handling complex decisions in the development of new drugs in pharmaceutical firms
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Handling Complex Decisions in the Development of New Drugs in Pharmaceutical Firms. Cassimon, Engelen and Yordanov. FUR XII , LUISS, Roma , Italy, 22-26 June 2006. Valuation of pharma companies. - PowerPoint PPT PresentationTRANSCRIPT
© Peter-Jan Engelen
Handling Complex Decisions in the Development of New Drugs in Pharmaceutical Firms
FUR XII, LUISS, Roma, Italy, 22-26 June 2006
Cassimon, Engelen and Yordanov
Slide nr.2 © Peter-Jan Engelen
Valuation of pharma companies Financial analysts typically split the value of a pharmaceutical company in three building blocks:
(i) existing marketed products;
Valuation is problematic with current models
(ii) new products in the mid to late stage of development (phase II and III of the clinical testing);(iii) early R&D.
Slide nr.3 © Peter-Jan Engelen
Real option characteristics of projects Financial option: right (not an obligation) to buy
or sell a certain asset at specific moments at a predetermined price
What are real options? Recognizing the project itself or certain components
as options A project is an option, whereby the company obtains
the right to all future FOCFs the project generates, in exchange for a predetermined price (investment cost of the project)
Different types of real options Growth options, options to delay, etc.
Slide nr.4 © Peter-Jan Engelen
Real option approach to R&D Benefits of real option approach
compared to traditional models:Can handle operational flexibility with
respect to investment decisions• Abandonnement, delay or adjustment of
projects, e.g. stop R&D of particular drug Takes into account the strategic
value of a project because of its interdependence with future projects• R&D give option to follow-up projects• Real option models are better suited to
value R&D
Slide nr.5 © Peter-Jan Engelen
Typical example of a growth option
success
large project
I
FOCF
failure
Project’s value = NPV(pilot) + ROV (follow-up) if >0, then invest
Pilot projectstart
typical: NPV < 0
t T
Follow-up project?
Real option value (ROV)
Slide nr.6 © Peter-Jan Engelen
Extending the growth option
Growth option
Sequential option
Sequential drug development option
Extension to multiple growth options
Application to a ‘regulated’ sequential option
Slide nr.7 © Peter-Jan Engelen
The drug approval process
Discovery(2-10 years)
Preclinical TestingLaboratory and animal testing
Clinical Phase I20-80 healthy volunteers used todetermine safety and dosage
Clinical Phase II100-300 patient volunteers used tolook for efficacy and side effects
FDA Approval
Additional Post-Marketing Testing
Clinical Phase III1000-5000 patient volunteers used tomonitor adverse reactions to long-term use
0 3 7 10 14years
© Peter-Jan Engelen
Opening the R&D black box
Slide nr.9 © Peter-Jan Engelen
Development of a new drug
success
success
success
success
failure
failure
failure
failure
pre
-cli
nic
al t
est
ph
ase
clin
ical
tes
t p
has
e 1
clin
ical
tes
t p
has
e 2
app
rova
l by
gove
rnm
ent
com
mer
cial
isat
ion
success
failure
NPV1
NPV2
fundamental research
success
failurecl
inic
al t
est
ph
ase
3
Slide nr.10 © Peter-Jan Engelen
R&D on new drug as a chain of options (a) first option – decision to start preclinical
phase;
(b) second option – decision to start first clinical trial phase;
(c) third option – decision to start second clinical trial phase;
(d) fourth option – decision to start third clinical trial phase;
(e) fifth option – decision to file for regulatory approval;
(f) sixth option – decision to launch the new drug on the market.
Slide nr.11 © Peter-Jan Engelen
How to value this chain of real options? Chain of real options in drug development
can be seen as a case of compound option models
Geske (1979) – 2-fold compound option (option on an option)
R&D of new drug – 6-fold compound option
We use the extended n-fold compound option model of Cassimon et al. (2004)
Programmed in Matlab
© Peter-Jan Engelen
Case-study
Xandee Biochemical, Ltd.
Slide nr.13 © Peter-Jan Engelen
Its research and product portfolio
preclinical clinical I clinical II clinical III FDA approval commerciali-zation
INS-84
FR-242
DIVE-4
MF-164
interim products
JR-32
MV of product portfolio is the sum of:•assets in place (interim products)•unexercised compound growth options (pipeline)
Slide nr.14 © Peter-Jan Engelen
Valuation of R&D and product portfolio
Product Phase Valuation model
INS-84 Preclinical 5-fold compound option model
JR-32 Preclinical 5-fold compound option model
FR-242 Clinical I 4-fold compound option model
DIVE-4 Clinical III 2-fold compound option model
MF-164 Approval 1-fold compound option model
Interim products
Commercialization
Discounted cash-flow model
Slide nr.15 © Peter-Jan Engelen
Details of its drug development pipeline Option ti Ki V n-fold COV
Panel A – Product JR-32 ( = 0.81; wacc = 23%) – Preclinical phase
1 1.5 8.3
2 2.5 29.1
3 4 55.7
4 6.5 14.1
5 8 50.6 81.7 30.4
Panel B – Product INS-84 ( = 0.64; wacc = 18%) – Preclinical phase
1 3 15.8
2 4 48.5
3 6 96.4
4 8.5 25.3
5 10.5 107.2 72.7 15.6
Legend: ti is the maturity date for the compound call option Ci (expressed in years), Ki is the exercise price for the compound call option Ci,; V is the current value of the underlying project; is the instantaneous standard deviation of the project return; wacc is the risk-adjusted discount rate of the project and COV is the compound option value based on the corresponding n-fold compound option model. Ki,, V, I and COV in million USD.
Slide nr.16 © Peter-Jan Engelen
Panel C – Product FR-242 ( = 0.78; wacc = 21%) – Clinical I phase
1 0.5 10.2
2 2 33.7
3 5 8.3
4 6.75 60.0 65.8 19.4
Panel D – Product DIVE-4 ( =0.63; wacc = 18%) – Clinical III phase
1 2 8.5
2 3.5 29.4 61.1 33.4
Panel E – Product MF-164 ( = 0.46; wacc = 15%) – Approval phase
1 1 25.2 43.8 16.2
Details of its drug development pipeline
Legend: ti is the maturity date for the compound call option Ci (expressed in years), Ki is the exercise price for the compound call option Ci,; V is the current value of the underlying project; is the instantaneous standard deviation of the project return; wacc is the risk-adjusted discount rate of the project and COV is the compound option value based on the corresponding n-fold compound option model. Ki,, V, I and COV in million USD.
Slide nr.17 © Peter-Jan Engelen
Decomposition of its market value
39%
15%12%
20%
14%
Preclinical
Clinical I
Clinical III
Approval
Launched
39% of its MV comes from early stage R&D86% of its MV comes from drug development pipelineOnly 14% of its MV comes from existing products
Slide nr.18 © Peter-Jan Engelen
Conclusions Product portfolio of a pharmaceutical firm
consists of exercised (assets in place) and unexercised (growth opportunity) real options
Real option component can be valued using generalised n-fold compound option models
Benefits:possible to decompose MV of product
portfolio in different components linked to specific phases of drug development process
Better insight in different value blocks of pharmaceutical firm (over the full range of phases of drug development)
Slide nr.19 © Peter-Jan Engelen
Contact informationIf you have …
•comments or suggestions,•proposals for research collaboration, or•proposals for consulting work,
… please contact us at:[email protected] EngelenUtrecht University, Vredenburg 1383511BG Utrecht, Netherlands