MaRS Best practices: Valuations in the biotech industry - Wayne Schnarr
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Transcript of MaRS Best practices: Valuations in the biotech industry - Wayne Schnarr
MaRS Best Practices Series
Special Valuation Series Nov. 12th, 2010
MaRS Best Practices Special Valuation Series
Friday Nov 12th @ Noon
Raymond King, Senior Manager Toronto Stock Exchange
Wayne Schnarr, Analyst, Equicom Toronto Stock Exchange
Disclaimer & Disclosure
The information contained in this presentation has been compiled by Equicom and/or Wayne Schnarr from sources believed to be reliable, but no representation or warranty, express or implied, is made by TMX Group, Equicom, its affiliates or any other person as to the accuracy, completeness or correctness. All estimates, opinions and other information in this presentation are subject to change without notice and are provided in good faith but without legal responsibility or liability. Additional information may be available to Equicom or its affiliates that is not reflected in this presentation.
This presentation is provided for informational purposes only and does not constitute an offer or solicitation to buy or sell any securities discussed herein in any jurisdiction. This presentation is not, and under no circumstances should be construed as, a solicitation to act as a securities broker, dealer or adviser in any jurisdiction. This presentation is prepared for general circulation and to provide an overview of investing in healthcare. This presentation does 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. To the fullest extent permitted by law, neither The TMX Group, Equicom, its affiliates nor any other person accepts any liability whatsoever for any direct or consequential loss arising from any use of or reliance of the information contained in this presentation.
Equicom may have advised or provided services to, or may in the future advise or provide services to companies, entities or persons referenced in this presentation.
Valuation and financial modeling
is a qualitative and numerical assessment of
risks and potential rewards
Each biological target, product and company has a unique set of risks and potential rewards.
Despite the uniqueness of each product and company, it is possible to establish a general valuation process in biotechnology
First,
a little introduction to capital markets
Global capital markets
Canadian capital markets
The pharmaceutical industry
Where is valuation important?
Investing
Financing
Partnering
Selling
Who invests in these companies?
Angel investors
Venture capital
Canada
US
Institutional funds
Canada
US, EU, ROW
Retail investors
Canada
US
Investors establish valuations
The value of a company is the price the next investor is willing to pay
Private company – price set by the VC willing to lead the next round
Public company:
Daily basis – set by the next trade
Financing – set by the lead investor
Why would you buy shares of a company?
Mature Healthcare Capital gains from an
increase in share price
Income from dividends and distribution
Why would you buy shares of a company?
Mature Healthcare Capital gains from an
increase in share price
Income from dividends and distribution
Biotechnology Capital gains from an
increase in share price
Investors also want liquidity
IPO Last one in Canada was IMRIS in late 2007
Sale or acquisition of the company
Breakup of MDS
2009: ViroChem by Vertex
BioChem Pharma, ALI Technologies, ID Biomedical, AnorMED, Arius Research (2008), CryoCath (2008)
What impacts daily buying & selling?
Valuation
Liquidity
Some institutions may only buy deals
News flow
Clinical events which can impact share prices
Development partners
Competitive products
Broad market performance
Sector preferences
Rising resource commodity prices attract high risk money
Investors in mature companies pay for growth
Investors in mature companies pay for growth from: An increase in sales of products or services;
and / or
An increase in profitability (earnings per share or eps); and / or
An increase in dividends or distributions.
Share prices in development stage biotechnology companies should be impacted by clinical, regulatory and financial events
Investors pay for:
Reduced risk; and / or
Increased potential reward.
Biotech investors also pay for growth
How do stock analysts value a biotechnology company that is several years from product approval and profitability?
Discounted earnings / cash flow Comparative valuation Event-based stock movement
Valuations by stock analysts
Now,
the easy part -
number crunching
Financial modeling – the basics
The components of financial modeling in increasing order of importance are:
The Excel spreadsheet
The assumptions for the spreadsheet
What you do with the numbers
Financial modeling – create the numbers
The first step is creating the numbers, no matter what method is going to be used to analyze them
Create a large spreadsheet or a series of linked spreadsheets
Horizontal – number of periods over which cash flows will occur (months, quarters, years)
Vertical – all cash flow categories, both expenses and revenues
Fill in all of the boxes
Valuation Tools – How To Analyze The Numbers
Net Present Value (NPV) The preferred valuation tool
Risk-Adjusted NPV Risk adjustments can be done here or at the
portfolio level Internal Rate of Return (IRR)
Uses the same spreadsheet and assumptions Payback Period
Very useful in manufacturing projects Monte Carlo Simulation
A structured sensitivity analysis
Net Present Value (NPV)
A project or product cash flow analysis that takes into account the fact that $1 received or spent in 2010 is worth more than $1 received or spent in the future
NPV = C0 + C1/(1+R)1 + C2/(1+R)2 + … Cn/(1+R)n C = cash flow in the specified financial period R = cost of capital (risk free or risk adjusted)
NPV – $100 received in the future
What is the value today of $100 received in future years (risk-free discount rate of 5%)?
Year NPV 2010 $100.00 2013 $86.38 2018 $67.68 2023 $53.03 2028 $41.55
NPV – effect of risk-adjusted discount rates
What is the value today of $1 billion received in 8 years using risk-adjusted discount rates?
Rate NPV 10% $466.5 M 15% $326.9 M 20% $232.6 M 25% $167.8 M 30% $122.6 M 35% $90.6 M
Using financial models These models are usually based on little information
and many assumptions The quality of your financial model will depend
upon the quality of your assumptions Better assumptions result from asking the right
questions They are generally not useful for absolute valuations,
unless they are based on historical sales data What can you do with the financial models?
Compare NPVs for different deal structures for the same product
Compare NPVs and risk profiles for different products
The hard part –
assessing risks
and
potential rewards
Risks & Rewards
‘only about 10% of the drugs which enter human clinical trials will eventually be approved’
The development of novel healthcare products is a high risk business
Neither big pharma nor stock analysts are good at picking winners
Risk cannot be eliminated
Risk can be mitigated by larger companies through portfolio management
Risks can be assessed
Risks & Rewards: A Balancing Act
Assessment of risks is much more important at the earlier stages of the development process
Assessment of potential rewards, based on product sales, becomes more important as the product progresses through clinical development
The only justification for taking these high risks is the potential large reward from successful product development
Risks and potential rewards change with time and must be continuously assessed and balanced
Risks & Rewards: Three Stage Process
Approval Risks
What are the risks which could impact the approval of this product?
Market Potential
What is the market potential for this product?
Market Risks
What are the risks which could impact the market potential for this product?
Financial: Capital Markets, Partnerships
Regulatory
Manufacturing
Clinical
Scientific
Approval Risks
Money is the scarcest asset
Money has been, and is likely to remain, the scarcest asset for Canadian healthcare companies
Funding must be continuously obtained from two primary sources
Capital markets
Partners
Supplementary funding is also available from other sources
Governments
Disease associations
Show me the money!
Canadian healthcare companies have historically been able to get sufficient funding from private and public capital market sources
Liquidity was also available from periodic IPO windows
In this context, companies preferred to periodically get financing in the public markets and continue development without a partner as long as possible
Show me the money, PLEASE!
The markets and financing strategies changed dramatically starting in the fall of 2007
Financing was more difficult
Valuations plummeted
IPOs were almost impossible
Companies have been forced to consider all strategic and financing options
For many small biotechnology companies, the focus became survival
Venture Capital Investment in Canadian Life Sciences Companies
Source: www.cvca.ca
Year Amount Financings
2004 $463 M 120
2005 $438 M 100
2006 $493 M 89
2007 $633 M 82
2008 $359 M 86
2009 $215 M 70
2010 (H1) $156 M
Investment in Public Development Stage Canadian Healthcare Companies
Source: Equicom Healthcare Reviews
Quarter 2005-2007 (average) 2009 2010
Q1 $378.4 $64.5 $115.2
Q2 $270.6 $177.5 $72.7
Q3 $97.3 $103.4 $65.5
Q4 $292.2 $152.8
Total $1,038.5 $498.2 $253.4
Critical Questions
Does the company have the financial resources to get to the next critical value-creation event, with a little breathing room?
If the answer is no, can the company obtain that financing?
If the answer is yes, and the event is positive, can the company then obtain additional funding either from the capital markets or a partner?
Information sources www.sedar.com
http://www.sec.gov/edgar.shtml
Partnering
Big pharma:
Has cash and infrastructure
Needs products
Small biotech:
Needs cash and infrastructure
Has products
Partnerships will continue to be signed
Risks: Partnering Deal Hurdles
Buyer’s perspective:
Buyers see thousands of opportunities every year
Buyers are risk averse
NIH (not invented here) syndrome by internal R&D teams
Detailed due diligence is expensive
Valuation and deal terms
Seller’s perspective:
Loss of control
Valuation and deal terms
Risks: Partner or Buy? (1)
When partnership discussions start, an acquisition is always on the table
If the junior partner is a private company:
VCs historically have preferred an IPO
Sale of the company is now the preferred option
The sale price can be split into up front cash and success payments
If the junior partner is a public company, it is potentially for sale every day to other SMEs, larger biotechs and big pharmas
Risks: Partner or Buy? (2)
From the potential partner’s (buyer’s) perspective, partnering is preferred because:
There is a lower initial financial risk
There is the same level of control over product development
There are no HR or other problems when shutting down local operations
Regulatory Risks: The Critical Question
The critical event prior to generating revenues from sales is regulatory approval.
“Is there is a pathway to regulatory approval?”
The starting point in assessing regulatory risk is the end of the process – regulatory approval.
Basic Approval Requirements
Two adequately controlled clinical studies which have been designed to prove the safety and efficacy of the new drug for a specific therapeutic indication
A single trial is acceptable for certain diseases such as cancer
Regulatory Approval Risks (1) Therapeutic indication
Is this the first product which the FDA will assess for this therapeutic indication? If yes, is there a scientific or medical consensus on how to assess the product?
If there have been unsuccessful pivotal studies, was it the product, therapeutic indication or the clinical design?
Is the proposed indication a new monotherapy, an addition to the current therapy or a therapy to be used only when there is no response to current therapies?
Regulatory Approval Risks (2)
Clinical Design
Are there any differences in clinical design for this new product versus clinical trials conducted for approved products?
Are there any differences in clinical design for the Phase 3 study and the preceding Phase 2 study?
If there are differences, what are the justifications for these changes?
Regulatory Approval Risks (3)
Standard of Care
Is there a single FDA-approved standard of care for the chosen therapeutic indication?
Is there more than one FDA-approved standard of care for the chosen therapeutic indication?
If there is not an FDA-approved standard of care, is there a standard of care accepted or approved by the relevant medical groups?
Are there products currently under regulatory review or in pivotal trials which, if approved, would result in a new standard of care?
Regulatory Approval Risks (4) Primary clinical endpoint
Is there a clinical endpoint accepted by the FDA for proving efficacy in this therapeutic indication?
If not, are there clinical endpoints accepted or approved by the relevant medical groups?
Are there any difficulties in the acquisition or interpretation of these endpoints?
Is the primary clinical objective a superior safety profile and non-inferior efficacy?
Regulatory Approval Risks (5)
Statistical analysis
What are the statistical assumptions used in the design of the clinical trial?
How are patient withdrawals handled?
Is there any history of large placebo effects in this type of clinical trial?
Regulatory Approval Risks (6) Statistical versus clinical significance
A result can be statistically significant but the clinical benefit can be so small that it may not be clinically significant
For example, is a statistically significant 2-week increase in survival also clinically significant when survival on the current standard of care is about 6 months?
This result may previously have only impacted potential sales but clinical significance is now being discussed at FDA advisory committee meetings
Regulatory Approval Risks (7) Safety profile
The safety hurdle has been raised at the FDA
The safety concern is highest for drugs which are intended for chronic use and for drugs to treat patients with medical conditions which are not immediately life-threatening
Manufacturing Approval Risk (1)
Manufacturing is a critical regulatory component
The manufacturing process has to meet GMPs
The facility has to meet GMPs and be inspected
Companies may face the following situation If the process or facility used for Phase 3 / approval is
not commercially viable, changes need to be made before significant sales can be developed
However, the cost of getting to a commercially viable process and facility prior to Phase 3 can require substantial scarce resources before knowing whether the product can be approved
Manufacturing Approval Risk (2)
GMP processes must be reproducible and validated
Chemical synthesis of small molecules is usually not a problem
Isolation of natural products from a biomass can usually be controlled
Recombinant manufacturing of proteins is complicated but controllable
Upstream production
Downstream purification
Finished dosage form
Manufacturing Approval Risk (3)
Manufacturing facilities are expensive
Small molecules
API – contract manufacturing
Finished dose – contract manufacturing
Biologics
Capital cost of fermentation or cell culture facilities is enormous
Contract manufacturing is available
Changes in manufacturing scale and facilities can change the clinical activity of a biologic
Scientific Risk If the answers to the following five questions are
yes, there is probably an acceptable level of scientific risk.
Do we know how the drug works?
Do we know what causes the disease and how the disease progresses?
Is the drug’s target a key factor in disease progression?
Are the animal models predictive of human results?
Does the preclinical data show that the drug is as effective as or superior to currently approved drugs or drugs currently in clinical development?
Manufacturing costs
COGS (cost of goods sold) are an important component of due diligence conducted by potential partners and investors
Rough guideline for COGS at commercial scale:
COGS for biologics should be less than 10% of the selling price and preferably below 5%
COGS for small molecule products should be less than 5% of the selling price and preferably less than 2%
Market Potential: Two Approaches
There are two basic approaches to estimating the market potential for a new product
The starting point for one approach is the number of patients with the medical condition, which is further refined by considering factors such as the number who are diagnosed, the number who are treated, success of current therapies and disease progression
The starting point for another approach is the sales of drugs currently used to treat patients with this specific or similar medical conditions
Patient-Based Approach (1) Estimated incidence of a specific medical
condition in the general population
Number of patients diagnosed Unless a patient is diagnosed, they cannot be treated
Diagnosis by disease severity
Treatments for Stage 1 through 4 cancers are dramatically different
Treatment for a specific disease stage How many patients receive first-line therapy?
How many are cured, how many die and how many relapse and receive second-line therapy?
Patient-Based Approach (2)
To go from an estimate of the number of patients treated annually to a market potential, you need to multiply by the annual drug cost
Information on drug costs can be obtained from various free sources Some companies do publish an approximate cost per
month or course of therapy
Drug benefit formularies (e.g. ODB Formulary)
Government studies (e.g. http://www.nice.org.uk)
Purchased information http://www.micromedex.com/products/redbook
Sales-Based Approach
Some information is available for free
Financial reports by public companies
Analyst reports
The most detailed information must be purchased and can be very expensive
http://www.imshealth.com/portal/site/imshealth
http://www.decisionresources.com/
http://thomsonreuters.com/products_services/healthcare/healthcare_products/
Canadian data - http://www.broganinc.com/ GWS-BIO
Approval Timing: First-In-Class
Clinical Data: Best-In-Class
Competition
Reimbursement
Patents
Market Risks
Market Risks: First-In-Class
Where several new drugs are structurally related, have the same biological target and similar safety and efficacy profiles, first-in-class (first approved) should have a market advantage
If the new drug is going to be a second or later market entrant, how is it going to take market share?
Market Risks: Best-In-Class
Where several new drugs are structurally related and have the same biological target, best-in-class (superior safety and/or efficacy) should become the class sales leader even when it is not first-in-class
If a new drug is not going to be best-in-class and it will reach the market after the superior product, should product development be terminated?
Market Risks: Three Levels of Competition
There are three levels of competition:
Currently approved drugs
Drug candidates at the same stage of development
Drug candidates at an earlier stage of development
Competition: Currently Approved Drugs (1)
Currently approved drugs are competition only if the new drug is attempting to replace one of the currently approved drugs
Currently approved drugs are not competition if the new drug is going to be used in combination with the currently approved drugs or will be used only after the currently approved drugs no longer provide the desired clinical benefit
Competition: Currently Approved Drugs (2)
Information sources
Drugs@FDA http://www.accessdata.fda.gov/scripts/cder/drugsatfda/index.cfm
Physicians’ Desk Reference http://www.pdr.net/home/pdrHome.aspx
Compendium of Pharmaceuticals & Specialties http://www.pharmacists.ca/content/products/ecps_english.cfm
Textbooks
Courses
Purchased reports
Competition: Drug Candidates (1)
Information sources:
www.clinicaltrials.gov
Analyst reports
Purchased reports
Competition: Drug Candidates (2)
Drug candidates at a similar stage of development can be categorized and the competitive threat assessed with respect to:
The biological target
Drug of the same chemical class, different chemical class or biologic
Comparative safety and efficacy in similar clinical trials
Drug candidates at an earlier stage of development are less important from a risk perspective but their development should be monitored
Market Risks: Reimbursement
Obtaining reimbursement for new drugs and medical procedures used to be a simple case of submitting paperwork
The pharmaceutical industry is fighting constantly to prevent restrictive formularies and comparative therapeutic testing
Launching new medical devises and diagnostics is much easier if the new products can be covered by existing payment codes
Market Exclusivity: Patents
The basic patent life is 20 years from date of filing
Patent life extension is available in the U.S. to account for regulatory delays and compensate for pediatric testing
Data exclusivity now provides periods of exclusivity during which a generic product submission cannot be filed or approved if it relies in any way on the regulatory filings of the originator product
Patent Risks: Critical Questions
Are there issued or filed patents which will provide a period of market exclusivity?
Would the product infringe on other patents (freedom-to-operate)?
Assuming product approval in year 20xy, how much market exclusivity is provided by both patents, patent extensions and data exclusivity?
Conclusion
Valuation and financial modeling is a qualitative and numerical assessment of
risks and potential rewards
Anybody can crunch the numbers
Better assumptions lead to better numbers
Better assumptions come from asking the right questions