Calling Biopharma Bankers—SOTP DCF and WACC Standards

When conducting a fully synergized SOTP DCF analysis for biopharma targets, especially for clinical-stage products, here are some key insights based on the most helpful WSO content:

1. Why Use the Buyer's WACC?

   • The buyer's WACC is typically used because, post-acquisition, the buyer's capital structure and risk profile govern the acquired asset. The cash flows of the target product are evaluated based on the buyer's risk-return profile and capital allocation strategy. This aligns with the buyer's perspective as the remaining entity post-transaction, ensuring consistency in valuation and decision-making.

2. When to Use the Target’s WACC?

   • While the buyer's WACC is standard, the target's WACC can be used as a sensitivity analysis tool. This approach helps highlight how the valuation might differ under the target's standalone risk profile. However, for intrinsic valuation exercises, the entity's own WACC (target's WACC) is often used to understand its standalone value, which can be useful for negotiation or understanding the seller's perspective.

3. Exclusion of Capex, Working Capital, and Interest Income/Expense:

   • For clinical-stage products, it is standard to exclude capex, working capital, and interest income/expense in the SOTP DCF. These items are often not directly attributable to the standalone product at this stage. Instead, the focus is on the product's cash flows, which are typically driven by R&D expenses, potential revenues, and other product-specific factors.

4. Biopharma-Specific Considerations:

   • Discount rates in biopharma are particularly tricky due to the unique risks associated with clinical-stage products. Traditional CAPM methods may not yield usable numbers, so investors often bucket companies or products by development stage and size, applying progressively lower discount rates to larger, more advanced companies or products.
   • For early-stage products, the valuation often hinges on the probability of success and market potential rather than steady-state financial metrics. This makes technical diligence and assumptions about success rates critical.

In summary, the buyer's WACC is the standard for post-acquisition valuation, reflecting the buyer's risk-return profile. The target's WACC is more of a sensitivity tool or used for standalone intrinsic valuation. Excluding capex, working capital, and interest-related items is common for clinical-stage products in SOTP DCFs, as these are not directly tied to the product's cash flows at this stage.

Sources: Biotech finance part 2: valuation methodologies and modeling considerations, Biotech finance part 2: valuation methodologies and modeling considerations, Corporate Development WACC Method, Highest valuation, LBO vs DCF - The final answer. Perspectives on special situations., Advice on recruiting for Rx groups Post-MBA