The solid performance of the healthcare sector over the past year has been enhanced by mergers and acquisitions, licensing, and other forms of deals in the sector. This most recent deal in the sector may not be the biggest when compared to traditional M&A, but it could prove to be a pivotal move for these two companies.

Ariad Pharmaceuticals Inc. (NASDAQ: ARIA) and announced the completion of a synthetic royalty deal through financing from PDL BioPharma, Inc. (NASDAQ: PDLI). Under the terms of the deal Ariad will receive $100 million in cash –$50 million upon the deal execution and an additional $50 million in one year. In exchange for this, PDL will receive a mid-single digit royalty on future sales of Ariad’s drug Iclusig until PDL receives a fixed internal rate of return.

As an option, Ariad can receive an additional $100 million at any time between 6 and 12 months from the date of agreement, on comparable terms.

The question that 24/7 Wall St. wants to address here is simple to ask, but will not be simple to get to an answer on — Is it ARIAD or PDL that really wins here?

What investors will want to know is that Iclusig is already approved in the U.S., EU, Australia, Israel, Canada and Switzerland. In the U.S., Iclusig is listed as a kinase inhibitor indicated for the following:

• Treatment of adult patients with T315I-positive chronic myeloid leukemia (chronic phase, accelerated phase, or blast phase) or T315I-positive Philadelphia chromosome positive acutelymphoblastic leukemia (Ph+ ALL).
• Treatment of adult patients with chronic phase, accelerated phase, or blast phase chronic myeloid leukemia or Ph+ ALL for whom no other tyrosine kinase inhibitor (TKI) therapy is indicated.

As for PDL, it will initially receive 2.5% of the worldwide net revenues of Iclusig until the one year anniversary of the closing date, at which time the royalty increases to 5.0% of the worldwide net revenues of Iclusig and remains until December 31, 2018.  Beginning January 1, 2019 and thereafter, the royalty rate will increase to 6.5%, subject to an additional increase to 7.5% if PDL’s funding exceeds $150 million.

If PDL does not receive payments equal to or greater than the total amount funded on or before the fifth anniversary of each of the respective fundings, Ariad will pay PDL the difference between the amounts funded by PDL and the amounts paid to such date.

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Now investors have to consider what Iclusig revenues have been, and what they could be ahead. Also, ARIAD ended its March quarter with roughly $304 million in cash and equivalents.

Earlier in 2015, when ARIAD reported its full 2014 results, the company said that Iclusig’s net product revenue guidance for 2015 was $130 million to $140 million. While ARIAD was targeting full company profitability out in 2018 at that time, the company had said that three new Iclusig clinical trials were planned to begin this year. Here is what ARIAD said about the 2014 results and this drug:

Net product revenues from sales of Iclusig were $21.4 million for the quarter ended December 31, 2014 and $55.7 million for the year ended December 31, 2014. Net product revenues for the fourth quarter include Iclusig revenues of $17.0 million in the U.S. and $4.4 million in Europe. Net product revenues in the fourth quarter represented a 47% increase from the prior quarter.

Harvey J. Berger, M.D., Chairman and CEO of ARIAD, said:

This financing allows us to accelerate initiation of the front-line trial of brigatinib and to ensure launch readiness as early as possible, while retaining strategic flexibility with respect to partnering and long-term commercialization of brigatinib. We are confident based on the latest clinical data on brigatinib and other ALK‐inhibitors, that brigatinib may be an important new cancer medicine for patients with ALK+ lung cancer. With the funding provided by this royalty transaction, we expect to start the front-line trial by early next year, ahead of our expected filing for initial marketing approval of brigatinib in patients with refractory ALK+ NSCLC.

He continued to explain the purpose of this type of financing:

This synthetic-royalty financing allows us to access the needed capital at low cost without selling any equity and gives us the greatest flexibility in implementing our corporate strategy.

PDL pays dividends to investors out of its royalty revenues and income. Another interesting aspect about PDL is that, unlike traditional biotech and pharma companies, it manages a portfolio of patents and royalty assets. It had invested about $780 million in total as of date of its 2014 annual report. Here is another interesting aspect that makes PDL very different from peers: it has only 10 employees!

Determining which company really won here looks a bit undecided as of this point. ARIAD gets to take in more immediate cash, while signing away royalties tied to Iclusig ahead. PDL gets a new revenue stream for the years ahead, and perhaps it could get upside if additional indications pay off. It is even possible that maybe both companies won. Royalty deals are also sometimes considered M&A-Lite strategies.

One thing that makes evaluating royalty deals from outside of the fishbowl is that it is hard to know what the real revenue expectations will be in the quarters and years ahead. Companies may make forecasts, but investors know that corporate officers can either give sandbagged guidance or overly aggressive guidance depending upon what they are trying to accomplish or project ahead.

Shares of Ariad were down 4.5% at $7.85 on Wednesday in mid-day trading. The stock has a consensus analyst price target of $9.25 and a 52-week trading range of $4.90 to $9.89. ARIAD has a market cap of almost $1.5 billion as of now.

PDL shares were up 0.4% at $5.91 in mid-day trading on a 52-week trading range of $5.76 to $10.26. The stock has a consensus analyst price target of $7.00. PDL BioPharma has a market cap of $955 million – and its cash balance and long-term investments were close to $720 million combined at the end of its March quarter.

Stay tuned.

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