. However, the pipeline will likely be a drag on the stock's valuation for some time to come. Until Wall Street begins to see meaningful progress in bringing a robust drug to market, it's difficult to imagine PDL being rewarded with a higher valuation.

For investors who do want to take a chance, a more conservative strategy might be worth considering, says Elijah Cunningham of Valuepoint Partners. The Little Rock, Ark., asset manager owns the PDL convertible bonds that expire in 2023, in addition to the company's common stock.

The bonds convert to 49.66 common shares at the bondholder's request. The current price of the bond reflects a 22% premium to the stock price. In other words, investors would need PDL shares to trade at about $21.25 to break even. The stock closed at $17.44 Friday. What's attractive is that the bondholder receives a yield of 2.6% while waiting.

The convertible acts like a call option on the stock, but one that pays interest and doesn't expire for 17 years. The worst-case scenario -- assuming the company stays solvent -- is that the stock doesn't appreciate and the bond is repaid in 2023. At that point, you'd have earned a yield to maturity of 2.3%.

>To order reprints of this article, click here: Reprints