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Friday File — Last of the year

Checking in on the "Executive Order 0001" Teaser, plus an update on Ligand

By Travis Johnson, Stock Gumshoe, December 23, 2016

I’ve got a couple things to look at for you today as we close out our last working week of the year (Stock Gumshoe will be closed until after the new year, though we’ll probably have a couple quick articles for you next week). The first is a look at a Casey teaser that a bunch of folks have been asking me about this week, and the second is a quick check-in on Ligand Pharmaceuticals, which has been the focus of some attention this week.

The Casey pitch is about, as you might expect, a “tiny stock” — and it’s very much a “Trump” play. Here’s how the ad gets our juices flowing:

“On his first day as President, Donald Trump will roll back one of Obama’s biggest mistakes… But not the one you expect.

“The result will unlock a $128 billion fortune in a forgotten part of America. And it could send a tiny $1 stock through the roof…

‘Trump’s election could be the best thing to happen to the stock market. And this company could be the best investment of his entire presidency.’ ~ Doug Casey, author of NY Times bestseller, ‘Crisis Investing'”

We’re seeing “Trump stocks” pitched left and right, of course, from the financials who would benefit from rising interest rates to the various construction and energy companies that would benefit from huge increases in infrastructure spending… but this sounds like another thing entirely. What are they talking about? More from the ad:

“Donald Trump can’t repeal Obamacare on his very first day – he needs the Senate’s help for that.

“And it will take some planning before he can start construction of a wall on the Mexican border.

“But on Friday, Jan. 20, President-elect Trump’s first executive order will roll back one of President Obama’s biggest mistakes….

“… the Trump transition team has studied the Presidential rules closely.

“They saw how President Obama issued ‘executive orders’ at an unprecedented rate.

“And the Trump team is planning to use the same strategy to reverse Obama’s massive expansion of red tape and regulatory overreach.

“Trump believes these regulations are what’s keeping American production low – and keeping American workers unemployed….

“… he’s not looking to help big banks or give a major corporation a tax break.

“He’s actually going to introduce a measure that should immediately add 3,000 jobs in a downtrodden, forgotten part of America…. Alaska.”

Ah, so now I think I know where we’re headed with this one. Sounds like Casey is looking at one of those big and as-yet undeveloped Alaska mines that’s trying to get environmental or regulatory approval… and, thankfully, there aren’t so many of those. Which one is the pitch about? More clues:

“Trump’s executive order will wake a sleeping giant – the Alaskan mining industry.

“And there’s one publicly-traded company in particular that could see their share prices soar almost immediately.

“This company’s stock is currently hanging around $1 – but according to the most recent study done in 2013 they’re sitting on a resource mother lode:

“The largest gold deposit in the world.

“They haven’t been able to pull this gold out of the ground – until Trump got elected….

“…underneath the surface of a remote property in Alaska, geologists believe there’s over 107 million ounces of gold.

“At today’s prices, that’s worth $128 billion.”

So that should be clear now, but we’ll grab these last couple clues from the ad just to be sure:

“‘Beneath hills blanketed with a crazy quilt of moss and lichen, lurks a multibillion-dollar fortune… perhaps the greatest lode on the planet,’ The New York Times said about this site.

“ added, ‘It is arguably the richest prize in mining.’

“The company’s share price is currently just around $1….

“There is the real potential here to make as much as 10 or 20 times your money.”

So yes, what’s being teased here is the proposed Pebble Mine in Alaska, which was left almost for dead a few months ago but has seen the flames of hope fanned a little bit by a recent decision to mediate their court case against the EPA… and fanned further still by Trump’s win in the election because of his professed goal of bringing the EPA’s regulatory impulses to heel.

Does that mean President Trump will sign an Executive Order on his first day that immediately grants the Pebble Mine a mining permit? No, that’s likely beyond his control… but his new EPA may well take a different tack in the lawsuit/mediation with the Pebble project, I have no idea.

The company that owns the Pebble Project is Northern Dynasty Minerals (NDM in Toronto, NAK in NY), and I personally hold some 2021 warrants on the stock. That’s an extremely speculative position for me, and I made it because of the huge upside potential if the mine does advance into permitting and looks like it will really be built someday… so I thought it worth a gamble even though I don’t know whether their chances of actually building a mine are 3% or 50% or some other wild guess of a number.

That’s because of the mammoth size of the deposit — you can read that New York Times article they quote, it’s from 2008 and available here, to give you some idea of the environmental controversy surrounding the project and some idea of the incredible size of the mineral deposit. The Pebble Mine could be, if built, the largest and most productive copper and gold mine in the world, and it would almost certainly be among the top five or ten mines in the world. This is not a small deposit, it’s one of the biggest gold and copper deposits ever identified, which is why there’s probably something better than a zero chance that it will be developed. There would certainly be no debate about this mine if it were a few million ounces of gold at stake — that would be nowhere near big enough for it to be worth building the massive infrastructure projects they’d require to produce gold safely (if such a thing is possible) in this location.

And even if you don’t care about environmental protection at all (most people do, of course, even former governor Palin and president-elect Trump), this is not a “no brainer” development — it would be incredibly expensive to build, and there is real fear that it will put at risk Alaska’s huge salmon fishery if any toxic cyanide or copper runoff makes it into the Bristol Bay. Fish is not a tree-hugger concern in Alaska, it’s not about wealthy Bostonians protecting their trout streams, it’s a major part of the state economy and a fishery and spawning grounds can’t necessarily be fixed if there’s a substantial mining incident and they get “broken.”

So I don’t consider this a “done deal” even under President Trump and his very clearly different strategy with the EPA — but with a strong and aggressive EPA the mine had probably almost a zero chance of being built, and the chances have improved in the last few months. You’ll have to make your own call about how much they’ve improved, and keep in mind that Northern Dynasty would still have to raise billions of dollars to build the mine (they had a big mining partner who was funding much of the permitting and assessment work several years ago, but Anglo American pulled out a couple years back, after the EPA effectively shut down the project).

Can a mine be safely built in this area? I suppose that most things are probably possible if you throw enough money and science at them… but I don’t know what the final determination will be on that, or even whether the size of the mine can match the cost of the environmental protection safeguards that would be required (it is a mega-mine, but that doesn’t mean the whole thing can be mined with whatever the environmental safeguards end up being… and building massive dams is not cheap). I do think that it’s likely the stock will continue to enjoy this reprieve at least until the mediation with the EPA begins to generate news, which I think is supposed to be next year, and perhaps it will be a more dramatic reprieve if Trump strikes down or rewrites the latest executive orders on the Clean Water Act. You can get an idea of some of the major issues and work the EPA has done on the EPA’s page about the Bristol Bay watershed/Pebble project here.

The stock is soaring today again, largely because Northern Dynasty has gone public with the fact that they expect the permitting process to be restarted in the first quarter of next year… and, importantly, that they have met with Trump’s transition team, including Myron Ebell (head of the EPA transition). That has been well-covered (Reuters article here, for example), which has helped the stock to rise… and, of course, the “Executive Order #0001” pitch from the Casey folks probably has helped as well.

And this soaring is not new — Casey has hinted at this pick before, as have others in the newsletter world, and it has been well-covered since their possible regulatory reprieve started to emerge as real back in the Summer — the stock is up 500% since the Summer lows when they were raising money, and up 150% since they announced their positive legal news (that they had funding to proceed through the litigation against the EPA back in September, and that they agreed to mediation with the EPA in October) and a bit later, started to enjoy the “Trump rally” as their hopes for a resumption of permitting have been fueled by Trump’s deregulatory and EPA-related statements.

So this is the very essence of a “story” stock — for the next year or two it will probably be driven by the regulatory hopes, not by the actual economics of the mine, and there’s at least a chance that the mine will advance toward permitting. That could have a huge impact on the share price, of course, particularly if the gold price rises again — the mine could theoretically be feasible at much lower gold prices (depending on what the environmental protections would cost and what parts of the deposit can be mined), given the massive size of the deposit, but rising prices obviously help. That’s why I considered it to be a reasonable speculation, I used long-dated warrants because they provide a touch more leverage but the stock itself is likely to be extremely volatile so you probably don’t need warrants to have a wild ride (either up or down, depending on how things play out with President Trump and the gold price).

The absolutely most leveraged bet is in the short-term warrants — there aren’t as many of those, they have a high strike price pf C$3, and they expire on September 14 next year. They are pricey given that short time period, they last traded at about 50 cents so they won’t be profitable unless NDM rises 40% in the next nine months, and they’re extremely illiquid so it might not even be possible to buy them anyway (at least, not at the price you’d prefer).

But the leverage is real — if you assume that the stock doubles from here in the next nine months, then the gain from buying the stock would be 100%. The gain from buying that Sept. 2017 warrant would be 300% (and the gain from my long-term warrants from here would be about 125%, assuming they continue to trade close to their exercise value with little premium).

Of course, if the stock goes up by only 20% in the next nine months (or falls), those short-term $3 warrants would expire worthless. That’s a very wild bet for most people. The longer-term warrants are well in-the-money so they don’t provide nearly as much leverage — the strike prices are 55 and 65 cents, so with the stock at C$2.50 you’re really only goosing your potential return in a pretty minor way (like in that above example, a 100% gain in the stock would equate to roughly a 125% gain in the B warrants I hold — that’s the most liquid and largest warrant, from their most recent financing). The stock itself may be a reasonable bet compared to those warrants, even though the warrants are trading as if they don’t have any leverage from those four or five years of potential, but I bought most of my long-term warrants a while ago at much lower prices so I’m just holding them now to see how things shake out next year. And yes, the long-term warrants also have downside leverage, as you’d expect — so if the stock falls by 30% the value of the B warrants would be expected to drop roughly 40%.

Northern Dynasty’s various warrants are detailed on their website here with the Canadian ticker symbols. I currently own both the A and B series, NDM.WT.A (C$0.55 strike, 7.9.20 expire) and NDM.WT.B (C$0.65 strike, 6/10/21 expire) in Toronto.

So Northern Dynasty stock is what Casey is apparently still thinking of as one of the best bets for a Trump presidency… and it may work out that way, we’ll have to see what happens, but I’d just reiterate that this is very speculative investing based on regulatory and political events, it’s not really about the mine’s economics just yet and, if the events go against Casey’s expectations (or against Northern Dynasty’s expectations, for that matter), the stock could give up the 500% gains of the past six months very, very quickly. Stories change much faster than fundamentals, and this is all about the story. I’m placing a bet on this horse, and since I used warrants it’s even a more speculative bet than Casey is likely suggesting… but, as with all bets, I’m very aware of the fact that there’s a good chance of losing 80-100% of my investment if things surprise in the other direction… it just seems worthwhile to me to risk that 100% loss for a potential 500-1000% return (or maybe a little more) if things go very well.

I like to do this kind of betting with small amounts of capital from time to time — sometimes it works and I get huge gains, as with some of my leveraged gold bets in the first half of 2016… sometimes it doesn’t work and those losses of capital drag down my overall returns, as has certainly been the case in many years in the past.

I’m absolutely not suggesting that any of you follow my lead on that, by the way — in financial terms, this is like betting on a few numbers in roulette… it’s fun and it leads to huge gains if you’re right (and lucky), but the expectation should absolutely be that it’s much more likely that you’ll be going home with empty pockets after a little adrenalin rush and a few free drinks. Doug Casey has been extremely successful with some of these high-risk junior mining investments in the past, but I’m sure he has also lost his full investment on some of them — maybe this one is a little easier to judge because it’s so dependent on environmental permitting and the incoming president has been clear about his desire to rein in an aggressive EPA, but don’t fool yourself into thinking it’s at all certain.

Lots of other investors are already expecting much better things out of Northern Dynasty as a result of first the small glimmer of light at the end of their tunnel in terms of the EPA litigation, and then the brighter light of deregulation after the Trump election win, so this is no hidden surprise… and that’s why the stock has gone from a market cap of C$100 million a few months ago (and C$50 million last year) to almost C$700 million today. The mine’s big enough that the stock could certainly soar higher, the company had a market cap of almost $2 billion at the height of optimism in 2011, but there’s still a huge amount of uncertainty and it could be that the stock is overreacting to implied promises from President Trump that might not come through as investors expect.

I don’t like to talk about illiquid and highly speculative investments very often, like those warrants, because even our relatively small group of Irregulars is more than large enough to have an impact on an investment that’s this illiquid, so I’ll try to be clear about not profiting from any attention I might drive to these investments in the short term — I will not sell my warrants for at least a month.

And that Ligand news?

Lemelson Capital, which tried very hard to take down Ligand Pharmaceuticals (LGND) with a short attack back in 2014 and was ultimately rebuffed by investors, is trying again.  This time it’s not an appeal to investors through one of those “open letters” or presentations that usually appear in press releases or on Seeking Alpha, it’s a letter to a Senate subcommittee that has been investigating pharmaceutical pricing — and the claim is no longer just that Ligand has aggressive accounting, pays its small cadre of executives way too much, and may have competition for their biggest royalty payers… it’s that Ligand is actually evil.

OK, maybe not evil, but Lemelson — who signs the letter not as the head of a short-selling investment fund but as the Rev. Fr. Emmanuel Lemelson, head of The Lantern Foundation (which is disingenuous but true, he started that religious foundation) — accuses Ligand of abusing the Orphan Drug Act, using subsidiaries to boost non-cash earnings like Enron, and using predatory pricing like former Ligand partner Martin Shkreli (this was back when Shkreli was CEO of Retrophin, which licensed its lead drug from Ligand and will pay milestones and royalties if sparsentan continues to advance to commercial sale, as has seemed likely of late).

You can read the letter from Lemelson if you’d like to see the details (it’s linked from his press release here) — the parts that are clearly true have been true for a long time: Ligand depends on a couple expensive drugs for most of their revenue, though I’ve not seen accusations of improper pricing for Novartis’ Promacta or Amgen’s Kyprolis from other quarters; Ligand pays its executives a huge amount, largely in stock and options, and reports non-GAAP and adjusted numbers that therefore look far better than the GAAP numbers; the Viking Therapeutics spinoff looks like it was a pretty cynical money grab during a hot biotech market; Roth Capital is a little embarrassing in its baldly promotional analyst coverage of Ligand.

I don’t know that the abuses of the Orphan Drug Act that are claimed are true, or that the accounting they do is improper as alleged by Lemelson… but Ligand has been a “hold your nose” stock for quite a while because of the high valuation and the fact that they’re essentially trying to harvest gains from an investment portfolio — these are hedge fund guys, not pharmaceutical guys, and that is part of what appealed to me (not necessarily as a person, but as an investor). Their goal is to buy up drug candidates cheap, or buy up drug delivery or platform technologies, and license those drugs and delivery platforms to the companies who will do the real R&D, spend lots of money for clinical trials, and, in the end, pay royalties or become big customers of Ligand’s drug delivery compound (Captisol) if and when the drug gets approved.

But being a financially-minded guy in the pharma world is perhaps more dangerous than usual right now. That’s what got Valeant and Shkreli in trouble, to some degree, because the obvious goal of an investor is to extract as much value from assets as possible… which means charging what the market will bear, which in their cases meant finding undervalued assets and “creating value” from them by raising prices. They went way too far, of course, but our health care system and its arcane regulation is set up in many ways to reward that behavior.

I am not sticking my head in the sand on Ligand, partly because image is critical for publicly traded pharmaceutical companies right now and no one wants to get hauled in front of a Senate Committee for hearings. I don’t know if Lemelson’s accusations will find friendly ears in the Senate, or if there’s a possibility that actual fraud exists, but there’s at least a small chance that this type of accusation could hurt Ligand’s shares — as his last short attack did, for at least a few months. Lemelson himself has been under the microscope as well for some of his past short-selling statements (he denies any wrongdoing and complained vigorously about that coverage from the press at the time).

Ligand is not an undervalued stock with lots of hidden strength, it’s a richly-priced royalty company that depends on both growing Kyprolis and Promacta sales and the advancement of some of their other possibly major royalties into meaningful cash flow in the coming years to help diversify away from Kyprolis and Promacta.

That doesn’t change with this latest salvo from Lemelson. I haven’t done anything with my position and don’t want to overreact to a very skewed (and so far largely ignored by the market) letter to Congress from a longtime short in Ligand shares, but there is and has always been a high level of risk in this name — and with Ligand, it’s small enough and concentrated enough in a few major royalty streams that there’s always the possibility of catastrophic news that could have the stock price overnight. That’s an important thing to keep in mind when you’re doing your risk assessments and thinking about position sizing (which is, in the end, the one guaranteed risk reduction technique — you can’t lose what you don’t invest). That’s why I reduced my position a couple years ago, to take some profit off the table and give me the stomach to allow LGND shares some breathing room — LGND remains a middling position for me, something like 2% of my individual equity portfolio, so I can stand big moves without panicking… but if real problems arise that seem genuinely problematic for Ligand’s future, I am perfectly willing to sell, especially if the actual fundamentals falter because of dropping Promacta or Kyprolis sales (both of those are still growing at the moment).

So I’m not blindly holding Ligand, but, as I’ve said a few times in the past, I wouldn’t make it a large position because of the risk exposure… I don’t think it’s worth buying above $100 unless you like risk, since it’s already pretty richly valued based on their expected royalty revenue over the next couple years, but I don’t see enough reason to think about selling yet. The news from Ligand itself has been weak this fall because of a small reduction in their earnings forecast that I wrote about here, but that was quite a while ago… more recently, they’ve seen some progress with more licensing deals, including a relatively high-potential one with Novartis for a capital-enabled version of Mekinist (their melanoma drug) that could result in milestones and royalties, but there will be ups and downs as things proceed. Still watching and waiting and holding, personally… and Ligand has not responded to this latest salvo from Lemelson, which is probably not surprising because it’s largely a rehash of his past criticisms and it might go away on its own, but we’ll see if he’s able to get any traction in the weeks ahead.

And that’s it for me — Merry Christmas, Happy Hanukkah, Happy New Year and the blessings of the season to all of you, whatever holiday you might be celebrating. I’ll be back with your next Friday File on the first Friday of the new year.

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6 years ago

This is the point where I set serious concern for the environment way over potential financial gains. The Pebbble mine would be environmentally devastating over a huge area. We already know that the existing EPA has been terribly lax in upholding protections from polluters, and with the incoming appointment to the EPA, it will do nothing but encourage that devastation. Please realize that we have to be stewards of this planet, and will be leaving a very questionable environmental legacy to our children as it is. We should stand strong in opposition to this project. Take a look at the Sierra club’s analysis on this-gather facts even if you may dislike them-at least read what they have to say. Find your profits in a “greater good’ investment.

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