Pipelines and R & D

The effect of drugs that have not been approved on valuation is difficult to assess. The pipeline is critical, but difficult to value:

  • the risk of not getting approval in a major market is difficult to assess without technical knowledge,
  • the effectiveness of drugs is also better assessed by someone is technical knowledge,

This why many sell side analysts covering pharmaceuticals have academic qualifications in medicine or biochemistry.

In many cases investors can make use of sell side research, companies own estimates (which are obviously biased, but nonetheless useful), and other sources to assess the potential revenues a particular drug may bring. If not, basic factors include:

  • the market size (e.g. how many people have the disease in question),
  • effectiveness compared to existing drugs and treatments,
  • cost of existing drugs and treatments,
  • the market share the company already has in that segment: e.g. predecessor drugs and drugs sold by the same specialist sales force,
  • risks to approval.

Where a pharma plans to license out a drug, this needs to be taken into account when modelling revenues.

The early stage pipeline is clearly the hardest part to value, and also often the most valuable part, especially for start-ups and high growth businesses. Beyond this is the vital question of how good a company is at adding new drugs to its pipeline. Many companies, especially those that specialise in a particular area have a search platform that allows them to (hopefully) produce a stream of new products to add to the early stage pipeline. This may consist of any, or a combination of, many things, including:

  • a unique technology,
  • databases (especially in areas such as genomics) and other information systems,
  • know-how, people, and the other general elements of successful R & D.

In general, the best indicator of a good research platform, or a strong R & D function is a good track record of adding new drugs to the early stage pipeline. Beware that some drugs may simply be licensed while still at an early stage, rather than developed in-house.

It is not just the quantity of new drugs that are added to the early stage that are indicators of strong R & D. The originality of the drugs matters as well: are they mere variants or reformulations of existing drugs, or completely new? A rough measure for small molecule drugs is the number of new chemical entities discovered relative to R & D spend.

One final word of caution: important as R & D is, it is not everything. Sales is just as important, and a company with strong sales and weak R & D might well be able to compensate for the latter through licensing in-drugs. Conversely, companies with good R & D and weak sales have to share revenues by licensing out drugs. In addition, business models vary, for example, a company may well specialise in an area that is profitable without a large number of new drugs.

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