Valuation and Other Biotech Mysteries – Part 1
May 10, 2011
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I have been doing valuations in various forms since 1981 when I started my MBA at York University. There are major differences between those initial valuations and the ones that I have been doing as a biotech stock analyst over much of the last 20 years. Those initial valuations were for assets or profitable companies, much easier than valuing biotech companies with products which may never get to market and for which potential peak sales are ten or more years away. There are some advantages to doing valuations now – the amount of easily available information and the ability to rapidly create and modify financial models.
When I taught the valuation section of a licensing course, I ranked the importance of three aspects of valuation as follows.
- The least important aspect of the valuation is the spreadsheet. Almost everybody has access to a computer and can create a spreadsheet, plug in some numbers and get a valuation of that company using standard formulae.
- The assumptions which are used to generate the input numbers for the spreadsheet are more important because poor or flawed assumptions on factors such as success rates, market potential and event timing will result in poor quality valuations.
- The most important aspect of valuations is how you use them to make decisions. Decisions in which valuations are important include the structure of licensing deals and the prices paid to acquire products or companies. Valuations can sometimes be useful in making decisions about biotech stock purchases or sales.
This series of articles is going to focus on information and questions. Information shapes assumptions, and better assumptions lead to better financial models and hopefully better decisions. There are numerous information sources, including many free and easily accessible databases. Asking the right questions allows you to obtain useful information and also to see what information is missing.
This series is titled ‘Valuation and other biotech mysteries’ because many people view biotech as a mysterious black box into which you throw a lot of money, wait a decade and see whether any products or returns on your investment emerge from the black box. Asking the right questions and accessing useful information removes some of the mystery and allows you to understand and balance, but not eliminate, the risks of the development process for drugs, devices and diagnostics.
When you create a valuation spreadsheet, the column headings usually define the period over which the valuation is being calculated. The first important question is ‘what events will occur and when will they likely be happening during his period?’ The next several parts of this series will look at the events which occur during the product development and regulatory approval processes.