Valuing a biopharma (small cap)

[Alekbaylee]

How does one go about valuing a small biopharma?

Prometic Life Sciences (PLI.TO) has come under my radar lately with its promising drug pipeline for metabolic syndrome and type 2 diabetes which is a major problem in N.A. and elsewhere but I have no idea how to approach this sort of business with no real recurrent or predictable revenues.

Anyone care to give some advice?

Thanks

 

[tengen]

Back in the day before I decided biotech was too much of a crap shoot, I did something like the following:

 

For each drug in the pipeline:

1. Look at the market size

2. Estimate time to market based on the current stage

3. Discount back to get present value of drug and multiply by probability of success

4. Subtract development costs

 

The problem I ran into was being overoptimistic on the probability of success and the timeline for approval as the FDA made the process more and more difficult. If a company has never successfully taken a drug to market, I'd give very little value to drugs that haven't made it to stage 3 and be very cautious about drugs that might seem close to approval. Partnerships with major pharma aren't necessarily as positive as one might think.

 

To digress slightly, I still own one stock from my bad old biotech days, Tekmira Pharma. I first bought shares way back in 2000 and, after a few major wins and losses, I calculate that I have made an annual return of ... wait for it. .. 4.2% per year!

[rukawa]

I would value the pipeline at zero.

 

The way I approach things that are hard to value is that I don't. I focus on the things that are easy to value and then I want to get the hard, intangible, difficult to value stuff for free. The way I view value investing is that your valuation is all about your down side. You want a valuation based on well understood things with a margin of safety that will protect your down side. The other stuff is all icing.

 

If all you have is icing then I would stay away.

 

That said I have seen Seth Klarman invest in situations like this. I have no clue how he does it. But I don't think he is thinking of the companies as going concerns. He is thinking from an acquirers point of view. You may get information on this if you look at the proxy statements when these types of companies are acquired. It will give you some idea of how the investment banks pitching these deals value the companies.

[InelegantInvestor]

You need to look at cash position and burn rate. If they can't cover the cost of getting a drug to market you will get diluted or it won't get to market.

 

You want to see a pipeline with multiple promising candidates because you can't accurately predict which will ultimately be approved.  Management that has experience getting drugs through the approval process is a big deal.

 

Even after all that, I would advise buying in a basket to spread the risk.

[netnet]

If you know the pharma space, keep reading.  If not run for the hills.

 

With a pipeline you basically have a series of (basically) binary events through the approval process.  First question does the company have a way to get through phase 3 with cash and or a partnership?  So you have to analyze the probability of success. 

 

Second what is the disease that is the target. Orphan status? Unmet need? How big is the market and what is the competitive landscape, a me too product that is incrementally better is not too attractive.

 

Given the above, what is the burn rate versus cash on hand?  Now a dilution is not the end of the world, but you have to be careful, as inelegant said, you also want a management that has done this before, so (hopefully) has an intelligent plan. 

 

How does Mr. Market look at the company?  If the company is a 5x on approval but only has a 10% chance, the expected value is only .5, i.e. you still need a margin of safety, if you could call it that!

 

You also have to think of this as very minor part of your portfolio.

 

Lastly, do you know of any great drug company investors?

[constructive]

Drug companies have been on fire the last 4 years. The biotech index has almost quadrupled, the majority coming from higher multiples, not earnings. From a macro perspective now is definitely not the time to be thinking about buying small cap pharma companies.

[Alekbaylee]

Thanks for the insight guys!

I'm gonna put this in the too hard pile as I realize that on top of my lack of knowledge in valuing this type of business, I'd need to understand -at least broadly- bioscience to assess its prospects.

The pipeline looked really great, but c'est la vie!

[InelegantInvestor]

With that particular stock, management seemed promotional(which may be why the pipeline looked great).  Things like liquidity and burn rate were not easily found, if at all, in earnings press releases.  Pipeline is years away from approval. Definitely in too hard pile, IMO.

[oddballstocks]

 

Lastly, do you know of any great drug company investors?

 

This is a great comment, lots to think about here.  I'm say that there aren't any great passive drug company investors.  Which probably means that the only way to be successful in this space is to have non-public information.

 

Drug companies are great drug company investors.  The big pharma companies have successful track records of creating/buying new drugs and brining them to market.  It seems two factors are needed for that, a LOT of cash, and a stable of experts at your disposal. 

 

My guess is that to correctly ascertain whether a drug has a chance you need to conduct a non-public due diligence phase.  An acquiring drug company can sign a non-disclosure and have access to the researchers developing the drug as well as all projections.  They can fact check what the company is saying with internal resources.  Outside investors save the largest ones just can't do this.

 

There might be some very specialized hedge funds or venture fund that can do this.  I met someone in Pittsburgh who had a venture capital fund dedicated to a very specific type of drug.  The fund was partially owned by a hospital system and he had the resources of a research department that specialized in this drug to screen candidate companies.

 

I think biotech is similar to distressed debt investing.  They are both segments of the market inaccessible to investors without significant capital or expertise.

[Alekbaylee]

Could have made a quick buck: 40% up in a month or so.

Oh well, too bad!

[Guest Schwab711]

 

Lastly, do you know of any great drug company investors?

 

This is a great comment, lots to think about here.  I'm say that there aren't any great passive drug company investors.  Which probably means that the only way to be successful in this space is to have non-public information.

 

Drug companies are great drug company investors.  The big pharma companies have successful track records of creating/buying new drugs and brining them to market.  It seems two factors are needed for that, a LOT of cash, and a stable of experts at your disposal. 

 

My guess is that to correctly ascertain whether a drug has a chance you need to conduct a non-public due diligence phase.  An acquiring drug company can sign a non-disclosure and have access to the researchers developing the drug as well as all projections.  They can fact check what the company is saying with internal resources.  Outside investors save the largest ones just can't do this.

 

There might be some very specialized hedge funds or venture fund that can do this.  I met someone in Pittsburgh who had a venture capital fund dedicated to a very specific type of drug.  The fund was partially owned by a hospital system and he had the resources of a research department that specialized in this drug to screen candidate companies.

 

I think biotech is similar to distressed debt investing.  They are both segments of the market inaccessible to investors without significant capital or expertise.

 

I was also taken back by the line, very interesting view. All I can think of is Klarman. The more I think about it he probably does use a team of experts.

 

Either way, I've actually had some success with biotechs in the past (even though each time I tell myself to avoid them).

 

QCOR (http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/qcor-questcor-pharmaceuticals/msg162673/) was my smallest of 4 positions for most of the 2 years prior to the merger. I also did well with a small bio-tech whose drug was approved in 25 countries throughout the world and the equity owned exclusive rights to the US market. Maybe someone will remember it (ticker was something like YBI or YPI?). They ended up getting approval and were bought out at 5x my price (I made a couple hundred dollars!). Overall though, I usually see carnage.

 

This is somewhat depressing to look at because some have gone up so much in 2 weeks but I found a bunch of small-caps with orphan status to follow them. I didn't see obvious value in any of them but I'm interested to hear what others think. These all seem like excellent buyout opportunities and possibly too small for Klarman's of the world. I really like the idea of a basket of orphan drug companies. Anyone want to start an orphan thread?

 

CANF, OMER, BSTC, POZN, ONCY, ARRY. I probably won't invest in any (ARRY is well known anyway) so hopefully someone gets use out of these. There are definitely some great healthcare companies out there though, whether biotechs or devices.

[jawn619]

Back in the day before I decided biotech was too much of a crap shoot, I did something like the following:

 

For each drug in the pipeline:

1. Look at the market size

2. Estimate time to market based on the current stage

3. Discount back to get present value of drug and multiply by probability of success

4. Subtract development costs

 

The problem I ran into was being overoptimistic on the probability of success and the timeline for approval as the FDA made the process more and more difficult. If a company has never successfully taken a drug to market, I'd give very little value to drugs that haven't made it to stage 3 and be very cautious about drugs that might seem close to approval. Partnerships with major pharma aren't necessarily as positive as one might think.

 

To digress slightly, I still own one stock from my bad old biotech days, Tekmira Pharma. I first bought shares way back in 2000 and, after a few major wins and losses, I calculate that I have made an annual return of ... wait for it. .. 4.2% per year!

 

I agree that this is the right way to do it. The difficulty usually is in #3. calculating the probability of phase 1, 2, and 3 trials accurately is something very few people can do accurately. Almost all of them would have to have some technical knowledge and credentials. For the layperson to say I think it has 40% chance to pass phase 2 is near impossible. After it get's approval, the drug has to do well and predicting that accurate is difficult in it's own right.