- R&D Cost by Phase: This can be provided by the Management of the company (as estimates). For the purpose of this analysis the figures provided by Bogdan and Villiger.
- Attrition Rates: Probability of approval by phase – Assumed based on past studies/cases
- Discount Rate: Discount rate of the project can be assumed to be the same as the discount rate of the company, if the company has one project or very few similar ones (i.e. same therapeutic area – same risk etc.) Discount rate (and more specifically, beta) decreases each time a drug passes to the next phase of clinical trials because the project becomes less riskier as the product gets closer to the market. The discount rate is estimated through the Capital Asset Pricing Model (CAPM).
- Post-approval revenues and costs: In order to value the company sales forecasts are needed. That is particularly hard and risky to do because of the uncertainty of the market, the economy, the regulation or even tax policies in general in 6-7 years from now. However, revenues and costs are necessary to estimate future free cash flows of the firm or the project.
- P&L and Balance Sheet items: Items such as Cost of Goods Sold (COGS), Selling, General and Administrative (SGA) costs, EBIT margin, CAPEX and Working Capital will be assumed as a % of sales based on comparable companies (high growth, medium growth and maturity companies).
- Free Cash Flow calculation (1/2): If revenue projections have already been obtained (from the company’s management) the next step is to estimate operating expenses that lead to EBIT. By assuming an appropriate tax rate, estimating CAPEX (capital expenditure on fixed assets), change in Working Capital and Depreciation & Amortization (using the relevant method, e.g. straight line) Free Cash Flow to the Firm (FCFF) can be calculated by using the following formula: FCFF = EBIT*(1-T) + (Depr’n & Amortisation) – CAPEX – Change in Working Capital
- Free Cash Flow calculation (2/2): If revenue projections have not been provided by the management of the company then there are two alternatives. The first one is the market method and the second is the comparable method. The former suggests that the market forecasts and statistics should be found (e.g. if the product is a cancer drug then forecasts for the oncology market need to be found – it would be even more relevant if forecasts of the subsector can be reproduced i.e. if the product is monoclonal antibody cancer drug, then research the monoclonal antibody cancer market). Then estimate the therapeutic area’s statistics (potential number of patients targeted for the treatment based on disease prevalence) estimate pricing (search for comparable products to see prices and look for social insurance reimbursement percentages) and of course examine market access and penetration issues that may arise and perform quantitative (by looking at past products) and qualitative analysis (ask doctors whether they would prescribe that drug or not, do questionnaires, focus groups etc.) based on this information.
Shire Pharmaceuticals acquired Viropharma for USD 4.2 bn. Was the price right? What does Comparable Multiples Method say?
In order to determine whether the price was right, a sample of comparable (publicly listed) companies was collected together with their multiples (Figure 1). Values marked with red colour represent outliers.
In Figure 2, the market value of equity of Viropharma was estimated based on the multiples presented above.
It should be noted that equal weights were given to all multiples which resulted in a weighted average market value of equity of USD 1,658 mn. From January 2012 to September 2013 (i.e. until Shire Pharmaceuticals showed interest which could have effect on share price), market capitalisation of Viropharma was ranging between USD 1,342 to USD 2,309 mn. with average market capitalisation (over the same period) being ~ USD 1,785 mn., converging highly to the market value derived through the Comparable Multiples Method (difference of the order of 7%). Therefore, it can be implied that the market valued Viropharma “realistically”.
On November 7th 2013 the market capitalisation of Viropharma reached ~USD 3,300 mn. The acquisition price is usually implied as follows:
Acquisition Price = Market Value of Equity + Control Premium + Synergies Premium
Control Premium is approximately 20% of the market value of equity. Since market value of equity and acquisition price are known, synergies premium should be of the order of USD 300 mn. This amount may also incorporate the Net Present Value of Viropharma’s pipeline (1 pre-clinical, 2 phase I and 5 phase II products). Indeed, according to the Financial Times through this acquisition, Shire Pharmaceuticals may achieve synergies of USD 150 mn. by 2015.
From a valuation perspective, it can be concluded that Shire Pharmaceutical’s offer converged to market reality, mainly arising from the reasonable total premium offered.