How Do I Invest In Biotech And Pharmaceutical Companies? – Low-revenue biotech companies can be worth billions. Consider the most important biotech M&A deal of 2017, when Gilead bought Kite Pharma for about $12 billion. At the time of the deal, Kite had accumulated deficits of more than $600 million, but it also had a number of CAR-T cell therapies that treat cancer. This article examines how to value such pipelines. It also focuses on risk-adjusted NPV valuation methodology, portfolios of multiple drug candidates, and how valuation is influenced by investor or entrepreneur characteristics.
The authors are certified experts in their fields and write about topics in which they have proven experience. All our content is reviewed and approved by experts in the same field.
How Do I Invest In Biotech And Pharmaceutical Companies?
Raphael is a partner in a crypto hedge fund. Before that, he founded and left a fintech company and worked as a banker and venture capitalist.
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If you have an interest or experience in biotech, it shouldn’t surprise you that biotech companies with little or no revenue can be worth billions. Consider the most important biotech M&A deal of 2017, when Gilead bought Kite Pharma for about $12 billion. At the time of the deal, Kite was still loss-making, with an accumulated deficit of more than $600 million, but significantly also had a number of CAR-T cell therapies that treat cancer. Kite was not necessarily an anomaly. About 80% of founders of Nasdaq Biotech Index (NBI) companies have no income; more than 150 companies representing more than $250 billion in market capitalization. And average venture capital investment in biotech has grown over the past decade from $4.6 billion in 2005 to $12.9 billion in 2015. As institutional investors, it’s clear that this cannot simply be explained by investor wealth. Instead, it’s meant to show that the pipeline generally justifies the company’s value.
This article examines how to value such biopharmaceutical company pipelines, with a specific focus on pharmaceutical companies (and not companies that focus not on drug development but on other medical devices). We’ll start by looking at how biotech company valuations differ from other stock valuations. Next, we focus on a risk-adjusted NPV valuation methodology and conclude with a discussion of several related issues: (i) how to think about portfolios of multiple drug candidates and (ii) how to price based on investor or lessee characteristics.
Drug development is expensive. An important study estimated that the total cost of developing a successful drug (which typically includes
Failed attempts) more than $2.5 billion. Other studies (see table below) put the total cost at about $1.4 billion. This number is lower than the $2.5 billion estimate above because the latter includes an estimate of the opportunity cost of capital invested, while the former represents only the out-of-pocket cost.
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Therefore, drug development requires a lot of capital from the start. Simply put, starting a pharmaceutical company is almost impossible and therefore needs investors from the beginning and at different stages of the development cycle. These investors can be venture capitalists (people like Domain, HCV, MPM and many others), strategic investors (meaning other pharmaceutical companies) and public market investors (so we end up with many companies. NBI ). Biotech fundraising is an easy topic in itself, but both investors and biotech founders/executives will need to master the value – even if approved, a commercial product may be many years in the future.
Timely: If you’re reading this from Asia, you may be aware that the Hong Kong stock exchange recently allowed biotech companies to be listed on a no-profit or profit-making basis, a valuation that will require what we do in this What to Do discussion article.
Biotech companies are not your standard widget maker that you learned to value in your MBA and/or CFA courses. Read on to understand some of the unique features of this industry.
As we’ve mentioned before, many biotech companies don’t yet have earnings, let alone earnings or cash flow metrics. In fact, the cash flow will be very negative before the drug is approved. This means that “standard” valuation multiples such as EV/EBITDA or P/E are less relevant. There are some alternative multiples, such as EV/R&D investment, which is essentially a cost-based valuation. The comparative value methodology is another popular methodology that uses comparable public market or M&A transactions. This is not generally applicable because most biotech companies are proprietary, so benchmarking is of limited use. Below we will consider an alternative method of evaluation.
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Even for established biotech companies, their historical earnings are often flat enough that estimates still need to be made from scratch rather than relying on past company experience/data or even other companies’ comparisons to guide forecasts. In other words, the typical approach of extrapolating past trends to forecast proved to be too much. For example, see below the current list of the Swiss pharmaceutical research company Idorsia and the order and diversity of both the mechanism of action (the process by which the drug produces a pharmacological effect) and the target indications (the use of this drug to treat certain diseases).
Biotech companies also face a long development cycle unique to the industry. The typical time for a new drug from investigational new drug submission (IND in the US) to entering the market after regulatory approval is approximately eight years, as shown in the chart below. During those eight years, the process follows regular phases of research, testing, and FDA review, during which the drug may fail.
Simply put, a drug is ultimately effective in treatment or not. Although effective, it may or may not be approved by regulatory authorities. Before approval, drugs go through a regular process (preclinical and clinical evaluation), at any point they can fail – and once they fail, the process is usually irreversible. This presents a different risk profile than most other businesses where the distribution of outcomes is less binary. In Silicon Valley, it is usually very difficult to “film” a failed drug. It’s true that in the early stages of non-biotech startups, failure is also a possible consequence, but if a startup fails, the results are very broad: this new mobile app could get thousands of downloads or tens of millions of downloads. with consequent impacts on earnings, cash flows and value. And when non-biotech startups face challenges, they almost always adapt their business models to survive. Just think back to when Netflix was a DVD shipping company before it was a streaming service, or when Instagram was a control app with games and photography features before it evolved into the dominant photo app it is today.
Therefore, we must take this different risk profile into account in our valuation analysis, for example when we generate a discounted cash flow (DCF) and choose an appropriate discount rate. There are generally two ways to do this:
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Risk-adjusted NPV has two main components: projected cash flows and scenario probabilities. We will first approach the cash flow projections for the scenarios, then the probabilities for the different scenarios.
As we mentioned earlier, pharmaceuticals are unique enough that we need to reconstruct these cash flow projections. Let’s first look at a typical, stylized cash flow profile and then review the individual cash flow drivers.
In the early years, there were only departures due to drug research and development costs. These costs will vary for each drug depending on factors such as the number of iterations during the discovery and preclinical phases, the study design(s) required in preclinical and clinical trials, and more. It basically consists of the years that show the output in the chart above.
Once a drug is on the market, here are the key factors we need to estimate to get revenue (and profit) forecasts. Note that we can of course expand this framework into more and more complex sub-controllers, but we’ll focus on the most important drivers in this introductory article. In the next section, to estimate revenue, we’ll generally follow the steps outlined in Arthur Cook’s book Forecasting for the Pharmaceutical Industry (we’ll use some of the controls shown in the gray boxes):
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The number of potential customers for a drug is a subset of people suffering from the target condition – a rough estimate is arrived at by running a series of filters in a funnel, again generally according to Arthur Cook:
Price is critical and will depend, among other things, on the pharmaceutical company’s need to obtain a reasonable return on its R&D investment in the treatment, as well as the value of the treatment compared to competing treatment options (if any).
Even for existing drugs it is of course difficult to get reliable price information, but you can find information on websites such as Drugbank or from a number of price data providers. Remember that there is often a significant difference between the two
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