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TUTORIAL
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Click Here to Open Tutorial in a Separate Browser
Window
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While this valuation calculator is developed to be intuitive,
easy-to-use, and self-explanatory, this tutorial provides step-by-step
instructions on how to use this calculator and how to best take advantage of
its features. There are multiple ways in which this calculator can be used:
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1.
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You can create your own risk-adjusted discounted cash flow (DCF)
valuation, just like Wall Street analysts.
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2.
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You can replicate other analysts' valuations in order to analyze
and/or adjust their numbers to your liking.
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3.
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You can quickly calculate valuations on multiple hypothetical
scenarios.
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4.
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You can quickly update a valuation prior to other analysts based
on newly released information.
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The valuation calculator can help quickly determine valuations
based on occurrences that can have an impact on the share price, such as:
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adding or dropping a
drug
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modifying royalty rates
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advancing a drug to
next phase
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modifying corporate spending (R&D, SG&A, PP&E, etc.)
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increasing or
decreasing time to approval
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increasing or decreasing outstanding shares
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adjusting the
discount rate
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adjusting valuation based on a capital raise
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modifying patient
populations and/or pricing
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accounting for a partnership
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adding or removing
milestone payments
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etc., etc.
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To develop
a valuation, you should have a general working knowledge about the
corporation and its drug pipeline.
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Note that the default data in the yellow highlighted cells
within this calculator are only hypothetical placeholders and need to be
modified by the user to develop a valuation.
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STEP 1 -
'Summary' tab
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The 'Summary' tab includes a basic summary of information,
assumptions, calculations, and valuations. It is within this page where the
final risk-adjusted discounted cash flow (DCF) calculation is performed to
determine the Equity Value of the company and the resulting Target Share
Price. All the yellow highlighted cells within the calculator are modifiable
by the user to develop the valuation.
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Steps to Cover
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Related Links
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1.
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Enter the
"Current share price" in the space provided.
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2.
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Enter the
"Number of shares outstanding" in the space provided. The number of
shares of common stock outstanding can be found on page 1 of the latest 10-K
or 10-Q Report.
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3.
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Select the
Probability of Success model you would like to apply to your valuation. If
you are unsure about which model to select, go to the 'Probabilities' tab and
review the different models. Informational links for each of the models are
provided. Alternatively, you can create your own Custom probability model by
entering your own probabilities in the "Custom" row
('Probabilities' tab). The "PhRMA (2003)" model is a believed to be
a good conservative and commonly used model.
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4.
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Select the
applicable "Tax Rate." This can be determined by selecting the
corporate tax state that the company uses. The corporate tax state is
identified as "address of principal executive offices." This can be
found on page 1 of the latest 10-K or 10-Q Report.
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5.
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Select which drugs
you would like to value by marking the appropriate check boxes. This
generally includes drugs that are at least in phase 1, but it can also
include drugs that are pre-clinical and in development. The drugs you select
to value will be displayed as individual tabs at the top of the page and will
require additional input to determine each drug's value. This will be covered
in 'STEP 3 - Drug pipeline' tutorial below.
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STEP 2 -
'Financials' tab
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The 'Financials' tab includes financial information from the
last four annual reports, including the latest net cash value from the most
recently filed report. Only the necessary financial information that is
needed to develop a valuation is included. The financial information is
labeled accordingly and should be fairly self explanatory. The yellow
highlighted cells can be modified by the user to make projected financial
assumptions regarding various corporate financial operations. More detailed
yearly manual adjustments can also be made to select fields in the Income
Statement section and are identified as yellow highlighted cells.
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STEP 3 -
Drug pipeline
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The Drug pipeline tabs are the drugs selected for valuation in
the 'Summary' page. Each drug has its own page for valuation and requires
sales related assumptions that need to be filled in.
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There are two different valuation models that can be used to
value a drug: a "Simple" model and a "Detailed" model.
Each model allows for valuations across three different regions: the United
States (U.S.), Europe (EU), and Rest of the World (ROW). Not all regions need
to be valued; it is typical for analysts to only value the U.S. and EU, while
reserving ROW for when more accurate information regarding this region can be
obtained, and when the drug nears commercialization.
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There is a high degree of flexibility to develop the most
accurate valuation through both models, including yearly increase in
population, percentage of patients getting diagnosed and treated, market
penetration rates, treatment costs, yearly percentage change of treatments
costs, partnership impact, royalty rates, cannibalization (decline in sales),
accounting for milestone payments, etc.
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If you select that the drug is partnered, this will assume that
the partner will bear all costs with regards to the Cost of Goods Sold
(COGS), and is therefore excluded from calculating the risk-adjusted revenue.
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The more you play around with the drug models and all the
various assumptions, the more comfortable you will become in understanding
how to create a good drug valuation.
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The more accurate the assumptions are, the more accurate the
valuation. It is therefore important to have the most accurate data and
assumptions possible. Much of this information is readily available on the
Internet, but it requires research and knowledge about the drug and the
condition/disease that is being treated.
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Tips and
tricks to find relevant information
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The company (and any relevant competitors) may provide drug
valuation information on its website and/or within some of its presentations.
This includes treatable patient populations, yearly growth rates, conditions
treated, annual costs, cost burdens, etc. It may also be possible to find
comparable sales information from other drugs that have already been allowed
and treat similar conditions with similar patient population sizes.
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Other analyst reports may provide valuable insights. Sometimes
detailed data is included in an analyst report, and other times only final
valuations of each drug are provided. If only a final drug valuation is
provided, it should be possible to reverse-engineer the numbers in such a way
so as to end up with the same drug valuation as the analyst. The result can
provide valuable insight across numerous areas, such as: 1) how will the
valuation change as the drug progresses through the clinic; 2) what happens
to the valuation based on a change in any of the other assumption metrics; or
3) is the analyst's valuation valid and what would a more accurate valuation
look like. Such insights can help identify hidden value and explain if price
targets are accurate, too high, or too low.
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Search
terms that can be used when researching information to develop drug valuation
assumptions
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Epidemiology
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Population
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Annual cost
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Prevalence
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Sales
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Annual
health care costs
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Incidence
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Revenue
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Annual
average costs
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Affects
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Drug cost
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Cost burden
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Diagnosed
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Drug price
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Economic
burden
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You can also contact the company and speak with Investor
Relations to get as much information on the company's drugs as possible.
Often times there are foundations or organizations regarding the
conditions/diseases that the drug in intended to treat, and that could be
another area to research in order find relevant information.
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Simple Model
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The Simple model is a quicker way of developing a drug
valuation. The main focused is on the "# of patients treated". This
is the total number of patients that are assumed to be treated through then
end of the 15 year valuation period (e.g. through 2033), wherein each
treatment is multiplied by the treatment cost to determine revenue. The
number of patients treated on a yearly basis is automatically calculated and
distributed in the correct years based on the assumptions entered. The Simple
model is just as accurate as the Detailed model as long as you have a good
idea as to the total number of patients that would be treated throughout the
15 year valuation period. A more detailed breakdown of the numbers is shown
in the charts on the lower half of each drug page. The more you play around
with this model, the more comfortable you will become in understanding how it
works.
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Detailed Model
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The Detailed model allows you to enter data to determine the
yearly treated patient population size. This model is more typical of what
analysts use when there is epidemiological and prevalence data available.
This model can also be used in reverse-engineering other analysts' numbers.
The number of patients treated on a yearly basis is automatically calculated
and distributed in the correct years based on the assumptions entered. A more
detailed breakdown is shown in the charts on the lower half of the page. The
more you play around with this model, the more comfortable you will become in
understanding how it works.
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STEP 4 -
'DR' (Discount Rate) tab
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The 'DR' tab includes a proprietary Discount Rate calculator,
along with information on how to determine the Discount Rate for biotech
companies. A survey by Avance of 242 respondents in the biotech/pharma
industry regarding Discount Rates is the main basis of the Discount Rate
calculator. The yellow highlighted cells within the Discount Rate calculator
are modifiable by the user to develop a suggested Discount Rate.
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The "Company Development Stage" is determined by the
latest phase level from all of the valued drugs. That Development Stage
determines a range of Discount Rates taken from the survey. You can select
the "Type of Discount Rate" to apply: this ranges from low to high,
wherein medium is the default. The more knowledgeable you become with
understanding discount rates, the easier it will be to determine the Type of
Discount Rate to apply, as the riskier the company, the higher the Discount
Rate.
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Additional
Factors
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The Proprietary Discount Rate calculator includes additional
factors to take into consideration that are believed to have an impact on the
Discount Rate. This includes: the percentage of institutional ownership, the
number of drug partnerships with large pharma companies, and the number of
years projected revenue is expected to surpass certain thresholds. The
"Percentage of Institutional Ownership" can be determined from
public websites, such as NASDAQ or Fintel. The "# of Drug Partnerships"
with large pharma companies should be public information accessible through
the corporate website. The number of years that projected revenue surpasses
certain thresholds is automatically calculated based on drug pipeline data
that was entered.
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If you would like to use a different Discount Rate than the
Adjusted Suggested Discount Rate determined by the calculator, you can
override the Discount Rate on the 'Summary' page by selecting the override
checkbox and entering your own Discount Rate.
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STEP 5 -
'Summary' tab
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Now that most of the valuation assumptions have been entered,
the remaining assumptions in the "Value of Shares" section within
the 'Summary' page need to be completed.
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1.
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The "Terminal Growth Rate assumption" can be adjusted
to your liking. 2.00% is a typical rate used for sustainable biotech
franchises.
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2.
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The calculated Adjusted Suggested Discount Rate from the 'DR'
tab is used as the Discount Rate. You can override this rate by selecting the
override checkbox and entering your own Discount Rate.
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3.
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The "Cash adjustment" field can be used to add or
subtract value from "Net Cash" (the following line item). This is
helpful when the next quarter numbers are released and the valuation
calculator has not yet been updated to reflect the current net cash on hand.
When adjusting "Net Cash", the proper quarter should be selected in
the "Net Cash Value adjusted after" field, as this has an impact on
the discount period in the DCF valuation.
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STEP 6 -
Double-check all tabs
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Lastly, be sure to double-check all of your inputs in each tab
located at the top of the page.
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Congratulations on creating your own risk-adjusted DCF
valuation, just like Wall Street Analysts.
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Useful
links
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