Warren Buffett, John Malone, Henry Singleton.
All are very well known for growing their companies and compounding share prices multiple times over.
More importantly, their success can largely be attributed to their capital allocation prowess, and being able to make the right investment decisions, at the right time, at the right price.
William Thorndike wrote an excellent book on these three CEOs and five others called The Outsiders (take a look here), that demonstrates how smart capital allocation can dramatically increase stock returns over the years.
I’d highly, highly recommend it for those who haven’t read it.
Nowadays, people are constantly trying to look for the next ‘Outsider CEO’ like Buffett, Malone or Singleton, in hopes of finding the next Berkshire Hathaway, Liberty Media, or Teledyne.
Yet outside of Canada, many haven’t heard of Paladin Labs and Jon Goodman, who grew Paladin Lab’s business and its stock price over 100x in 20 years before selling to Endo Pharmaceuticals.
Even lesser known, is his new company, Knight Therapeutics (TSE:GUD, OTCMKTS:KHTRF), which has been touted as Paladin Labs 2.0.
But before we get into Knight, what does an ‘Outsider’ CEO really look like? And why should Goodman be placed in the same breath as Buffett and Malone?
Let’s look at a few key traits of outsider CEO’s:
- Share repurchases when the stock is undervalued / Using stock as currency when the stock is overvalued
- High insider ownership of the stock
- Patient and prudent acquisition strategy. Never overpaying, and waiting to buy companies on the cheap
We all know Buffett, Malone and Singleton are well known for having these traits, but how about Goodman?
Normally, most companies by back their stock when things are going well, and their stock is overvalued. Just look at the amount of buybacks over the last few years. It’s a terrible way to allocate capital if the stock is overvalued.
In 2007-2008, when the Paladin’s stock was likely undervalued, Goodman bought back close to 7% of it’s float when practically no one was buying back their stock. The stock would almost double by the end of 2009. Not a massive buyback, but still smart capital allocation.
As for insider ownership, Mr. Goodman owns over 20% of Knight’s stock directly and through his holding company, Long Zone. According to Mr. Goodman on the Q4 earnings call,
“Our management team is personally heavily invested in Knight Equity. And do not plan to sell one share until we sell them all, which last time took about 19 years.”
Now that’s a properly aligned management team.
Besides a few larger stakes in various pharmaceutical companies, Knight is mainly comprised of cash, loans to various companies and investments in various funds. It’s still slowly building up it’s drug pipeline to become a true pharma company.
When I first bought Knight back in 2014, it was trading for less book value, which at the time was mainly cash and the value of the Priority Review Voucher it had.
Recently, Knight just completed it’s biggest capital raise of $230mm at $8 a share, which would be about 20% over book value. Not exactly a cheap valuation for a company that’s mainly comprised of cash and investments right now. Because of this, Knight has been getting a bit of flak recently for some of these equity raises.
That doesn’t mean it’s a bad capital allocation move.
Remember, smart capital allocators use stock as a currency when they believe the stock is overvalued. With the pharma industry in distress recently and valuations plummeting, it looks like Knight is positioning itself to make an acquisition on the cheap, by issuing stock while it’s overvalued. Another brilliant capital allocation move.
It gets even better: Knight has actually been rumored to be in talks with Endo to buy back Paladin Labs on the cheap.
Depending on if that’s true, it’s highly likely that any deal would value Paladin cheaper than the $1.6 billion Endo paid for it back in 2014.
Now that would be a textbook capital allocation move.
Knight is definitely going to be worth revisiting if a deal gets announced, but until then, investors should stay patient and wait for a better opportunity to buy into Knight, like back in March when there more pronounced panic in the pharma industry. Knight has been on a tear ever since:
In the meantime, I’d highly recommend reading through some of Knight’s press releases:
Someone on that IR must be a big fan of puns!
Article by AlphaTree Group