SWKH - SWK Holdings

[Cunninghamew]

I do not currently own this stock, but thought it was interesting enough to writeup for future reference. Right now it is a little more than I am willing to pay, but I have a close eye on the co.

 

SWK Holdings (SWKH) was originally a shell company sitting on cash and a  massive hoard of NOLs. Last year they found an operating biz for this shell. They hired two Dallas hedge fund managers to essentially run a specialty healthcare finance biz and put the cash to work.

 

SWKH generates money in 1 of 2 ways:

 

1. They use their balance sheet to make loans to pharma companies and buy pharma royalty streams. This is the core of their business.

2. They generate fee income form external clients. I.e. they might make a loan for $10mm to a pharma co. SWKH might provide $6mm and they might raise an additional $4mm from external clients. Those external clients will pay SWKH mangement and incentive fees on that loan (or royalty). The remaining $6mm would just be a receivable on SWKH's balance sheet. The advisory business allows them to run a more diversified portfolio and have more purchasing power than they would otherwise.

 

Back of the napkin valuation

 

Current market cap is about $45mm. They have $17.8mm of cash on the balance sheet. Through the last 10-q they had put $21.75mm of capital to work (will discuss in more detail). So in a sense you are paying $45mm to own $39.6mm of cash and royalties and loans.

 

The magic question are:

 

What is the NPV of the loans/royalties? What is the earnings power of the company once they are fully invested? How much can the fee biz generate once they are fully invested? How good is management at buying royalty streams and underwriting these loans? How incentivized is management?

 

Let me start off talking about management. It is managed by Brett Pope and Winston Black. They use to run a hedge fund called PBS Capital here in Dallas that employed a similar strategy, but I think also invested in public equities. I have seen past letters from the fund and from what I can recall it was successful. Additionally, Carlson Capital owns a large stake in SWKH, so they probably recruited these guys. Previously, they were employing a similar strategy for Highland Capital here in Dallas. I have a good resource to learn more about these guys, so I will dig into this more at a later time.  Regarding their compensation, they both are paid a base salary of $200k and get a carry on pre-tax profits. They also have a butload of options struck a different prices that would be very material to them if they could get there. Right now the stock is at $1.11. 20k are outstanding at $1.24 / 10k at $2.65 / 20k at $2.67 / 90k at $2.95 / 20k at $3.5. They are fairly young / value investors / and def. financially motivated to make this work.

 

Regarding their current investments. I don't know how to discount each investment and have no expertise in this space. My recommendation would be to assign your own discount rate to each and see if it is interesting.

 

First investment - 12/5/2012 - Term loan to a private neurology co. SWK provided $6.5mm and external clients (fee payers) $16mm. The loan matures on 12/5/2017. The loan shall acrrue interest at either a base rate of Libor + applicable margin with a minimum floor of 16% interest. They also are entitled to a exit fee ($2mm max potential), which gets accreted to interest income over the life of the loan.

 

Second investment - 12/20/2012 - They acquiried the marketing rights to a beta blocker for hypertension from Holmdel. They sourced $6mm of this investment to SWK and $7mm to external clients. SWK will recieve quarterly distribution of cash flow generated by the drug according to a tiered scale. Until SWK receives 1x cash on cash return, it will receive approx 87% of the products cash flow. As the cash on cash return multiple increases their interest will decline, but it will never go below 45%.  (note this is accounted for using the equity method on their BS if you look it up everything else is considered a finance receivable)

 

Third invesment - 4/2/2013 - Purchased a royalty stream on the net sales of Besivance for $6mm. Besivance is marketed by Baush & Lamb. They own 40.13% of the stream and the remainder is owned by Bess Royalty LP. nder the agreement, whent he purchasers receive a 1x cash on cash return of the toal purchase prices, InSite will be entitled to retain 25% of the royalty stream received about $4.2mm annually. The royalty stream will be returned to InSite if the purchasers receive a 2.75x cash on cash return. Insite recorded $1.2mm and $2.1mm in royalties for the years 2011 and 2012. Patent protection extended to mid-2021.

 

Fourth investment - 6/12/2013 - SWK purchased two royalty streams from Tissue Regeneration Therapeutics. The initial purchase totaled $2mm. Additional contingent consideration includes (i) $1.25mm payable upon aggregate royalty payments reaching a certain theshold and (ii) annuall sharing payments due to TRT once aggregate royalty payments received by the Company exceed the purchase price paid.

 

Fifth investment - 8/8/2013 - this is not in my original numbers as it occured during the 3rd quarter. SWK Funding LLC provided Tribute a term loan in principal of $6mm, which may be increased by an additional $2mm at Tribute's request on or before 12/31/2014. The loan matures on 8/8/2018 and accrues interest at an annual rate of 11.5% plus Libor, with Libor beign subject to a floor of 2% (i.e. min interest is 13.5%). Tribute entered into a guaranty and collateral agreement granting the SWK a security interest in substantially alll of the co's assets. In connection with the loan, Tribute issued SWK Funding 755,794 common share purchase warrants with each warrant entitling SWK Funding to acquire one share at $0.5954, exercisable at any time prior to 8/8/2020.

 

Long story short - assuming they were strong underwriters this could be a valuable portfolio. Furthermore, they have only deployed about 1/2 their capital base. If they can continue to deploy the capital base and bring in outside partners that pay fees the earnings power will grow.

 

I am going to stop here, bc I think that is a reasonable introdcution.

 

 

[Carvel46]

Good summary. I own it. I would be interested in reading any PBS Capital letters you have. Please post or message me (if you feel comfortable sharing them). Thx.

[Cunninghamew]

Carvel,

 

I actually have less than I thought, but I probably deleted some or saved them in illogical areas (that at the time seemed logical). Anyways, I was able to find 3 decent letters from 2010, which I have attached. I have some monthly updates, but they are not worth reading.

 

I would note that the letters are geared to public equity investments, but that they did start making pharma royalty investments in this fund around the start of 2010 for a seperate acct they managed. Despite the equity bent I think you will find they provide insight into how these people think about investing.

 

Out of curiosity when did you invest? Did it have to do with these guys or where you buying when it was a cheap cash shell?

PBS_Capital_Fund_Quarterly_-_2Q10.pdf

PBS_Capital_Fund_Quarterly_-_1Q10.pdf

PBS_Capital_Fund_Quarterly_-_3Q10.pdf

[johnheiderscheit]

I looked at this at 80 cents and almost pulled the trigger but my worry up here 30% higher is the last point you sort of threw out, paraphrasing "good investment if they are good underwriters".  They probably ARE going to be good underwriters but with biotech and drug valuations pretty frothy (obviously my opinion) I think there is a high risk that they are piling in at the top.  Their presentations suggest they think they can earn 15-20% ROEs with little leverage and those types of projections always make me nervous.

[Carvel46]

Cunningham,

I bought in May. Was an easier decision at a lower price. At today's price I haven't bought any more due to their concentration with investments and my desire to understand their investment process more. Also, their current advantage of playing in a small pond--makes me question their runway. I hope they'll do what LRE does--stay smaller and simply pay big dividends in 5 plus years. Then grow their external investment business. Or maybe they'll wind it up. Thanks for the letters!