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Putting A Price On Biotechnology, 2001
Putting A Price On Biotechnology, 2001
© Amy Center
currency of rNPV. R&D and clinical trials Revenue stages
For “orphan drugs” (conditions affecting <200,000 people in the United States), Factor 1—Cost
take into account: The cost of drug development can be esti-
•Fewer clinical trials and subjects required—estimate numbers by comparing with mated using industry standards2,3, and any
previous trials for the indication deviations from these standards must be
•50% of clinical trial costs returned as tax credits justified. Acmed’s development incurs the
•Seven years of market exclusivity in the United States (even in the absence of patent costs associated with additional animal
protection) studies, clinical trials, and filings to the
FDA. By comparing with clinical data from
currently marketed asthma drugs, it is pos-
ed between milestone payments and royal- ma market is intense, and the anticipated sible to estimate how many subjects will
ties on gross sales) due pre-market market share for Acmed may be just 5%—a need to be enrolled in clinical trials.
biotechnology developers is about 40% of “moderate to small” share on the spectrum Clinical trials involving asthma inhalants
gross product revenue (see “Parameters for of market shares currently captured by such as Acmed are data-intensive because
biotechnology”). pharmaceutical companies. The annual multiple tests are performed over a rela-
To illustrate the rNPV method, we have gross return of Acmed will therefore be tively extended time period, and the trials
created a hypothetical scenario: A company about $290 million. Of this sum, 60% is will be conducted in the United States, so
has developed Acmed, a potential treat- reserved for the eventual marketing and the costs for each subject will be at the top
ment for asthma. The preclinical science manufacturing partner, and 5% is reserved end of the range.
and intellectual property are sound, and as a royalty for the university that invented Overhead costs vary considerably
Acmed has passed initial testing in animals Acmed. This leaves 35%, or an annual between companies, and the value of the
and is now ready to enter phase 1 trials. return of about $100 million, as the royalty technology will vary in parallel. The same
The company is seeking venture funding due the biotechnology company that devel- situation arises in other walks of life: For
and partnering opportunities with multi- ops Acmed through pre-market research example, if you can repair your own house,
national pharmaceutical companies, so and development stages. total repair costs are lower, and the house is
what should they charge for Acmed today? Consultation with a patent attorney sug- effectively worth more to you than it would
The annual market for asthma treat- gests that Acmed will be defended from have been to an unskilled owner. However,
ments is around $5.8 billion. To estimate competition for the next 18 years. The pay- in this example we have left out the “over-
Acmed’s market share, the product is com- off for Acmed is, therefore, $100 million a heads” and estimate Acmed’s intrinsic
pared with other asthma medications on year for 18 years minus the years that it value. The total cost of developing Acmed
the market. Competition within the asth- takes to get the product to market. It is $23 million (see “Acmed costs”).
should take eight years to carry out clinical
trials and have the drug approved by the Factor 2—Risk
Acmed payoff US Food and Drug Administration (FDA), It would be grossly inappropriate simply to
$1 billion = $100 million/year for 10 years and so Acmed’s potential payoff for the subtract the costs from the payoff to esti-
(beginning in year 9) biotechnology company is $1 billion (see mate Acmed’s intrinsic value. Such a calcu-
“Acmed Payoff ”). lation would imply that each clinical trial
Risk adjustment
The risk-adjusted value, rV, of an endeavor in which the risk changes is the payoff (P) times the current risk (R0), minus each associated cost
(Ci) times the likelihood (R0/Ri) of having to pay each cost.
Equation (1)
For example, what would be the value of the following series of coin-tossing wagers?
A coin is tossed twice. The person throwing the coin bets $5 that the first toss will come up heads. If the coin comes up heads on the first toss,
he is allowed to make second wager of $20. If heads comes up a second time, the payoff is $100.
P = $100
R0 = 25% (two tosses)
Ri = 50% (the second toss)
C0 = $5
Ci = $20
If the wager series were made many times, the bettor would
net $10 on average for every time the game was played. (You
can easily confirm this by averaging the four possible
outcomes of flipping a coin twice.)
equation—is what tomorrow’s cash flow cal companies1. Research and development rNPV
would be worth today. (R&D) risk is accounted separately by To calculate the true present value of
The amount that future money loses in development stage. biotechnologies, revenue, cost, risk, and
value each year is termed the “discount The effect of discounting can be dramat- time must be combined into a single calcu-
rate”. Discount rates normally include ic. For example, if clinical trials began lation of rNPV. In the rNPV equation,
many factors including risk. However, in today, Acmed would not begin earning rev- Equation (2), the present value of each risk-
the Acmed example, the discount rate is enue for another nine years. Furthermore, adjusted cost is subtracted from the present
independent of R&D risk. We assume here the $1 billion in total revenue generated is value of the risk-adjusted payoff to arrive at
that the discount rate is equivalent to the spread out over 10 years (Acmed’s has only the rNPV of the biotechnology.
20% internal rate of return generally 18 years of blocking patent life remaining). By adding together all of Acmed’s costs and
expected by the primary sources of capital Assuming a 20% discount rate, the NPV of risks and then discounting for time, the true
available to biotechnology companies— Acmed’s payoff cash flow is only $117 mil- rNPV is finally revealed. Today, Acmed is worth
venture capitalists and large pharmaceuti- lion total (calculation not shown), and this about $18 million (see “Acmed’s rNPV”).