Real Options Analysis

1
(No Transcript)
2
Tools for Valuing Biotech Investments

• BC Biotech - CFO RoundtableVancouver, B.C.
  September 12, 2002

Alan Greer Greer Consulting ag_at_greerconsult.com (6
04) 682-6943
3
Todays Presentation

• Purpose
• introduce/discuss innovative modeling tools for
  technology valuation
• Outline
• Biotech Valuation Needs / Approaches
• The Biotech (ENPV) Model
• Further Discussion

4
Biotech Valuation Needs

• RD program design
• financing, MAs
• licensing/partnering agreements and
• strategy development.

• TOOLS
• discounted cash flow (NPV)
• expected value / decision trees
• simulation
• real options analysis

5
Limits to Traditional Valuation

• Valuation requires
• Long history of earnings/market prices
• Current financial statements that reflect
  underlying assets
• Peer group of readily comparable (traded) firms
• BUT, small biotech firms
• No earnings history
• IP asset value not on companies books
• Seek novel technology with no/few comparisons

6
Valuation of Fundamentals

• Fundamental value is function of
• Cash flows generated by asset
• Life of asset
• Expected growth
• Riskiness of cash flows

7
Modeling Approaches
Option Pricing
FLEXIBILITY (STAGED INVESTMENTS)
Decision Tree Analysis (Expected NPV)
Monte Carlo Simulation
RISK / UNCERTAINTY
Discounted Cash Flow (Net Present Value)
LONG TIMEFRAME
8
Growth and uncertainty
9
Biotech ENPV Model

• Spreadsheet-based (Microsoft Excel)
• Model has common analytical "engine" can drive
  different applications
• STRATEGY model
• compares different scenarios re. timing of
  licensing
• DEAL model
• compares deal terms offered by two parties
• Illustrative examples
• key model data/results altered to camouflage
  confidential information

10
Key Model Assumptions
11
Expected Value

• Probability-weighted average of possible outcomes

EXPECTED VALUE 80 X -10 M 10 X 90
M 10 X 10 M 2 M
10 M LOSS
12
Drug Development
21.5
13
Modeling Cash FlowDrug Development
Risk factors
14
Modeling Cash FlowDrug Development (Expected
Value)
15
Modeling Cash FlowDevelopment Commercialization
Risk factors
16
Modeling Cash Flow Development
Commercialization (Expected Value)
21.5
17
Modeling Cash Flow Development
Commercialization (Expected Present Value)
Divide by (1discount rate)year
18
Modeling Cash Flow Development
Commercialization (Expected Present Value)
ENPV 57 m
19
Monte Carlo Simulation
20
Monte Carlo Simulation
21
Strategy Model Scenarios
22
Results Strategy Model
23
Results Strategy Model
24
Deal Model

• Models licensing negotiation between two parties
• Pharma X
• Biotech X
• Early stage deal with provisions for
• License fees, milestones, research funding
• Allocation () development costs, profit-sharing
• Royalty rates, brackets.
• Compares competing offers and different
  assumptions of both sides

25
Deal Model Inputs
26
Results Deal Model
27
Limits of Models

• All models are wrong. Some are useful.
  George Box
• Forecasting uncertainty
• Modeling error
• Spreadsheet error

28
Uncertainty and flexibility
29
Biotech real options

• Types of options
• Defer - delay/advance research for compound
• Abandon - option to abandon prior to full
  commitment of funds
• Learning - Invest in additional research re.
  alternative indications, comparison with other
  drugs
• Growth/strategic - platform/pipeline with future
  unforeseen potential

• Underlying asset
• Product (with patent protection)
• Exercise price
• Cost of next phase
• Volatility
• Technical (private) - development risk
• Market (public) competition/price risk
• Time limit
• Patent life

30
Summary

• Biotech (ENPV) Model
• fundamental (cash flow) basis for valuation
• allows for scenario comparison / tailoring of
  assumptions
• uses expected value Monte Carlo methods to
  assess risk/uncertainty
• customizable to suit different business needs
  (e.g., deals, strategy, financing)
• easily adapted to other biotech applications
  (e.g. tools, medical devices)