ralph.villiger@avance.ch

Noordwijk, April 29, 2011

Valuation of Early-Stage Technologies

Industry Perspective

HEADLINESI promise you EUR 100 in a year if Holland becomesfootball European champion (odds: 13%*).

Starter

How much should you pay?

*Source: Oddschecker.de

In 13% of the cases

you receive EUR 100.

In 87% of the cases

you receive EUR 0.

Starter

Your expected payoff is :

13% x 100 + 87% x 0 = EUR 13.

You then discount this value, because you only get it in a year, so maybe EUR 12.

Starter

And if I gave you EUR 1,000,000 in case they win?

In 1 (1988) out of 13 cases you receive EUR 100 (8%).

In 12 of 13 cases you receive EUR 0.

Your expected payoff is :

1/13 x 100 + 12/13 x 0 = EUR 8.

With a little discount maybe EUR 7.

Alternative Calculation - Historical

• Risk matters:

• We don’t pay the full price.

• We are not even ready to pay the “fair” price.

• Past is not indicative:

• Today’s team is different.

• Historical odds are different than current odds.

2 important consequences

• Market Method vs. Forecast Method

• Market odds and historical odds

• Forecast vs. Risk (Probability that it happens)

• Apply the odds

• How?

What’s the link to valuation?

It is essential to incorporate risk in the valuation. Butwhat is risk?

•Product fails in R&D.

•Development takes an all different path.

•Forecast is wrong/uncertain.

2 main tasks:

•Get the forecast

•Quantify the risk

Early-Stage = Risky

We see three main methods:

1.Comparables (market derived values).

2.NPV (net present value).

3.rNPV (risk-adjusted net present value).

Risk in valuation

• Comparables to determine the market’s appetite.

• Forecast-based method to emphasise differences.

• Always use 1 and (2 or 3)!

Input Parameters – Success Rates

Probability of success 11%

rNPV

Sum of all risk adjusted discounted cash flows.

rNPV

Sum of all risk adjusted discounted cash flows.

rNPV

Sum of all risk adjusted discounted cash flows.

rNPV

Sum of all risk adjusted discounted cash flows.

NPV vs. rNPV

Some prefer including risk in discount rate instead of using success rates.

Not every industry is the same

Drug development industry is very well organised.•Development follows clear paradigm.•Statistical data available (success rates).

• Attrition is very high.•Product sales available.

The pharmaceutical industry invented rNPV.•Uses valuable data on risk.•Better quantifies risk.•More objective.

Not every industry is the same

• Very few industries have success rates.• Mostly risk is included in discount rate.

Always compare what the discount rate would correspond to in terms of success rate! Example: Medical Device

Certain CF Uncertain CF(in size)

5% 10%?

Uncertain CF

?

Discount rate

In every industry different, because of differences in:•Competition.•Regulation.•Timelines.•Life Cycles.

In drug development:•With success rates (rNPV): 7% - 20%.•Without success rates (NPV): 7% - 80%.

Sources: 1.Rodman-Renshaw2.Survey Avance-Biostrat3.Pepperdine

4. Frei/Leleux (Nature Biotech)5. William Sahlman, HBS6. Damodaran

Best Practice

Compare a market derived value (observed transaction) and a forecast based model.

Problem: observable transactions are usually in later stage.

Example: Biovex

Example: Biovex

• Biovex: British biotech company, in January 2011 acquired by Amgen for USD 425 mn + USD 575 mn in milestones (= USD 1,000 mn). Main product was Oncovex in phase 3 trials.

• Client has a product similar product in phase 1.

• What can we conclude from this deal?

Example: Biovex

1. The value of the deal is about USD 510 mn.

2. Calculating back (client is about 6 years and two phases behind) we derive a value of USD 70 mn at phase 1.

3. We can also determine more or less what sales potential the two parties (Biovex and Amgen) expected from such a product.

$ 425 mn

$ 510 mn

Phase 3Phase 2Phase 1

Example 2

Licensor: Kyowa Hakko Kirin (Jp)Licensee: Amgen (USA)

Year: 2008License: Worldwide except Asian countriesIndications: Lymphoma, Allergic RhinitisCompound MAB, Phase 1

Upfront: USD 100 MioMilestones: up to USD 420 Mio (development, approval, and sales)Royalties: double digit

Example 2

First Remarks:• High upfront compared to rest of milestones (incl. 2 indications)• Double digit royalties for Phase 1 deal indicates high sales potential

Even if we backload the deal and keep it minimal we get:

Sales Upfront Ph 2 Ph 3 NDA Launch/ Sales

Roy Value Share

IRR Amgen

Roy/ Deal

USD 1 bio 100 10 20 40 350 10% 58% 15.9% 22%

USD 2 bio 100 10 20 40 350 10% 31% 22.2% 39%

We can conclude with certainty that Amgenexpects high sales. Even with minimal royaltiesUSD 2 bio do not seem high (VS, Roy/Deal).

AmgenMilestonesRoyalties

Book

Valuation in Life Sciences

Springer Verlag, 2010

3rd edition