Last
month saw an interesting project for ATPBio, and one to mark the sign of the
times. We were retained by a European VC to provide an outside commercial evaluation
and strategic review for a portfolio company. In particular, the VC was keen to
assess the company’s strategic plan in light of the current economic and
funding climate.
The overall objective was to advise what course of
action should be set if the company were to continue to build upon existing
progress and be able to position itself for exit in around two years. Given
that the company is working in a popular therapeutic area (inflammation) and
has its most advanced project already in phase II with scientific proof of
principle, this was not an unreasonable goal.
PIPELINE PROJECT REVIEW
This forms the core of a commercial and strategic
review, since pipeline projects command the lion’s share of a company’s
valuation. A review should lead to a ranking to determine which programs are
the key value drivers – it is rarely as simple as just ranking the most
advanced programs the highest.
We considered a qualitative and quantitative
assessment. The qualitative view was a top-down benchmarking analysis looking
at similar deals in the therapeutic spaces and stages of development. Given the
significant change in market conditions and sentiment of late, deals were
generally examined only in the last 18 months. While a benchmarking analysis is
helpful, limitations include that each deal is very different, and with only a
few closely relevant deals available to examine, there is no statistical
significance to creating average deal sizes. Though, such benchmarking does
afford a useful “look and feel” of what is possible, and gives an indication of
what has occurred recently.
The quantitative assessment involved a bottom-up
analysis by building NPV models for each program. These models considered
market size, market growth and penetration, launch date, revenue growth and
profit, patent expiration, milestones and royalty payments, and appropriate
discount rates. Clearly, numbers plugged into an NPV model for a therapeutic
program can have a wide variation, depending on whether assumptions used are based
on conservative or aggressive scenarios, with resulting wide variation in
valuations. However, providing a consistent approach is used across the board
for all programs (at least within the realms of possibility) then a relative
picture begins to emerge, from which one can begin to develop a ranking. We
tend to favour and encourage conservative assumptions: take care of the
downside then the upside will take care of itself.
We also considered the spectrum of relative complexity
for further development for clinical stage programs. For example, projects
focusing on skin diseases with topical treatments are relatively
straightforward to recruit for and to monitor progress based on clinical
outcomes. By contrast, certain orphan indications, by their nature, address
rare and difficult to treat disease conditions, with associated complexity in
trial recruitment and logistics, trial design and end-points. And somewhere in
the middle, are conditions requiring systemic treatment for serious and life
threatening diseases affecting large patient populations.
VALUE INFLECTION POINTS
Ahh, that wonderful cliché strived for by investors
and company managements across the globe. For at the end of the rainbow is a
value inflection point. As we all know, this pot of gold is where a buyer or
trade partner is suddenly willing to pay a significant premium to development
costs to date, given the degree of de-risking that has already occurred.
In truth, this is part art and part science, depending
on how efficiently a company has developed assets to a certain stage, and to a
large degree on benchmarking of similar deals in the space. If a company has
managed to develop assets very efficiently, a highly respectable return on
investment may be possible at, say, end of phase I. However, the same asset
developed in a heavily cash hungry, infrastructure rich environment may not
work even at phase II.
So, to truly give indication of a value inflection
point, it’s not sufficient to just give a benchmarked industry standard approach
for any given therapeutic area (so typically at phase II); one must also
consider the finances and the efficiency of investment and budgeting within the
individual company.
INVESTMENT REQUIRED
In more abundant economic climes, companies can shoot
for the moon, and plan ambitious projects with additional work-up and gold
standard style clinical trials. More funds are generally available for
investment, enabling a greater wish-list of work to be performed. Assuming such
work is done properly, and read-outs are positive, this should put a company’s
projects in stronger position for future partnering or trade sale negotiations.
However, in today’s market cost control is king, so the
key is to find a common denominator: what is the minimum investment required
per program to get to a validated clinical read-out which will be acceptable to
potential big pharma partners or trade buyers? i.e. what is critical rather
than “nice to have”? This is the optimal scenario.
This information is likely to come from a couple of
sources: early discussions with future partners defining their internal needs,
and the clinical trial development team (e.g. Chief Medical Officer and
associated team members). Management must then balance these criteria against
the VC and shareholder imperative – what’s the minimum spend possible to
achieve such an output?
STRESS TESTING
In the words of Harvey MacKay, “Failures don’t plan to
fail; they fail to plan”. Stress testing is contingency planning for drug
development. What happens if a given program fails, is delayed, or if only a
smaller amount of investment is available than indicated in the optimal
scenario above?
By considering such alternative scenarios, a
management team can still plot a course of action to help build value while
avoiding the risk that comes with an all-or-nothing plan where value is
entirely dependent on a single program succeeding in a single development plan.
In some ways it is like navigating a journey through the ocean – sometimes
plain sailing but knowing what to do when the storms hit.
We developed such stress tests for the VC client’s
portfolio company, enabling a positive NPV even for several sub-optimal
scenarios. Of course, in drug development, there is real possibility that all
programs fail completely, with total destruction of value. Though,
incorporating this into the stress testing exercise allows investors to see
“value at risk” and mitigate even this crisis outcome through broader portfolio
planning.
OTHER CRITICAL POINTS
Ideally, to develop a strategic plan which has a
defined objective over 1 to 2 years, a company and its investors must be in a
strong enough financial position to consider alternatives. Financial factors which
would impact the development and execution of a sound strategic plan include
cash runway remaining within the company, the impact of dilution on existing
investors, valuation, and VC specific concerns (e.g. life of fund, ability to
follow on).
Essentially, companies should actively engage in such
a review process while they still have financial staying power – cash starved
companies in fire-sale or shut-down mode have left it too late and will be in
no position to negotiate terms for partnering, new investment or even programs
of work.
We were also asked to provide feedback on some of the
softer issues, such as the management team and advisory board. Throughout the
project, the VC and company management demonstrated an unusual and refreshing
degree of openness, humility and genuine interest to find the most suitable
alternatives for the portfolio company. Invariably, a good strategic review
will also include recommendations for where to cut spend or planned investment.
An open and receptive investor/ management team is essential to take advantage
of such negative recommendations as well as the positive.
So, in summary, despite the challenges of the current
economic crisis, one very positive outcome arises for investors and company
management that want to stay in the game. Everyone has to examine current
practice, review plans, and figure out new and creative ways to get the best
return on their investment dollar; thereby sowing the seeds for a sustainable
industry.
This article
was written by Raman Minhas. He is CEO of ATPBio, a consultancy firm
providing strategic insight and transaction support to the life sciences
industry.
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