Interview Question - Healthcare IB

Happy to help on this and any other questions you may have on HC banking and technicals.

For comps and precedents, you would look at EV / Peak Sales multiples. These multiples can be PTRS (probability of technical success) adjusted or un-adjusted. Typically, you can look at un-adjusted peak sales multiples if your comps/precedents lists include similar companies, i.e. the risk of those companies is similar to the risk of the company you are examining. If your list includes a variety of companies with different risk profiles, you would need to probability-adjust the peak sales data, i.e. your target is a Phase I or II company but your comps/precedents include companies that are Phase III or NDA filed.

For the DCF, there are two primary ways you can look at a biotech company. The first, and more "traditional" is a run-off DCF that includes a forecast period that extends through the patent expiry of your company's product(s). Say this translates into a 20 or 25-year DCF, which captures the patent expiry of the company's product(s). Depending on the type of drugs (e.g., biologic, small molecule) you'll likely have different erosion curves following LOE, which also may affect how you view terminal value. For instance, say you have a product that isn't likely going to face a ton of generic competition upon LOE. If that's the case, your erosion following the "patent cliff" may only be 25-30% annual revenue decline. If your forecast captures 2-3 years of that decline, you may elect to use a TGR of ~-25% through perpetuity. If you are expecting a product to have a lot of generic competition, the erosion might be more severe, say 50% annual decline, which may result in you electing to use a ~-50% TGR. In practice, some clients in buy-side M&A engagements instruct banks to conduct a lead-asset valuation through patent expiry and simply not include terminal value. An example of this may be a DCF analysis through 2030 where your product(s) lose exclusivity in ~2027 and you don't include any terminal value. You'll capture some of the erosion through 2030, but you won't assign any additional value to a terminal value (granted at that point a TV at a -50% TGR would be minimal anyway). I don't have the link readily available, but Deloitte has a great analysis of what typical erosion looks like for small molecule products.

The other methodology you may use in conducting an intrinsic valuation of a biotech company is consider valuing the company on a "going concern" basis. The basis of this methodology is to capture any potential "platform" value the company may have due to its potential for additional drug discovery. What does this mean in actual practice as a banker? Basically, you look at a shorter forecast period (perhaps a 10 year DCF instead of a 20 year), increase R&D spend to reflect an ongoing investment in the business (as oppose to a product-specific R&D forecast that includes spend to get product(s) through clinical trials and minimal R&D maintenance spend following launch), and a positive terminal growth grate (nothing ridiculous, I am talking less than 5% here). The goal? You get a value that is reasonably higher (not absurdly higher) than your product run-off DCF, which reflects the potential value in the company's platform beyond it's existing clinical assets (run-off asset DCFs do not include assets that have not entered the clinic given how early-stage they are).

As mentioned above already, when valuing biotech assets that are pre-commercial, you need to risk-adjust your cash flows. There are a TON of publications available (e.g. Nature Review, DiMasi, etc.) that benchmark the likelihood of success for all types of drugs at every stage. Depending on the company you are valuing, you may consider using data based on oncology products only (to be even more specific, solid or liquid tumor), CNS drugs, rare disease drugs, etc. People have cut this type of data all sorts of ways that give you the benefit of considering different options for your analysis. From my experience, there is no universal best-practice to risk-adjusting cash flows -- I have seen other banks perform this analysis different ways. The way I think about it (or rather, my group) is looking at the cumulative probability of success and how that evolves over time. It's hard to illustrate that point without a simple spreadsheet, but it essentially means in the early years of your forecast you would multiply your pre-commercial costs by a higher PTRS than the later years once the product launches. Example: product is currently in phase 2, so say the first 2 years your risk-adjustment is 100% (because the product is already in the trial and you're going to spend all that money no matter what until you get the results), then the risk-adjustment drops to 70% for phase 3 (because there is a 70% chance of getting from phase 2 to phase 3), then drops to 35% because there is a 50% chance to getting from phase 3 to NDA filing, and then drops to 32% because there is a 90% chance from getting to approval from NDA filing. Thus, you have you pre-commercial years of your forecast being risk-adjusted at higher percentages than your long-term forecast once the product launches (starting in year of approval, all of your cash flows would be risk-adjusted at a 32% PTRS).