James Carthew: BioPharma Credit shines in weak markets

Shares in the 7%-yielding lender to US drugs companies could make a useful addition to any income portfolio, if investors are comfortable with the concentration risk.

BioPharma Credit (BPCR ) is a unique London-listed fund that could make a useful addition to any income portfolio. For the past four years this £1.3bn lender to US life sciences companies has been paying out 7% in dividends, and over the five-and-a-quarter years since flotation it has generated an annualised investment return in dollars of 6.4%.

Fund manager Pedro Gonzalez de Cosio co-founded Pharmakon Advisors LP, the debt specialist behind the investment company, in 2009. The firm can boast an impressive track record with no defaults and just one loan returning less than 10% annualised, and that was by design rather than by accident.

When I last wrote about the closed-end fund in September 2019, there was one cloud on the horizon. One borrower, Lexicon Pharmaceuticals, had just had a drug approval rejected and its finances were looking compromised. As testament to Pharmakon’s underwriting skills, however, Lexicon was able to repay its loan in full out of the proceeds of selling its key revenue-generating drug, and BioPharma Credit was unaffected.

Throughout its life BioPharma Credit has had significant cash reserves which have held back the underlying growth in net asset value. At the end of May 2022, however, it was fully invested and had drawn down $138m on its credit facility. This is as close that the fund has been to firing on all cylinders since launch, and de Cosio is optimistic about returns for the rest of 2022, which could mean it tops up payouts with a special dividend for a fourth year.

Biotech equities have been one of the worst-performing sectors of the market for some time. That is not a worry for this fund, however. The problem in the biotech sector is largely one of sentiment towards loss-making companies. BioPharma Credit only lends to businesses with significant cash flow from approved, commercial-stage products. It tends to insist that its loans are secured against the revenue from these drugs.

Drug sales are not much correlated to economic cycles, or equity and bond indices. Advances in drug discovery have allowed smaller and medium-sized companies to take an increasing share of total drug revenues. BioPharma Credit’s borrowers are listed companies that often turn to debt or share issues to finance research and development. Weak equity markets, which make share or, more commonly, convertible loan issues more expensive are therefore good for BioPharma Credit’s business.

With just 11 loans, the portfolio is concentrated: two debts to Collegium and Sarepta alone account for 44% of net assets. That concentration risk is a factor investors should consider. De Cosio would like to expand the number of loans to around 20 over time. That involves expanding the fund though, as it still important to the business model that BioPharma Credit, and BioPharma Credit Investments V, the private fund managed by Pharmakon that invests alongside it, can write large cheques if required. That could be difficult with the shares trading on a 6% discount below asset value.

BioPharma Credit’s 50% share of a $650m loan to Collegium Pharmaceutical is the largest loan today. It helped to finance the acquisition of BDSI, a company that Pharmakon knew well because it had also borrowed money. With two management teams that they knew well, three revenue-generating pain management drugs, a $600m+ market value and over $100m in the bank, Collegium looked like a good credit. The four-year loan gets repaid in quarterly instalments from year two and carries interest of 7.5% over Libor, the old inter-bank lending rate. BioPharma Credit also earned fees when the loan was agreed and funded.

It might seem odd that BioPharma Credit can earn high returns from loans to large, listed, cash-generative businesses. However, the complexity of the loan underwriting deters competition. Pharmakon has a 16-strong research and investment team backing up the fund managers. It maintains close contact with a wide pool of potential borrowers and this familiarity with the companies and their products allows it to act quickly when required.

The duration of the portfolio is short, so it is important for BioPharma Credit to be able to make three to four new investments a year to replace loans as they mature. That pressure is compounded by the tendency for many of these borrowers to repay their expensive loans early.

That was neatly illustrated on 28 June when BioPharma Credit announced it was expecting an early repayment of its $110m loan to Epizyme from that company’s takeover by Ipsen. The transaction is expected to close by the end of the third quarter. However, the fund is protected in these circumstances by a range of pre-payment penalties. In this case, BioPharma Credit will receive between $3m-$7 m in prepayment and make-whole fees on top of the interest it is owed. Sometimes those fees can provide a significant boost to returns.

For much of its life, BioPharma Credit has been hard for private investors to access, but it moved across from the LSE’s Specialist Funds Segment to a premium listing on the main market last October. I thought that might have been the trigger for a re-rating, but the shares continued to trade at or often below asset value, a discount that has recently widened.

With half the loans arranged on floating rather than fixed rate terms, BioPharma Credit looks to benefit from rising interest payments. The weakness of the pound over the last year has been good news for UK-based investors. As a result, the dividend yield has recently risen to 7.4%, making the shares hard to ignore in my opinion.

James Carthew publishes research at QuotedData. Any opinions expressed by Citywire, its staff or columnists do not constitute a personal recommendation to you to buy, sell, underwrite or subscribe for any particular investment and should not be relied upon when making (or refraining from making) any investment decisions. In particular, the information and opinions provided by Citywire do not take into account people’s personal circumstances, objectives and attitude towards risk.

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