During this diligence process we can see another interesting shift. A gap appears between the acceleration of value and the
development investment as the product survives the clinical trials. This is apparent in Figure 9 (page 31)— and don't be fooled
by the scale of this chart. The value scale axis on the left is at 10 times the dollar scale of the development-spend axis
on the right. The value creation is outpacing development investment starting in Phase I. This analysis is very useful in
helping the originator determine the best time to do a deal. In this case, it is in the originator's best interests to wait
at least until Phase II before doing this deal.
Figure 10 shows how risk-adjusted value increases faster than development spend during Phase I, while development costs outpace
value gains during Phase II. In this case, a $61 million investment in development gets the product well into Phase II, increasing
the value of the product by $321 million. Without going into the calculation, this comes to an annual investment return ratio
(IRR) of 99 percent.
An originator is more likely to negotiate a large upfront payment and high royalties, if he can hold onto the drug well into
Phase II, since the product would then be a more viable (and valuable) drug candidate. It is possible that a premium will
be put on the deal, as there is a certain scarcity of quality Phase II compounds available for license. The difference between
the IRR and the cost to fund the development can be retained by the originator's investors, should they pursue this approach—remembering,
of course, the steep probability that the project will fail during this period. The decision must be based on the investor's
capacity to put large sums of money at high risk.
We all are interested in comparing the deals we've done or contemplated to what deals others are making—if for nothing else
but a sanity check. The problem is that the publicized terms of biopartnership deals are often difficult to compare because
crucial information is left out. For instance, royalties are usually one of the largest value components of a deal in which
the product is actually launched. But the value of royalties is rarely included in any amounts announced as part of the deal
value—which primarily comprises upfront payments, milestone payments, equity investments, and reimbursed R&D expenses.
Determining the true value of these components can be tricky. For instance, some deal milestone-payment provisions may cause
only a portion of all possible milestones to be payable even if the product is launched. The equity-investment component is
often expressed as the total equity purchase, instead of premiums paid above the market value of the stock, which represent
the actual transfer of value from one partner to the other. Furthermore, R&D expenses included as part of the deal value are
typically part of complicated co-development arrangements, in which both parties create value.
However, R&D expense, when borne by the partner, is not usually included in deal value. This reporting inconsistency, among
others, makes deal values difficult to compare. Throw in options and creative financial instruments, and it can be very difficult
for an outsider to add up the true value of the deal for each side of a transaction. But even after all that, it's still interesting
to check out the terms of other deals.
A couple of examples will illustrate this point. The pie chart in Figure 11 shows the proportion of the terms in our case-study
deal as they would typically be publicized. Press releases and other community communications typically make the deal look
like an equal partnership.
But Figure 12 shows the same deal with the royalty component included. We've expressed royalties as the NPV of the royalty
stream discounted back to the launch year—which makes a big difference. Since the royalties are less likely to occur (compared
with the upfront payment) and are therefore of less value, we probability adjust them in Figure 13 using the same process
we've just been discussing, to arrive at this view of the situation. Royalties are still a major part of the deal value, and
the upfront payment again looms large (49 percent).