NUCLEON

1
NUCLEON

• The date is December 1990
• Nucleon is a small biotechnological company
  specialized in RD, no manufacturing capabilities
• Potential products CRP (cell regulating protein)
  and 2 other products
• In order to get to the market the drug must be
  approved by FDA-gtsuccessful clinical trials

2
DILLEMA

• Vertically integrate downstream into (pilot)
  production or buy the production on the market

3
Biotechnology

• Biotechnology a relatively new field
• Nucleon one of over 200 companies, most of them
  specialized in RD.
• Companies racing to be first to clone a gene
  (proprietary position)
• CRP attractive niche
• Burn wound treatment
• Kidney failure

4
Biotechnology

• Strategies of BT companies -gt most RD, some
  integrated into manufacturing, some also into
  marketing

5
Legal framework

• Competition was mostly in RD establishing a
  strong proprietary position was crucial
• Risks of establishing a strong proprietary
  position
• New legislation (difficult to predict court
  rulings)
• Time demanding to obtain a patent
• Most companies could not wait until patent was
  granted (time lag)

6
Drug development process

• Drug development process was very complex
  (growing genetically altered bacteria was very
  much an art)
• Nucleon currently produced quantities well below
  those needed for clinical trials (scale up 10x)
• Due to complexity of process scaling up was
  unpredictable

7
Human clinical trials

• To get FDA approval drug had to undergo three
  phases of clinical trials
• Phase 1 trials assessed basic safety -adverse
  reaction (6-12 months)
• Phase 2 (determining appropriate dosages on a
  small sample-gt1-2 years)
• Phase 3 trials assessed products efficacy
  (multiple hospitals and large number of patients,
  2-5 years)

8
Financial environment

• Poor capital availability (buyers market)
• Venture capitalists expected returns of 30
• Nucleon just about to receive another 6 mil
  from its venture capitalist
• With additional infusion (6 mil ) and cash on
  hand, Nucleon had about 6,5 mil .
• Market analysts expected that situation on
  capital market would improve in 1992

9
Manufacturing options for clinical trials

• Three different options for Phase I and II
• The new pilot plant
• Contract manufacturing
• Licensing product to another company
• Two options for Phase III
• V. I. into commercial manufacturing
• Licensing out manufacturing and marketing rights
  at Phase III

10
Phase I and II three options
Pilot production in the new pilot plant
Contract manufacturing outside the firm
Phase I and II
Licensing out in Phase I
11
The new pilot plant

• Pilot plant capacity (600 m2) would meet
  Nucleons requirements for Phase I and II
• Investment outlay can be found in exhibit 3
• The pilot facility could however not be used for
  Phase III (stricter requirements)
• It was beyond Nucleons financial capability to
  build such a plant at this time

12
Contract manufacturing

• Biggest advantage no major capital investment (if
  CRP failed contract could be easily terminated)
• Companies offering contract manufacturing had
  facilities and their personnel in place
• Contract manufacturing not inexpensive (see
  exhibit 4)
• Industry experts believed that excess capacity
  would accumulate in the future
• Much time needed to transfer process due to high
  complexity

13
Licensing out-Phase I

• Nucleon could license the product immediately
  (before human clinical trials)
• Get 3 mio cash on hand (immediately) and
  royalties equivalent to 5 of gross sales (upon
  FDA approval)
• Gross sales estimates (exhibit 5)

14
Phase III two options
Vertical integration into manufacturing
Phase III
Licensing out in Phase III
15
Vertical integration into commercial
manufacturing

• Before Phase III Nucleon could V.I into
  manufacturing
• 21 Mio required to perform scale up (provided
  by venture capitalist if intermediary results
  promising)
• If FDA approved the drug Nucleon received 5 mio
  upon FDA approval and royalties equal to 40 of
  the partners gross sales

16
Licensing out in Phase III

• Under this option Nucleon could expect to receive
  7 mio upon FDA approval of the drug and
  royalties equivalent to 10 of the partners
  gross sales

17
Back to the case Methodology

• Use decision tree for determining possible
  scenarios
• Number of factors has to be considered
• Qualitative arguments (pros and cons of every
  alternative)
• Organizational change
• Technology transfer costs and risks
• Long term strategic options
• Other
• Quantitative arguments (Financial returns-NPV)

18
Study question 1(work in groups of 4)

• Develop a proper decision tree

19
Study question 2(work in groups of 4)

• Develop a table with pros. and cons. for
• Phase III and
• Phase III

20
Study question 3(work in groups of 4)

• Based on the NPV make recommendations

• Assumptions
• Discount factor 30
• Gross sales represent after tax cash flows
• Sales after 2002 grow constantly at 5
• Depreciation tax shield CF and Phase III cost are
  approximately equal
• How do you feel about these assumptions?

• Calculating NPV
• Estimate operating CF (exhibit)
• Discount factor (30 )
• General approach (use different discount factors
  according to risk of each CF)

21
NPV calculation

• First calculate pilot manufacturing V.I.
• Based on NPV calculation make recommendations

22
Study question 4(work in groups of 4)

• Pilot plant might be used for other projects
  (products). Estimate how much can Nucleon save on
  variable expenses by investing in pilot plant

23
Help for question 4 Real options

• Pilot plant might be used for other projects
• By investing we save on variable expense
• Investment outlay and variable expenses can be
  estimated from exhibits 3 and 4
• Calculate break-even point

24
REMARKS Financial considerations

• NPV represents expected value of many possible
  outcomes (in reality there is only one)
• Nucleon has only one project outstanding (no
  diversification)
• One aspect to consider is preference of venture
  capitalist

25
REMARKS Long term strategic options

• RD company
• RD with pilot manufacturing capabilities
• Integrated manufacturing enterprise