Jonathan Goodman: A Canadian Outsider CEO

Partly out of interest in the company and partly because the share price is so much lower now than when I sold the stock, I’ve been looking at Knight Therapeutics and writing a new post about it. To provide a bit of context for that post, I thought I should repost this and another old Knight post. This post about Jonathan Goodman does as good a job as anything explaining why I remain interested in Knight despite its performance. I believe you could expect the new Knight Therapeutics article on Monday, and the other old Knight article later today. Thanks as always for reading and supporting.

Jonathan Goodman has been involved with pharmaceuticals all his life. His father Morris founded Pharmascience when Jonathan was in his teens, and Jonathan took Paladin, a division of Pharmascience, public with Mark Beaudet when he was 26 at an IPO price of $1.50. He did so wanting to break away from Pharmascience by selling only branded products, performing no R&D and not manufacturing. I’ll let him tell you a bit more about Paladin, as well as Knight, in this video.

Goodman runs a very unique pharmaceutical operation. Paladin in-licensed drugs in Canada that were nearly ready for commercialization, or were being sold but not focused on by others. Canada is a small market, with a population of around 38 million today, and rigorous, unique regulations for getting a drug to market. Paladin realized that many pharmaceutical companies would not want to deal with the hassles of Health Canada, then dealing with the provinces over pricing, etc, so it could often get the rights to drugs for exceptional prices.

Paladin, under the leadership of Goodman (and Beaudet) had 19 consecutive years of record revenue. Goodman wasn’t involved with all of it though.

Revenues and EBITDA at Paladin

There has been tonnes of ink spilled on this but I’ll touch on it briefly. In 2011, Goodman got into a cycling accident that left him in a coma for months, and most medical professionals expected him to die or be a vegetable for life. While he was in the coma, Beaudet and the rest of the management team ran the company admirably, perhaps exceptionally, and Paladin didn’t miss a step. The accident has become a huge part of the Jonathan Goodman narrative, but I won’t dwell on it beyond using it as a data point on his determination and commitment to the companies he runs.

Goodman came back to work about a year after the accident, and didn’t recognize Paladin. In his words:

It had become a democracy. I love democracy as a theory, but I don’t think it’s necessarily the best thing for a company. I’m more of a dictator.

• Jonathan Goodman

Unlike the Outsiders Thorndike wrote about, Goodman did not, and does not, run a decentralized operation. It was losing his dictatorship at Paladin that led him to selling it. He found a buyer in Endo, which wanted to buy a foreign company in order to perform a tax inversion and move the company HQ to Ireland. And Goodman negotiated one hell of a sale. Paladin shareholders received 1.6331 shares of the new Endo, $1.16 of cash, and one share of Goodman’s new spinoff company, Knight Therapeutics. And for Knight he negotiated the worldwide rights to Impavido, a priority review voucher* to expedite the FDA approval process, $1 million of cash, and even Paladin’s office furniture.

* I’d like to expand on that priority review voucher, as I think it is illustrative. Goodman negotiated to take the voucher with him to Knight, with no idea what its value was and no similar transactions to help determine a value. But as you can see in the video above, he thought about it logically and did some napkin math to figure out its value. “How much would Pfizer pay for four more months on the Lipitor patent? It’s valuable, I don’t know what it’s worth though”. How is that for logic? He was able to see value in something, and likely got it for as cheap as he did (essentially free) because he could see the value where Endo could not. And even more than him actually seeing the value, he was able to realize it. Biomarin sold a PRV not long after Knight went public, for $67.5 million USD. Just four months later, Goodman sold his for $125 million USD. The whole episode goes to show Goodman fighting over every dime. He had the foresight to fight for the PRV instead of whatever else he could have negotiated for, and then had the guts to hold out for much more once he saw for how much someone else could sell it.

On the day before the acquisition closed, Paladin Labs shares traded for $142.06. If a Paladin shareholder bought on the day of the IPO, and sold the day before the Endo acquisition closed, they would have realized a 27% CAGR, vs 8.7% for the S&P 500.

If a Paladin shareholder instead said to themselves “I trust Jonathan Goodman and I only want to be invested with him”, sold their Endo stock on March 5, 2014, and used those proceeds and the cash proceeds from the deal to buy Knight stock, their Knight stock would be worth $260.40 today, almost a 24% annual return since the Paladin IPO.

Goodman has killed it, and shareholders have been rewarded by investing alongside him.

How has he done it?

Balance Sheet

I value my sleep over making more money. We’re kind of the inverse of Valeant.

– Jonathan Goodman

Since raising $1 million in the Paladin IPO, neither Paladin nor Knight have used even a dollar of debt. As he mentions in the quote above, this is unorthodox for the pharmaceutical space. While fans of the perfect capital structure may wish that Goodman was willing to lever up a bit, his industry is littered with companies that took on way too much debt and blew up or have stock prices in the dumps due to the debt they took on. Look no further than the aforementioned Valeant and Endo. There’s a happy medium between no debt and Valeant debt, but Goodman has gone against the grain and proven it can work.

Instead of debt, Goodman has funded his businesses by issuing shares when they appeared overvalued, and with internal cash flows.

With almost no business to speak of, Goodman raised $255 million by issuing Knight shares and warrants within weeks of going public. Then before the year was done, he issued shares at $6.75 (up from Knight’s spinoff price of $3.50) for another $87 million.

In mid-2015 he issued 10.33 million shares of Knight, at an even higher price, to acquire 28.3% of Medison Biotech, an Israeli pharmaceutical company he intended to become his partner for in-licensing Knight’s products in the country.

And finally in 2016 he issued shares at $8.00 and $10.00 to raise another $330 million.

All told, Goodman issued shares in a company with almost no revenue to acquire 28.3% of Israel’s 4th largest pharmaceutical company and raise almost $700 million.

At that point he stopped, and sat in wait with his pile of cash.

Capital Deployment

Goodman has a contrarian view on raising capital, what about deploying said capital?

Paladin dabbled in lending money to smaller companies looking for capital in exchange for high interest rates (mid-teens), occasional equity kickers, and product rights either as part of the deal or as part of the security behind the loan. He took this unique source of deals to Knight, where in five years he has lent over $170 million to 15 different companies. On these loans Knight has realized mid teens returns without considering the more than 15 products’ rights it has received.

If you watch the video at the top of this post, you’ll see Goodman mention his strategy of investing as an LP in life science funds with a history of good returns, with the hope of the usual return of LPs and receiving product rights. After five years, he has admitted this didn’t work out as hoped – that the investee companies of these funds haven’t had an interest in handing out product rights once they have their money. The funds have provided decent returns – Knight has invested $107.4 million and has received distributions of $39.4 million with the investments having a fair value of $126.1 million – and received the rights to two products, so it was probably still a worthwhile endeavor considering the cash otherwise did not have a high return home. The idea however was to get product rights, so given the lack of rights coming in the door, Goodman has stopped the fund investments, beyond what Knight has already committed (another $48.4 million).

There’s two ways to look at this failure.

• Goodman made a mistake, and the issues securing product rights via funds (which Knight now lists as: lack of “new” opportunities, GP fiduciary duties and conflict with LPs) should have been easy to foresee.

• The possible upside of a bunch of product rights in addition to the fund returns warranted the experiment, and the downside was limited to whatever the downside of the funds were (which presumably was low if Goodman vetted them).

I personally agree with the second view. Goodman knew he’d have a large pile of cash to deploy, and if things had turned out differently who knows how high the upside could have been. It was an experiment, it didn’t work out, and yet Knight is still earning a 10+% return on these investments.

Ever since Paladin, Goodman has acquired stock in smaller pharmaceutical companies as a way to get close to them for the purpose of acquiring product rights, but it has often resulted in that and great capital gains. This is excerpted from a Raymond James report on Knight:

For example, in March 2010, Paladin purchased a 45% stake in Pharmaplan Ltd., which was subsequently acquired by Litha Healthcare Group in February 2012, with Paladin exiting its position at $72.9 mln or a 14% return. Similarly, in July 2011, Paladin purchased 14.9% of Afexa Life Sciences (total consideration of approximately $8.0 mln) with a view of acquiring outright,the developer of Cold-FX. However, as a result of a bidding war with Valeant Pharmaceuticals, Paladin walked away from its final offer of $0.81 per share, selling its position in the company for $13.1 mln in October2011, a 63% return.

Goodman has continued the strategy at Knight, which currently holds stock in several public and private companies.

The most important use of capital though is how attractive the in-licensing agreements that Knight pulls off are.

Analysts estimate that Paladin was built up to a $270 million revenue company by acquiring product rights at less than 6x EBITDA, and an average of 7x P/E. Goodman has shown incredible discipline in acquisitions of products and companies:

The #1 determinant of ROI is acquisition price, you have to get that right… Pharmaceutical markets are still very frothy, there is still a lot of dumb money chasing too few opportunities. I won’t make that mistake by paying too much for an asset.

– Jonathan Goodman

That quote came just recently, when there was activist pressure for Goodman to spend his cash hoard faster. While the activist investor is dumb, disrespectful, and deceitful, it did bring out the best of Goodman, who went out and spread his gospel – swing for singles (not home runs), don’t compromise on price, and focus on lower risk, late stage drugs.

Goodman’s obsession with price, and never paying more than what something is worth, is wonderfully shown in the story of how he bought his current house.

Source: The Globe & Mail

Long Term Orientation

Goodman is a famously long term thinker. When he started Knight, he told everyone that would listen “Knight is an investment for your grandchildren”. He’s only kept up that sentiment. His focus on the long term should be obvious to anyone paying attention (and if I’ve done my job, anyone reading this), so I’ll just leave you with two wonderful quotes as evidence.

For investors, if their investment horizon is not their grandchildren, we are not the right company for them. Paladin had 19 years of record revenues but for 12 of those years, our stock was flat. It took us 19 years to become an overnight success.

– Jonathan Goodman

I’m telling everyone to hold on. Be patient. You’re going to be justly rewarded. We’re going to have to move the decimals over, like we did last time.

– Jonathan Goodman

Skin in the Game

Goodman and his family owned about one third of Paladin, and he invested a bunch of his own money into Knight in the early equity issuances. Today, he has ~$180 million tied up in Knight stock, and owns over 15% of the company.

More telling than the absolute amount is the timing of his purchases and his attitude towards owning the stock.

First his timing. Goodman received Knight shares in the Paladin spinoff of course, but he also invested $75 million in the earliest equity financings, showing faith in the company, and himself, when there was little reason to invest besides the bright future. Then he started buying stock around $7.50, which happens to be the price range I bought in at, when he was facing the activist pressure from Meir Jakobsohn, Medison’s CEO. Part of it was likely so he had more votes to shut that campaign down, but he continued buying after he won the vote, which leads me to the second point.

His reason for owning shares is refreshing. People always say “there’s only one reason insiders buy”, and it’s mostly true (there are exceptions, such as board ownership mandates). That one reason is certainly true for Jonathan Goodman. It is obvious that he owns Knight stock because he wants to make lots of money, for him and his family. He has said repeatedly, including directly to me at the 2019 AGM, that he won’t sell a single share of Knight until he sells them all, and he’ll only do that at a much higher price.

Share Buybacks

Probably the most remembered characteristic of the Outsider CEOs was their use of share buybacks. I can’t bend the narrative and pretend that Jonathan Goodman creates “cannibal” companies, or that he is some huge proponent of buybacks. But I can say that he has used them, and done so with his eye on the value that it would create for shareholders. In 2007 and 2008, Goodman bought back 7% of its float. That isn’t a huge buyback effort, but keep in mind the environment he was doing that in – there were all sorts of options for a well capitalized company to buy at that time. And also keep in mind the return on those repurchases; Paladin shares traded between $10 and $12 in those years, and less than seven years later Paladin was sold for over $100/share.

Goodman also bought back about 5% of Knight this past summer at prices around $7.50. He did this partly as an acknowledgement he raised too much money given the price of pharmaceutical assets (he over capitalized since the pricing environment he wanted never came), and likely to placate some large investors that agreed with Jakobsohn that Knight had too much cash. Regardless of the reasons, Goodman’s history of buybacks suggests he wouldn’t do it if shares weren’t priced very attractively, so shareholders should benefit greatly.

It’s worth mentioning that Jakobsohn (and the other investors I assume talked to Goodman) weren’t clamoring for buybacks, all they cared about was a return of capital. It was Goodman who specified that if he returned capital, it would be through buybacks to avoid the taxes. That sounds like a few of The Outsiders, doesn’t it?

“Swing you bum!”

In spite of Goodman’s incredible track record, this year he was the subject of “activist” pressure from Jakobsohn, his supposed associate, whose main gripe was simply that Goodman was too patient. And the whole thing was very dumb.

At the risk of legitimizing the campaign any more than it already was, here are Jakobsohn’s points:

• Goodman owns 25% of Pharmascience, vs ~15% of Knight, so a dollar of earnings to Pharmascience means more to him than a dollar of earnings to Knight. He more than once intimated that Goodman would let Pharmascience win deals if it and Knight were both after them.

  • Okay, yeah, but everybody already knew that, and the same was true at Paladin. That didn’t stop him from making Paladin succeed. This was akin to calling Goodman dishonest.

• Goodman let all sorts of great deals pass because he is too scared and was milking Knight for his salary.

  • Something Meir never did was show that deals he mentioned as missed opportunities (which included early stage drugs and cannabis deals) ever had good economics. Not doing a deal doesn’t mean you lost. You invest in Knight because you think Goodman picks drugs wisely, and doesn’t overpay.

• The board of Knight was loaded with cronies from Paladin who wouldn’t push back against Goodman.

  • Maybe, but a board similar to Knight’s led to returns that crushed the market.

• Goodman focuses on products that are too small. Jakobsohn wanted Knight to focus on “diamonds” – a stupid term he made up referring to what Goodman would call “home runs”.

  • Again, everyone invested with Knight knew Goodman went after small drugs. Know what you’re buying.

• Knight was valued at a low price to book multiple because Goodman turned it into a financial company with the lending and funds.

  • Goodman had already stopped making fund investments by the time the campaign went public. And Jakobsohn didn’t happen to mention all the product rights these had led to. The thing that made Jakobsohn look dumbest was his insistence that Mr. Market was the ultimate decider of right and wrong over the short term.

The whole thing was very annoying. Other than the outright lies and name calling, all Jakobsohn was doing was yelling “swing you bum!” from the bleachers.

What was interesting about it was how many retail investors heeded Jakobsohn’s siren call, and started clamoring for Goodman to pay out his pile of cash as a special dividend. Admittedly, most of the people agreeing with Jakobsohn are idiots and/or didn’t know what they were investing in, but there were a few investors I respect who could at least see the other side. The smart ones were saying that it was wrong to raise so much money and then not spend it for years. And a few mentioned Goodman had all this cash during “pharmageddon” (2016ish) and didn’t pull the trigger on anything major.

Goodman ended up “winning” the fight – only one of Jakobsohn’s candidates was elected to the board, and they simply took Jakobsohn’s place on Knight’s board – but it did have an effect. It is most likely that Knight would not have bought back any shares this summer if Medison hadn’t raised a stink.

It also may have contributed to Goodman’s next big move.

Grupo Biotoscana Acquisition

A company with a huge pile of cash is akin to an artist with all the paint and brushes but no canvas to paint on, to borrow and butcher a line from Warren Buffett.

It remains to be seen how it will turn out, but the acquisition has all the makings of a beautiful painting.

Knight is purchasing Grupo Biotoscana (GBT), a Latin American specialty pharma company operating in 10 countries, for $369 million.

The deal is being done at a reasonable valuation, approximately 12x earnings and 8.5x EV/EBITDA (Knight will be taking over ~$49 million of debt, but Goodman is surely going to pay that off as soon as he has control). Keep in mind that GBT has been growing revenue at a bit more than 20% and has a large pipeline of products to keep that growth up.

The valuation showcases Goodman’s capital allocation skills, but the deal should offer synergies that really make it attractive.

• For one, the countries that GBT operates in offer similar problems as Canada – they are small drug markets (even if the populations are large) with different regulations so pharmaceutical companies are more likely to outlicense products than to deal with the hassle of selling there.

• Second, GBT’s markets are growing faster than North America, offering a strong tailwind for organic growth.

• And third, Knight’s negotiating position is greatly improved if it can ask ask for the product rights in 11 countries, vs just Canada. Knight already tries to receive the product rights in multiple countries, with the idea of outlicensing those drugs themselves, But most of those foreign product rights have sat wasted so far. Now Knight can show a clear path to actual sales, making a partnership more attractive.

The deal takes Knight from a pile of cash, loans, fund investments, and a small pharmaceutical business to a $300 million revenue international pharmaceutical business, and Goodman still has over $280 million of cash and investments worth another almost $200 million. Knight is finally a canvas on which Goodman can truly paint a masterpiece.

Conclusion

Goodman has blown away the market and his peers by doing almost everything different from them. He uses no debt when the most successful pharma companies load up on it, he does little to no R&D, and he focuses on small drugs in secondary markets. No matter where you put the end point, he has delivered 20+% returns to shareholders over the course of his 24 year career. He has faced more adversity than almost any other CEO – literally coming back from his death bed – and runs Knight because he loves the pharmaceutical business (paraphrasing – “the greatest business in the world, you get to make people healthier and make a good living doing it”) and he loves building a business (he referred to Paladin as his baby on more than one occasion).

Jonathan Goodman is invested alongside shareholders, and isn’t shy that he owns so much of Knight for the sole reason that he wants to build a lot of wealth over a long period of time. Not many CEOs will tell you they are building their company for their grandchildren, but Goodman has, and it’s  that attitude which leads me to call him a Canadian Outsider CEO.