Brand valuation is a major part of business valuation in certain industries such as food & beverage and consumer home products. For example, Coca-Cola’s brand value is estimated at USD 73 bn. (see here), accounting for 40% of Coca-Cola’s current market capitalization.
But how does brand valuation apply in the context of pharmaceuticals? In theory, a pharmaceutical company’s brand has minimal value when it comes to generating revenue. That is because (again, in theory) doctors seek to prescribe drugs with high efficacy, safety and cost-effectiveness and thus, brand name does not (or at least, should not) affect doctors’ decisions.
Therefore, it is interesting to investigate brand value in the context of OTC (i.e. drugs that can be bought without a prescription from a doctor, e.g. aspirin).
Through my analysis I will attempt to value Bayer’s consumer care division and estimate the amount of value that is attributed to “brand name”. The reason I chose Bayer is that it generates significant OTC revenues and financial information on its OTC business unit is publicly available.
The following steps will be followed to estimate the brand value of Bayer’s OTC business:
Step 1: Estimate Market Value of OTC business.
This will be achieved by using the EV / EBITDA and EV / EBIT multiples of Bayer and apply them to OTC business’s financials.
- Cash for the OTC business will be estimated by using an analogy of OTC EBITDA or EBIT to Total EBITDA or Total EBIT (depending on the multiple used to estimate market value of equity).
- Debt for the OTC business will be calculated based on the cash estimated as described in the bullet point above.
A brief DCF model will be also used to validate the estimate market value of equity using the multiple approach.
- EBIT*(1-T) of OTC business will be assumed equal to Free Cash Flow (i.e. change in working capital is assumed negligible and capex is assumed to be equal to D&A.)This assumption is completely rational. When calculating terminal value in perpetuity Capex is equal to D&A in all DCF models. Terminal value is ~60% of the overall DCF value. Therefore, the potential effect of D&A not being equal to CAPEX (during the forecast period) on the DCF-derived market value of equity will be very small. The second assumption that can obviously be challenged is that change in working capital is assumed to be 0 which may not be the case. But since this is a “brief” DCF model, change in WC will be indeed assumed to be 0.
- Tax rate = 25%
- Forecast period growth rate = compound annual growth rate in previous years (2007 – 2014) = 6.7%, a rational assumption for the sales forecast part of a simple DCF model.
- Growth to perpetuity = 2%
- WACC of OTC business = WACC of Bayer = 9.29% This assumption can indeed be challenged since the risk profile of the OTC business is possibly lower than, for example, Bayer’s pharmaceutical business (OTC business’s WACC could be in the range between 6% – 8%). But again, for the sake of this exercise, it is assumed that OTC WACC is equal to overall WACC.
Step 2: Estimate Brand Value as % of Total Vale
The royalty relief method will be used to estimate the brand value of the Bayer’s OTC business. Across 26 comparable out-licensing deals that took place during the period 2000 – 2015, the average royalty rate for pharmaceuticals was close to 10%. It should be noted that due to lack of data available (or lack of deal-making) on OTC products, the sample of deals includes mainly prescription drugs.
Based on the forecast period growth rate, the WACC and the growth rate to perpetuity, the brand value of the OTC business was estimated using the DCF method.
- Estimating Market Value of Equity of OTC Business
A/ Multiples Approach
Bayer’s breakdown of financials by business unit for FY 2015 is presented below:
Based on the 2015 average market capitalization, the Enterprise Value of Bayer was calculated:
The Market value of equity of the consumer care (OTC) business was estimated using both the EV / EBITDA and EV / EBIT method. EV that was estimated to stand at USD 100.6 bn. was divided by the company’s EBITDA and EBIT, arriving at an EV / EBITDA multiple of 9.8 and EV / EBIT multiple of 14.2. By applying those multiples on OTC business EBITDA and EBIT, we arrive at an EV of the OTC business of USD 14.3 bn.
As mentioned previously, cash was calculated using the % of EBITDA of Bayer that is attributed to the OTC business (i.e. 14.2%) multiplied by Bayer’s total cash (USD 1,859 mn.). Instead, debt was calculated based on the % of cash that is attributed to the OTC business multiplied by Total debt. Both methods result in the same value, i.e. USD 11.7 bn.
B / DCF Approach
WACC was calculated as follows (bond values and coupon rates were taken from Bayer’s 2015 financial statements). Cost of equity was calculated using the Capital Asset Pricing Model: risk free rate + beta*market risk premium, where risk free rate = 10 year U.S. government bond as of 31.12.2015 = 2.2%, Bayer’s beta = 1.34 (as referenced in NASDAQ) and market risk premium = 6.7% (Ibbotson).
Free cash flow was calculated as follows: EBIT*(1-T)*(1+CAGR)^n + (EBITDA – EBIT), where n = year 1, 2, 3… and EBITDA less EBIT = D&A (added back since it is a non-cash item). Also, CAGR = 6.68% and T = 25% as indicated in Step 1.
Using the DCF approach, the Market value of equity of the OTC business is estimated at USD 10.0 bn.
C / Final Market Value of Equity of OTC business
A 25% weight was assigned to the EV / EBITDA and EV / EBIT method (i.e. a total weight of 50% for the multiples approach) and a 50% to the DCF method. The weighted average market value of equity of the OTC business was calculated as USD 10.9 bn.
2. Estimating Brand Value using the Royalty Relief Method
Using a royalty rate of 9.72% and the same CAGR and WACC as in previous steps, the brand value of the OTC business is estimated at USD 7.5 bn.:
The results show that the market value of equity of Bayer’s consumer care business is approximately USD 10.9 bn. and its brand value is USD 7.5 bn. This implies that close to 70% of the value of Bayer’s consumer care business is attributed to its brand.
The key takeaway from this analysis is that brand value of pharmaceutical firms strongly correlates with OTC revenue and hence total value. Investing in marketing and brand promotion can boost the value of an OTC business and as a result, increase cash gained in deal-making. Companies that operate in various healthcare related sectors can be strongly benefited from their brand , since consumer awareness of those firms is amplified (e.g. Johnson & Johnson). As a result, the price premium put on a potential sale of the business can also be higher.