Speaker: Wayne Schnarr, healthcare consultant and analyst, Equicom, TSX
Canada's biotechnology and cleantech communities have a history of developing world-leading technologies —but for these industries to grow, they must have access to new capital to fund research and development that will allow Canada to maintain its position as a world leader.
project management information system lecture notes
MaRS Best practices: Valuations in the biotech industry - wayne schnarr
1. 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
2. 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.
4. 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
9. Where is valuation important?
Investing
Financing
Partnering
Selling
10. Who invests in these companies?
Angel investors
Venture capital
Canada
US
Institutional funds
Canada
US, EU, ROW
Retail investors
Canada
US
11. 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
12. Why would you buy shares of a company?
Mature Healthcare
Capital gains from an
increase in share
price
Income from
dividends and
distribution
13. 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
14. 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)
15. 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
16. 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.
17. 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
18. 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
20. 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
21. 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
22. 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
23. 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)
24. 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
25. 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
26. 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
27. The hard part –
assessing risks
and
potential rewards
28. 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
29. 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
30. 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?
32. 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
33. 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
34. 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
35. 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
36. 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
37. 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
38. Partnering
Big pharma:
Has cash and infrastructure
Needs products
Small biotech:
Needs cash and infrastructure
Has products
Partnerships will continue to be signed
39. 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
40. 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
41. 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
42. 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.
43. 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
44. 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?
45. 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?
46. 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?
47. 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?
48. 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?
49. 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
50. 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
51. 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
52. 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
53. 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
54. 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?
55. 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%
56. 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
57. 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?
58. 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
59. 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
61. 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?
62. 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?
63. 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
64. 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
66. Competition: Drug Candidates (1)
Information sources:
www.clinicaltrials.gov
Analyst reports
Purchased reports
67. 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
68. 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
69. 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
70. 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?
71. 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