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Valuing Pharma R&D Pipeline - Views on News from Equitymaster
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  • Jun 29, 2001

    Valuing Pharma R&D Pipeline

    Over the past couple of years, Indian companies have demonstrated success in their R&D investments. The drug pipeline of these companies also offers potential going forward. It is clear that the multiple which companies with R&D focus get is substantially higher than what other pharma companies command. This has been a global trend as shown in the graph below. It implies that markets factors in the potential of research molecules in pipeline much ahead of its launch.

    However, valuation of such a pipeline is a difficult exercise. The success in R&D is not directly linked with the R&D spend of the company. In such a situation, discounting expected future revenues from these molecules seems to be the best possible way to value the pipeline. In case of molecules, which are out licensed, discounted future earnings can be calculated by discounting future milestone/ royalty receipts, while in other cases it could be by discounted portfolio valuation of molecules, which show reasonable visibility.

    The following broad factors need to be taken into account for cash flow assumptions.

    • Financial Strength of the company: Typically, R&D investments have a long gestation period with huge cost involved. Given low operating margins of Indian companies, the only option for them is to license the molecules to multinationals and earn milestone payments/ royalty income. However, the financial strength of the company should be strong enough to finance the cost till it enters into licensing agreement.

    • Stage of Clinical trials: On an average out of 10,000 molecules screened, only 1 molecule ideally reaches the final stage. Hence, the valuation of research molecules depends on the stage of clinical trials it is undergoing. The idea being to judge the likelihood of molecule making to the market. It is extremely difficult to judge the success of a molecule when it is in very early stage, obviously a lower probability is assigned for a molecule in phase I of clinical trials. A 50-60% probability can be assigned to a molecule in Phase III of clinical trials.

    • Market Potential and time to market of the molecule

    Let us take a practical example of Ranbaxy. The pharma R&D pipeline with reasonable visibility can be valued at Rs 165 mn as can be seen in the table below.

    Valuation of R&D Pipeline
    Year Cipro-D Asthma BPH1 BPH2 Total Discounting
    factor @15%
    FY2001 5       5 1 5.0
    FY2002 30       30 0.87 26.1
    FY2003 20 5 5   30 0.76 22.7
    FY2004 30 5 5 5 45 0.66 29.6
    FY2005 30 15 10 5 60 0.57 34.3
    FY2006 30 15 10 10 65 0.50 32.3
    FY2007 0 15 10 10 35 0.43 15.1
    Net Present Value 165.1

    However, one needs to understand that valuation of the pipeline changes drastically as the molecule meets with each clinical stage. Further, while discounting the future potential from the R&D pipeline, investors should also bear in mind the risk from failure of a molecule.

    They have been several instances of molecules failing even after reaching the last Phase III of clinical trials. By this time investors build in lot of expectation from its success, which could result in steep fall in valuations. Just to give an example Astra Zeneca recently had to withdraw its molecule Viozan after it reached Phase III of clinical trials as it failed to show sustained additional longer-term benefits that were expected in comparison to other therapies. The company was researching on the molecule since a long time.



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