Biotech Valuation Calculator Tutorial

TUTORIAL

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:

You can create your own risk-adjusted discounted cash flow (DCF) valuation, just like Wall Street analysts.

You can replicate other analysts' valuations in order to analyze and/or adjust their numbers to your liking.

You can quickly calculate valuations on multiple hypothetical scenarios.

You can quickly update a valuation prior to other analysts based on newly released information.

The valuation calculator can help quickly determine valuations based on occurrences that can have an impact on the share price, such as:

•

adding or dropping a drug

•

modifying royalty rates

•

advancing a drug to next phase

•

modifying corporate spending (R&D, SG&A, PP&E, etc.)

•

increasing or decreasing time to approval

•

increasing or decreasing outstanding shares

•

adjusting the discount rate

•

adjusting valuation based on a capital raise

•

modifying patient populations and/or pricing

•

accounting for a partnership

•

adding or removing milestone payments

•

etc., etc.

To develop a valuation, you should have a general working knowledge about the corporation and its drug pipeline.

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.

STEP 1 - 'Summary' tab

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.

Steps to Cover

Enter the "Current share price" in the space provided.

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.

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.

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.

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.

STEP 2 - 'Financials' tab

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.

STEP 3 - Drug pipeline

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.

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.

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.

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.

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.

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.

Tips and tricks to find relevant information

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.

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.

Search terms that can be used when researching information to develop drug valuation assumptions

Epidemiology

Population

Annual cost

Prevalence

Sales

Annual health care costs

Incidence

Revenue

Annual average costs

Affects

Drug cost

Cost burden

Diagnosed

Drug price

Economic burden

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.

Simple Model

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.

Detailed Model

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.

STEP 4 - 'DR' (Discount Rate) tab

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.

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.

Additional Factors

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.

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.

STEP 5 - 'Summary' tab

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.

The "Terminal Growth Rate assumption" can be adjusted to your liking. 2.00% is a typical rate used for sustainable biotech franchises.

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.

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.

STEP 6 - Double-check all tabs

Lastly, be sure to double-check all of your inputs in each tab located at the top of the page.

Congratulations on creating your own risk-adjusted DCF valuation, just like Wall Street Analysts.