The Cross-Border Biotech Blog

Biotechnology, Health and Business in Canada, the United States and Worldwide

The Biotech Partnering Process – Questioning The Deal Structure: Part 19 of Valuation and Other Biotech Mysteries

[Ed. This is the nineteenth part in Wayne’s series. You can access the whole thing by clicking here. Please leave comments or questions on the blog and Wayne will address them in future posts in this series.]

The deal structure as outlined in Part 18 of this blog series is not meant to be a perfect, detailed model, or even realistic. However, this is a model which can be easily used to change assumptions and see what the impact is on the cash flow and NPV. Here are two examples.

What happens to the NPVs if the peak sales are halved or doubled from the original model?

Scenario NPV ($ million)
  Pharma Share Biotech Share
Pharma alone
Market doubled $4,656
Original scenario $2,256
Market halved $832
Partnership
Market doubled $3,391 $1,511
Original scenario $1,292 $776
Market halved $256 $408

In the partnership scenario, the biotech share NPV changes at approximately the same rate as the sales since they just collect more royalties and pay more taxes. This analysis does not account for any additional products developed internally or by acquisition. The pharma share NPV changes at a significantly higher rate than the sales because we have not changed sales, marketing or corporate expenses in these scenarios. Pharma would certainly try to adjust expenses if it saw sales growing only to half of projected levels.

If the biotech company needed an extra $100 million upfront, what adjustments could pharma ask for in order to not decrease its NPV? If the sales milestone is eliminated and the tiered royalties are reduced from 20%/25% to 18%/23%, pharma share NPV drops only $10 million while the biotech share NPV goes up $9 million. Pharma should probably ask for more, such as reduced approval milestones, because it is taking a much higher upfront risk.

“Is this deal structure in the best interests of shareholders?” This is the first question that the board and management of a biotech company should be asking when considering the structure of a partnering deal. The answer is as variable as the products and the shareholder bases.

In many cases, partnering is not the preferred type of transaction. For a private company with a VC shareholder base, the VC preference is an acquisition instead of a partnering transaction. The preference might swing to a partnering transaction if there was a stable and receptive IPO market. For a public company with a largely institutional shareholder base, the preference is also probably an acquisition, subject to suitable pricing.

In the final parts of this blog series, we are going to shift away from the biotech and pharma perspectives to the perspectives of the capital markets, including investors, analysts and investment bankers. Who are the players and what are their roles and objectives?

The objective of investors in smaller biotech companies is strictly capital gains from increased share prices. In order to meet that objective, investors could choose from amongst several different investment strategies, which we will start discussing in the next blog.

Note: Prospectus offerings for Canadian biotech companies from about 10 years ago contained a statement similar to the following, which I considered an accurate representation of the risk associated with biotech investing.

An investment in the common shares of Company X should be considered highly speculative due to the stage and nature of our business and should only be made by persons who can afford a total loss of their investment.

The statement in current prospectus offerings is not as extreme but it does reference from 3 to 10 pages of product, company, regulatory and general risk factors.

An investment in the Offered Securities involves a high degree of risk. Prospective investors should consider the risk factors described under “Risk Factors” in this short form prospectus and in the Company’s Annual Information Form.

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