March 19, 2013 at 06:00 AM EDT
This Biotech Patent Leader Generates an 8.3% Dividend Yield
I was a hard-working journalist in the early 1990s - and the whole Human Genome effort was transforming biotechnology into front-page news - when the Oakland Tribune offered me a job as a financial writer. When the editor explained that biotechnology would be one of my "beats" ... well, I jumped at the chance. It was one of the best career decisions I ever made. Biotech was an exciting beat to work ... and that was an exciting time to work it. So I immersed myself in my assignments. And that meant that I talked at length with patients, company executives, industry analysts, financiers, top researchers, and senior officials at the U.S. Food and Drug Administration (FDA), the federal agency that approves all new drugs sold in the United States. A five-part series that I produced about a pioneering therapy for multiple sclerosis generated a lot of accolades and was one of my favorite achievements from the four years I spent on the biotech beat. But the real benefit was in the insights that I gained, and the lessons I learned. They've paid off for me in a big way through the years. And now they're going to pay off for you. To continue reading, please click here...

I was a hard-working journalist in the early 1990s - and the whole Human Genome effort was transforming biotechnology into front-page news - when the Oakland Tribune offered me a job as a financial writer.

When the editor explained that biotechnology would be one of my "beats" ... well, I jumped at the chance.

It was one of the best career decisions I ever made.

Biotech was an exciting beat to work ... and that was an exciting time to work it. So I immersed myself in my assignments. And that meant that I talked at length with patients, company executives, industry analysts, financiers, top researchers, and senior officials at the U.S. Food and Drug Administration (FDA), the federal agency that approves all new drugs sold in the United States.

A five-part series that I produced about a pioneering therapy for multiple sclerosis generated a lot of accolades and was one of my favorite achievements from the four years I spent on the biotech beat.

But the real benefit was in the insights that I gained, and the lessons I learned.

They've paid off for me in a big way through the years.

And now they're going to pay off for you.

Biotech Patents Generate Cash

You see, I not only learned how the industry worked, how to identify future blockbuster drugs, and how to tell which biotech stocks have the firepower to survive clinical testing to become an actual revenue-generating company.

I also learned that one indicator in particular can show you whether or not a biotech has big-profit potential.

I'm talking, of course, about patents.

A biotech, you see, is no different than any other kind of high-tech firm: If it has enough patents, it can use them as a cash-generating machine.

I don't mean it has to auction them off, like some troubled tech firms have been doing of late. A biotech with a hefty patent portfolio can simply license its technology to other companies. That brings in revenue without all the high costs - and big risks - of actually making the drug.

That's where PDL BioPharma Inc. (NASDAQ: PDLI) comes in. It's a leader in what's now known as "humanized" monoclonal antibodies.

That leadership has paid big dividends for the company.

And it can do the same for you, too.

Based in Incline Village, Nev., PDL has several drugs on the market. But it's been succeeding by letting Big Pharma do all the heavy lifting.

Consider that PDL has licensed its technology to such heavyweights as Roche Holding Ltd. (OTC ADR: RHHBY), Novartis AG (NYSE AG: NVS), Pfizer Inc. (NYSE: PFE) and Johnson & Johnson (NYSE: JNJ).

As I see it, this is a great business model. For investors at this point, it pays to think of PDL as really more of a patent play than a true science firm.

Not that the underlying science isn't great. It's just that PDL's main sales and profits stem from its relationships with much bigger firms.

PDL's six main drugs bring in more than $300 million a year in royalty revenue. PDL refers to its portfolio as the "Queen et al patents." They expire in 2014, pending changes to those products lines that could yield either new compounds or create new uses for existing molecules.

This is one of the reasons why PDL's stock remains so low-priced and the fundamentals so appealing for at least for the next year.

With a market cap of about $1 billion, PDL trades at less than four times forward earnings, or about one-third that of the overall market.

And talk about high internal returns. It has a profit margin of an astounding 56%. Not only that, but it has a return on assets (ROA) of nearly 80%.

PDL certainly knows what to do with all that cash - it returns it to the shareholders. The stock pays an annual dividend of 60 cents a share, for a current yield of 8.3%.

A yield like that greatly reduces the risk of buying this stock. Think of it this way: If you held PDL for a year and lost 10% on the stock price you'd still almost break even.

Not Your Typical Biotech Stock

It is a rare small-cap tech leader that offers such a strong dividend.  Founded in 1988, the firm specializes in making hybrid antibodies. These contain a high degree of human cells.

The idea is to use these compounds so that they don't trigger an immune response. At the same time, the drugs target cancer cells more precisely, which can be a more-effective way to treat this malady than by using strong drugs that also kill a lot of healthy cells.

In fact, two of PDL's Top Three selling drugs target cancer. They are:

  1. Avastin, a tumor-starving therapy used as a first-line treatment with certain cancers that invade the colorectal system, the lungs and the kidneys.
  2. Herceptin, which prevents the over-expression of the HER2 protein found in breast cancer.
  3. And Lucentis, a compound that inhibits the growth of a protein that leads to the age-related eye damage that can cause blindness.

Now, as much as I like PDL's business model, I do see some risks. The most obvious is the possibility of one of its drugs being pulled from the market for safety reasons. But this holds true for every member of the sector.

More to the point, the company has set itself up to generate new sales as its patents begin to expire. So, by far the biggest risk is seeing the stock price go down because the firm can't add enough new revenue.

But just last week,  PDL announced that that it's projecting a better-than-expected $92 million in royalty payments during the first quarter. That's up 19% from the year-ago quarter and easily eclipses the $86 million that analysts were looking for, says FactSet Research.

PDL gets the royalties based on the sales of its drugs by other companies in the prior quarter and says the increase comes from higher payments for the drugs.

Should you buy this stock now?

Well, this isn't your typical "breakout" biotech.

But that's not a bad thing.

As my biotech lesson demonstrates, the deeper the collection of patents a company holds, the more business options that it has. Those patents are like a business "moat" that can keep potential rivals at bay - enabling the patent-holder to generate some hefty profit margins.

So if you're looking for a high-yielding play in the biotech/Big Pharma - and can accept a moderate level of risk - PDL could be a nice addition to your portfolio.

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