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Pharma: Assessing R&D value...

Sep 13, 2006

Indian pharma companies have been making strides in R&D after the introduction of the product patent law in the country. That said, it takes around 10 to 12 years for an NCE (new chemical entity) to hit the market and the top Indian companies namely, Dr. Reddy's, Ranbaxy, Wockhardt, Sun Pharma, Nicholas Piramal and Biocon, are investing anywhere between 5% to 10% of their annual revenues in R&D activities. This, considering the resource crunch that domestic companies face, is by no means a small amount. The problem associated with valuing an R&D pipeline is that the revenues generated do not match the expenses undertaken. This is because the success ratio of a molecule hitting the market is considerably low. However, the R&D costs borne by the company include costs incurred for both successful and unsuccessful molecules. Globally, the historical average for the pharma industry R&D productivity has been just over one NCE launch per year. In comparison, Indian pharma companies have yet to launch a single NCE in the market and hence the valuation of the pipeline becomes all the more difficult. That said, it becomes important to keep a track of the progress of the NCE through various stages. Here we enumerate some of the factors that investors need to be aware of with regards the R&D pipeline of pharma companies.

Stage of clinical trials: The progress of a molecule (whether it is in the pre-clinical stage or Phase III or so) is important as it gives a rough idea of possible launch dates of the molecules if all goes well. However, the risk of failure increases significantly, the further the drug is from the market.

Number of molecules under development: It is important for pharma companies to strike a balance by having various molecules in different stages of clinical trials. This is to ensure a steady flow of drugs into the market in the future. It must be noted that the risk of a failure has been currently estimated at 9 out of 10 in Phase I, 6 out of 10 in Phase II and 5-6 out of 10 in Phase III (Source: Deutsche Bank). As far as domestic companies are concerned, most of the molecules under development are either in the pre-clinical, Phase I or Phase II clinical trials.

Therapeutic area targeted: Assuming that a company is developing a drug for treating a disease for which there is already a well-established market, the potential of the same could be estimated by determining the likely market share that this molecule would garner. In this scenario, the company's marketing and distribution network and the potential advantages of the drug over drugs of a similar kind in the market will be crucial factors. If the targeted therapeutic area is one where there is not much competition, then the potential for the same could be roughly estimated by considering the likely number of patients and the likely price for the drug.

To sum up...
While global pharma companies are developing molecules through the entire stage of clinical trials on their own, domestic pharma companies, which are facing resource constraints, are looking to develop molecules through collaboration and out-licensing. Typically, a drug begins to generate revenues only after it is launched in the market. However in the case of out-licensing, a molecule begins to generate revenues (in the form of milestone receipts) before the launch itself, depending upon the progress of the same. In this case, future earnings can be calculated by discounting future milestone receipts. Whatever be the case, while valuing the R&D pipeline, the risk of failure cannot be ignored. In fact, domestic pharma companies such as Ranbaxy and Dr. Reddy's have faced failures in the past.

As far as valuations are concerned, those companies, which have a strong product pipeline generally, tend to enjoy higher valuations as compared to others. For instance, MNC pharma companies such as GSK Pharma and Aventis have earned higher valuations as compared to domestic companies based on the fact that the former can leverage on the R&D pipeline and products of their research-intensive parent companies. Going forward, the years 2009 and 2010 could be the turning point for domestic pharma companies if the R&D programme stays on track. Key molecules to watch out for will be Glenmark's 'Oglemilast' for asthma/COPD, Dr. Reddy's 'Balaglitazone' for diabetes and Ranbaxy's 'RBx 11160' for malaria.

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