Last month saw an interesting project for ATPBio, and one to mark the sign of the times. We were retained by a European VC to provide an outside commercial evaluation and strategic review for a portfolio company. In particular, the VC was keen to assess the company’s strategic plan in light of the current economic and funding climate.
The overall objective was to advise what course of action should be set if the company were to continue to build upon existing progress and be able to position itself for exit in around two years. Given that the company is working in a popular therapeutic area (inflammation) and has its most advanced project already in phase II with scientific proof of principle, this was not an unreasonable goal.
The project brief included an examination of the company’s current position. This was in terms of a pipeline project review, potential value inflection points, projected budget and additional investment required to reach these, and scenario based stress-testing to allow for contingency planning. An assessment of each of these areas was necessary to arrive at an overall strategic recommendation, and what course of action would lead to the optimal return for the VC: getting the most “bang for your buck”. Each of these areas, and impact on overall recommendations, is considered below:
PIPELINE PROJECT REVIEW
This forms the core of a commercial and strategic review, since pipeline projects command the lion’s share of a company’s valuation. A review should lead to a ranking to determine which programs are the key value drivers – it is rarely as simple as just ranking the most advanced programs the highest.
We considered a qualitative and quantitative assessment. The qualitative view was a top-down benchmarking analysis looking at similar deals in the therapeutic spaces and stages of development. Given the significant change in market conditions and sentiment of late, deals were generally examined only in the last 18 months. While a benchmarking analysis is helpful, limitations include that each deal is very different, and with only a few closely relevant deals available to examine, there is no statistical significance to creating average deal sizes. Though, such benchmarking does afford a useful “look and feel” of what is possible, and gives an indication of what has occurred recently.
The quantitative assessment involved a bottom-up analysis by building NPV models for each program. These models considered market size, market growth and penetration, launch date, revenue growth and profit, patent expiration, milestones and royalty payments, and appropriate discount rates. Clearly, numbers plugged into an NPV model for a therapeutic program can have a wide variation, depending on whether assumptions used are based on conservative or aggressive scenarios, with resulting wide variation in valuations. However, providing a consistent approach is used across the board for all programs (at least within the realms of possibility) then a relative picture begins to emerge, from which one can begin to develop a ranking. We tend to favour and encourage conservative assumptions: take care of the downside then the upside will take care of itself.
We also considered the spectrum of relative complexity for further development for clinical stage programs. For example, projects focusing on skin diseases with topical treatments are relatively straightforward to recruit for and to monitor progress based on clinical outcomes. By contrast, certain orphan indications, by their nature, address rare and difficult to treat disease conditions, with associated complexity in trial recruitment and logistics, trial design and end-points. And somewhere in the middle, are conditions requiring systemic treatment for serious and life threatening diseases affecting large patient populations.
VALUE INFLECTION POINTS
Ahh, that wonderful cliché strived for by investors and company managements across the globe. For at the end of the rainbow is a value inflection point. As we all know, this pot of gold is where a buyer or trade partner is suddenly willing to pay a significant premium to development costs to date, given the degree of de-risking that has already occurred.
In truth, this is part art and part science, depending on how efficiently a company has developed assets to a certain stage, and to a large degree on benchmarking of similar deals in the space. If a company has managed to develop assets very efficiently, a highly respectable return on investment may be possible at, say, end of phase I. However, the same asset developed in a heavily cash hungry, infrastructure rich environment may not work even at phase II.
So, to truly give indication of a value inflection point, it’s not sufficient to just give a benchmarked industry standard approach for any given therapeutic area (so typically at phase II); one must also consider the finances and the efficiency of investment and budgeting within the individual company.
In more abundant economic climes, companies can shoot for the moon, and plan ambitious projects with additional work-up and gold standard style clinical trials. More funds are generally available for investment, enabling a greater wish-list of work to be performed. Assuming such work is done properly, and read-outs are positive, this should put a company’s projects in stronger position for future partnering or trade sale negotiations.
However, in today’s market cost control is king, so the key is to find a common denominator: what is the minimum investment required per program to get to a validated clinical read-out which will be acceptable to potential big pharma partners or trade buyers? i.e. what is critical rather than “nice to have”? This is the optimal scenario.
This information is likely to come from a couple of sources: early discussions with future partners defining their internal needs, and the clinical trial development team (e.g. Chief Medical Officer and associated team members). Management must then balance these criteria against the VC and shareholder imperative – what’s the minimum spend possible to achieve such an output?
In the words of Harvey MacKay, “Failures don’t plan to fail; they fail to plan”. Stress testing is contingency planning for drug development. What happens if a given program fails, is delayed, or if only a smaller amount of investment is available than indicated in the optimal scenario above?
By considering such alternative scenarios, a management team can still plot a course of action to help build value while avoiding the risk that comes with an all-or-nothing plan where value is entirely dependent on a single program succeeding in a single development plan. In some ways it is like navigating a journey through the ocean – sometimes plain sailing but knowing what to do when the storms hit.
We developed such stress tests for the VC client’s portfolio company, enabling a positive NPV even for several sub-optimal scenarios. Of course, in drug development, there is real possibility that all programs fail completely, with total destruction of value. Though, incorporating this into the stress testing exercise allows investors to see “value at risk” and mitigate even this crisis outcome through broader portfolio planning.
OTHER CRITICAL POINTS
Ideally, to develop a strategic plan which has a defined objective over 1 to 2 years, a company and its investors must be in a strong enough financial position to consider alternatives. Financial factors which would impact the development and execution of a sound strategic plan include cash runway remaining within the company, the impact of dilution on existing investors, valuation, and VC specific concerns (e.g. life of fund, ability to follow on).
Essentially, companies should actively engage in such a review process while they still have financial staying power – cash starved companies in fire-sale or shut-down mode have left it too late and will be in no position to negotiate terms for partnering, new investment or even programs of work.
We were also asked to provide feedback on some of the softer issues, such as the management team and advisory board. Throughout the project, the VC and company management demonstrated an unusual and refreshing degree of openness, humility and genuine interest to find the most suitable alternatives for the portfolio company. Invariably, a good strategic review will also include recommendations for where to cut spend or planned investment. An open and receptive investor/ management team is essential to take advantage of such negative recommendations as well as the positive.
So, in summary, despite the challenges of the current economic crisis, one very positive outcome arises for investors and company management that want to stay in the game. Everyone has to examine current practice, review plans, and figure out new and creative ways to get the best return on their investment dollar; thereby sowing the seeds for a sustainable industry.
This article was written by Raman Minhas. He is CEO of ATPBio, a consultancy firm providing strategic insight and transaction support to the life sciences industry.