Pharma & Biotech
`
`Drug Development
`Valuing the pipeline – a UK study
`
`March 2009
`
`

`

`Introduction
`
`Mayer Brown is pleased to report on the findings of a study examining the methodologies
`used to value drug development programmes. The study was conducted by members of
`our Pharmaceutical, Biotechnology & Life Sciences practice in the London office.
`
`The year has started with major consolidation in the pharma sector and predictions
`that the biotech industry will see unprecedented levels of bankruptcies. There are
`also reports that the current market circumstances provide a “big buying opportunity”
`for pharma. Yet others question whether pharma is prepared for any major disruption
`involving biotech companies, which may result in the end of key partnerships. These
`are just some of the events and questions currently facing those participating in the
`sectors, with the overall focus remaining on increasing the chances of successful drug
`discovery development.
`
`As lawyers, we remain committed to providing specialist legal expertise facilitating
`innovation in the pharma and biotech sectors. We believe the findings of the study
`contribute to the information currently available to investors to assess the value
`proposition offered by funding drug development programmes and by senior
`management seeking to identify those programmes that are most likely to maximise
`company value. The findings are also relevant to understanding the values assigned by
`parties in negotiations for the acquisition or licensing of drug development programmes
`and the approach of financial analysts in setting equity prices.
`
`To all the individuals who participated in the study, we sincerely appreciate your
`cooperation. For those reading, we welcome any opinions you may have on the issues
`sought to be considered in this report.
`
`If you would like more information, please contact the author of this report, Sangeeta
`Puran (spuran@mayerbrown.com) or any other member of our Pharmaceutical,
`Biotechnology & Life Sciences practice, including:
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`European contact: Jeffrey Gordon (jgordon@mayerbrown.com)
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`US contact: Jamison Lynch (jlynch@mayerbrown.com)
`
`Please remember that this report contains general information, much of which has been provided by third parties
`and which we have not independently verified. We hope it will interest you but you should not rely on this report in
`relation to specific matters as it has not been prepared with a specific set of circumstances in mind, nor of course is
`this report an invitation or inducement to engage in investment activity.
`
`

`

`Contents
`
`The valuation of drug development projects
`
`Executive Summary
`
`1.
`
`Introduction to valuing drug development projects
`
`1.1 Summary of project lifecycle and cash flows
`
`1.2 Cash Flow Modelling – NPV
`
`1.3 Risk adjusted NPV
`
`1.4 Scenario analysis, decision–tree modelling and Monte Carlo simulation
`
`1.5 Real Options
`
`1.6 Comparables
`
`2. Findings on the methods currently used to value drug development projects
`
`2.1 Risk adjusted NPV
`
`2.2 Comparables
`
`2.3 Multiple methodology approach
`
`3. Findings on the VC approach to valuing early stage projects
`
`4. Findings on the biotech and pharma approaches in acquisition, licensing
`and partnering
`
`4.1 Projects on offer
`
`4.2 Outright acquisition
`
`4.3 Other arrangements
`
`4.4 Sources of value discrepancy
`
`4.5 Project value splits
`
`5. Findings on the analyst approach
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`6. Forecasting challenges
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`6.1 Inputs for projecting revenue
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`6.2 Determining risk parameters
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`6.3 Forecasting costs
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`6.4 Forecast period
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`6.5 Pharmaceuticals versus biopharmaceuticals versus medical devices
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`The valuation of drug development
`projects
`
`Drug discovery, research and development (“drug development”) follows a sequence
`of distinct stages, each of which aims to generate “economically valuable specific
`knowledge”1 about the drug candidate in question. In this way, the implementation of a
`drug development project generates intellectual assets capable of transfer or licensing.
`
`Determining the monetary value of these intellectual assets is central to internal research
`prioritisation, investor funding decisions, business development negotiations and equity
`analysis in the pharmaceutical and biopharmaceutical sectors.
`
`A range of methods, each with differing computational complexities and limitations, can
`be used to assign a value to a drug development programme.
`
`This study considers:
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`the methods currently used to value drug development projects;
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`the different ways in which these methods are applied by different sector participants;
`and
`
`the key challenges in forecasting the revenues, costs and risks associated with drug
`development.
`
`The study was conducted by interviewing individuals over a period of four months2 in
`the UK from a representative sample of twelve leading industry participants, including
`small biotech business development (“biotech”), large pharma and large biotech
`business development (“pharma”), financial analysts (“analysts”) and venture capitalists
`(“VCs”).3
`
`1 Arojärvi, O., 2001. How to Value Biotechnology Firms: A Study of Current Approaches and Key Value Drivers.
`Helsinki School of Economics and Business Administration [URL: http://www.finbio.net/publications/pro-gradu-
`arojarvi-01-en.htm].
`2 September 2008 to January 2009.
`3 A copy of the questionnaire is available on request.
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`of drug.
`commercial sales
`Launch
`
`markets.
`approval in major
`Obtain marketing
`
`can start in Phase III.
`force construction)
`(including sales
`market launch
`Preparation for
`
`infrequently.
`that occur
`adverse reactions
`and monitor
`significant efficacy
`Establish statistically
`
`efficacy.
`designed to study
`whereas Phase IIB is
`requirements
`to assess dosing
`Phase IIA is designed
`and Phase IIB.
`divided into Phase IIA
`Phase II can be
`
`efficacy data.
`obtain preliminary
`Verify safety and
`disease/condition.
`targeted
`in patients with
`Test drug candidate
`
`toxicity of candidate.
`and excretion and
`metabolic effects
`distribution,
`assess absortion,
`dosages and
`Establish safe
`
`efficacy profile.
`safety and
`Assess
`
`candidate.
`synthesis of drug
`Discovery and
`
`Purpose
`
`volunteers
`1000 to 3000 patient
`
`volunteers
`100 to 300 patient
`
`volunteers
`20 to 80 healthy
`
`animal studies
`Laboratory and
`
`Laboratory studies
`
`Population
`Typical
`
`1-2 years
`
`2-4 years
`
`1-2 years
`
`1-2 years
`
`Time
`
`Marketlaunch
`
`Regulatory review
`
`PhaseIII
`
`PhaseII
`
`PhaseI
`
`Pre-clinical
`
`Discovery
`
`Clinicaldevelopment
`
`Earlystage
`
`Outline of the stages of drug development
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`2
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`Executive Summary
`
`Complex science, long development times, the high risk of technical failure and changing
`regulatory and market conditions make it difficult to derive reliable values of a drug
`development project solely through the application of valuation methodology. Based
`on the views of the participants of this study, the current market conditions create new
`uncertainties and limitations around the tools used to value drug development assets.
`
`For instance, in pricing negotiations, valuing drug development projects by comparison
`with prices paid in recent comparable commercial transactions for similar projects at
`similar stages of development is used. We now have reports of the effective disappearance
`of biotech IPOs and a fall in the number and value of private equity deals in the sector,
`together with the public bio/pharma market currently having a low value. In these
`conditions, even if a comparable project can be referred to, there is the additional
`uncertainty relating to the extent to which previous values can be drawn upon. As one
`participant remarked:-
`
`“Given the current market circumstances, everything is in a bit of a muddle.”
`(pharma)
`
`Given funding constraints, some consider outright acquisitions of drug development
`projects as now more popular than complex licensing and partnering deals. Participants
`in the study reported seeing biotech rights owners using auctions on lead products to push
`up the value of upfront payments in a proposed licence deal as a prelude to suggesting
`an outright disposal. From a valuation perspective, these negotiating practices arguably
`further muddle the pool of comparable transactions.
`
`The current market conditions include shifting categories of projects of interest to buyers
`and investors. Some point to an increase in early stage deals. Aside from comparables,
`risk adjusted Net Present Value (“NPV”) is the other tool predominantly used to value
`drug development projects, but the values yielded from it have long been considered
`unreliable because of the greater guess-work involved in forecasting cash flows and
`risk at an early stage of drug development. However, the current market uncertainties
`may also mean that “good quality assets” are less constrained by previous values. “Good
`quality assets” are seen as continuing to secure high prices. Notably, a pharma buyer
`is likely to place less relevance on comparables and focus more on what the individual
`project is worth to it:-
`
`“Availability of deals has increased rather than prices falling. Licensees’
`expectations are still as high. Good quality assets (rather than ‘bottom
`feeders’) will still have a high price.” (pharma)
`
`“If one looks at the share price, things seem cheaper then once the fight begins,
`you cannot be sure that the price will not go up. There are no Phase III projects
`around.” (pharma)
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`Methodologies used to value drug development projects
`
`The participants were asked to identify the methods they used to value drug development
`projects. Most participants only used risk adjusted NPV and comparables. Few
`participants (mainly the pharma participants) regularly used other methodologies such
`as scenario analysis, decision-tree analysis, Monte Carlo and real options.
`
`Of course, the purpose and scenario for which a valuation exercise is undertaken, and by
`whom it is undertaken, ultimately explains the method used.
`
`For example, VCs do not use NPV modelling when assessing early stage projects because
`of the greater guess-work involved in forecasting cash flows and risk at an early stage of
`drug development. VCs instead focus on “business plan” type factors and what the value
`will be to an acquirer. Paramount to the VC investment decision is the exit strategy.
`
`“The starting point of the investment is: how do we get out of this?” (VC)
`
`Some consider that even if IPOs return, these no longer offer a complete exit to VCs, who
`are now focused on an exit by trade sales. Consequently, VCs are having to be cleverer
`in how they position their portfolio companies. They do not want to position a portfolio
`company as a “one product” company, but nor can a company be too diverse:-
`
`“The key challenge lies in how to position the company with products and
`technologies that are compatible.” (VC)
`
`In comparison, analysts will rely on values derived from NPV modelling, but they tend
`to focus on late stage projects. More specifically, the focus is on when the drug candidate
`will be launched and when relevant sales will peak. This focus on late stage projects
`was criticised by the biotech participants for ignoring the fact that the value for biotech
`companies currently lies in being acquired. If an early stage project is of interest to an
`acquirer, then the acquirer will place a positive value on the project for which the analyst
`may have given no value.
`
`Valuation in acquisition, licensing and partnering negotiations
`between biotech rights owners and pharma buyers
`
`The theoretical value derived from valuation methods, when considered in isolation,
`assumes that a drug development project has an intrinsic value. Yet, most participants
`explained deal values simply on the basis of who wants/needs the asset more.
`Consequently, the key sources of value discrepancy continue to depend ultimately on
`qualitative factors and the subjective criteria specific to the rights owner and the buyer,
`and of course the negotiating power of the parties.
`
`Cash flows, together with prospects of independent fund-raising, are factors relevant to
`determining what the project will be worth to a cash-strapped biotech rights owner. For a
`pharma buyer, key factors include strategic factors (e.g. whether the project fills an important
`strategic gap in the buyer’s product portfolio) and the synergies that a buyer can exploit (e.g.
`whether the buyer can leverage its existing sales force to market the new product).
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`Therefore, it is important to identify the subjective criteria and qualitative factors
`relevant to the other side and to address these issues early by having in place strategies
`and practices that best emphasise relevant criteria and factors.
`
`Participants were also asked to comment on the typical value split between rights owners
`and buyers. Most participants were reluctant to acknowledge any typical split, preferring
`to treat each deal on a case-by-case basis.
`
`Examples of the factors that would influence the value split include:
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`how innovative the drug candidate is and its sales potential: The emphasis is on the
`sales forecast. In addition to a shift towards early stage deals, some participants
`observed buyers being increasingly open to considering drug candidates with smaller
`markets if the end product can be marketed within their sales force machinery.
`Buyers are also seen as now applying more rigid requirements on what a product
`profile must look like in order to succeed, e.g. the safety and efficacy profile that
`must be achieved in order for it to be worthwhile for the buyer to take the product
`to market. Consistent with this, participants also consider buyers more likely to
`terminate development projects;
`
`the development stage and the risk to be assumed by the buyer: A notable source of
`technical discrepancy arises in assessments relating to the true stage of development
`of a project. Buyers see rights owners as overestimating the clinical stage of
`development. Other participants believe that development overestimation should
`be less of an issue given the increased guidance from regulators (in particular, the
`US Food and Drug Administration) throughout clinical development;
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`unsurprisingly, the scope of rights disposed of; and
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`the extent to which the payment structure is frontloaded: In terms of payment
`structure, participants see rights owners as preferring structures that secure as
`much cash today as possible despite the fact that frontloaded structures are usually
`associated with a buyer requiring a larger percentage of the project value.
`
`Finally, competition amongst the bidders is a key driver of deal value and value splits.
`The pharma participants acknowledged that, whilst they will work on their initial
`valuation and bid in detail, competition will change everything. As explained by one of
`the pharma participants:-
`
`“We would of course not offer more unless we had to, e.g. if we were at risk of
`losing the deal. We would tend to work up the initial valuation in ‘exquisite
`detail’ then go in with a bid, and competition would change everything. It is a
`question of ‘how hungry are you?’ Passion takes over from common sense. For
`example, where there is an important strategic gap in the portfolio, the price
`would go up – but one would not start from that position.” (pharma)
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`5
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`Forecasting challenges
`
`As to the current function of quantitative valuation, valuation methods remain an
`important tool for capturing the variables which are important to a drug development
`project:-
`
`“Valuation can be seen as a tool to make a decision, a tool to persuade someone
`else to make a decision, or a tool for what is a piece of carpet haggling.”
`(biotech)
`
`Participants were asked about challenges in quantifying the revenues, the costs and
`the risks of a drug development project. They were generally comfortable with their
`approach to forecasting the costs of development, but significant uncertainties exist
`around forecasting revenue potential and risk.
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`Revenue: The key challenge relates to an inability to control or predict shifts in the
`factors influencing a new product’s ability to gain market share. In particular, many
`struggle in assessing the impact of competition on market share, with key differences
`in revenue depending on whether a product is first to market or second to market.
`Whilst best estimates can be given based on the current understanding of the market,
`educated guess-work cannot, of course, account for unknown development projects.
`In this context, development timetables are also critical (and difficult to get right)
`because loss of time will have a knock-back effect on the all important competitive
`position.
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`Risk parameters: Participants continue to rely on industry averages even though the
`limitations of applying industry averages to specific therapeutic indications are well
`understood.
`
`Values derived from quantitative modelling are most sensitive to changes in revenue
`and risk parameters, which explains the importance in accurately estimating these
`parameters. The participants also highlighted new uncertainties due to the current
`market circumstances. For example, there was a difference in opinion on whether
`discount rates should be changed in line with changes in interest rates. One participant
`referred to the misuse of discount rates:-
`
`“Discount rates are not used properly. For instance, discount rates do not
`necessarily change with changes in interest rates.” (biotech)
`
`Others defended not changing discount rates on the basis that they are an estimate over
`the long term life of a drug development project.
`
`Despite being perceived by the other groups as possessing informational advantages,
`pharma participants indicated that they too struggle with forecasting revenue and risk
`parameters.
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`

`

`Therefore, the key function of quantitative modelling is as a tool to gather insights into
`as many possible sources of value and uncertainty, requiring participants to remain
`proficient in their approach to valuation. In addition, the warnings against relying on
`a value derived from any single one approach points to considering whether there is a
`broader scope to apply the lesser used methodologies such as real options:-
`
`“Any one model is just one picture. We typically use several models for one
`project, to capture any variables particularly important to the project and the
`decision making process.” (biotech)
`
`“None of the methods alone is a single decision tool … you combine them.”
`(pharma)
`
`An understanding and appropriate quantification of as many possible sources of value
`and uncertainty remains important to decreasing the risk of underselling or overvaluing
`drug development projects.
`
`7
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`

`

`1. Introduction to valuing drug development projects
`
`Valuation can involve a market, cost or income approach. This section seeks to provide a
`basic introduction to valuation theory. We start with NPV, which considers the cash flow
`opportunities of the asset in question and incorporates the income approach.
`
`1.1 Summary of project lifecycle and cash flows
`Figure 1 shows the typical project lifecycle from a cash flow perspective. During the early
`research stage, project cash flows tend to be negative. Early stage research can take
`several years, but is not as expensive as clinical development. The drug is launched upon
`marketing approval being issued, followed by relatively fast market penetration. A stable
`period of revenue generation follows. Finally, revenues decline following patent expiry.
`The project lifecycle is such that even though the basic term of patent protection lasts 20
`years from the date application for patent was filed, the period during which revenues
`can enjoy patent protection is effectively reduced to the patent term remaining after
`regulatory approval.
`
`Figure 1 - Example of a project lifecycle curve from a cash flow perspective
`Figure 1 - Example of a project lifecycle curve from a cash flow perspective
`
`+
`
`+
`
`Cash flows
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`Patent period
`
`Patent expiry
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`3
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`Patent period
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`19 20 21
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`24 25
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`Years
`Patent expiry
`26 27
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`Cash flows
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`Early research
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`-
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`1
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`2
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`3
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`4
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`5
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`7
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`8
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`Early research
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`Launch
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`-
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`Launch
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`19 20 21
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`24 25
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`26 27
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`Years
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`9
`10
`Advanced
`clinical
`development
`
`Advanced
`clinical
`development
`
`Financial models vary on how far into the project lifecycle they forecast. Patent expiry
`is a typical endpoint, based on revenues facing erosion after patent expiry. A famous
`example is Eli Lilly’s anti-depressant Prozac, where patent expiry in 2001 paved the
`way for regulatory approval of Barr Laboratories’ generic version, Fluoxetine. Prozac
`reportedly lost 73% of market share within two weeks of generic launch4.
`
`4 Tuttle, E, Parece, A, & Hector, A, 2004. Your patent is about to expire: what now? Pharmaceutical Executive,
`November. [URL: http://www.analysisgroup.com/Pharma_Exec November_2004.pdf]
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`The extent and rapidity of sales and price erosion can vary. A product owner may use
`patent term extensions and regulatory exclusivities to extend the period of protection.
`The introduction of generic competition may also be delayed, for example:
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`a drug may operate in a niche category that is too small, or with a brand presence too
`strong, to attract competition on patent expiry;
`
`a drug may be too complex to produce, particularly where the manufacturing
`processes are also protected; or
`
`in the case of competition from follow-on biologics, the current lack of clarity on
`regulatory requirements (especially in the United States) poses a key challenge to
`their launch.
`
`The endpoint of a forecast period may also be the point beyond which information
`required to forecast is unavailable or unreliable.
`
`1.2 Cash Flow Modelling – NPV
`NPV is also known as discounted cash flow or DCF. NPV, when applied to a drug
`development project, involves deriving cash flows over a forecast period by projecting
`the costs of development and the revenues from commercialisation activities. These
`cash flows are then discounted in accordance with finance theory to derive a net present
`value of the drug development project.
`
`Forecasting costs of drug development
`The costs associated with drug development can be broadly grouped as follows:
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`Discovery and pre-clinical development costs: These include costs relating to
`
`discovery (resulting in the synthesis of a drug candidate) and testing in assays and
`animal models. Assessing pre-clinical costs for a specific development project
`is difficult because pre-clinical costs are usually incurred as part of wider R&D
`programmes involving multiple projects.
`
`Clinical development costs: These include costs relating to trial design, patient
`
`recruitment, investigator and clinician costs, monitoring costs, data analysis, close-out
`and reporting results, and those related to the production of the clinical trial supplies
`and animal testing during the clinical period. Clinical development costs will vary
`depending on the therapeutic indication, with increased costs associated with chronic
`and degenerative diseases. This increase is driven by the number of patients needed
`in a clinical trial, the treatment costs per patient (e.g. outpatient versus intensive care
`treatment, cost of diagnostic procedures and co-medications, durations of treatment
`and requirements of follow-up) and the length of the clinical trial. Of the stages of
`drug development, Phase III is the most expensive and time-consuming.
`
`Regulatory review costs: The costs of marketing approval need to be considered on
`
`a territorial basis, with most drugs at least aiming for approval in the major markets
`(United States, Japan and certain Europe countries). The costs of preparing
`submissions in connection with marketing approvals can vary depending on the
`amount and quality of data.
`
`Launch, manufacturing and marketing costs: Marketing expenses start well
`
`before marketing approval. Launch, manufacturing and marketing costs are usually
`projected on the basis of conventional assumptions (e.g. the marketing expenses
`for year 1, 100% of the revenues, the marketing expenses for year 2, 50% of the
`revenues etc). The specific requirements of the target market are also important.
`For instance, hospital products are characterised by lower marketing costs than
`products promoted to specialists or primary physicians.
`
`9
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`

`

`Forecasting revenues
`Forecasting the likely eventual revenues of a drug candidate once developed, involves
`determining the size of the target market, the market share likely to be attained and
`subsequent market growth.
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`Market size
`
`The bottom-up approach5 focuses on the number of patients and calculates market
`size by evaluating the following parameters:
`
`–
`
`–
`
`–
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`number of patients;
`
`number of patients receiving treatment; and
`
`price of treatment per patient.
`
`The other approach used is a top-down approach6 which involves extrapolating from
`existing sales data of products in the same therapeutic class as the drug candidate
`of interest.
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`Market share
`
`Commentators will typically include the following in a list of factors influencing a
`new product’s ability to penetrate a market:
`
`–
`
`–
`
`–
`
`–
`
`–
`
`–
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`competition from available treatments and products, as well as those in
`development;
`
`pricing;
`
`relative advantages compared with current treatments (i.e. cost/benefit
`analysis);
`
`dosage and formulation of the candidate;
`
`clinical evidence of efficacy and safety; and
`
`patient/physician product loyalty.
`
`This is by no means exhaustive of the factors relevant to assessing market share.
`The distinction between volume market share (based on number of treatments) and
`value market share (based on sales value) is also relevant.
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` n
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`Market growth
`
`The current market growth will only be a guide to future growth prospects. The
`factors behind market growth need to be identified and the distinction between
`volume and value growth is also relevant. Sales volume growth will be affected
`by changes in population growth, spread of an illness, frequency of occurrence,
`frequency of diagnosis, and treatment practice. Sales value growth depends on
`changes in pricing and product mix (older products may have significantly lower
`prices than newer, more efficacious ones).
`
`Standard sales evolution curves are also used. By looking at historical peak sales
`of drug products, different scenarios of rates of ramp-up to peak sales and rates of
`market erosion can be analysed.
`
`5 The bottom-up approach is also known as an epidemiological-based approach.
`6 The top-down approach is also referred to as a market-based approach.
`
`10
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` n
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`Price premium
`
`Novel products that are more efficacious than existing products are typically priced
`at a premium. However, this must be balanced against the number of patients/
`physicians who will switch to a more expensive product. Also, during the forecast
`period other products may lose patent protection and become subject to competition
`from generics. Patient/physician switch to generics needs to be considered. Pricing
`regulations and policies are also relevant in pricing analysis.
`
`Discounting to adjust for time and risk
`An amount of money received today is worth more than the same nominal amount of
`money received in the future. Conversely, a dollar received tomorrow is worth less than
`a dollar received today. Applying this principle to forecasted cash flows means that not
`only are future revenues worth less today than in the future, but also future investments
`will “cost” less today. Finance theory requires that a discount rate be used to translate
`the future cash flows into today’s value.
`
`Finance textbooks illustrate how discount rates account for risk. By way of example, the
`capital asset pricing model calculates the discount rate on the basis that investors require
`a project to generate at least the same return as would be expected from investing in
`risk-free investments and a premium for accepting the risks of investing in assets whose
`value is highly volatile. In the case of drug development, the key risk relates to failure of
`the drug candidate to meet the required safety and efficacy profile. Drug development
`may also be abandoned for economic reasons, e.g. change in market conditions resulting
`in a reduced commercial market.
`
`Whilst not qualifying as a discount rate in the strict textbook sense, VCs tend to set
`discount rates representing the internal rate of return expected by their fund investors.
`
`Once a discount rate has been identified, the present value of the net cash flow at each
`relevant time point (i.e. stage of development ) can be calculated.
`
`Despite being widely used, the use of NPV in valuing drug development projects is not
`without limitations. The remainder of this section considers the key limitations of NPV
`and the valuation methods seeking to overcome these.
`
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`1.3 Risk adjusted NPV
`NPV does not properly account for technical risk
`Technical risk (e.g. scientific or technological risk) is mitigated as a drug candidate
`advances through each phase of development. The use of discount rates in NPV to
`simultaneously adjust for time and technical risk is argued to penalise long term projects
`relative to short term projects7. Risk adjusted NPV takes technical risk outside discount
`rates, instead accounting for it by adjusting the cash flows at each stage of development
`by the probability of the drug candidate successfully reaching launch from such stage. In
`turn, a lower discount rate applies.
`
`Limitations
`The calculation of probability rates is problematic, particularly in relation to the
`pre-clinical stages. Many unsuccessful pre-clinical projects are quietly discontinued.
`Available probability rates tend to be presented as industry averages. The challenges
`of applying these rates to a specific therapeutic indication are well understood. Where
`the drug mechanism is understood (such as in hypertension, diabetes and asthma), the
`relevant probabilities of technical success are likely to be higher than industry averages.
`Similarly, projects dealing with lesser understood diseases (such as cancer) may be
`associated with lower probabilities of technical success.
`
`1.4 Scenario analysis, decision–tree modelling and Monte Carlo simulation
`NPV does not account for different outcomes
`NPV valuation is based on a single projection of inputs, which are impossible to
`calculate with any certainty. Scenario analysis, decision-tree modelling and Monte Carlo
`simulation seek to deliver a range of values based on likely variations to more than one
`input.
`
`Scenario analysis
`Scenario analysis models the outcome of different scenarios on value. For instance,
`different revenue scenarios, based on the probabilities of the scenarios eventuating, can
`be modelled to examine the effects on value. Other examples include scenario analyses
`of different development options (e.g. development for indication X versus indication
`Y) and different commercialisation options (e.g. the stage to which the drug candidate
`should be developed before out-licensing or partnering).
`
`Decision-tree modelling
`Decision-tree modelling considers the impact on project value of different scenarios
`(e.g. technical failure or success) at nominated decision points along the development
`path. Typically, decision points occur at the completion of each stage of the development
`path. The relevant impact on value can be pictorially represented together with relevant
`pay-offs if the project is abandoned at any decision point in the event of technical
`failure.
`
`7 Randerson, D., 2001. Forensic Accounting Special Interest Group Valuing a Biotechnology Company. Acuity
`Technology Management Pty Ltd, Melbourne [URL: http://www.icaa.org.au/upload/download/Valuing%20
`biotech%20companies.doc.pdf]. In this regard, the high rates applied by VCs are considered to invariably render
`research and development programmes to a negative value.
`
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`Monte Carlo
`Monte Carlo methodology simulates adjustments to multiple inputs (e.g. market size,
`expenditures, pricing and time to market) to produce an overall distribution of possible
`outcomes. This is achi