The Business Development and Financial Reporting Relationship: Forecasting and its Impact on the M&A and Purchase Accounting Process

Transcription

1 The Business Development and Financial Reporting Relationship: Forecasting and its Impact on the M&A and Purchase Accounting Process March 18,

2 Introductions Christine Zeikel Camron Uhr John Phillips Principal 100 Kimball Drive Parsippany, NJ Office (973) Senior Manager 695 Town Center Drive Costa Mesa, CA Office (714) Director 100 Kimball Drive Parsippany, NJ Office (973)

3 Agenda Topic Key Points Deloitte s Corporate Development Survey: M&A Professionals Thoughts on Forecasting Perspectives around forecasting from M&A professionals POV Top reasons deals fail to meet expectations Top reasons deals meet expectations Inferences on how communication between stakeholders in the M&A process is key Early stage forecasting Forecasting revenues and the associated difficulties How introducing rigor and models to the process can improve results Framing, defining value drivers, and quantitative analysis to interpret forecasts for better decision making Critical forecast assumptions and their impact on intangible asset valuations Typical intangibles valued in pharma / biotech acquisitions Key assumptions that can influence the level of goodwill and annual amortization in a transaction Coordination between the business development team, business unit management, and accounting and finance to evaluate impact of deal 3

4 Deloitte s Corporate Development Survey M&A Professionals Thoughts on Forecasting 4

5 Corporate Development Survey Survey Details What it is Each year hundreds of executives involved in the M&A process get surveyed on questions and issued related to the M&A process. The focus of the survey is on process, how various groups interact with each other, decision makers / drivers, and largest contributors to success or failure in M&A transactions Latest survey had over 400 respondents - 60 of which were from life science and healthcare companies ( LS&HC ) Primary Industry 1% Business & Professional Services Annual Revenues of LS&HC Respondents 14% 19% 16% 11% 8% 31% Consumer & Industrial Products Energy & Resources Financial Services Life Sciences & Health Care Technolgy, Media & Telecommunications 69% 31% 19% 66% $10B+ $5B - <$10B $1B - <$5B <$1B Who responds Corporate development teams CEOs CFOs Controllers / Finance professionals Boards of directors Others 7% 17% 7% CEO/President CFO 4% Head of corporate development/m&a 10% 8% 28% Corporate development/m&a executive Corporate development/m&a staff Controller/finance Board director Other 19% 5

6 Corporate Development Survey Results How would you rate the efficiency of your company s M&A approval process? 49% 57% 19% 12% 25% 28% 7% 3% Excellent Good Fair Poor All Responses LS&HC During the next 2 years, do you expect the average number of deals that your company pursues in a typical year will increase or decrease? 49% 54% 43% 37% 8% 8% Increase Stay the same Decrease All Responses LS&HC 6

7 Corporate Development Survey Results How confident are you in the accuracy of financial forecasts that underlie your company s deal decisions? 67% 71% 25% 22% 8% 7% Very confident Somewhat confident Not confident All Responses LS&HC Who has primary responsibility for developing your company s M&A business case forecast? 41% 31% 27% 21% 14% 15% 7% 3% 12% 15% 3% 2% 1% 2% 2% 3% Corporate development Finance CEO CFO Business unit management Marketing/Sales External advisors Other 7

8 Corporate Development Survey Results Have you observed a consistent pattern in the accuracy of your company s forecasts? 43% 45% 26% 23% 20% 15% 11% 17% No discernible pattern Cash flow typically overstated Consistently accurate All Responses LS&HC Cash flow typically understated What is the greatest positive contributor to your company s M&A business case forecast quality? 39% 30% 30% 27% 25% 20% 18% 9% 1% 2% Comprehensive identification and understanding of key value drivers Experienced people responsible for forecast M&A targets that are very similar to core business All Responses LS&HC Honesty and objectivity of forecast assumptions Other 8

9 Corporate Development Survey Results Primary Reason Deals: Fail to Meet Expectations Expected value creation not realized Execution failures / too optimistic future scenarios Over expectations Over optimistic financial projections. Over promise; under deliver. Overly optimistic forecasts Overpayment based on reliance around cost synergies Overstated savings potential and synergies + poor consideration for strategic integration and cultural ethos overvaluation and poor integration Optimistic projections Poor projections of future earnings unreasonable expectations in valuation Valuation based on unrealistic expectations Unrealistic expectations Unrealistic expectations unrealistic short term targets Unrealistic upfront expectations and drastic changes in market conditions. Poor objective definition and measurement It been tough in this economy, we acquired a few service providers and which lost revenue due to customers bringing their services inhouse Market conditions are less robust than expected models tend to be too aggressive, and markets change faster than expected Optimistic plans run into competitive marketplaces Changes in market conditions after acquisition market development Our deals are almost always 'revenue synergy' based deals. And even though we always are very conservative in our estimates, the synergies never materialize as quickly as we project. some of the potential synergies have not materialized as originally planned They do not achieve the projected growth or expected synergies. Forecasts are overly optimistic. lack of initial understanding of what the target asset brings to the table market forces; faulty assumptions in underwriting Overestimate initial synergies (first 2-3 years); deals generally eventually meet expectations but takes longer Overly optimistic projections and synergy shortage Overvalued at outset unrealistic projections/expectations to get deal approved Integration and business opportunity was inflated by the prospective sellers poor business case 1) Corporations do not plan adequately and think strategically/long term 2) The Deal Makers" do not always put adequate monitoring processes in place, e.g. score cards, metrics etc." Timing and inability to foresee hurdles/challenges Missing to understand the core Unique Selling Proposition (USP) of the target. Ill-formulated strategic premise/over-estimation of acquisition benefits on part of business unit sponsors. Unclear strategic rationale Poorly defined objectives Premium that is required to be paid to complete the deal exceeds projected return on investment 9

10 Corporate Development Survey Results Primary Reason Deals: Fail to Meet Expectations Expected value creation not realized Execution failures / too optimistic future scenarios Over expectations Over optimistic financial projections. Over promise; under deliver. Overly optimistic forecasts Overpayment based on reliance around cost synergies Overstated savings potential and synergies + poor consideration for strategic integration and cultural ethos overvaluation and poor integration Optimistic projections Poor projections of future earnings unreasonable expectations in valuation Valuation based on unrealistic expectations Unrealistic expectations Unrealistic expectations unrealistic short term targets Unrealistic upfront expectations and drastic changes in market conditions. Poor objective definition and measurement It been tough in this economy, we acquired a few service providers and which lost revenue due to customers bringing their services inhouse Market conditions are less robust than expected models tend to be too aggressive, and markets change faster than expected Optimistic plans run into competitive marketplaces Changes in market conditions after acquisition market development Our deals are almost always 'revenue synergy' based deals. And even though we always are very conservative in our estimates, the synergies never materialize as quickly as we project. some of the potential synergies have not materialized as originally planned They do not achieve the projected growth or expected synergies. Forecasts are overly optimistic. lack of initial understanding of what the target asset brings to the table market forces; faulty assumptions in underwriting Overestimate initial synergies (first 2-3 years); deals generally eventually meet expectations but takes longer Overly optimistic projections and synergy shortage Overvalued at outset unrealistic projections/expectations to get deal approved Integration and business opportunity was inflated by the prospective sellers poor business case 1) Corporations do not plan adequately and think strategically/long term 2) The Deal Makers" do not always put adequate monitoring processes in place, e.g. score cards, metrics etc." Timing and inability to foresee hurdles/challenges Missing to understand the core Unique Selling Proposition (USP) of the target. Ill-formulated strategic premise/over-estimation of acquisition benefits on part of business unit sponsors. Unclear strategic rationale Poorly defined objectives Premium that is required to be paid to complete the deal exceeds projected return on investment 25 of the 43 reasons noted relate to forecasting or unrealistic expectations 10

11 Corporate Development Survey Results Primary Reason Deals: Meet Expectations Detailed due diligence and conservative projections. effective due diligence Conducting good operational due diligence on the target company Due diligence and realistic modeling and integration are important Deal success depends on properly analyzing the target and how it integrates into the buyer's operations. Deals meet expectations through critical diligence and integration efforts. Good due diligence & execution of integration plan Meet - Upfront modeling and planning with realistic expectations Pay the right price Paying fair value. Proper analysis at the pre-closing stage and proper integration post-closing Proper analysis is done before the acquisition. Quality of due diligence Quality of due diligence and integration stability of underlying assumptions; small deviation of future events around anticipated expectations The enormous amount of Due Diligence performed by our firm makes a huge difference in the success! The modeling process at the company is very sophisticated and is an excellent indicator of target growth. Usually there are unexpected results good and bad that balance each other out. With proper discovery on the front side it is only the unknowns that impact the transaction. We are very diligent on the review and setting of expectations cost effectiveness Communication For our company we have underestimated our ability to drive savings in our supply chain which have resulted in higher levels of synergies in subsequent years. maintenance of proper control procedures Management team capability at the tuck-in Quality of management core market culture fit Clear strategic fit, accessing new higher growth markets, close attention to integration. focus Good research, planning, and well defined expectations Selection process & integration plans Strategic fit strong relation with customers and market conditions Synergy capture & strategic value We are conservative buyers Up front planning and having a clear vision on strategic direction upside brought by synergies exceed - strong integration team and similar culture mgmt involvement and integration efforts Organization of post deal incorporation Personnel being acquired Plus & minus's of Employee engagement, Agility at which the company goes put to market its new products. Pre-Integration Planning Realistic goals and mutual strategic fits Realization of growth expectations. Speed of the integration following acquisition The execution prowess and abilities of the executive tasked with leading the new business and handling integration is critically important, as are the resources allocated to integration and the development of a clear integration plan. We have a dedicated integration team. 11

12 Corporate Development Survey Results Primary Reason Deals: Meet Expectations Detailed due diligence and conservative projections. effective due diligence Conducting good operational due diligence on the target company Due diligence and realistic modeling and integration are important Deal success depends on properly analyzing the target and how it integrates into the buyer's operations. Deals meet expectations through critical diligence and integration efforts. Good due diligence & execution of integration plan Meet - Upfront modeling and planning with realistic expectations Pay the right price Paying fair value. Proper analysis at the pre-closing stage and proper integration post-closing Proper analysis is done before the acquisition. Quality of due diligence Quality of due diligence and integration stability of underlying assumptions; small deviation of future events around anticipated expectations The enormous amount of Due Diligence performed by our firm makes a huge difference in the success! The modeling process at the company is very sophisticated and is an excellent indicator of target growth. Usually there are unexpected results good and bad that balance each other out. With proper discovery on the front side it is only the unknowns that impact the transaction. We are very diligent on the review and setting of expectations cost effectiveness Communication For our company we have underestimated our ability to drive savings in our supply chain which have resulted in higher levels of synergies in subsequent years. 18 of the 48 reasons noted related to proper diligence and realistic expectations maintenance of proper control procedures Management team capability at the tuck-in Quality of management core market culture fit Clear strategic fit, accessing new higher growth markets, close attention to integration. focus Good research, planning, and well defined expectations Selection process & integration plans Strategic fit strong relation with customers and market conditions Synergy capture & strategic value We are conservative buyers Up front planning and having a clear vision on strategic direction upside brought by synergies exceed - strong integration team and similar culture mgmt involvement and integration efforts Organization of post deal incorporation Personnel being acquired Plus & minus's of Employee engagement, Agility at which the company goes put to market its new products. Pre-Integration Planning Realistic goals and mutual strategic fits Realization of growth expectations. Speed of the integration following acquisition The execution prowess and abilities of the executive tasked with leading the new business and handling integration is critically important, as are the resources allocated to integration and the development of a clear integration plan. We have a dedicated integration team. 12

13 Key Insights from the Survey Communication Between the Deal Team and Others in the Organization is Critical to Success Forecasts Impact Deal Expectations and Realization of Success in M&A How does this affect key individuals in business unit management or accounting / finance 25 out of 43 responses of why deals fail to meet expectations are focused around the realization of forecasted expectations and forecasted synergies. Almost 60% of the responses 18 out of 48 responses of why deals meet expectations are focused around proper due diligence and realistic expectations Experienced people responsible for forecast was highest contributor to forecast quality (39%) The majority (78%) of respondents were only somewhat confident or not confident in forecast assumptions in the context of an M&A deal 68% of respondents indicated no discernable pattern or over stated cash flows when reviewing transaction forecasts relative to actual performance Corporate development teams were the largest group primarily involved in developing business case forecasts for M&A transactions The transaction forecast and its related assumptions impact: Ability to support the purchase price paid in a transaction The structure of the deal and the related accounting implications Inputs incorporated into intangible asset valuations in the context of purchase price allocations between intangible assets and goodwill Development costs, probabilities of technical and regulatory success, and timing of launch for in-process research and development assets (R&D assets) these are the primary assumptions most responsible for later period impairments Ensuring that business unit management and the accounting and finance group buy-in to forecast assumptions creates joint responsibility and consensus for transaction the outcome An understanding of how business case forecasts and deal structures can impact the accounting outcome of a transaction and the ability to communicate such concerns and issues up front can smooth the post-close accounting process for all parties 13

14 Managing Uncertainty Maximizing Valuation Impact with Early Asset Forecasting 14

15 Discussion Focus Forecasting the sales revenue generated from a pharmaceutical company's drug is probably the most important estimate you can make about future cash flows, but it can also be the most difficult. The modeling of early assets is a high risk activity as early assets face many risks and uncertainties. Given the vast amount of time and money involved in bringing a new pharmaceutical product to market, companies are finding it essential to integrate valuations early into the drug development process. Early-stage (E-S) forecasting and valuations enables companies to identify and invest in compounds with the greatest potential market value and increases their chances of launching a blockbuster drug. The objective of today s presentation is to give a point of view on forecasting and valuation of early-stage (pre-clinical through Phase IIa) assets that may be in your current pipeline or the pipeline of a licensing or acquisition target. 15

16 Senior management can often be skeptical of forecast results, especially those generated for assets that are early in development Some thoughts include: Forecasts are inaccurate Most likely reaction to a Bad forecast is to ignore the results; other reactions include: Refine the forecasts Forecasts are biased Forecasts are too general Forecasts are too detailed Change pricing or share assumptions to hit a number 16

17 Why do products fail to achieve expectations? Target Product Profile Wishful thinking Promotion Manufacturing Competitive entrants Launch delays Slow adoption Clinical trial design Prescribing logistics Pricing Reimbursement,$ MM LY LY+1 LY+2 LY+3 LY+4 LY+5 17

18 Corporate Development 2013: E-S forecasting Deloitte surveyed executives involved in Corporate Development decisions at their organizations. The survey was conducted online in April 2013, with 435 respondents, which included Corporate Development executives, C-suite executives, directors, heads of business units or divisions, finance officers, and other deal professionals. The M&A business case forecast is the foundation that provides insight and confidence to decision makers as they deliberate over investment decisions. Survey respondents report an almost universal desire to improve the quality of their forecasts, but many struggle with how to do it. We are seeing increased interest in codifying the forecast process, roles and responsibilities, methodologies, and leading practices in M&A playbooks. A key question for management is: could the improvement in value creation from better deal decision-making be worth the cost and effort of enhancing the current forecasting process? Forecasting is a team sport and, rather than aiming solely for precision, looking for innovative ways to sharpen the quality of a forecast is important. This happens largely by investing the time up-front to frame the analysis, focusing on input quality, and using the analytical frameworks best suited to provide insight into the decision at hand.. 18

19 A robust early-asset revenue forecast is at the core of every good investment decision just as much as a Phase IIb target Investment decisions require NPV / ROI analyses These analyses require a revenue forecast 19

20 but most forecasts are wrong Nature Reviews Drug Discovery 12, (2013) More than 60% of consensus forecasts analyzed were +/- more than 40% of the actual peak revenues A significant number of consensus forecasts were overly optimistic by >160% of the actual peak revenues Forecasts are inaccurate for numerous reasons Vast uncertainty in a 10+ year horizon Vast numbers of potential competitors Unpredictability of clinical data Evolving regulatory, commercial, and payer environment Scientific evolution and innovation Dramatic changes in treatment paradigm 20

21 The importance of ensuring an early-stage asset forecast is as robust as possible is because E-S forecasting is a core process that affects many functional areas Return on Investment Expected Values Margins Options Valuation Volumes Sales Revenue Expected Values Time Horizon Health Care Policy Managed Care Probability Effect Monte Carlo Simulation Probability Effect Timing In-Line Products New Products Opportunity Costs Licensing Marketing Costs Promotional Costs Instruments Allocation Sales Force Size Sales Force Structure Sales Force Allocation Sales Force Cost Global Regions Countries Business Units 21

22 Patient versus Rx models Patient Models (Market Potential) Projection Models (Treated Market) allow you to model the entire market for a disease enable modeling of growth rates through increased diagnosis or drug treatment rates enable modeling of change in market dynamics, e.g. biologics as a new treatment option decompose the opportunities better on all variables (e.g., improved compliance due better safety profile) use the best available information on the currently treated market compliance and persistence rates are inherent in the data reflect the data reported by the audits often require factoring of Rx data if the model is indication specific. Patient models provide an assessment of commercial opportunity and helps with understanding of key revenue drivers 22

23 Patient-based versus Patient-flow Patient Based Models Used for markets where treatment paradigms and patient populations are not changing over time Static, cross-sectional Isolated variables Capture equilibrium Compartmentalized Concrete Transparent Spreadsheet software Data-Driven Patient Flow Models Used for markets where treatment paradigms and patients are in transition or evolving Dynamic, transitional Interactive, relational variables Capture continuous state changes Abstract Black box Complex system software Conceptual, reality-focused relapse By specialty untreated treated %diagnosed death remission maintain fail %treated relapse death 23

24 Looking at product launches in similar markets can help to determine if a valid analog exists Nature of the market Nature of Disease Acute, chronic, asymptomatic, symptomatic, widely recognized, infrequently diagnosed, infrequently treated Nature of Treatment numerous treatment options available, few treatment options available Nature of Competition High, Medium, or Low in terms of the number of competitors a the level of activity Product attributes Product Novelty Unique mechanism of action, me-too product Route of Administration oral, injectable, infused Side Effects / Safety drug interactions, common & adverse reactions, contra-indicated in pregnancy Product Labels first line, second line, refractory Lifecycle Strategy life extension, new formulation Commercial environment Order of Entry Price compared to current Standard of Care Reimbursement Coverage Target Audience Promotional Level Level of expenditure and quality of expenditure 24

25 Companies often prepare for now rather than how to forecast under uncertainty Pre-Transaction Capabilities and systems often prepare for operating in the current environment under business as usual how will the transaction change the current environment? Post-Transaction Forecasts require thorough treatment of uncertainties underlying the transaction Expectations for forecasts include predicting risks and impacts, and how to mitigate or prepare for uncertainty How does the risk-return position of the company change as a result of the transaction? To continue to drive value, new capabilities may be required to navigate the new normal Four villains of decision making when it comes to E-S forecasting early-stage assets: Narrow framing Confirmation bias Short-term emotion Overconfidence Source: Decisive, by Chip Heath and Dan Heath,

26 A range of planning risks should be considered when building a robust risk profile of an early stage asset These risks have been identified through a combination of secondary research and Deloitte intellectual property frameworks Macro environment risks Have potential effects across the entire value chain Extended value chain risks Originate in upstream and downstream partners Operational risks Relate to internal process risks Develop/PTRS Commercial Planning Source Make Deliver/Return Supply Demand Tier N Tier 1 3 rd Party Services Distributors End Users Economic Environmental/Social Responsibility $ Geopolitical Hazards! Infrastructure / Resources Regulatory Security Functional risks Exist among enabling functions that support value chain processes Finance Human Resources Information Technology Legal $$$ Note: Though not depicted above in order to maintain simplicity, risks are often highly inter-related with impacts spanning across functions internal to the company and externally within the extended value chain. 26

27 Risk-adjusted E-S forecasting helps develop a robust evaluation of risk within budgets See chart (right) Chart sources: Deloitte models from Deloitte R&D ROI study Core benefits Deeper assessment of uncertainty in cash-flow and earnings forecasts Quantitative understanding of which risks contribute most to exposure Outputs provide insights into opportunity for capturing upside Enabling integrated scenario modelling and multi-risk perspectives Focus management time and efforts on the key risk and value drivers Enhanced confidence in delivery of plans and budgets Facilitates transparent challenge and review 27

28 People and process can improve forecast quality Nearly twice as many respondents in Deloitte s Corporate Development study said that the qualitative process of framing the value drivers was more important to forecast quality than the objectivity of quantitative assumptions The involvement of experienced people was also key Comprehensive identification and understanding of key value drivers Experienced people responsible for forecast M&A targets that are very similar to core business Honesty and objectivity of forecast assumptions Other 1% 18% 25% 27% 30% Source: Corporate Development 2013: Pushing Boundaries in M&A 28

29 Framing drivers of value and risk is perhaps the most valuable process step Analysts open up spreadsheets too soon Proper framing is important for: Identifying the right questions Focusing on the important aspects Obtaining organizational buy-in Creating an efficient, well-managed process Framing approaches to consider Objectives: what are the decision criteria? Risk: how could we be wrong? Alternatives: have we identified options? Environment: have we enabled brainstorming and idea sharing? Stakeholders: is the full value chain represented in the process? What could cause specific assumptions to be twice as high (low)? Pre-mortem: identify extreme future headline, and ask What would cause that outcome? 29

30 Early-Stage programs need to be evaluated by assessing uncertainties that impact future returns Scenario analysis drives greater insight into uncertainties and inform strategic alternatives Scenario analysis assesses future value under uncertainties Variability of future returns is quantified Alternatives are generated to identify higher value-added returns NPV scenario analysis Low case P=10% NPV=$5M P = probability Uncertainties Uncertainties Uncertainties Base case P=50% NPV=$20M Illustrative High case P=10% NPV=$50M Illustrative Reimbursement Pricing Competitor actions Uncertainties impact on program NPV Clinical Expected NPV of program Market demand Illustrative Program A I Alternatives Max. return alternative Baseline strategy Min. cost/risk alternative Exit alternative Exp. NPV NPV NPV NPV NPV Assessment of specific uncertainties impacting a program is done using market and Amgen data (e.g., technological advances, market dynamics, macro-environmental drivers, regulatory, competitive actions) Scenario analysis for each uncertainty is conducted to estimate NPVs Expected NPV (i.e., at 50% likelihood) and variability of returns are established by aggregating assumptions across scenarios NPV sensitivity to each uncertainty is determined (i.e., change in NPV for Low and High case of an uncertainty assuming Base case for all other uncertainties) Alternative program strategies are developed by considering different approaches to: Increase return within existing conditions (e.g., same risk exposure, same resource requirements) Create value under different conditions (e.g., more investment, reduced downside risk) Alternatives evaluation is done similarly to the original strategy (i.e., expected NPV and sensitivity to uncertainties) 30

31 Quantitative analysis and the art of modeling Alternative modeling tools for risk-adjusted forecast: Cash flow models Sensitivity analysis Scenario analysis Simulation models Decision tree models Principals to consider for good risk-adjusted models: Structured to predict real-world dynamics Transparent and easy for others to understand assumptions Dynamic and able to handle a robust set of what-if questions Insightful to inform decision makers beyond number crunching PTRS Pricing Long-Term Base Growth Market Demand Strategic Growth Geographic Shift Tornado Diagram Which risk factors impact value the most? Illustrative 10 th Percentile Likelihood Breakeven of Enterprise Value ($ mn) Expected NPV 90 th Percentile Risk Profile What is the likelihood of hitting certain outcomes? 31

32 Interpreting the forecast for better transaction decisions Play with the forecast: analyze and interpret value driver impacts and overall deal risk/reward get gain deal insights Understand risk: how can outcomes vary, and what will drive that variance? What can we do to improve the management of that variance? Be selective: focus on outputs that will inform (and not confuse) decision-making, don t overwhelm them with data and intermediate impacts. Inform negotiations: Analyze bid structures and inform negotiations Share the risk: if the risk/reward equation is unbalanced, can risk be shared by structuring a contingent payment or other contingent structure? 32

33 Critical Forecast Assumptions And Their Impact on Intangible Asset Valuations 33

34 Critical Assumptions in Pharma/Biotech Asset Valuations Asset Overall Business Assumptions Developed Product Technology To-be-developed Products (IPR&D) Trademark / Trade Name Contracts Rarely Valued Assets Customer Relationships Non-Compete Agreements Critical Forecast Assumptions Forecasted revenues and revenue growth assumptions Forecasted margins Incremental expense model vs. stand-alone business forecast Synergies Economic / useful life Peak sales volume Patent life and product performance post patent expiry Entrance of generics and impacts to pricing over time Maintenance R&D expense Development R&D expense vs. Maintenance R&D expense post-approval Probability of Technical and Regulatory Success ( PTRS ) assumptions Time to market Clinical trial phase transitions / development roadmap Economic / useful life Peak sales volume Patent life and product performance post patent expiry Economic / useful life of underlying product(s) Brand continuity Term of the contract Renewal options / extensions Rationale for Non-Valuation Sales are delivered primarily through prescribing physicians not typically recognized as an asset for pharma / biotech companies Rarely valued for pharma / biotech companies as transfer of IP makes competition legally challenging Contingent arrangements also reduce the value of non-compete agreements as they generally remove the desire to compete of selling shareholders 34

35 Overall Business Assumptions Critical Assumptions and Their Impact on the Valuation and Related Amortization Assumption Forecasted Revenue and Margins Synergies Incremental expense model vs. stand-alone business model Impact These assumptions play a significant role in understanding the level of goodwill and amortization in a given transaction In general, the more years of the forecast where the totality of the business s revenues and margins are accounted for by developed products and to-be-developed products, the lower the goodwill amount As the years of the forecast where all cash flows are accounted for by an identifiable asset extend past 7-10, goodwill would be expected to be relatively low Conversely, if cash flows rapidly shift from identifiable assets to future products that are yet to be identified, the amount of goodwill in the transaction would be significant The more synergistic value around product expansion and/or customer cross-selling in the forecast also tends to drive higher goodwill amounts Synergies related to cost rationalization tend to influence the margins of intangible assets and increase intangible value rather than goodwill Market participant definition becomes key in terms of how to look at the cost structure of a transaction. If the development expense is sufficiently high that the most likely buyer is a diversified pharma / biotech company with the cash resources to bring the product to market, an incremental cost structure becomes more viable, especially if synergistic gains make a strategic buyer the most likely alternative If most market participants would need to run the business in a unique fashion, a stand-alone business model becomes more appropriate Non-traditional distribution channels New therapy with niche sales force requirements 35

36 Developed Product Asset Assumptions Critical Assumptions and Their Impact on the Valuation and Related Amortization Assumption Useful Life Patent Life Forecast Beyond Patent Entrance of generics Impact These assumptions play a significant role in understanding the level of goodwill and potential amortization in a given transaction In general, the longer the asset lives (cash flow forecast associated with the asset), the larger the value, the less room for goodwill Patent life is not always the end of a product s useful life: Biotech assets have historically been subject to less competition beyond the patent expiry period due to the challenge of creating a generic version Certain strong branded pharmaceuticals can maintain market presence for a few years post patent or be channelled into a generic version worth maintaining (heavily dependent on company strategy) Important to forecast the expected impact on the product such as price erosion and/or abandonment upon generic challenge and entry to the market Longer asset lives increase value, but will generally result in lower annual amortization (although higher total amortization) Illustration: (1) 10 year asset valued at $1.0 billion = $100 million straight line annual amortization (2) Same asset, 14 year life, valued at $1.2 billion = $85 million straight line annual amortization Maintenance R&D Expense R&D expenses must be delineated between expenses incurred to develop products and expenses incurred to monitor / maintain a commercialized product The more maintenance R&D efforts required, the lower the value Typically, the more serious the side effects or invasive the treatment, the more maintenance R&D is required to monitor patients of the therapy 36

37 IPR&D Product Asset Assumptions Critical Assumptions and Their Impact on the Valuation and Related Amortization Assumption Useful Life Patent Life Forecast Beyond Patent PTRS Assumptions Time to market Clinical phase transitions Development roadmap Development R&D vs. Maintenance R&D expense Impact Similar impact as those discussed for developed products PTRS assumptions should be developed by clinical phase of development to properly forecast probability-adjusted development costs over the course of development Buy-in of PTRS assumptions by the group that understands the science and clinical trial process for the therapy is critical this is one of the most significant assumptions that, if wrong, can trigger an impairment of an IPR&D asset Similar to PTRS, time to market is the second most critical assumption as significant delays to market can also trigger an impairment of an IPR&D asset Time to market also influences when the forecast begins to incur pre-launch sales and marketing expenses; these costs can be significant depending on the therapy Forecasts should closely tie in to any development roadmaps created by the business units or regulatory groups in order to sync all relevant timelines R&D expenses must be delineated between expenses incurred to develop products and expenses incurred to monitor / maintain a commercialized product Developmental R&D expenses need to be tied to the clinical phase transition / development roadmap as probability of successful clinical phase transitions can impact forecasted R&D costs Upon commercialization / launch, R&D expense allocation needs to swap to a maintenance R&D expense metric The more maintenance R&D efforts required, the lower the value Typically, the more serious the side effects or invasive the treatment, the more maintenance R&D is required to monitor patients of the therapy 37

38 Trademark and Contract Asset Assumptions Critical Assumptions and Their Impact on the Valuation and Related Amortization Assumption Impact Trademarks / Trade names Useful Life Brand Continuity Similar impact as those discussed for developed products Strength of the brand and breadth of a brand is a key component to understanding brand continuity. Typically, a brand wouldn t be valued separately unless it persists beyond the original product IP and can be leveraged across multiple products or product generations Contracts Term of the Contract Extensions or Renewals Contracts, including collaboration agreements or royalty arrangements with a defined payment structure and term are typically valued as distinct assets. Cash flows related to the contract need to be segregated from others An understanding of the contract terms and what renewal or extension options may exist is key to properly forecasting the separated cash flows If extensions or renewal options exist, a probability of the likelihood for renewal or extension needs to be estimated for each renewal or extension period The longer the term and higher the renewal probabilities are, the more value will accrue to the asset 38

39 Questions & Comments 39

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