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Biopharma Valuation Inside Out

03

Biopharma remains attractive while the healthcare industry facing headwinds in the capital market

China's healthcare industry has been rapidly rising supported by the aging population, the rising consumption, and the more commonly seen tumors and cardiovascular diseases. The COVID-19 pandemic has also strengthened people’s awareness of personal health, which is one of the main reasons behind the aggressive development of the biopharmaceutical industry.

Impacted by the outbreak of COVID-19 pandemic, world geopolitical crisis, and global inflation, investment activity of healthcare has been slowed. Investors are more cautious about their investment decisions. Despite the cool down of the overall healthcare industry, biopharmaceutical sector remained resilient with 741 investments recorded in 2021. Total transaction value reached RMB204.8 billion, accounting for 53% of the healthcare industry.

Healthcare Industry Investment Breakdown

Healthcare Industry Investment Breakdown

Characteristics of the Biopharmaceutical Sector: High return comes with high risks

Biopharmaceutical is a typical capital-intensive and technology-intensive industry, characterized by high investment cost, long R&D period, low success rate and high risks.

  • High R&D investment cost: In 2021, the total R&D-to-revenue ratio for biopharmaceutical companies listed on the High-tech Board reached 59%, whereas the ratio for companies across all industries was merely 10%.
  • Long R&D period: The R&D of new drugs must go through three stages: drug discovery, preclinical research, and clinical trials. The process typically takes about 8-15 years.
  • Low success rate: Pharma Intelligence data shows that the probability of success from Phase I to Phase II clinic trial was 52%, Phase II to III was 28.9%, Phase III to NDA/BLA was 57.8%, and passing NDA/BLA was 90.6%.
  • High risk: the centralized procurement of drugs has greatly impeded drug company earnings. For example, the centralized procurement of insulin has resulted an average decline of price between 48% and 73% across 31 provinces that have adopted the policy.

New Drug Development Process

New drug development process

Source: Wuxi AppTec Prospectus, Colliers

Based on the above characteristics, pharmaceutical companies pose great importance to the R&D pipeline planning and try to avoid overly depending on the financial performance of one singular product. Therefore, the valuation of biopharmaceutical companies, especially the valuation of companies that have not yet generated revenue or achieved profitability, requires valuation professionals to make reasonable judgments on the prospects of the company's R&D pipeline while considering national medical policies and market demand.

The transformation of the valuation rationale of biopharmaceutical companies

Starting from 2020, the valuation of listed biopharmaceutical companies has declined affected by factors such as the expansion of centralized procurement of new drugs, the increased competition, etc. The declines of both price-earnings ratio and the price-to-book ratio reflect the equity market’s concerns over listed biopharmaceutical companies that are not yet profitable and still require large R&D investment.

The characteristics of biopharma industry also reflect on the valuation methodology. Compared with listed companies, non-listed biopharmaceutical companies are facing more uncertainties in the process of drug development. In order to ensure the safety of drugs, new drug development includes multiple stages such as lead, preclinical, clinical phase I-III, and review. The success of the previous stage affects the decision of the next stage. Putting that under consideration, we generally use the decision tree combined with the discounted cash flow method to value biopharmaceutical companies in the primary market.

What is a decision tree?

What is decision tree

In practice, the method of “decision tree-discounted cashflow” is the quantitative process of the future return and risks. The result of this methodology is largely influenced by the following key parameters:

  • Investment in innovative drug R&D, pharmaceutical factory construction, overall planning and operation of drug manufacturing
  • Number of targeted patients, overall prevalence of the disease and rate of willingness to receive the innovative drug treatment
  • Market penetration rate, recovery rate and medical expense per capita on annual basis
  • The earning period based on the uniqueness, exclusiveness and IP protection period
  • The quantified impact of centralized procurement of drugs on expected returns
  • The cost of marketing and promotion of innovative drugs

The valuation procedures are as follow:

  • Benchmark the first-year revenue to evaluate the terminal value of the drug related assets
  • Discount the terminal value by R&D development stage success rate to arrive the value as of the current valuation date
  • Sum the value of each individual drug or technology to obtain the corporate value

Future Outlook

Looking forward, more favorable policies are expected to promote clinical-oriented new drug R&D and encourage pharmaceutical companies to transform from “Fast-follow” to “First-in-class”. Industry-leading biopharmaceutical companies with genuine innovation and differentiated R&D pipelines are expected stand out. Meanwhile, the capital market has loosened the regulation and allows not-yet-profitable biotech companies to be listed on the HKEx and the High-tech Board. Companies with diverse R&D pipelines, sufficient funding, and remarkable clinical trial results will be able to achieve high valuations.


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