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The following segment was excerpted from this fund letter.
Landec Corporation (NASDAQ:LNDC)
Landec Corp. is new to the portfolio, and is an example of an investment archetype that should be familiar: good co. / bad co. A year or so ago, the company owned several businesses, including a packaged salad business, a processed avocado business (shelf stable guacamole), a salad oil business, a breathable produce packaging business and… a high quality injectables focused CDMO known as Lifecore Biomedical. With a 2-year-old son and a 1-year-old daughter, Sesame Street is presently the sound track of my life, and “one of these things is not like the others.”
With help from activist investor and friend of LWC Legion Partners, LNDC has realized that pairing commodity based packaged food businesses with a high quality CDMO makes zero sense, and LNDC has been selling off the food businesses in order to become a pure play CDMO. We bought our shares around $10, and I estimate that Lifecore Biomedical is worth somewhere between $14 and $25 a share today, and that value will grow substantially in the years to come.
At this point, the bulk of the remaining food business is the avocado business, which was purchased 4 years ago for $80M. It is not impossible to believe that the value of this business has declined, but if the CDMO is worth somewhere between $14 and $25 per share, this implies that the market thinks the avocado business is worth somewhere between negative $120 million and negative $440 million. I think this is overly pessimistic.
Notably, the company has been clear that they intend to use the proceeds from the sale of the avocado business to pay down and refinance debt, which is catnip for investment bankers. Those same investment banks have already had their CDMO focused research analysts out to meet with management of Landec, but management has indicated that so far commentary has been, “we will have to wait until the avocado business is gone before launching coverage.” But when Landec becomes a pure play CDMO – probably within the next few months – I suspect that awareness will raise quickly, and the stock will re-rate substantially higher.
Also contributing to this potential re-rating is the fact that at present LNDC is categorized under “packaged food and meats” by the Global Industry Classification Standards (GICS), that powers equity screening tools that are relied upon by the estimated 80% of market participants that make their investment decisions based solely on quantitative inputs. In other words, at present health care focused investors – and investors that may want to hide in healthcare during uncertain economic times – may not even know that Landec – or more appropriately Lifecore Biomedical – exists.
In addition to these non-economic factors, Lifecore is primed to benefit from fundamental improvement. Historically Lifecore was milked for cash to help support the food businesses. However, more recently Lifecore has made substantial investments to expand capacity in fill/finish of injectable-grade pharmaceutical products, and is on pace to more than double capacity by 2025 in order to meet expected demand from the existing pipeline.
Again, how cheap is cheap enough? Is an implied value for the avocado business of negative $120M to negative $440M not enough? Should we wait until the implied value is negative $500M? Why not negative $700M? At some point you just have to say that this does not make any sense, hold your nose, and accept that the market can do whatever it wants in the near term.
However, over reasonable periods of time the market will find some level of rationality. Neither I nor anyone else can tell you with any certainty what will happen next with inflation or interest rates, but at the risk of being flippant, I feel pretty confident that at some point within the next few years the market will realize that a high quality CDMO with competitive attributes similar to Avid Bioservices is more attractive than commodity packaged salads and pre-made guacamole.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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