■This article is from Fudan Financial Review
■Author: Huang Xiaoling, Valuation Partner, Transaction Advisory Group, PricewaterhouseCoopers
Huang Xiaoling
Valuation Partner, Transaction Advisory Group, PricewaterhouseCoopers
It's the one-year anniversary of the opening of the Science and Technology Innovation Board (STB), a milestone moment in the history of China's capital markets. milestone in the history of China's capital market. The success of the board reflects the enthusiasm of the capital market in embracing "hard science and technology" companies, and the power of biopharmaceutical companies among the many companies that have landed on the board should not be underestimated. In the context of encouraging innovation, biomedical enterprises that do not yet have revenues can choose to list on the fifth set of criteria to realize the docking with the capital market and help their own development.
Biomedical enterprise valuation "high start high hit"
Into 2020, in the new crown pneumonia epidemic global pandemic background, the health care industry's counter-cyclical characteristics highlight, once again become the market focus. Among them, the new crown pneumonia vaccine research and development and the related vaccine industry plate is the biomedical plate in the important sub-panel is expected. The birth of new vaccine varieties is an important driving force of the vaccine plate, and the birth of new heavyweight varieties are often closely linked with the need to curb the prevention and treatment of fast-spreading, harmful diseases. Since 2020, the world has started a time trial for the development of a new crown pneumonia vaccine. According to data released by the World Health Organization (WHO), as of August 6, 2020, six vaccine varieties have begun to lay out Phase III clinical trials, three of which are from China.
The process of the development of the new crown pneumonia vaccine has also touched the volatility of the capital market. According to the China Vaccine Industry Association in February 2020 released public information, China has 18 companies are carrying out the development of the new crown pneumonia vaccine, which has a number of listed companies. It is worth noting that the overall pharmaceutical sector has seen valuation increases in the wake of the outbreak, with the valuation of listed companies related to the R&D of the new coronavirus vaccine rising particularly significantly. Some of the above listed companies involved in the research and development of the new crown pneumonia vaccine price-to-sales ratio multiples (i.e., share price / revenue per share) as an indicator, you can see that their valuation levels before and after the outbreak of different ranges of increase (Figure 1), fully reflecting the capital market on the new crown pneumonia vaccine research and development process and the commercialization of the huge market expectations.
Note 1: Data samples are sourced from S&P Capital IQ and PricewaterhouseCoopers analysis
Note 2: The data analysis point is December 31, 2019 and June 30, 2020
Figure 1 Changes in the market-to-sales ratio of some listed companies involved in the research and development of the New Crown Pneumonia vaccine
Looking globally, while the several large international While several international giants continue to lead the market, vaccine research and development enterprises in the direction of biotechnology, represented by Moderna, are also expected by the market on the path of research and development of the new coronary pneumonia vaccine with its development of new technology paths such as mRNA vaccines. Comparing the size and price-to-sales multiples of these companies, we can find an interesting phenomenon: Both in the domestic and international capital markets, many emerging vaccine research and development companies, although the current revenue scale is small, but the market still gives a very high valuation level. This also caused a new market thinking: how to understand this up to hundreds of times the price-to-sales ratio? In the face of the booming biopharmaceutical industry, how to grasp the reasonable investment value? How will the business decisions of enterprises affect the valuation?
Note 1: Data samples are from Wind database, S&P Capital IQ, and PricewaterhouseCoopers analysis
Note 2: Data analysis point is June 30, 2020
Chart 2: Domestic and foreign emerging vaccine research and development companies generally have high valuations
The author believes that the phenomenon of such high valuation multiples is due to the fact that the market adopts market value, which is the highest in the world, as well as the highest in China. "future-proofing". This forward-looking valuation perspective has broken through the traditional valuation system, reflecting the capital market's high degree of inclusiveness towards companies with "high science and innovation" attributes and the market's encouragement for science and innovation-oriented innovative companies to raise capital through IPOs. Therefore, if the traditional price-to-sales multiple is used to measure the valuation level under the new perspective, the multiple will be "extremely high". At the same time, high valuations are associated with high volatility, and every step of a company's development is tied to its valuation level.
Returning to the origin of the value of biopharmaceutical companies
How to look at the valuation of biopharmaceutical companies? First of all, it is important to understand that "valuation" is the market value, and capital market data will provide very important clues and information. A good valuation is one that can stand the test of the capital market, and at the same time the volatility of the capital market itself will convey important market expectations and attitudes. When something new appears in the market, different market participants often have different attitudes. It is like how to look at a half filled bottle of water, some observers see the full half and others see the empty half, different people have different views. This in itself reflects the systematic, complex, and forward-looking nature of valuation, and challenges the market acumen, industry accumulation, professional judgment, and valuation experience of valuers.
The process of valuation is a cocooning process, but also a process of beginning with the end. Valuation cannot be separated from exploring the industry characteristics of the valuation object. Take the biopharmaceutical industry as an example, enterprises in the industry generally have a long research and development cycle, huge investment in the early stage and the economic return is concentrated in the later stage, etc., in the research and development stage requires a lot of financial support, and the product is almost impossible to generate revenue before being approved for marketing. Therefore, biopharmaceuticals is a high-input and high-risk industry. Corresponding to the high investment and high risk is the high value at the end of the process and the milestone value growth model in the process. As we all know, new products have to go through a long and arduous journey from R&D to market. In the journey of preclinical trials, clinical phase I, clinical phase II, clinical phase III, and marketing application, the value of the pipeline will have milestone growth with each new stage.
How to grasp the value drivers of a biopharmaceutical company, the author believes can be summarized in the following six points:
First, the pipeline in R&D - in which track. The products and pipeline in development are the core of a biopharmaceutical company's value. The number of pipelines, the corresponding indications, and the related intellectual property protection are the core guarantee factors for valuation, and have been the subject of great attention from the capital market.
Second, the market capacity - how high is the ceiling.
Market capacity determines the ceiling of valuation, and is an important consideration when deciding on the strategic layout of the R&D pipeline, as the value of the pipeline is ultimately realized through the commercialization of the product. After a new drug is launched, the indication area, the number of patient groups, and the awareness and treatment rate of the drug determine the overall market capacity of the product, while the market competition pattern and the ability to reach patients affect the market penetration rate of the product, which ultimately determines the final sales scale of the drug as well as the sales revenue curve.
Third, the cost of R&D - how much it costs. R&D is the engine of a biopharmaceutical company, and clinical trials are the most expensive part of a new drug's development process, so the level of R&D costs can reflect the R&D process to a certain extent. But at the same time, the level of R&D costs is also related to R&D efficiency, and the more efficient the R&D, the higher the value of the company.
Fourth, the success rate of R&D - what is the return on investment.
The value of a biopharmaceutical company is affected by the R&D status of each pipeline and the R&D success rate. There are structural differences in the R&D success rates of pipelines at different stages of development and with different indications. The R&D success rate is also different between China and the international market, and the R&D success rate needs to be carefully analyzed in light of the national situation, the specifics of the pipeline, and the degree of innovation.
Fifth, timing - when to get paid. The important time nodes are in the R&D and commercialization phases, which involve many considerations such as indications, clinical cycles, approval and launch processes, and commercialization strategies. From a valuation perspective, for pipelines in the early R&D stage, the later the time node, the closer to the commercialization stage, the higher the corresponding value. For pipelines that have been successfully commercialized, how long it takes to reach peak sales and the trend of the sales curve after reaching the peak has a direct impact on the valuation level.
Sixth, the business model - how value is distributed.
Sixth, how the value is distributed. The essential impact on valuation is the distribution mechanism of value. Under the entrusted authorization model, the source of income of biotechnology companies is mainly for the authorization fee, milestone payments, sales share of income, etc., while in the independent production and sales model, the valuation is more important to the company's commercialization ability, including whether it has a mature sales team and sales channels, and whether it has a wealth of experience in marketing. Enterprises need to decide which business model to adopt based on their different competitive advantages, market positioning and pioneering capabilities, and conduct multi-dimensional and multi-scenario analysis based on the valuation model for business decision-making.
Exploring the Chinese path of valuation techniques in the biopharmaceutical industry
Due to the characteristics of biopharmaceutical companies such as the large differences in the pipeline mentioned above, huge upfront investment, and a long time span, the valuation techniques applied to them are fundamentally different from those of traditional industries, and therefore the valuation of biopharmaceutical companies should be long term and based on foresight.
Measuring economic value is the core of valuation. There are two dimensions to consider when exploring economic value: the scientific perspective and the commercial perspective. The scientific perspective includes key factors such as indications, patient numbers, awareness, and consultation rates; the commercial perspective is also known as the commercialization strategy, which includes important factors such as product pricing, the competitive environment, the life cycle, and health insurance policies. The valuation work is also about taking the disease model, business model and the key elements they involve together and converting them into an economic language that investors and the capital markets understand, resulting in a valuation model.
Figure 3 Valuation model for a biopharmaceutical company
The specific application of valuation methodology can be explored through both relative and absolute valuation approaches. Focusing on the valuation methods applicable to biopharmaceutical companies, international valuation practice has applied methods under both approaches.
Figure 4 Valuation methods for biopharmaceutical companies
On the one hand, the relative valuation method is a "market-focused" valuation method, which requires the establishment of a reasonable reference.
The recent financing method can reflect the valuation level of biopharmaceutical companies to a certain extent within a certain period of time, and at the same time, it can be a good way to show and track the magnitude of valuation changes; the comparable transaction case method or the method of comparable listed companies is more suitable for more mature companies, and the commonly used benchmark multiples include the market price ratio, the price-to-earnings ratio, etc.; the growth of biopharmaceutical companies still relying on financing to support the drug research and development may not be able to directly apply the method of relative valuation. Biopharmaceutical companies may not be able to directly use financial indicators for benchmarking analysis, and need to further decode the analysis from the perspective of core business elements and corporate development milestones.
On the other hand, the absolute valuation method is a "modeling" valuation approach, which measures the "intrinsic" value of pipeline products through the establishment of valuation models.
In order to reflect the long research and development cycle of biopharmaceutical companies, short-term unprofitability and other characteristics, based on the project risk modified discounted cash flow valuation method and discounted peak sales method has become the most commonly used methods in this industry.
The basic idea of using discounted project risk-based cash flow valuation is to introduce the key variable of R&D success rate on top of the traditional discounted cash flow method to make valuation adjustments. This approach is rigorous and detailed, taking into account the fact that there is a certain probability of failure risk at each stage of R&D, the need to differentiate between products, differentiate between R&D phases, and consider the applicable risk modification for each R&D phase, as well as considering the basis for the risk modification based on the nature of the different cash flows of the product pipeline tier and the overall enterprise tier.
The discounted peak sales approach is a "highly condensed" valuation methodology that has emerged in practice, which focuses on four key variables of the product pipeline: time to peak sales, required rate of return, peak revenue, and peak revenue multiple. This approach still adheres to the "connotation" valuation idea, but the practical level is easier to practice than the discounted cash flow valuation method, but also to a certain extent borrowed from the idea of relative valuation method, in practice has a very broad application prospects.
Figure 5: Operational steps of the discounted peak sales method
Meanwhile, in more and more local Chinese valuation practices, the market capitalization / R&D cost multiples have been gradually introduced. In the case of a biopharmaceutical company that focuses on innovation and R&D, and has a clear expectation of future sales, but whose financial indicators such as revenues, profits, and cash flows do not reflect the scale of its future expectations, the R&D costs reflect to a certain extent the value of the biopharmaceutical company's investment in and accumulation of R&D as the "engine" of the company's value. The application of such valuation multiples also belongs to the scope of the relative valuation method, with certain Chinese characteristics, and the market is also discussing and exploring the positive relationship between the accumulation of R&D costs and the growth of enterprise value, as well as the basis for the application of this method. For example, the accounting treatment of capitalization or expensing of R&D costs in the financial treatment itself needs to be fully considered in the valuation process.
In the author's opinion, there is still a gap between the overall experience of domestic biopharmaceutical companies in valuation, the maturity of the capital market itself, and the international market, but the speed of development should not be underestimated. The listing boom of biopharmaceutical companies to promote the entire Chinese valuation of the technical development of the community, at the same time the valuation of the community itself also need to take into full account the impact of the Chinese local environment, to create a new methodology, new ideas applicable to the local environment in China. The origin of valuation is to seek truth from facts and fully reflect market data and market participants' judgment on future expectations. The biopharmaceutical enterprise industry itself is a long-term, patient industry, and the path of valuation enhancement cannot be separated from the development milestones, the realizability of future economic benefits, and the risk and cost factors of realizing those economic benefits.
Timing the situation and embracing the capital market
Biomedical enterprises have a long research and development cycle and high risk of capital investment, so financing channels have become a major difficulty in the development of enterprises. Like all "hard technology" companies in the development period, biopharmaceutical companies need capital to realize their rapid development, but also need to choose the appropriate financing channels according to their own development stage and characteristics.
Figure 6: Development and Financing Stages of Biopharmaceutical Enterprises
Since the launch of the Science and Innovation Board (SIG), the biopharmaceutical industry has benefited greatly. As of August 17, 2020, among the 163 listed Sci-Tech Board companies, the number of biopharmaceutical companies reached 26, accounting for more than 15% of the market value.
The launch of the Techchina board has provided biopharmaceutical companies with an important financing channel, and has also boosted the overall valuation of the biopharmaceutical sector in the A-share market, especially providing a valuation anchor for companies that do not yet have a mature product, and has also improved market liquidity.
At the same time, the market has also seen the return of Hong Kong stocks to the market of the Science and Technology Board (STB), and the phenomenon of STB-listed companies going public in Hong Kong. One more financing channel for companies is more ammunition in reserve to support more research and development. Whether listing and financing in both places will be considered by the market as the standard for biopharmaceutical companies to go public, we will wait and see. It is foreseeable that in the future, with the continued opening up of the Science and Innovation Board (SIG) and the provision of listing options for multiple types of enterprises, a more open VC environment and other innovative financial products will bring more financing options to biopharmaceutical companies, helping them to seize the development opportunities given by the times.
Looking forward to the economic development prospects in the post epidemic era, under the new development pattern of a domestic macrocycle as the main body and a domestic and international double cycle that promotes each other, domestic demand is expected, in which the biopharmaceutical industry is not only the hand that creates a new impetus for economic growth, but also the unswervingly implementation of scientific and technological innovation in an important direction.
"Never waste any crisis" - for the biopharmaceutical industry, the epidemic test is both a challenge and an opportunity. In the context of the overall volatility of the market rise, biopharmaceutical companies, especially the vaccine, diagnostic and therapeutic sectors related to the new crown pneumonia epidemic valuation levels appeared a new round of upward. Biomedical enterprises are favored by the capital market while the capital market also has high expectations for biomedical enterprises. Facing the wave of the times, biopharmaceutical companies need to understand value from the perspective of the capital market, show value, enhance value, base on China, layout the global, take the product pipeline as the core, refine the value factors, establish the valuation perspective from the perspective of business logic and strategic decision-making, optimize the development strategy, enhance the innovation ability, so as to seize the opportunity of the times and create value for the society.
On the other hand, under the environment of the Science and Innovation Board (SIC), which is favorable to the hard science and technology industry, including biomedicine, it is important to recognize the characteristics of the biotechnology industry and adopt tailor-made valuation techniques to help the capital market deepen the valuation of the industry, and to help enterprises optimize their decision-making on the road to growth and accelerate their development. It is an important professional role for valuation consultants to be at the forefront of the industry. As a leader in the capital market at home and abroad, PwC is willing to base on the regulations, standards and practices of China's capital market, make full use of the industry experience and data accumulated at home and abroad, and play an active role in the valuation and pricing of the companies on the SGX-STEM board through its professional transaction and valuation services, and contribute its expertise to the outstanding Chinese biopharmaceutical companies running on the road of rapid development.
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