Life Sciences Sector June Webinar:
Valuation of Investments in Medical Devices and Pharmaceutical Products
Jason Hall, PhD, CFA
Director of Cardinal Economics & Finance and Lecturer in Finance
University of Michigan
Jason Hall provides advice on issues of valuation, risk & return, litigation support and regulation. His work applies across industries including medical devices, pharmaceuticals, auto parts, mining, oil & gas, fast food, and energy.
Jason has expertise in valuation of projects, listed and unlisted shares, options, and intangible assets; analysis of the risks and expected returns of projects and portfolios; and estimating the probability of default. His advice has been relied upon by corporations in the United States, Australia and Singapore, the pricing regulator in Sydney, the New South Wales Treasury, the Australian Competition Tribunal and the Australian Taxation Office.
Tuesday, June 27, 2017
1:00 - 2:00 p.m. (Eastern)
12:00 - 1:00 p.m. (Central)
11:00 - 12:00 p.m. (Mountain)
10:00 - 11:00 a.m. (Pacific)
Investments in medical devices and pharmaceutical products have particular characteristics – they are multi-stage projects and have low probability of success, yet the potential payoffs if success occurs are very high. These characteristics make them risky bets. But the risk is often overstated which leads to valuations that are too low.
Why is the risk overstated? Because at each stage of investment the business learns two things. It receives new information about the odds of future success, and gains insights into alternative, valuable uses for its research. This means that at each stage the business has the option to change the nature of its investment. It can abandon development before spending huge amounts of capital, or take the project in a different and more valuable direction.
The appropriate way to handle projects with these features is real options analysis. An investment in research creates a package of options that executives can exercise at later stages. The options de-risk the investment, in contrast to an alternative project that has high up-front costs and is irreversible.
The options embedded in an investment in medical devices or pharmaceutical products has implications for contract design and royalty rates. The more options embedded in the project, the more valuable is the intellectual property, so the licensee of IP should ensure that the licensee can exploit the IP’s full potential under the contract. Royalty rates reflect three things – the value of the IP, the exclusivity of the agreement and the relative bargaining status of the licensee and licensor. The latter two features essentially allocate value amongst the contracting parties. But a necessary first step is to ensure that we understand the value of the IP.
The difference between valuable options and risk. If a project has uncertain outcomes and the investment is irreversible, that uncertainty represents risk. If an investment has uncertain outcomes but we can change the nature of the project as new information comes to light, risk is lower and value is higher.
How to estimate value for an investment in which there are multiple stages and there are options to change the nature of project at each stage.
How this particular idea applies to investments in medical devices and pharmaceutical products, which at the outset have low chance of success but have very high payoffs if success occurs due to their large markets which and economies of scale.