The biotech and life sciences industry is experiencing a continuing rebound in 2024. After an overall market slowdown in investments and acquisitions, late Q4 2023 started to show signs of improvement, and those trends are continuing in 2024.
However, strategic acquirers and investors are now exercising greater caution with their funds, making accurate valuations of biotech firms more critical than ever.
Despite this cautious sentiment, there is significant money on the sidelines waiting to be deployed into the biotech sector. Firms with solid valuations and metrics can still attract the investment and acquisition partners needed to succeed.
Because biotech firms operate on much longer timelines regarding revenue development, determining biotech valuations requires a specialized approach and industry experience. In this article, we’ll highlight key insights on how Objective Investment Banking & Valuation approaches biotech firm valuations in this complex and transitioning market environment.
Understanding the Biotech Landscape in 2024
After a slowdown in biotech M&A activity and overall investment in 2022 and early 2023, Q4 of 2023 started to show signs of a reversal of those trends. The previous slowdown in M&A activity resulted in pharmaceutical companies stockpiling more capital reserves to increase their firepower. All of this is taking place against the backdrop of rising public equity markets which are now reaching new highs after previously dealing with inflationary and interest rate uncertainty, which is now abating.
These factors suggest a strengthening biotech sector and one that will attract top strategic partners for those firms who value their business correctly.
Recent regulatory changes have made it more challenging to land that “blockbuster” mega-merger that was common during the biotech highs of 2021. Smaller deals can avoid much of the new FTC scrutiny and may be more attractive to investors and pharmaceutical companies looking to make fast acquisitions and partnerships.
Finally, new technology is revolutionizing the space with AI and machine learning allowing for faster pipelines, testing, and development. While these improvements are in their nascent stages, they could prove to be a significant x-factor related to valuations in the short to medium term. Biotech firms that show leadership in successfully leveraging these new technologies may be able to boost their value.
Key Considerations for Biotech Valuation
While biotech firms may see themselves more holistically, an accurate valuation requires that key components of the firm are broken down and viewed independently. These components are then weighted and summed to achieve a final valuation.
Another key consideration is whether a biotech firm’s value lies in its pipeline of therapeutics or the technology and platforms those are built on. This differentiation between service-based and therapeutic-based biotech firms plays a pivotal role in how the company is valued. Service-driven or therapeutic-driven biotechs will also require a different narrative to be presented to potential investors as the cash flow models will differ.
Innovation and Intellectual Property
Pipelines and R&D are at the heart of a biotech company’s speculative value to investors. The more pipelines a company has, the lower the overall risk, which can lead to higher valuations.
The stage of those pipelines also drives valuations. Pipelines can run from the inception of a new treatment to the product’s launch. The further along that process is, the higher the valuation.
However, there are metrics that have to be considered during this process. Enterprise Value to R&D Expense Ratio (EV/R&D ratio) allows investors to measure how much is being spent on pipelines relative to the overall valuation. Higher multiples of EV/R&D ratios are based on the anticipation of more promising results from current pipelines.
Regulatory Milestones and Approval Probabilities
Regulatory milestones involve what phase each current treatment or technology is in. Later stages warrant higher multiples and also have lower discounting due to the probability of success being higher.
Probabilities involve various metrics including the past success rate of the company and the history of the team involved. Comparisons between competitors to look at success rates for similar pipelines across the industry are also used.
Market Potential and Competitive Landscape
Future cash flow projections can be difficult and require analyzing the projected market size and the target demographics of the treatment.
Some metrics for this valuation include:
- Disease incidence rates
- Diagnostic capabilities
- Adoption rate of the treatment by healthcare providers
- Market access or obstacles
- Future uses beyond the initial proposed treatments
- Collaboration and licensing opportunities
Competitor analysis is also important at this valuation stage. How much of an innovative advantage a firm has and whether they are a first mover in the space can heavily influence multiples.
Financial Performance and Funding
A significant challenge for biotech valuations relates to how most biotechs will experience negative cash flows for years. This means traditional enterprise metrics such as EV/EBITDA or P/E ratios are not useful.
Even for existing biotechs with proven histories, each development pipeline can be highly unique and may not translate to newer projects.
Past performance from a team does factor into valuations though, and funding sources based on each phase completion and approval impact cash flow projections. These can be compared to R&D expenses to gain insight into how well a biotech company can fund its project through to approval and launch.
Risk Analysis and Discount Rates
The majority of risk for a new biotech company is whether or not a pipeline moves on to the next approval phase or delivers an approved therapeutic or service to market. This risk is incorporated into valuations through discount rates relative to projected cash flows.
Essentially, the higher the discount rate applied, the higher the risk of a pipeline not making it to market or the next phase of trials. For example, an early-stage pipeline may have a discount rate of 40% applied to its future cash flow projection. A late-stage pipeline can have a discount rate as low as 10%, with the average being around 19%.
Beyond the risk of being approved or not, discount rates also take into account the opportunity costs and spending involved in the R&D process. Determining the discount rate goes beyond metrics or calculations and requires experience in the biotech space and a proven track history of accurate valuations. Small changes in discount rates can have a significant impact on valuations and investor interest.
Valuation Methodologies for Biotech Companies
To help create a baseline for a biotech company’s valuation, there are several methods commonly used to help with the process.
Discounted Cash Flow (DCF) Analysis
Discounted Cash Flow (DCF) analysis is a method used to estimate the value of an investment based on its expected future cash flows. The process involves projecting the future cash flows and then discounting them back to their present value using a discount rate.
This is critical since biotech companies often require years before any revenue is generated. DCF analysis allows for the uncertainties and costs during that time to be accounted for within the final valuation.
Risk-Adjusted Net Present Value (rNPV)
Risk-adjusted net present value (rNPV) is the most straightforward way to value biotech companies. Most valuations will start with rNPV calculation as a baseline.
With rNPV, the goal is to predict cash flows for different scenarios and then determine the probability of each scenario.
The first step is to determine cash flows. To do this, we’ll consider the following factors.
- Number of potential customers (after market launch)
- Pricing structure for the therapy
- Profits vs revenue based on margins for the specific therapy
- Revenue declines due to competitors or market changes
- Licensing and partnerships
- Whether or not the therapy is a cure
The next phase of calculating rNPV is to determine the probabilities of various scenarios during the development phases and final market approval.
Most valuations will start with a baseline of probability anchored in the past performance of comparable biotech companies and similar therapies. Next, adjustments are made to each probability as milestones are reached or evidence changes.
The final step is to discount these cash flows back to the present to determine the current valuation. This step requires experience and nuance since you must determine how much risk you’ve already factored in when developing your probability models.
Comparables Analysis
Comparables analysis involves public companies or recent deals involving companies in similar development stages.
For public companies with existing products, the enterprise value to R&D expense ratio (EV/R&D ratio) will offer insight into how investors value the company relative to its spending and cash outflows. The higher this ratio, the more bullish investor sentiment is for that company and market segment. Two challenges to accurate comparables analysis are if the company is offering a completely novel service or therapeutic. The other is if market comparables are private companies. Private companies tend to have higher discount rates applied, which can hurt the valuation despite other metrics being positive.
Future Outlook and Innovation’s Impact on Valuation
Technology such as AI and machine learning are poised to create faster pipelines and accelerate overall innovations within biotech research. These advances have the ability to make more accurate valuations since certain time frames can be compressed. However, more pipelines from a growing number of companies will mean investors need to be even more meticulous in their valuations and decision-making. Regulatory trends are always an x-factor in biotech. Staying ahead of those trends and accurately anticipating their impact on markets will be key to accurate valuations, especially in the early phases of development.
Objective’s Approach
Valuing a biotech firm requires specific financial models and meticulous analysis. At Objective Investment Banking & Valuation, we aim to provide invaluable insights for key stakeholders while crafting a compelling, data-driven narrative that captures the attention of strategic or private equity acquirers.
Numbers only tell part of the story when it comes to valuing biotech innovation, let our extensive experience in the industry help tell the full story and game-changing potential of your biotech company.
Contact Objective Investment Banking & Valuation to learn more about biotech valuations and how we can maximize your company’s value in the eyes of investors and partners.
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Disclosure
The above testimonials may not be representative of the experience of other customers and past performance is not a guarantee of future performance or success.
This news release is for informational purposes only and does not constitute an offer, invitation or recommendation to buy, sell, subscribe for or issue any securities. While the information provided herein is believed to be accurate and reliable, Objective Capital Partners and BA Securities, LLC make no representations or warranties, expressed or implied, as to the accuracy or completeness of such information. All information contained herein is preliminary, limited and subject to completion, correction or amendment. It should not be construed as investment, legal, or tax advice and may not be reproduced or distributed to any person. Securities and investment banking services are offered through BA Securities, LLC Member FINRA, SIPC. Principals of Objective Capital are Registered Representatives of BA Securities. Objective Capital Partners and BA Securities are separate and unaffiliated entities.
