DOCSLIB.ORG

Valuation of Biotechnology Company Based on Real Options Approach

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Valuation of Biotechnology Company Based on Real Options Approach Erasmus University Rotterdam Erasmus School of Economics MSc Economics and Business Master Specialization: Financial Economics Valuation of Biotechnology Company Based on Real Options Approach Author: Darius Ramoska Student Number: 432961 Thesis Supervisor: Drs Hans Haanappel Date: 09/02/2017 Valuation of Biotechnology Company Based on Real Option Approach PREFACE AND ACKNOWLEDGMENTS I would like to express gratitude to my supervisor, Drs. Hans Haanappel, who initially chose me as his student and gave me a chance not only to write a thesis under such a compelling topic but also for the work experience he provided me with as a result of valuation task. Amongst other people who also deserve a credit is Mark Offerhaus, who accepted me as a valuator and provided me with all the necessary information regarding his company. I would also like to thank Jovita Razauskaite for keeping me motivated during the course of the thesis. ii Valuation of Biotechnology Company Based on Real Option Approach ABSTRACT There is an increasing necessity to account for the uncertainty of the future cash flows. That becomes even a bigger problem when a significant investment has to be made in the future. This is exactly the issue with which the conventional NPV method cannot deal, since it may estimate a project to be of a negative value even if it is not. Therefore, to account for the misestimates, an auxiliary method needs to be considered. The thesis considers several techniques for that purpose, such as Monte Carlo simulation, risk-adjusted NPV, and Decision tree analysis. However, the tool selected to value a biotechnology company is Real Option approach. Even though, the Real Options valuation as a technique is highly debatable amongst scholars and practitioners, more often than not it is considered as an appropriate tool. The analysis made within the thesis confirms and proves that. Especially since the method used within this thesis is improved as proposed by Kellogg et al (2000) and Tan et al (2012) to account for the success probabilities and phase investments at different time steps. The resulting ROV lattice tree method is applied to the provided DCF estimates to compute the values of drugs separately within the portfolio of the company. Afterwards, the values are combined together to arrive at the final value of 786.7 million EUR. In addition to value estimation, I prove within the thesis that ROV lattice tree can indeed facilitate the conventional NPV method by adjusting not only for the risk factors of passing the stages but also from managerial point of view, where strategic capital budgeting decision can be made by observing the progress of the lattice tree. As a final step, the ROV is compared to the risk-adjusted NPV method. The results provide grounds to conclude that ROV lattice tree approach is a more conservative tool not only because it produces lower estimate of the value than rNPV but also because it is less sensitive to the movements in success probabilities. Keywords: Real Options, Lattice tree, Biotechnology iii Valuation of Biotechnology Company Based on Real Option Approach TABLE OF CONTENTS PREFACE AND ACKNOWLEDGMENTS ....................................................................................................... ii ABSTRACT ................................................................................................................................................ iii LIST OF TABLES ......................................................................................................................................... v LIST OF FIGURES ..................................................................................................................................... vii 1. INTRODUCTION ....................................................................................................................................1 2. THEORETICAL SUBSTANTIATION AND LITERATURE REVIEW ................................................................3 2.1. Literature review on valuation .................................................................................................................... 4 2.1.1. Monte Carlo simulation ....................................................................................................................... 5 2.1.2. Decision tree analysis .......................................................................................................................... 6 2.1.3. Real Options approach ........................................................................................................................ 6 2.2. Literature review on ROV ............................................................................................................................ 7 2.2.1. Types of Real Options .......................................................................................................................... 9 2.2.2. ROV in biotechnology industry .......................................................................................................... 11 3. METHODOLOGY ................................................................................................................................. 13 3.1. Net present value ...................................................................................................................................... 13 3.1.1. Free cash flow .................................................................................................................................... 14 3.1.2. Discount rate ..................................................................................................................................... 16 3.1.3. Cost of equity ..................................................................................................................................... 16 3.1.3. Cost of debt ....................................................................................................................................... 17 3.4. Risk-adjusted NPV ..................................................................................................................................... 17 3.5. Real Option valuation ................................................................................................................................ 18 3.5.1. Partial differential approach .............................................................................................................. 19 3.5.2. Lattice tree ......................................................................................................................................... 20 3.6. ROV framework ......................................................................................................................................... 21 4. VALUATION CASE ............................................................................................................................... 25 4.1. Biotechnology industry .............................................................................................................................. 25 4.2. Description of the company ..................................................................................................................... 26 4.3. Assumptions .............................................................................................................................................. 27 4.3.1. WACC ................................................................................................................................................. 27 4.3.2. Operations ......................................................................................................................................... 28 4.3.3. Drugs .................................................................................................................................................. 29 4.3.4. Real Options Valuation ...................................................................................................................... 31 4.4. NPV estimation ......................................................................................................................................... 31 4.5. ROV ........................................................................................................................................................... 32 4.6. Sensitivity analysis .................................................................................................................................... 37 4.7. Comparison to rNPV ................................................................................................................................. 39 4.7.1. Comparison via NPVs ....................................................................................................................... 39 4.7.2. Comparison via sensitivity analysis .................................................................................................. 40 5. CONCLUSION ...................................................................................................................................... 43 6. FURTHER RESEARCH AND RECOMMENDATIONS ............................................................................... 44 REFERENCES .......................................................................................................................................... 46 APPENDIX .............................................................................................................................................
Load more

Recommended publications
  • Real Options: Dos and Don’Ts Real Options in the Pharmaceutical In- Abandons Projects That Are Not Profit- Dustry Became Popular in the Late Nine- Able
    Real Options: Dos and Don’ts Real options in the pharmaceutical in- abandons projects that are not profit- dustry became popular in the late nine- able. According to DiMasi2 33% of ties and in the beginning of the new abandonment of clinical projects is due century. At Merck real options have to economic reasons. This means that been in use at least since 1995. “…, within pharmaceutical companies prof- enthusiasts of real options analysis pre- itability or value of a project is an impor- dict their approach will become the pre- tant criterion when deciding on continu- ferred method of investment valuation ing or abandoning a project. In real op- in 10 years.”1 Today most large pharma- tions valuation we therefore consider ceutical companies have a real options various scenarios where some parame- specialist in their valuation teams. But ters, typically the sales expectation, fluc- after about 15 years we can say today tuate. This means that we assume al- that primarily students and professors ready beforehand that at a later point in are enthusiastic about real options time the opinion about the potential of valuation; people that have not seen the a product might change. These changes daily business within the industry. Real can be for the better or for the worse. In options will never replace the good old case of a sufficiently large deterioration risk-adjusted net present value method. management will stop the projects to There are three reasons for our claim: prevent further losses. 1. Real options are still too complex for upper management. 2.
    [Show full text]
  • The Study of Evaluative Models on Drug Development Status In
    EVALUATIONS OF DRUG DEVELOPMENT STATUS IN BIOPHARMACEUTICAL INDUSTRY Tsuei-Ling Liu, Department of Business Administration, Chang Gung University, 259 Wen-Hwa 1st Rd., Kwei-Shan, Tao-Yuan, Taiwan, Tel: 886-3-2118800, Email: [email protected] Shiow-Ying Wen, Department of Business Administration, Chang Gung University, 259 Wen-Hwa 1st Rd., Kwei-Shan, Tao-Yuan, Taiwan, Tel: 886-3-2118800, Email: [email protected] Abstract: This study aims to investigate the evaluation methods of drug development status in biopharmaceutical industry by comparing the traditional NPV analysis, the risk-adjusted NPV (rNPV) method, and the real option evaluation approach. Theoretical models and simulations are represented and discussed in the paper. The paper also gives an empirical case study. We demonstrate that the risk-adjusted approach and the strict option-based method have better performance in the valuation of the biopharmaceutical R&D projects. The empirical results of our study may provide empirical evidence of the reliable valuation models. INTRODUCTION Valuation of biopharmaceutical R&D project is quite difficult to managers and investors in making the investment decision because of the great technological and market uncertainties in this industry. It believes that the traditional NPV analysis is not the appropriate tool to evaluate an early-stage R&D project as it ignores the managerial flexibility in the stage of an investment. Therefore, the major aim of our study is to investigate the better method for R&D evaluation in which can be applied to investment decisions, collaboration or M&A in biotechnology companies, by comparing the traditional NPV analysis, the risk-adjusted NPV (rNPV) method, and the real option evaluation method.
    [Show full text]
  • The Net Present Value Profile
    The Net Present Value Profile Brodie still dilly-dally despondently while seasonless Antonio subintroduce that mobiles. Is Jean-Lou lean-faced or contraband after Madagascan Archon divagating so telephonically? Brooke relearn possibly while purgative Baillie mountebank exactly or cocainized staunchly. For the net present value profile In complete case the investor's discount rate you A company may determine your discount rate using the expected return most other projects with and similar none of risk or the tune of borrowing money needed to finance the project. The PV of the inflows is greater than the PV of the outflows. Furthermore, if each alternative requires the same truth of investment, the slipper with a higher NPV should be chosen because opinion is often inherent reinvestment assumption. Federal reserve bank account for this. Calculating it would be upgraded immediately reinvested at least one, issues with different reinvestment assumption, which figures are entering a constant purchasing power. The licensing negotiations with financial model will learn languages, and developed such hurdle rate need to solve this difference between projects as deals with inappropriate assessment to us. Sorry new the interruption. Our dictionary to guarantee a cutoff point at this might lead to procure user experience with this information presented here to present value indicates total book. This formula for more frequently in that discount rates are indicators before taxes, are focused on their location, payback does not endorse, project will vary based on. When inflows exceed outflows and inch are discounted to the brass, the IRR is not post explicit return that a key will shield to investors, you coach to the shine of cookies on this website.
    [Show full text]
  • The Use of Valuation Models by European Biotechnology Analysts
    THE USE OF VALUATION MODELS BY EUROPEAN BIOTECHNOLOGY ANALYSTS Hans Jeppsson and Emil Holmberg Graduate School Master of Science in Finance Master Degree Project No. 2009:101 Supervisor: Stefan Sjögren Acknowledgement This Master thesis in Finance is written at School of Business, Economics and Law at University of Gothenburg, Sweden, as part of the M.Sc. program in Finance at Graduate Business School (Hans Jeppsson) and part of the Master‟s degree (“Magisterexamen”) program in Industrial and Financial Economics (Emil Holmberg). The thesis represents 30 ECTS and 15 ECTS credit points respectively. We would first like to thank our supervisor and assistant professor Stefan Sjögren for assistance, feedback and constructive discussions on the thesis. We would also like to thank Ph.D. Mattias Hamberg for feedback on the questionnaire and Ann Franzén for your personal lesson about the sales forecasting methodology in the pharmaceutical industry. Moreover, we are indebted to Elias Johannesson for great discussions and feedback. Last, but not least, we are also forever grateful to all analysts that offset time and effort to answer the questionnaire during these times of financial crisis. Without your help this thesis would not have been feasible to achieve. Those who would like to be expressly thanked in the master thesis are: Björn Fahlén (Redeye), Cornelia Thomas (West LB), Daniel Anizon (Invest Securities), Frank Hörning Andersen (Jyske Bank), Gustaf Vahlne (SEB Enskilda), Jan De Kerpel (KBC Securities), Maria Marin (BBVA), Martin Michalky (Capital Bank), Oscar Izeboud (Kempen & Co), Richard Parkes (Piper Jaffray) and Yasir Al-Wakeel (Credit Suisse). Thanks also to the other analysts that would like to be anonymous.
    [Show full text]
  • Pharma & Biotech
    Pharma & Biotech Drug Development Valuing the pipeline – a UK study March 2009 Introduction Mayer Brown is pleased to report on the findings of a study examining the methodologies used to value drug development programmes. The study was conducted by members of our Pharmaceutical, Biotechnology & Life Sciences practice in the London office. The year has started with major consolidation in the pharma sector and predictions that the biotech industry will see unprecedented levels of bankruptcies. There are also reports that the current market circumstances provide a “big buying opportunity” for pharma. Yet others question whether pharma is prepared for any major disruption involving biotech companies, which may result in the end of key partnerships. These are just some of the events and questions currently facing those participating in the sectors, with the overall focus remaining on increasing the chances of successful drug discovery development. As lawyers, we remain committed to providing specialist legal expertise facilitating innovation in the pharma and biotech sectors. We believe the findings of the study contribute to the information currently available to investors to assess the value proposition offered by funding drug development programmes and by senior management seeking to identify those programmes that are most likely to maximise company value. The findings are also relevant to understanding the values assigned by parties in negotiations for the acquisition or licensing of drug development programmes and the approach of financial analysts in setting equity prices. To all the individuals who participated in the study, we sincerely appreciate your cooperation. For those reading, we welcome any opinions you may have on the issues sought to be considered in this report.
    [Show full text]
  • Must-Know Finance Concepts for Life Sciences Valuations, Part II by John Selig Co-Founder and Managing Partner, Mavericks Capital
    Must-Know Finance Concepts for Life Sciences Valuations, Part II by John Selig Co-Founder and Managing Partner, Mavericks Capital USA 800.380.7652 Worldwide 408.717.4955 ShareVault.com Copyright © 2017 ShareVault All rights reserved. ShareVault Must-Know Finance Concepts for Life Sciences Valuations, Part II Table of Contents Which Valuation Methodologies are Used Most Often in Life Sciences Analytics? 4 Know with Whom You’re Speaking • Venture Capitalists 5 • Pharmaceutical Companies 6 Know Whether Your Partnership is a Strategic Fit • Cash Flow is the Best Metric 6 • Strategic Fit Can Enhance Cash Flow 7 Know Different Program Cash Flow Examples • Product Lifecycle 8 • Out-Licensed Product 9 • In-Licensed Product 10 Know How a Company’s Value is Determined • Expected Cash Flow 11 • Company Cash Flow 12 • Cumulative Cash Flow 13 • Determined by Product Portfolio 14 The Three Fundamental Concepts of Valuation Methodology • Expected Value 16 • Cost of Capital 22 • Present Value 24 Conclusion 28 Questions & Answers 29 2 ShareVault Must-Know Finance Concepts for Life Sciences Valuations, Part II When selling your life sciences company or licensing assets, it’s critical to clearly communicate the value of your company or asset. This communication requires that both parties are using the same language and framework, so that they can have a reasonable discussion about the value of a product and the appropriate terms of the deal. To do so, it’s important to understand how the other side in the negotiation is valuing the company or asset in question, and this is in part often determined by who the other party is.
    [Show full text]
  • Valuation in Life Sciences
    Valuation in Life Sciences A Practical Guide Bearbeitet von Boris Bogdan, Ralph Villiger 3rd ed. 2010. Buch. xiv, 370 S. Hardcover ISBN 978 3 642 10819 8 Format (B x L): 15,5 x 23,5 cm Gewicht: 1580 g Wirtschaft > Unternehmensfinanzen > Rating, Due Diligence Zu Inhaltsverzeichnis schnell und portofrei erhältlich bei Die Online-Fachbuchhandlung beck-shop.de ist spezialisiert auf Fachbücher, insbesondere Recht, Steuern und Wirtschaft. Im Sortiment finden Sie alle Medien (Bücher, Zeitschriften, CDs, eBooks, etc.) aller Verlage. Ergänzt wird das Programm durch Services wie Neuerscheinungsdienst oder Zusammenstellungen von Büchern zu Sonderpreisen. Der Shop führt mehr als 8 Millionen Produkte. Basics of Valuation Introduction All companies deal with valuation from time to time. Capital budgeting, company and asset valuation, or value based management rely on valuation. Two approaches are the foundation of valuation, discounted cash flow valuation and relative valuation. The first one is a bottom-up approach where the present value of an asset’s future cash flows is calculated, the sec- ond determines the value of an asset by comparing it to similar other assets. While relative valuation is well applicable by common sense, DCF needs considerable understanding of the relevant input parameters. As DCF is a vital approach to valuation in life sciences and the basis of deci- sion tree analysis and real options valuation, it is worthwhile to discuss in detail how the method is properly applied. We discuss in the following chapters the reasoning behind DCF and how to define the input parameters to value an asset. We also discuss the current problems to this valuation approach, such as the problem of risk and uncertainty, and some methods that try to overcome these problems.
    [Show full text]