“There’s no shame in holding cash.”

It’s a refrain you hear from many fund managers these days after witnessing the market grind ever higher. And no hedge fund manager has uttered that phrase more than Baupost Capital’s Seth Klarman. The legendary value investor has actually started returning money to clients, finding few real bargains in this market.#-ad_banner-#

But when Klarman does spot an investment opportunity, he goes big. Lately, he’s been building sizable stakes in a pair of young companies that few would consider to be deep value plays. They are contrarian plays from a contrarian investor.

Idenix: A Blockbuster Or A Blowup?
An estimated 150 million people are infected with hepatitis C, making it one of the most widespread diseases in the world for which current treatments are considered to be inadequate. Though there are current treatments such as Interferon, a recent Wall Street Journal article noted that “a growing number of people infected with hepatitis C are putting off therapy, choosing instead to roll the dice and wait for a new generation of drugs to become available.”

First out of the gate is Gilead Sciences (Nasdaq: GILD) and its sofosbuvir drug, which got a 15-0 thumbs-up last month from an FDA advisory panel. AbbVie (Nasdaq: ABBV) is expected to seek FDA approval for its own hepatitis C drug in 2014.

But Klarman thinks Idenix Pharmaceuticals (Nasdaq: IDIX), with its hepatitis C drug candidate IDX20963, could be the blockbuster in this market. He started buying shares of Idenix in 2011, and thanks to ongoing buying efforts (including a purchase of 3 million shares in this year’s third quarter), now owns nearly 30 million shares, worth roughly $135 million at current prices. That makes him the company’s largest stockholder.

Klarman’s Rising Stake

Klarman would likely concede that IDIX is an atypical stock for him. In fact, his average purchase price is 21% higher than the current price, a rare misstep for investor that often speaks of a “margin for error” with his purchase prices.

Indeed, by a range of measures, this isn’t the kind of stock you’d associate with this legendary value investor. Idenix is burning through more than $100 million a year in clinical trials, has no chance at revenues for at least several years, and has a fast-rising short interest that now exceeds 18 million shares — nearly 20% of the float. Wall Street analysts almost universally rate the stock as a “hold.”

A quick glance at this chart reveals a sudden spike in recent weeks: Shares rose 40% on Nov. 1 when Idenix said that its IDX21437 drug is entering into clinical trials (in Canada and Belgium). UBS, which rates the stock as “neutral” due to Gilead Sciences’ first-mover advantage, nonetheless considers the news to be a promising development: “We like the strategy of studying (IDX21437) overseas first and then bringing it into U.S., as it may represent a faster path to market considering the FDA’s conservatism in (nucleotide) development. Further, with the (hepatitis C vaccine) market larger than we previously thought and HCV screening enabling a sustainable market into the 2020s, we believe there can be a significant opportunity even for early-stage programs.”

Time will tell if Klarman’s early-stage focus here will pay off.

The Safer Play
Yet Idenix isn’t even Klarman’s biggest biotech investment. Instead, it’s a growing stake in Theravance (Nasdaq: THRX), now worth roughly $660 million, that has biotech investors abuzz. In contrast to Idenix, where Klarman has been averaging down, he’s been averaging up with his investment in Theravance as it moves ever higher.

In May, the FDA approved Breo, a twice-a-day inhaler that treats chronic obstructive pulmonary disease (COPD). Just as Idenix is going after the large hepatitis C market, Theravance’s COPD drug is aimed at an ailment that afflicts 250 million people worldwide.

Breo isn’t the first COPD drug to hit the market, but it has a relatively long period of efficacy. Lining up partner GlaxoSmithKline (NYSE: GSK), which has a sales force equipped to effectively sell the drug, is one of the reason why analysts think annual sales could eventually reach into the billions. Theravance also has a once-a-day COPD product called ANORO in its pipeline, which could extend the sales opportunity even further.

Merrill Lynch, which rates shares as a “buy” with a $50 price target, believes Theravance’s earlier stage “respiratory pipeline is broad and has shown great promise.” They expect the company to generate more than $500 million in sales by 2015, up from just $8 million this year.

Risks to Consider: The risk profiles for these two companies are quite different. The biggest risk for Theravance is a sales trajectory that is slower than investors currently anticipate; for Idenix, it’s the possibility that it never gets out of clinical trials at all.

Action to Take –> The fact Theravance has a $4 billion market value while Idenix is valued at around $600 million reflects the relative maturity of each company’s drug development efforts. Klarman had the foresight to invest in Theravance many years before any drugs came to market, and he appear to be taking the long view with Idenix as well.

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