QD view – 7% yield opportunity, but read the small print
As we have discussed before, many investors struggle to buy shares in funds that are listed on the Specialist Fund Segment. There are also a few platforms that have a problem with funds that are listed in London but whose quote is in a currency other than sterling. One fund that fell foul of both until this week was Biopharma Credit. Biopharma Credit’s shares are now traded on the Premium Segment of London Stock Exchange’s Main Market. It has also created a sterling line of stock – ticker BPCP – which will be identical to the existing US dollar shares – ticker BPCR – except for the currency that they trade in.
A big fund in a niche area
With a market cap of about $1.35bn, Biopharma Credit is big fund. It does what it says on the tin – makes loans to biotech and pharmaceutical companies. This is a niche area of the lending market and that means that there is less competition, which in turn means higher returns are available. Everything is being done in US dollars and, generally, revenues/capital will not be hedged back into sterling; investors should remember that they are buying a US dollar exposure, even if they buy the BPCP line of stock.
Biopharma Credit’s shares are trading at a small discount to NAV – 1.8%. The NAV isn’t much changed since the fund was launched – it is fractionally below the $1 per share issue price – all the shareholder return is coming from the dividend. The dividend yield is a chunky 7.1%, which is bound to attract investors.
Focused portfolio
The portfolio is very concentrated – of $1,378m of portfolio assets at the end of August, $350m (25.4%) was accounted for by a loan to Sarepta, $150m was a loan to LumiraDx, $149m was a loan to Bristol Myers Squibb, $113m was a loan to Collegium and $110m a loan to Epizyme. That’s 63% in the top five investments.
The cash balance at that date was $211m – the fund often has cash on its balance sheet as the managers look for new investments. This is a drag on returns, although the balance sheet is potentially more efficient than it once was as the managers have a revolving credit facility that they can use to make new investments in anticipation of funds flowing back from existing investments.
Considerable reliance on skill of the manager
The success of the fund is heavily dependent on the skill of the management team at Pharmakon Advisers. Fortunately, they have considerable experience and a good track record, with over $5bn invested in more than 40 transactions to date. 27 of those loans have been repaid in full and only one (back in 2012) lost money. In 2020, Pharmakon looked at 243 potential opportunities before selecting just three new investments for the fund.
Pharmakon gets a base fee of 1% of net assets. There is also a performance fee which works out at 10% of returns over 6% per annum. Half of this gets paid in shares if the fund is trading at a discount. An average 5% discount over any three-month period would trigger share buy backs at a 1% discount (but only if there is cash available from income and capital profits after meeting the dividend target). There is also a discount triggered continuation vote if the shares trade at a 10% discount or more on average for a year.
Loans are secured against existing revenue streams for proven products. However, the nature of this industry is that a company’s fortunes can change pretty much overnight as a product’s license is revoked or a new therapy comes along that is more effective/cheaper. Pharmakon earns its fee with the due diligence that it does on the companies and their products, and with its negotiating skills when it comes to the paperwork.
The structure of these loans varies but a typical structure might involve a high-ish coupon and upfront fees. It is quite common that the borrower repays a loan early. In those cases, Biopharma Credit is compensated handsomely. The loans may be at fixed or floating rates. The fund is unlikely to be much affected by a modest rise in interest rates.
An example
It might be worth looking at the example of Sarepta, which makes treatments for neuromuscular diseases. It has three main licensed products for the treatment of Duchenne muscular dystrophy.
The Sarepta loan was made in April 2019 and upsized in May 2020. Biopharma lent the money alongside other funds – its share of the overall $550m loan is 64%. The loan is due for repayment in one lump sum (a bullet repayment) in December 2024. Sarepta had $1.7bn of cash on its balance sheet at the end of June 2021, so hopefully this will not be a problem.
Don’t bet the pharm!
I am very pleased that ordinary investors can now invest in Biopharma Credit more easily. I hope that many other funds in the Specialist Funds Segment follow suit, as Oakley Capital Investments said it plans to do on today’s show. I think Biopharma Credit makes an interesting diversifier for a portfolio of funds. However, this is, I would suggest, not a fund to put too much of your investing pot in.