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RPRX Will Have a Low Yield Until the Lock-Up Ends

Wait until well after the lock-up period expires and the supply squeeze in RPRX stock subsides

Royalty Pharma (NASDAQ:RPRX), which just went public in mid-June expects to pay its shareholders a dividend. I estimate RPRX stock will have a low dividend yield of about 1.3%.

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This is based on the company’s final prospectus. On pages 15 and 61, the company says that “we anticipate that amount of our quarterly cash dividends will be about $0.15 per share.”

So here is the calculation. The annual dividend of 60 cents per share divided by its recent price of $45.73 is 1.31%. This is a fairly low dividend yield for this type of company, a royalty holding company.

How to Calculate RPRX’s Payout Ratio

Based on the company’s prospectus, it looks like ongoing earnings will be about $71.24 million per quarter, at least at first. This is what the pro forma earnings were for Q1 2020, prior to the IPO.

There will be about 607.035 million shares outstanding, including 365.827 million Class A shares. These Class A shares are the only share class allowed to receive the dividends declared by Royalty Pharma. This is based on information taken from page 196, which discusses the Class A shares.

Therefore, the Q1 2020 earnings per share are about 11.7 cents per share. This is calculated by dividing $71.24 million quarter net income by 607.035 million shares, post the IPO.

That tells me that paying a 15 cent quarterly dividend is not sustainable if the company is able to only make 11.7 cents per share.

Some might disagree with my calculation. They will point out that there are only going to be 365.8 million Class A shares available to receive dividends. In a sense, this answer could be about semantics.

For example, if the dividend per Class A share is 15 cents, that means that the payout will close only $54.87 million. This is less than the $71.24 million Royalty Pharma made in Q1. Using this way of calculating dividends per share, the payout ratio is 77%.

Why Did RPRX Stock Rise So Fast?

I do not think that the initial IPO price of $28 was too far below the company’s inherent value. At that price, the company had a market value of about $17 billion.

Assuming the company makes net income of roughly $300 million per year, this puts RPRX stock on a price-earnings multiple of 56 times. Even if we are off by a factor and earnings are 100% higher, the company’s P/E multiple would still be high at 28 times.

So why did RPRX stock shoot up 63% to $45.73 per share in early July? I think the answer lies on page 196 of the final IPO prospectus. There it says that 77.68167 million Class A shares will be non-restricted. This represents just 21.2% of the total Class A shares. That is a very small amount.

In fact, if you include the total of both Class A and Class B shares that comprise the market value of the company, only 12.8% of the total 607.035 million shares are tradeable. Remember only Class A shares are publicly traded and can receive dividends.

Here is my point. Since only a small portion, 12.8%, of the company’s total market value (now worth $27.7 billion) is freely tradeable, the price shot up dramatically. This is economics 101: high demand with less supply (the curve shifts the left) means the price must move up to equalize demand and supply.

What to Do With RPRX Stock?

The supply squeeze with Royalty Pharma will take a while to work out. For example, there is a 180 day lock-up period with regards to the other 78.8% restricted Class A shares.

Moreover, I believe that when the company declares its first dividend, RPRX stock could move higher. It is not clear to me that investors currently understand that it will pay a dividend.

This should happen sometime around the first week of September for a payout at the end of September. This is based on what the company said it will do on page 61 of the prospectus.

But after six months, watch out. I suspect RPRX stock could fall. So buyer beware. A good portion of the locked-up shares could decide to sell. This would have the effect of raising the effective dividend yield of the stock to make it more attractive.

I would wait until well after the lock-up period expires before considering making an investment.

Mark Hake runs the Total Yield Value Guide which you can review here. As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. 

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