Valuation Issues in a Changing Environment

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Valuation Issues in a Changing Environment

  1. 1. “ Valuation Issues in a Changing Environment” <ul><li>Bingham McCutchen, LLP </li></ul><ul><li>Life Sciences Practice Group </li></ul><ul><li>Presentation By: </li></ul><ul><li>Brad Cashion, CFA </li></ul><ul><li>Managing Director </li></ul><ul><li>The Mentor Group, Inc. </li></ul><ul><li>Direct – (949) 297-4094 </li></ul><ul><li>[email_address] </li></ul><ul><li>June 11, 2010 </li></ul>
  2. 2. Agenda <ul><li>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. </li></ul><ul><li>Trend in Valuation Multiples </li></ul><ul><li>Valuation of Life Science Company Equity for Issuing Common Stock as Compensation </li></ul><ul><li>Overview of Rates of Return for Life Science Companies based on the Stage of Development </li></ul>
  3. 3. Transaction Multiples All SIC Codes – Private Companies <ul><li>Year Volume % Median Mean </li></ul><ul><li> Increase EBITDA EBITDA </li></ul><ul><li>2006 10.1% 5.9x 20.35x </li></ul><ul><li>2007 8.2% 4.9x 13.85x </li></ul><ul><li> 11.7% 3.4x 12.77x </li></ul><ul><li> -58.1% 2.7x 11.78x </li></ul><ul><li>YTD n/a 4.9X 7.67x </li></ul>
  4. 4. Transaction Multiples All SIC Codes – Public Companies <ul><li>Year Volume % Median Mean </li></ul><ul><li> Increase EBITDA EBITDA </li></ul><ul><li>2006 6.3% 14.13x 25.77x </li></ul><ul><li>2007 -3.7% 14.44x 28.86x </li></ul><ul><li> 20.6% 16.24x 25.43x </li></ul><ul><li> -70.3% 12.41x 17.31x </li></ul><ul><li>YTD n/a 13.26x 34.33x </li></ul>
  5. 5. Transaction Multiples Life Science – Private Companies <ul><li>Year Volume % Median </li></ul><ul><li> Increase EBITDA </li></ul><ul><li>2006 19.04% 6.66x </li></ul><ul><li>2007 -11.5% 5.88x </li></ul><ul><li> 23.9% 9.30x </li></ul><ul><li> 5.14% 7.30x </li></ul><ul><li>YTD n/a 11.45x </li></ul>
  6. 6. Transaction Multiples Medical Devices – Private Companies <ul><li>Year Volume % Median </li></ul><ul><li> Increase EBITDA </li></ul><ul><li>2006 8.2% 7.42x </li></ul><ul><li>2007 -14.8% 6.86x </li></ul><ul><li> 34.8% 6.83x </li></ul><ul><li> -67.7% 8.34x </li></ul><ul><li>YTD n/a 14.94x </li></ul>
  7. 7. Leverage Multiples <ul><li>Year Low Median High Median EBITDA EBITDA </li></ul><ul><li>2006 4x 6x </li></ul><ul><li>2007 4x 6x </li></ul><ul><li>2008 3x 5x </li></ul><ul><li>2009 2x 4x </li></ul><ul><li>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. </li></ul><ul><li>Leverage may be higher based on the income statement if the balance sheet leverage is low, meaning there is significant liquidity </li></ul>
  8. 8. Valuation Methodologies Life Science Companies <ul><li>There are 3 methodologies utilized: </li></ul><ul><li>Income Approach – using projected cash flows discounted to present value. </li></ul><ul><li>Market Approach – using market transaction multiples </li></ul><ul><li>Cost Approach – not the best for Life Science companies </li></ul>
  9. 9. Life Science Company Rate of Return Based on Stage <ul><li>Stage of Development Average Rate of Return </li></ul><ul><li>Discovery Stage 80% </li></ul><ul><li>Pre-clinical Stage 60% </li></ul><ul><li>Phase I Clinical Trials 50% </li></ul><ul><li>Phase II Clinical Trials 40% </li></ul><ul><li>Phase III Clinical Trials 25% </li></ul><ul><li>New Drug Application Stage 20% - 25% </li></ul><ul><li>Product Launch Stage 15% - 20% </li></ul><ul><li>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. </li></ul>
  10. 10. Rate of Return Based on AICPA Practice Aid for Pharmaceutical Companies <ul><li>Stage of Development Avg. Rate of Return </li></ul><ul><li>Start Up 50% - 70% </li></ul><ul><li>Early Development 40% - 60% </li></ul><ul><li>Expansion 30% - 50% </li></ul><ul><li>Bridge / IPO 20% - 35% </li></ul><ul><li>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. </li></ul><ul><li>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. </li></ul>
  11. 11. <ul><li>Four “equity allocation” methodologies </li></ul><ul><li>Current Method – allocates value to each class of equity without regard to the future growth of the equity. </li></ul><ul><li>2. Option Pricing Method – treats all equity classes as call options on the total enterprise value </li></ul><ul><li>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 </li></ul><ul><li>4. Back-Solve Method – utilizing the latest round of financing and “back solves” for the implied enterprise value </li></ul><ul><li>These are not valuation methods, but rather allocation methods for computing the value of different classes of equity </li></ul>The AICPA Practice Aid – “Valuation of Privately Held Equity Securities Issued as Compensation”
  12. 12. Current Method <ul><li>There are 2 times when this method is used: </li></ul><ul><li>A liquidity event is imminent </li></ul><ul><li>The Company is at such an early stage of development that: </li></ul><ul><li>a. No material progress has been made in the business plan </li></ul><ul><li>b. No significant common equity value has been created </li></ul><ul><li>c. There is no reasonable basis for estimating the amount and timing of future common value </li></ul>
  13. 13. Option Pricing Method <ul><li>This method is best when: </li></ul><ul><li>Management is unable to reasonably estimate the Company’s future outcomes (IPO, M&A) </li></ul><ul><li>Potential outcomes can be estimated, but the value at future events cannot be estimated </li></ul><ul><li>The expected future outcomes are anticipated to follow a lognormal distribution </li></ul>
  14. 14. “ PWERM ” <ul><li>This method is best when: </li></ul><ul><li>Management is able to reasonably estimate the Company’s future outcomes </li></ul><ul><li>The value of the Company for each scenario can be reasonably estimated </li></ul><ul><li>The expected future outcomes are anticipated to follow a non-lognormal distribution with spikes & dips in value </li></ul>
  15. 15. Back Solve Method <ul><li>This method is best when: </li></ul><ul><li>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. </li></ul><ul><li>The valuation analyst is comfortable that the recent round of financing is sold at a market price. </li></ul>
  16. 16. Other Valuation Considerations for Life Science Companies <ul><li>Future rounds of financing and potential dilution </li></ul><ul><li>When using the methodologies, is a discount for lack of marketability appropriate </li></ul><ul><li>Discounts for Lack of Control have been discouraged by the SEC </li></ul>
  17. 17. Qualitative Considerations for Pharmaceutical Companies <ul><li>Pharmaceutical Cos are dependent on their marketing organizations to increase sales </li></ul><ul><li>Regulators are concerned about marketing payments being made to persuade doctors to write prescriptions </li></ul><ul><li>Frequently Pharma Cos engage the services of “physician leaders” who serve advisory roles to a target market </li></ul>
  18. 18. Qualitative Considerations for Medical Device Companies <ul><li>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 </li></ul><ul><li>However, the relationship between Medical Device Cos and doctors is essential for: </li></ul><ul><li>1. Product Design </li></ul><ul><li>2. Product Development </li></ul><ul><li>3. Research & Clinical Trials </li></ul><ul><li>4. Physician Training </li></ul><ul><li>5. Marketing </li></ul>
  19. 19. Regulatory Issues in the Life Science Sector: Anti-Kick Statutes & The Stark Law <ul><li>Due to Government Regulations, valuations are frequently needed for: </li></ul><ul><li>Management Service Contracts </li></ul><ul><li>Reasonable Compensation </li></ul><ul><li>Clinical Trail Arrangements </li></ul><ul><li>Patient Data Sets </li></ul><ul><li>Intellectual Property </li></ul>

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