Ligand's Drug Deal Is Labeled a Loser

Downgrades followed the biotech's deal to buy back most Avinza royalties.
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Shares of

Ligand Pharmaceuticals

(LGND) - Get Report

dropped 29% Wednesday after the company turned in a subpar third-quarter performance and renegotiated a royalty deal with Irish drugmaker

Elan

(ELN)

that met with scorn from analysts.

Three investment banks downgraded Ligand Wednesday on the news. Shares were off $2.11, or 29.5%, to $5.03 in recent trading.

Tuesday night, Ligand reported a narrower net loss of 10 cents per share, but analysts were looking for a net loss of just a penny per share, according to Thomson Financial/First Call. Third-quarter revenue rose 32% to $25.3 million, but again, that was below Wall Street expectations. Sales of the painkilling drug Avinza of $6.2 million disappointed, and the company lowered sales guidance for the remainder of the year.

But the news that got analysts really screaming was a two-part restructuring of Ligand's Avinza license and supply agreement with Elan. Ligand said it intends to spend $100 million to reduce the Avinza royalty it pays to Elan from 30% to 35% to roughly 10% of net sales.

Second, the company said it plans to spend $19.8 million to repurchase and retire 2.2 million shares of company stock currently owned by Elan. The reworked agreement essentially gives Ligand nearly all rights to Avinza, which Ligand licensed from Elan in 1998.

To pay for the new agreement, Ligand said, it would raise $135 million through a five-year convertible debt offering.

"The restructuring of the Avinza license and supply agreement and the Ligand stock repurchase and lockup represent major progress toward realizing the full value of Avinza and increasing Ligand shareholder value," said Ligand Chairman and CEO David Robinson in a statement.

Unimpressed

Banc of America Securities biotech analyst Mike King downgraded Ligand to market perform from buy, raising serious issues with the new Elan deal.

"Given the slower-than-expected launch of Avinza and the current lack of a co-promotion partner, we are concerned that Ligand will be unable to reach a sufficient Avinza sales level to justify the transaction," he wrote in his downgrade note. King's firm doesn't have a banking relationship with Ligand.

Diving into the details, King says the $135 million convertible debt will add significant dilution to current shareholders -- as much as 24% -- if the offering is fully converted to common stock. "Ligand has spent several prior quarters cleaning up the balance sheet to remove debt; this offering puts the company farther in the hole than it has ever been before," he says.

And even though Ligand is buying back 2.2 million shares of stock owned by Elan, the Irish drugmaker still controls 12.2 million Ligand shares, a majority of which can be sold into the open market after a lockup period expires in six months.

The Food and Drug Administration approved Avinza in March as a once-a-day painkilling treatment for patients who suffer from moderate-to-severe pain over an extended period of time. The drug sells into an estimated $2 billion market (Oxycontin is the largest and best-known competitor), but Ligand is focusing initial marketing efforts mainly on patients who suffer from cancer- and HIV-related pain, or about one-third of the total market.

Tuesday night, Ligand lowered 2002 Avinza prescription guidance, which King believes makes it nearly impossible for the company to meet its sales forecasts. "They have implicitly overpaid for the product," he says.

Legg Mason analyst Stefan Loren highlighted similar problems as he downgraded Ligand to sell from hold.

"Overall, we are disappointed in Ligand's quarterly performance, expect downward revisions in expectations, and believe the convertible offering and six-month lock up perpetuate the overhang on the shares," wrote Loren. His firm has a banking relationship with the company.