valuation issues in a changing environment
TRANSCRIPT
“Valuation Issues in a Changing Environment”
Bingham McCutchen, LLPLife Sciences Practice Group
Presentation By:
Brad Cashion, CFAManaging Director
The Mentor Group, Inc.Direct – (949) 297-4094
June 11, 2010
Agenda
My Goal is to briefly touch on several topics to provide enough information so that you know what questions to ask and what to look for in valuations.
• Trend in Valuation Multiples
• Valuation of Life Science Company Equity for Issuing Common Stock as Compensation
• Overview of Rates of Return for Life Science Companies based on the Stage of Development
Transaction MultiplesAll SIC Codes – Private Companies
Year Volume % Median Mean Increase EBITDA EBITDA
2006 10.1% 5.9x 20.35x2007 8.2% 4.9x 13.85x2008 11.7% 3.4x 12.77x2009 -58.1% 2.7x 11.78x2010 YTD n/a 4.9X 7.67x
Transaction MultiplesAll SIC Codes – Public Companies
Year Volume % Median Mean Increase EBITDA EBITDA
2006 6.3% 14.13x 25.77x2007 -3.7% 14.44x 28.86x2008 20.6% 16.24x 25.43x2009 -70.3% 12.41x 17.31x2010 YTD n/a 13.26x 34.33x
Transaction MultiplesLife Science – Private Companies
Year Volume % Median Increase EBITDA
2006 19.04% 6.66x
2007 -11.5% 5.88x2008 23.9% 9.30x2009 5.14% 7.30x2010 YTD n/a 11.45x
Transaction MultiplesMedical Devices – Private Companies
Year Volume % Median Increase EBITDA
2006 8.2% 7.42x
2007 -14.8% 6.86x2008 34.8% 6.83x2009 -67.7% 8.34x2010 YTD n/a 14.94x
Leverage Multiples
Year Low Median High Median EBITDA EBITDA
2006 4x 6x 2007 4x 6x2008 3x 5x2009 2x 4x
Current coverage ratio is 1.3x or greater. Lenders are looking at what the collateral is, how much liquidity the business has and the direction of cash flow.
Leverage may be higher based on the income statement if the balance sheet leverage is low, meaning there is significant liquidity
Valuation MethodologiesLife Science Companies
There are 3 methodologies utilized:
1. Income Approach – using projected cash flows discounted to present value.
2. Market Approach – using market transaction multiples
3. Cost Approach – not the best for Life Science companies
Life Science Company Rate of Return Based on StageStage of Development Average Rate of Return
Discovery Stage 80%Pre-clinical Stage 60%Phase I Clinical Trials 50%Phase II Clinical Trials 40%Phase III Clinical Trials 25%New Drug Application Stage 20% - 25%Product Launch Stage 15% - 20%
These are rates of return that are used to compute the present value of the projected cash flows. These returns can also be used to compute the reasonability of valuation multiples.
Rate of Return Based on AICPA Practice Aid for Pharmaceutical Companies
Stage of Development Avg. Rate of Return
Start Up 50% - 70%Early Development 40% - 60%Expansion 30% - 50%Bridge / IPO 20% - 35%
These are rates of return that are used to compute the present value of the projected cash flows. These returns can also be used to compute the reasonability of valuation multiples.
Significant milestones and stage of development play a key role in assessing risk and ultimately the required rate of return, which affects the value of the equity.
Four “equity allocation” methodologies
1. Current Method – allocates value to each class of equity without regard to the future growth of the equity.
2. Option Pricing Method – treats all equity classes as call options on the total enterprise value
3. Probability Weighted Expected Return Method (“PWERM”) – the value of each class of equity is determined based on several scenarios and a weighted average is computed
4. Back-Solve Method – utilizing the latest round of financing and “back solves” for the implied enterprise value
These are not valuation methods, but rather allocation methods for computing the value of different classes of equity
The AICPA Practice Aid – “Valuation of Privately Held Equity Securities Issued as Compensation”
Current Method
There are 2 times when this method is used:
1. A liquidity event is imminent2. The Company is at such an early stage of
development that:a. No material progress has been
made in the business planb. No significant common equity
value has been createdc. There is no reasonable basis for
estimating the amount and timing of future common value
Option Pricing Method
This method is best when:
1. Management is unable to reasonably estimate the Company’s future outcomes (IPO, M&A)
2. Potential outcomes can be estimated, but the value at future events cannot be estimated
3. The expected future outcomes are anticipated to follow a lognormal distribution
“PWERM ”
This method is best when:
1. Management is able to reasonably estimate the Company’s future outcomes
2. The value of the Company for each scenario can be reasonably estimated
3. The expected future outcomes are anticipated to follow a non-lognormal distribution with spikes & dips in value
Back Solve Method
This method is best when:
1. There has been a recent round of financing in another equity class that can be used as a referenced transaction to “back solve” for the implied equity value.
2. The valuation analyst is comfortable that the recent round of financing is sold at a market price.
Other Valuation Considerationsfor Life Science Companies
• Future rounds of financing and potential dilution
• When using the methodologies, is a discount for lack of marketability appropriate
• Discounts for Lack of Control have been discouraged by the SEC
Qualitative Considerations for Pharmaceutical Companies
• Pharmaceutical Cos are dependent on their marketing organizations to increase sales
• Regulators are concerned about marketing payments being made to persuade doctors to write prescriptions
• Frequently Pharma Cos engage the services of “physician leaders” who serve advisory roles to a target market
Qualitative Considerations for Medical Device Companies
• Regulators are focusing on the relationship between Medical Device Cos and doctors who promote the sale of product to make sure they are compliant with applicable laws
• However, the relationship between Medical Device Cos and doctors is essential for:
1. Product Design
2. Product Development
3. Research & Clinical Trials
4. Physician Training
5. Marketing
Regulatory Issues in the Life Science Sector: Anti-Kick Statutes & The Stark Law
Due to Government Regulations, valuations are frequently needed for:
• Management Service Contracts
• Reasonable Compensation
• Clinical Trail Arrangements
• Patient Data Sets
• Intellectual Property