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Category Archives: Biotech Valuation Series

Valuation and other biotech mysteries – Part 26: Some Final Thoughts

[Ed. This is the twenty-fourth part in Wayne’s series. You can access the whole thing by clicking here
As with all commentary on this blog, these comments do not consider the investment objectives, financial situation or particular needs of any particular person, and investors should obtain professional advice based on their own individual circumstances before making any investment decision.]

Wayne Schnarr - seriousIt has now been 35 years since I earned my Ph.D. in chemistry and started wondering how I would make a living and what my career path would be. I sent out over 50 letters to the pharma companies in Canada in 1977 – I got one reply, from Eli Lilly I think – to fill out a form. After 30 years in the pharma/biotech and financial industries, I have had the opportunity over the last few years to sit back and observe those industries, as well as having drinks and chats with many friends who are still working in those industries. Here are a few final thoughts for your consideration.

  • The only constant is change – whether it is disease treatments, the pharmaceutical industry, capital markets or your career paths.
  • The pharma industry is alive and well. Annual global sales of prescription and non-prescription drugs are over $1 trillion and still growing at a higher rate than GDP growth. The U.S. will remain the single largest market at over 30% and Canada will remain at about 2% of the global market.
  • In 2005, the industry spent almost as much on share buybacks plus dividends as it did on R&D.
  • The pharmaceutical industry has historically and will continue to adapt to dramatic scientific, medical, economic and political changes. Just consider a few things which have shaped the industry we see today.
    • Antibiotics from fungal sources
    • Vaccines for polio and smallpox in the 1950s
    • Thalidomide, increased government regulation and the focus on safety in the 1960s
    • Rational drug design
    • The blockbuster era starting about 1980 with the first billion dollar drug Tagamet
    • The U.S. Drug Price Competition and Patent Term Restoration Act of 1984, usually referred to as the Hatch-Waxman Act, and the emergence of generics
    • Biotech equivalents of natural human proteins, including HGH, insulin, G-CSF and EPO
    • The emergence of monoclonal antibodies
    • The biotech boom of 1999-2001
    • Annual drug costs approaching $500,000 annually for certain orphan diseases
    • Restrictive formularies and comparative efficacy analysis by governments and other payers
    • The blockbuster patent cliff
    • ?????
  • M&A is not a new growth strategy for pharma – just look at the list of companies bought by Pfizer over the last 30 years.
  • In the 1980s, the big pharma companies sold off everything that did not look like a blockbuster. Now they are buying back those assets for steady revenue and growth.
  • We could not predict the timing of past biotech booms and we probably cannot predict when the next biotech boom will occur. In my opinion, the biggest boom was just luck – proteomics and genomics came along just as a huge capital pool was exiting the tech boom and looking for an alternative high return investment. Other smaller booms have risen and fallen along with the broader capital markets.
  • The biotech industry had dreams of being different and perhaps better than pharma in terms of development success rates and clinical impact of the products. Its tools were initially different and some independent biotech companies thrived. However, there is really only a single industry with some company differentiation based on therapeutic focus and types of products.
  • The fate of most biotech companies is to fail. Most junior mining companies doing exploration over the last few years have failed to make discoveries which justify building a new mine. It is just a fact of life in these industries.
  • Successful biotech companies will most likely face the ‘acquire or be acquired’ situation. The fate of most successful biotech companies is to be acquired. Investors usually prefer the premium share price that goes with being an acquisition target. Management would naturally prefer to be the acquirer and keep their jobs.
  • Is there an alternative to acquire or be acquired? Is it possible to give 10% of the revenue stream from a licensed drug to the management and let them try to repeat their success, while 90% of the revenue stream is distributed to shareholders?
  • Nobody in pharma or biotech or among their investors can consistently pick winners. Some are more selective in their initial investments and others may exit their losers more quickly.
  • One of the hardest lessons to learn in biotech investing was ‘good companies are not always buys’.

I hope this blog series has been at least interesting and perhaps even useful to its readers by pointing out the many questions which you need to ask.

Valuation and other biotech mysteries – Part 25: Undervalued compared to its peers?

[Ed. This is the twenty-fourth part in Wayne’s series. You can access the whole thing by clicking here
As with all commentary on this blog, these comments do not consider the investment objectives, financial situation or particular needs of any particular person, and investors should obtain professional advice based on their own individual circumstances before making any investment decision.]

Wayne Schnarr - seriousAnalyst reports will usually verbally describe a stock as fairly valued, under-valued or over-valued. For profitable companies, this verbal description is usually based on a comparative numerical analysis where the company valuation based on share price is compared to an analysis such as NPV. Analysts do make assumptions in this analysis but they usually start from a solid financial history and also have management’s guidance.

The situation is substantially different for a company at the clinical development stage for a new drug product. The only financial history is the cash burn and any NPV analyses have so many assumptions that the analyses are of questionable absolute value. If there is no useful NPV-based comparator, analysts and CEOs sometimes turn to the valuations of their peers for comparisons.

Read more of this post

Valuation and other biotech mysteries – Part 24: Event-Based Trading

[Ed. This is the twenty-fourth 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. 

As with all commentary on this blog, the opinions expressed herein are the author’s own and are not to be construed as investment advice. The author and his immediate family members may have long or short positions in the shares of some companies mentioned in or assessed during the preparation of this blog and may buy, sell or hold such securities at any time. Past share price performance may not be an indicator of future share price performance. This blog and its contents do not consider the investment objectives, financial situation or particular needs of any particular person. Investors should obtain professional advice based on their own individual circumstances before making an investment decision.]

Wayne Schnarr - seriousEvent-based trading is actually a very common investment strategy. For public companies in many industrial sectors, the key events are the quarterly and annual financial results. The timing of these announcements is regulated (no later than x days after period end) and, if the release date is not announced by the company, investors can approximate the short period within which the financial results will be released. Trading strategies are based on actual and anticipated shorter term share price movement and not necessarily on the longer term prospects for a product or company.

Read more of this post

Investing in Junior Mining –Consider Biotech Stocks Also: Part 23 of Valuation and Other Biotech Mysteries

[Ed. This is the twenty-third 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.
As with all commentary on this blog, these comments do not consider the investment objectives, financial situation or particular needs of any particular person, and investors should obtain professional advice based on their own individual circumstances before making any investment decision.]

Many Canadian small cap investors have probably done most of their investing in resource companies. Although monoclonal antibodies, gold, copper and oil have substantially different chemical properties, discovery activities, manufacturing processes and commercial uses, the investment strategies used are more similar than one might expect because the commercialization processes are similarly long, expensive and high risk.
Read on for similarities, differences and strategies…

Some Questions When Considering Investing in Canadian Healthcare Stocks: Part 22 of Valuation and Other Biotech Mysteries

[Ed. This is the twenty-second 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.]

Note: as with all commentary on this blog, these comments do not consider the investment objectives, financial situation or particular needs of any particular person, and investors should obtain professional advice based on their own individual circumstances before making any investment decision.
If you and your financial advisor(s) are discussing investing in Canadian healthcare stocks, here are some points for you to consider. Read more of this post

Capital Markets – The Biotech Analyst: Part 21 of Valuation and Other Biotech Mysteries

[Ed. This is the twenty-first 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.]

In the 20 years since I started my first stint as a biotech stock analyst, both the biotech and financial industries have seen major changes. I was the third new biotech analyst hired in 1992 by a Canadian investment dealer, bringing the total to 5 or 6 at that time. During the biotech boom there were over 30 analysts in Canada but that number has declined back to the 1992 levels. There were only about a dozen public Canadian biotech companies in 1992 whereas there are now about 100 developing therapeutics, diagnostics and medical devices. Here are answers to three common questions about biotech stock analysts: Read more of this post

Biotech Capital Markets – Who are the players? Part 20 of Valuation and Other Biotech Mysteries

[Ed. This is the twentieth 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.]

I am starting the final part of this blog series with a description of the main players in the capital market – what do they do, who do they interact with and how do they generate revenue. These blogs will be written for the person who has little or no knowledge of capital markets. For simplicity, I am only going to deal with equities (stocks) in the public market.

Read more of this post

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.

Read more of this post

The Partnering Process – Deal Structure: Part 18 of Valuation and Other Biotech Mysteries

[Ed. This is the eighteenth 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.]

Assuming that a partnering deal is signed, what are the usual financial components?

  • Up-front cash usually has no conditions and is a non-dilutive financing. Big pharma generally does not want equity as it just clutters up their balance sheets and is an even bigger problem if the partnership gets terminated.
  • Clinical and regulatory milestone payments are fairly standard. The basic milestones are the initial U.S. and E.U. approvals but may include approvals of additional indications if they increase the market potential.
  • Sales milestone payments have become more common in the last decade. If the pharma partner does not believe the market potential, milestones can be included for reaching certain annual or cumulative sales milestones.
  • Royalties on sales are generally no longer a simple X% on net sales. They can be tiered, increasing after annual or cumulative sales milestones are reached.
  • If there is an R&D program, who conducts it and who pays for it?
  • Who executes and pays for the clinical and regulatory programs?
  • Some companies would like to retain or have an option on some sales and marketing rights in specific territories. These rights may cease to exist if there is a change of control at the smaller company.

The only way to learn about deal structures is to create a fictional deal, make the spread sheet and start looking at the impact of structural changes on the product NPV. The following assumptions have been used to create the attached Excel workbook. Read more of this post

The Partnering Process – Before Crunching The Numbers: Part 17 of Valuation and Other Biotech Mysteries

[Ed. This is the seventeenth 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.]

Assuming that all interested potential partners know that you have a specific asset for sale, how does a licensing deal get completed?

Sellers should place themselves in the chair of the person at the potential licensing partner. From the potential partner’s perspective, there are four basic criteria which would need to be met before licensing a product or technology. Read more of this post

Some Partnering Basics: Part 16 of Valuation and Other Biotech Mysteries

[Ed. This is the sixteenth 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.]

If partnering is basically the process of selling an asset, the first step is to let people know more about the asset which is for sale. Three initial questions to be answered are:

  • What companies do you talk to;
  • Who do you talk to at these companies; and
  • What do you tell them?

The answer to the first question is easy – you talk to all companies which may have an interest in commercializing your asset. The list of companies should be easy to prepare by looking at information sources already discussed in this blog series, including:

  • Annual reports and pipeline reviews by pharma and biotech companies;
  • Searching www.clinicaltrials.gov for all companies running clinical trials in the therapeutic fields targeted by your asset; and
  • Subscription newsletters and databases.

The people who need to be targeted are those who are both directly and indirectly involved in the partnering process. Since you can never predict which initial contact will lead to the deal, you have to target all potential contacts at all potential partners. Read more of this post

Partner, Sell, or Go it alone: Part 15 of Valuation and Other Biotech Mysteries

[Ed. This is the fifteenth 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.]

This is a discussion that the management and board of a company need to start as the company is being formed and continue throughout the development of a new drug product. The decision on any specific drug product is probably as unique as that drug product and can change along with the market in which that drug will compete. There is a fourth option – stop all product development – which also needs to be assessed at each review. In this blog, we will assume that the information is positive and the product merits further development.

There are many interested parties in this decision, each of which may have different objectives. Read more of this post

Assessing Potential Market Share for a New Drug: Part 14 of Valuation and Other Biotech Mysteries

[Ed. This is the fourteenth 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.]

In the previous post, we looked at epidemiology and pricing to estimate the market size for a new drug. As we continue to look at the potential rewards from successful drug development, we need to consider market share.

A new drug product which is being assessed will probably share its market with:

  • currently approved drugs;
  • some drugs currently at the same or later stage of development; and
  • some drugs which are at an earlier stage of development. 

An assessment of market share is not static and should be continuously updated as new information becomes available. Until all of the Phase 3 data is available on a new drug, market share assessments are really guesstimates. Phase 3 data from two new drugs which were compared to either a placebo or an older standard of care, but not to each other, might not be sufficient to allow a winner to be selected. A major pharma licensing deal with a product that is two years behind might change your ranking of that drug. Read more of this post

Potential Rewards from Successful Drug Development: Part 13 of Valuation and Other Biotech Mysteries

[Ed. This is the thirteenth 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.]

Finally we have reached the point of looking at the potential rewards from successful drug development. The potential reward can be estimated using the following step-wise analysis. Read more of this post

Expansion and Diversification Strategies in the Pharmaceutical Industry: Part 12 of Valuation and Other Biotech Mysteries

[Ed. This is the twelfth 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.]

Brand, human prescription drugs is the core business of the pharmaceutical industry. Risk can be diversified and potential reward can be increased by having drugs in multiple therapeutic areas. Expansion and diversification could also involve other types of drug products and healthcare activities. The best current example of healthcare diversification is Johnson & Johnson. If you look at the longer term stock chart (NYSE:JNJ), you will see that the share price continued to climb from 1999 to 2005 and has since been in a volatile trading range.

This post will look at expansion and diversification into generics, vaccines, consumer products, diagnostics, medical devices, animal health and pharmacy benefits management. Read more of this post

Valuation and Other Biotech Mysteries – Part 11: Changes in Pharmaceutical Industry Product Portfolios and Strategies

[Ed. This is the eleventh 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.]

As described in the prior post, the modern pharmaceutical industry has evolved from the patent medicine companies selling herb and alcohol combinations into an industry developing complex and personalized medicines such as gene and cell therapy. The first blockbuster drug, Tagamet (cimetidine), developed by Smith, Kline & French (SK&F) is a great base for a case study of various industry strategies. Read more of this post

Valuation and Other Biotech Mysteries – Part 10: Some Pharmaceutical Industry History

[Ed. This is the tenth 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.]

Very few novel drug development companies have made, or are likely to make, the transition to profitable and sustainable entities which market their own drugs in competition with pharma companies. Most companies have chosen to license their products to larger pharma companies, generally during the clinical development program. In addition, all drug development companies are potential acquisition targets. Since the larger pharma companies play such an important role in the fate of the smaller companies, it is important to understand both the history and current status of the pharmaceutical industry. Read more of this post

Valuation and Other Biotech Mysteries – Part 9: Retail Investors

[Ed. This is the ninth 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.]


In addition to the private institutional VCs, there are the retail investors who are willing to take similar risks with both private and public companies. I will focus on Canadian retail investors in this post.

Retail investors who invest in private companies usually do so through a fund which offers tax incentives. I have discussed flow-through funds, which are not currently available to biotech companies, in a previous series of posts. Historically, the largest investment vehicle has been the LSIFs or labour-sponsored investment funds, which are now being referred to as RVC funds or retail venture capital funds. There are a number of fund managers and the tax incentives vary by province.

Read more of this post

Valuation and Other Biotech Mysteries – Part 8: The Current State of Healthcare Venture Capital

[Ed. This is the eighth 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 world of healthcare VCs has changed dramatically in the two decades which I have spent in capital markets. VCs are impacted by changes in the broader capital markets, changes in healthcare capital markets and changes in the industries on which they focus. Read more of this post

Valuation and Other Biotech Mysteries – Part 7: Funding the Cost of Developing a New Drug

[Ed. This is the seventh 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.]

Assuming that the average direct cost of developing a new drug through regulatory approval will be at least $200 million, how and where do small companies get that funding? While these companies should access all potential sources of funding including government agencies and disease associations, the major sources of funding will likely be capital markets and pharma partners. Read more of this post

Valuation and other biotech mysteries – Part 6: The cost of developing a new drug

[Ed. This is the sixth 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 Tufts Center for the Study of Drug Development has been the source of the most comprehensive studies of new drug developments, including costs, success rates and strategies. Their estimates include the cost of the failures and the lost income from simply investing in government bonds. Neither of these factors is relevant to our current discussion although the former is critical to the success of the industry.

The clinical development pathways for both Theratechnologies Inc. (TSX:TH) (NASDAQ: THER) and Oncolytics Biotech (TSX:ONC)(NASDAQ:ONCY) have been outlined in previous parts of this blog series  and it is appropriate to look at the expenses for these companies. The expenses of Cardiome Pharma Corp. (NASDAQ: CRME) (TSX: COM) in their development of both intravenous and oral forms of vernakalant are also shown below. The information for all three companies was found from their annual financial statements at www.sedar.com in about 30 minutes.

Read more of this post

Valuation and other biotech mysteries – Part 5: More strategy and structure for Phase 3 clinical trials

[Ed. This is the fifth 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.]

In the previous case study, we looked back at Theratechnologies and theFDA approval of EGRIFTA™ (tesamorelin for injection). Now let’s look at a product still in Phase 3, REOLYSIN®, a formulation of the reovirus being developed for the treatment of cancer by Oncolytics Biotech (TSX:ONC)(NASDAQ:ONCY). Read more of this post

Valuation and other biotech mysteries – Part 4: Strategy and structure for Phase 3 clinical trials

[Ed. This is the fourth 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.]

Very few independent Canadian biotech companies have successfully completed the development of a novel drug – so my first comment is congratulations to Theratechnologies. Now, let’s study what they did so we can learn how to assess other companies attempting the same feat. To repeat, my approach is to start at the end – regulatory approval – and study the pathway to that endpoint.

The FDA approval states that EGRIFTA™ (tesamorelin for injection) is indicated for the reduction of excess abdominal fat in HIV-infected patients with lipodystrophy. This approval is based primarily on proof of safety and efficacy from the Phase 3 trials. In order to determine their Phase 3 clinical strategy, Theratechnologies ran Phase 2 trials for a variety of indications, including COPD, sleep disorders, HIV-lipodystrophy, hip fractures, type 2 diabetes and flu vaccinations. They chose HIV-lipodystrophy as the best entry point for the commercialization of tesamorelin and may have considered the following factors in choosing this strategy.

  • Relative strength of the Phase 2 data for the various indications
  • Probability of success in Phase 3
  • Ability to recruit patients for the Phase 3 trials
  • Easily defined and measured clinical endpoints
  • Market potential for each indication
  • Interest of potential commercial partners for each indication

These are typical strategy and structure questions which help assess the risks and rewards about any pending or ongoing Phase 3 clinical trial program. We will look at quantifying potential rewards and more complete assessment of risks later in the series.

Here is a list of some clinical and regulatory events which occurred during the Phase 3 trials and subsequent regulatory review of tesamorelin (pulled from various AIFs in about 20 minutes).

Year

Month

Event

2004

June

Announced Phase 3 clinical strategy

2005

March

FDA approval to start first Phase 3 trial
 

June

First patient enrolled in first Phase 3 trial

2006

March

Patient enrolment completed in first Phase 3 trial
 

August

SPA for second Phase 3 trial
 

October

Last patient in first trial completed 3 months of treatment
 

December

Positive 3-month data from first Phase 3 trial

2007

January

Started patient enrolment in second Phase 3 trial
 

May

52-week treatment completed in last patient in first Phase 1 trial
 

September

Completed enrolment in second Phase 3 trial
 

October

Positive 52-week data from first Phase 3 trial

2008

April

26-week treatment completed in last patient in second Phase 3 trial
 

June

Positive 26-week data from second Phase 3 trial
 

October

EMD Serono licensed U.S. rights to tesamorelin
 

December

Positive 52-week data from second Phase 3 trial

2009

May

Filed New Drug Application (NDA)
 

November

Announced that the FDA will schedule an advisory committee meeting

2010

January

Announced that FDA will reschedule advisory committee meeting due to administrative delay at FDA
 

May 25

Briefing documents for advisory committee released
 

May 27

Advisory committee meeting; 16 – 0 vote in favour of recommending FDA approve tesamorelin
 

November

EGRIFTA (tesamorelin for injection) approved by the FDA for the treatment of HIV-lipodystrophy

By looking at this list, we can create a general list of Phase 3 questions. It is unlikely that any company will answer all or even most of these questions, so other sources such as analyst reports are useful.

  • How many Phase 3 clinical trials will be needed?
  • How many patients will have to be enrolled in these trials?
  • Will the trials be run concurrently or consecutively?
  • How long do you expect patient enrolment to take?
  • What is the timing of the interim analyses at which an independent board will assess continuance of the trials?
  • How long do you have to treat and follow the final patient before you can compile the final data?
  • What delay do you expect from the time top-line final data is released until an NDA (or BLA) can be filed?
  • Will the NDA be subject to accelerated or standard review timelines?
  • What will the cost of these clinical trials be, exclusive of ongoing corporate expenses?

The most complete outline of the clinical trial structure is contained in the Investigators Brochure and Clinical Trial Protocol but these are confidential company documents. The best current disclosure on trial structure is usually found at http://clinicaltrials.gov. This searchable database can be used to find the structure of a specific clinical trial, all clinical trials for specific medical conditions, the drugs being tested in those trials (competition information) and much more.

For the biotech investor, run a historic price chart for TSX:TH, plot all of the events in the table above and see what effect, if any, there was on the share price. If you did this for several companies that took products through Phase 3, whether successful or not, you may be able to spot some trends on what events you think impact share prices. Remember that share prices will also be impacted by other factors including company financings, announcements from competitors, sector trends and global financial events.

Valuation and other biotech mysteries – Part 3: What are you valuing?

[Ed. This is the third 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.]

Most likely you will be valuing a company, a product or a technology. The valuation of the stream of expenses and revenues for the development and commercialization of a product or a service is the simplest situation. If you are valuing a company, you are valuing its portfolio of products and technologies. In most cases, the current and potential future value of a single product, which is usually the lead product, probably accounts for the majority of the value of a biotech company.

Valuing a technology can be more difficult. Many companies claim to have a platform technology, which can be used to develop multiple products, potentially with multiple partners in multiple therapeutic areas. When a technology has a portfolio of products and partners, there is diversification and reduction of risk. If you want to take a simple and conservative approach to the valuation of a technology, do a valuation of the most important product in that portfolio, which is often the most advanced product. There are situations where technologies get ‘hot’ and valuation of only the lead product is not a useful valuation tool – we will look at ‘hot’ technologies later on in this series.

Therefore, you are probably valuing a product and I am going to assume it is a novel drug. In order to generate substantial revenues, that drug will have to be approved by the U.S. regulatory agency (Food and Drug Administration or FDA) since the U.S. is still the largest single pharma market. The U.S. and EU markets still account for about 75% of worldwide pharma sales.

The approval will be for one or more specific therapeutic uses of the drug, each specific therapeutic use being defined by the disease and the patient population. When you start the valuation of a product, two of the first questions will be ‘What specific therapeutic uses will be approved by the FDA’ and ‘What is the pathway to that regulatory approval’.

For those blog readers who have not looked at these questions before, one of the best teaching tools is a case study. The first case study will be Theratechnologies (TSX:TH) and the recent FDA approval of its lead drug EGRIFTA™ (tesamorelin for injection). At this point, I want to highlight two important sources of information (remember – get information and ask questions).

Valuation and other Biotech Mysteries Part 2: Some Basic Mathematics

[Please note that this blog series has not been pre-written. The subject of the next post in the series will be determined by where the current post leaves off and any questions that readers send me or leave as comments on the posts.]

When you create a valuation spreadsheet, you are plugging in numbers representing revenues and expenses which are going to occur over several years. When you do the basic addition and subtraction in this spreadsheet, you hopefully end up with a positive number because, if the number is negative, you are valuing something that is not economically viable.

However, we all know that a dollar received now is worth more than a dollar received ten years from now. This is extremely relevant for a biotech company because most expenses occur before any of the revenues. You need to adjust all future revenues and expenses so they are calculated in current dollars and the sum is called the ‘net present value’ or NPV. The key factor in this calculation is the discount rate or ‘risk-free cost of capital’. At this time, I would use a discount rate of 8% in doing an NPV analysis. You can get more detailed information from statistics textbooks or entering NPV in your web browser or spreadsheet help function.

While we all generally accept that a current dollar is worth more than a future dollar, you actually have to do the calculation to see the impact of time on the value of your money. The table below shows the NPV of a guaranteed $100 payment received now or from one to ten years from now, using discount rates of 8% and 20%.

Year

Discount Rate

 

8%

20%

Now

$100.00

$100.00

1

$92.59

$83.33

2

$85.73

$69.44

3

$79.38

$57.87

4

$73.50

$48.23

5

$68.06

$40.19

6

$63.02

$33.49

7

$58.35

$27.91

8

$54.03

$23.26

9

$50.02

$19.38

10

$46.32

$16.15

I used the term ‘risk-free’ above because it does not take into account the risks associated with biotech, which can be large and numerous. There is a continuous need to understand and balance the risks and potential rewards. In the next few parts of this series, we will continue looking at valuation of the potential rewards before we move onto looking at the risk side of the equation.

Valuation and Other Biotech Mysteries – Part 1

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.

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