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Knight Therapeutics: A solid long-term bet in the health care space

Fabrice Taylor, CFA, publishes the President's Club investment letter, for which he and The Globe and Mail have a distribution agreement.

When it comes to speaking to investors, Jonathan Goodman says all the right things. "I value my sleep."

"I'm obsessed with making money."

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"I'm building this for my grandchildren."

Translation: I don't take crazy risks, I make money for shareholders and I'm a patient, long-term builder.

But Mr. Goodman is not only a good promoter. He's a proven wealth creator, which explains why his latest venture, Knight Therapeutics, enjoys such a big market value despite minimal revenue (so far) and a pile of cash he has yet to deploy. Knight's sales in the fourth quarter of 2014 were a little more than $100,000. Its market value is $700-million.

But Knight's rich valuation isn't only about sector rotation into health care. It's a bet on Mr. Goodman (the ticker is GUD in case there's any doubt). Mr. Goodman is famous in investment circles for building Paladin Labs over almost two decades and then selling it to Endo Health Solutions for a total stock return of 9,000 per cent.

His next act, Knight, is basically the next iteration of Paladin, a company that distributes innovative drugs in Canada and does interesting deals to secure such distribution rights.

Will it succeed as Paladin did? By Mr. Goodman's own admission, "the market in Canada is much more competitive. Paladin's success spawned a lot of wannabe Paladins. Knight is a Paladin wannabe."

Here's the problem: It takes a long time to build a portfolio of commercial drugs. What does a wannabe Paladin do in the meantime?

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If it's run by Mr. Goodman, it does a whirlwind of deals that are already producing one-off revenue sources and gains.

While the first-quarter revenue was negligible, the company earned more than $125-million in net income on the sale of what's called a priority review voucher – a type of regulatory fast-tracking for specific drugs that treat neglected diseases.

Mr. Goodman has also done plenty of deals with other companies, lending them money at a healthy rate of interest and getting equity "kickers" as part of the deal.

For example, Knight lent CRH Medical Corp., a Canadian listed health-care concern, $30-million (U.S.) in December to help the company make a U.S. acquisition.

The Knight loan bears interest at 10 per cent plus other considerations, and Knight also received three million shares of CRH. Knight shortly after sold its shares for a gain of $10-million (Canadian). CRH has also paid Knight back $8-million (U.S.) on the loan so far.

Knight has a few such loans on the books, and I find this approach very interesting as it allows Mr. Goodman and his team to recycle Knight's cash balance over and over again to generate revenue and profit while the pharmaceutical business grows and matures over the coming years. Knight had $417-million of cash and marketable securities on Dec. 31, 2014.

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So I figure that as long as the team finds deals – "we're seeing a lot," says Mr. Goodman – there will be plenty of value creation until the bread-and-butter pharmaceutical business is built out and starts to deliver.

Another Knight strategy is to invest in life sciences funds, which gives Mr. Goodman tremendous intelligence on what's happening in the industry and also allows him to secure the distribution rights for drugs that will be developed by the portfolio companies in these funds.

Mr. Goodman likes to tell the story of a CEO who wouldn't give him the time of day when he ran Paladin, but who returned his call promptly after Knight invested in a fund that is a big backer of the CEO's company, opening the door to a possible distribution agreement.

While the company's approach may make it hard to pin a value on it, to buy this stock (as I did, but at much lower prices) is to bet on a lean firm with a top-tier acquisition team, decades of experience and the ability to act nimbly and intelligently with your money and theirs (Mr. Goodman invested $75-million in the company when Knight went public).

Health-care stocks are hot. Maybe they'll cool off. But this is not a short-term investment. It's a long-term bet. And as Mr. Goodman says, wearing both the promoter's and the entrepreneur's caps, "I won't sell a share until I sell them all."

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About the Author
Investment Columnist

Fabrice Taylor, CFA, publishes the President’s Club investment letter, for which he and The Globe and Mail have a distribution agreement. More

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