Portfolio Risk Analysis

Kimber Hardy

November 2012

2

The Flaw of Averages

Sam L. SavageJohn Wiley & Sons, Inc., 2009

3

Pipeline values and risk…

… single, average values can be misleading

…. “plans based on average assumptions are wrong on average”

4

Role of Portfolio Management

Portfolio Management

• Align portfolio with Strategy• Maintain portfolio balance• Maximize portfolio value

Portfolio Management

• Align portfolio with Strategy• Maintain portfolio balance• Maximize portfolio value

Company StrategyR&D investment allocation

Company StrategyR&D investment allocation

Resource Management Resource Management

TA1TA1 TA2TA2 TA3TA3 NMEDev

NMEDev LCMLCM ResRes

Total R&D InvestmentTotal R&D Investment

Company StrategyCompany Strategy

Resource supply and demand, by project and Department

Total R&D InvestmentTotal R&D Investment

Project Prioritization & Optimization

Pipeline-derived salesValue and Risk

Portfolio Value Change

Project Strategic Commercial Operational CostsProject score

Rank

A 90 70 50 60 68 1

B 65 65 50 75 64 2

C 85 85 30 50 63 3

D 75 80 30 65 63 4E 55 45 55 90 61 5

-500

0

500

1'000

1'500

2'000

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Launch probabilityN

PV

€ m

illio

ns

Pipeline value change: + 1100 m € (+24%)

Pip

elin

e va

lue

(€m

illio

ns)

-800400

1’500 5’600

4’500

20112010

0

20

40

60

80

100

120

2012 2013 2014 2015

Res

ou

rce

use

(%

)

Dept A

Dept B

Dept C

Dept D

0

500

1'000

1'500

2'000

2'500

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

€ m

illi

on

s

50%

25%

10%

75%

90%1'000

1'500

2'000

2'500

3'000

5

eNPV: often used for (late-stage) project valuation

Success

Failure

50%

50%

eNPV*

0 4 7 10

–50 90 100 100 100

–50 0 0 0 –50

Probability of Success

Cash Flows by Year

NPV*

25

eNPV: to account for timing and technical risks, NPV and probabilities are combined

*at 10% discount rate

6

-250 -50 0 +200 +400

project value (€m)

p

rob

ab

ilit

y

0.01

0.02

0.03

0.04

0.05

Fails in Preclinical. Project stopped

Successful Development &

Registration. Generates sales

-250 -50 0 +200 +400

Mean value €80m

project value (€m)

p

rob

ab

ilit

y

0.01

0.02

0.03

0.04

0.05Fails in Clinical. Project stopped

Project values: range of possible outcomes

Mean value by itself doesn’t capture

enough about the value and risk of the

project

7

Many ways to present project values and risks e.g.

Phase III Filing TPC outcome Market environment Outcome Probability

ME positive40%

Optimum TPC10%

60%ME negative

ME positive40%

Succeed Base TPC90% 80%

60%ME negative

ME positive40%

Minimum TPC10%

60%ME negative

Succeed45% 10%

Fail

55%Fail

Scenario 6 Launch 2.4%

Fail 4.5%

Fail 55.0%

Scenario 4 Launch 19.4%

Scenario 5 Launch 1.6%

Scenario 2 Launch 2.4%

Scenario 3 Launch 13.0%

Scenario 1 Launch 1.6%

-250 -50 0 +200 +400

project value (€m)

pro

ba

bil

ity

0.01

0.02

0.03

0.04

0.05

NPV given Technical Success, Rebif in Colorectal Cancer

$5,800

Low

 2001

$5MM

$5,800

 0%

7

  20%

20%

$7,100

High

 2003

$28MM

$7,100

 -3%

40

40%

40%

TPP

0 50 100 150 200 250 300 350 400 450 500

Product Profile

EU Market Share

US Final Market Share

EU Annual Launch Costs

EU Price Growth Rate

EU Initial Price

US Annual Launch Costs

EU Launch Year

Material cost per mcg

US Initial Price

Base Value: $170 million

 MAP

30%

30%

 25

 -2%

$6,500/yr

$20MM

 2002

Base

 $6,500/yr

BaseCase

Sensitivity analysis Decision trees and scenarios

Monte Carlo simulation Value change over time

8

How to analyse and present pipeline values, ranges and risks?

9

Typical portfolio analyses

Project Strategic Commercial Operational CostsProject score

Rank

A 90 70 50 60 68 1

B 65 65 50 75 64 2

C 85 85 30 50 63 3

D 75 80 30 65 63 4E 55 45 55 90 61 5

-500

0

500

1'000

1'500

2'000

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Launch probability

NP

V

€ m

illi

on

s

Pipeline value change: + 1100 m € (+24%)

Pip

elin

e va

lue

(€m

illio

ns)

-800400

1’500 5’600

4’500

20112010

0

500

1'000

1'500

2'000

2'500

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

€ m

illio

ns

50%

25%

10%

75%

90%1'000

1'500

2'000

2'500

3'000

Pipeline-derived sales

Project prioritization

Project value and risk

Pipeline value change

10

It can be very useful to show an analysis of potential sales with ranges …

0

500

1'000

1'500

2'000

2'500

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

€ m

illio

ns

50%

25%

10%

75%

90%1'000

1'500

2'000

2'500

3'000Pipeline-derived sales *

*indicates that there is a 10% probability that sales will be greater than the value shown and 90% probability that it be less

11

Pipeline value change: + €1’100m (+24%)

Pip

elin

e va

lue

(€ m

illi

on

s)

-800400

1’500 5’600

4’500

20112010

… or an analysis of portfolio values with an indication of confidence limits

12

An analogy with Financial Portfolios Probability analyses increasingly used: e.g. assessing downside risk in pension portfoliosPension PlanningSimulation

Initial Amount ($000) 1'000 24% chance of depletion.Withdrawal/yr. ($000) 75

Portfolio of Funds*Gold 10%Mixed Fund 25%Large Cap 25%Cash 40%

10%90% $0

$500

$1'000

$1'500

$2'000

0 5 10 15 20Years

Fu

nd

s R

emai

nin

g

Median 10% 90%*Illustrative only! Adapted from www.ProbabilityManagement.org

13

13

Pipeline Value as the sum of project mean eNPVs

505

599

625

286

820

250

450

488

835

163

580

0

1'000

2'000

3'000

4'000

5'000

6'000

Proj AProj BProj CProj DProj E

Proj Z

Total pipeline value = €5’600m

14

14

Pipeline Value as the sum of project eNPVs

This is a mean value

How to show more information about the portfolio: values and risks?

For example, what’s the probability that the value is less than €2’000m? 505

599

625

286

820

250

450

488

835

163

580

0

1'000

2'000

3'000

4'000

5'000

6'000

Proj AProj BProj CProj DProj E

Proj Z

Total pipeline value = €5’600m

15

Defined scenarios for projects

Scenarios

High (x%) Base (y%) Low (y%)

Competition

Pricing & Reimbursement

Price

Patent status

Launch date

Year of peak sales

Marketing Strength

Etc.

16

Scenarios vs. Sensitivity analysisBoth useful, but prefer scenarios as more clearly defined

NPV given Technical Success, Rebif in Colorectal Cancer

$5,800

Low

 2017

$5MM

$5,800

 0%

7

  20%

20%

$7,100

High

 2015

$28MM

$7,100

 -3%

40

40%

40%

TPP

0 50 100 150 200 250 300 350 400 450 500

Product Profile

EU Market Share

US Final Market Share

EU Annual Launch Costs

EU Price Growth Rate

EU Initial Price

US Annual Launch Costs

EU Launch Year

Material cost per mcg

US Initial Price

Base Value: $170 million

 MAP

30%

30%

 25

 -2%

$6,500/yr

$20MM

 2016

Base

 $6,500/yr

BaseCase

Sensitivity analysis

17

Global peak sales(€ millions)

20%

60%

20%

= scenario probability

Sales forecasts & costs defined for each scenario

1036

819

519

High Base case

Low

e.g. for sales...

18

Project probability of success

CMR & KMR benchmarks

– Useful background information when assessing project probabilities

– However, benchmarks for certain therapeutic areas have insufficient data

– And certain types of project differ markedly from benchmark• E.g. phase III projects from small vs. large Pharma companies

Phase III Oncology trials: 2000 to 2009*

Company size Positive Phase III

<$300m 0/21 (0%)

>$1’000m 21/27 (78%)

*A. Feuerstein & M.J. Ratain. J. National Cancer Institute.103(20):1-2. Nov 2nd 2011

19

Commercial and Technical Risks: project data needed for Monte Carlo simulation of portfolio value

54%

46%

750

400

200

-240

-220

NPVPhase III Filing Scenario Outcome Probability

20%

Succeed

60%

Succeed

Fail

Fail

Scenario 1

Scenario 2

Scenario 3

Launch

Launch

Launch

Fail

Fail

11%

11%

32%

6%

40%

20%

60%

10%

90%

60%

40%

20

Portfolio value: Monte Carlo simulation

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Cumulative distribution

€ m

illi

on

s

Proj A

Proj B

Proj C

Proj A

Proj B

Proj C

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

21

Portfolio Value Ranges

« Value at Risk »22% of median value

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Cumulative distribution

€ m

illi

on

s

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

22

Portfolio Value Ranges

The shape of the curve describes the value – risk profile of the portfolio

23

-1'000

0

1'000

2'000

3'000

4'000

5'000

6'000

7'000

8'000

9'000

0% 5% 10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%

100%

Cumulative distribution

Po

rtfo

lio

val

ue

(€ m

illi

on

s)

Portfolio values: “the flaws of averages”

Portfolio AMean value: €500m

Low Risk/ Low Reward

Portfolio BMean value: €500m

High Risk/ High Reward

24

Impact of correlation on portfolio risk/reward profile

Four phase II projects: 70% correlation vs. no correlation

-2'000

0

2'000

4'000

6'000

8'000

10'000

12'000

14'000

0% 5% 10%

15%

20%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

85%

90%

95%10

0%

Cumulative distribution

Val

ue

(€m

)

4 projects. 70% correlation

4 projects. No correlation

70% correlation

no correlation

25

But a final word on keeping presentations to the Board simple. At most this…

0

500

1'000

1'500

2'000

2'500

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

€ m

illio

ns

50%

25%

10%

75%

90%1'000

1'500

2'000

2'500

3'000

26

Pipeline value change: + €1’100m (+24%)

Pip

elin

e va

lue

(€ m

illi

on

s)

-800400

1’500 5’600

4’500

20112010

… or this to show confidence limits

27

The Flaw of Averages

Sam L. SavageJohn Wiley & Sons, Inc., 2009