Valuation Analysis in Pharmaceutical
Licensing and M&A Transactions
A Tutorial
By Tim Opler, Benj Garrett and Susan Langer
January 2014
• Discuss role of valuation and project assessment
• Introduce valuation tools
• Show how to use the tools in business development
• Go over a variety of cases
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I
AGENDA
Agenda
Table of Contents
1.
2.
3.
4.
5.
6.
7.
8.
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Value Creation and Business Development
Valuation of Pharmaceutical Projects
Revenue Forecasting
Cost Estimation
Risk Estimation
The Discount Rate
Valuation Considerations in Licensing
Valuation Considerations in M&A
VALUE CREATION AND BUSINESS DEVELOPMENT
Revenues and Costs Over Time ($ millions)
350
300
250
200
150
100
50
0
-50
1
2
3
4
5
6
7
8
9
10
11
-100
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Acquisition Cost
R&D
Launch Cost
Selling Cost
Other Cost
Revenue
12
13
VALUE IS CREATED BY INVESTMENT FOR FUTURE PROFIT
Typical Value Creating Profile
PROCESS
Value Creation Process
Assessing
the
projects
Finding
projects
that fit
Negotiating
deals for
the projects
in the face
of
competition
Delivering
on the
potential of
the projects
Realizing
the value
Assessment and negotiation calls for strong valuation and analysis
work. This is our focus today.
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Evaluation Criteria
Financial Analysis
• What is the time
horizon to peak
revenues for each
product?
• What will sales and
marketing costs be?
• What are the total
cash requirements?
• What is the value of
each product
opportunity?
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Ability to Execute /
Risks
• How achievable are
the returns and how
significant are the
risks?
• Do we have the
competencies to
succeed?
• Can we control the
key success factors?
Fit with Future
Strategy
Perception of Wall
Street / Shareholders?
• How does each
product fit with our
long-term vision?
• Are there other
products in the
pipeline to realize our
goals?
• What is the
opportunity cost of
pursuing these
initiatives?
• Is Wall Street likely to
invest in a company
pursuing these
products?
• How has Wall Street
responded to other
companies that have
adopted this
strategy?
HOW FINANCIAL ANALYSIS FITS INTO STRATEGY
Where Financial Analysis Fits into Business Development Strategy
Example: Licensing Process at Bristol-Myers Squibb
Identify
the
Opportunity
Initial
Technical
Evaluation
Detailed
Technical
Evaluation
Detailed
Commercial
Evaluation
Technical
Due
Diligence
Commercial
Due
Diligence
Final
Approval
Contract
Negotiations
Source: Talk by BMS: “The Role of Licensing / Business Development in the Pharma Industry”, 2004.
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Product Profile / Pricing / Competition
Sales Forecast
P&L Assumption (COGS, S&M, R&D)
Deal Terms
Manufacturing / Tax Considerations
PTRS
Risk Adjusted NPVs & IRRs
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BRISTOL-MYERS SQUIBB VALUATION PROCESS
Bristol-Myers Squibb Deal Valuation Process
Illustrative Table by Kazuo Edaza of BMS
Assets
Opportunity ID
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
PTRS
92%
78%
20%
80%
74%
58%
30%
85%
27%
53%
81%
26%
59%
72%
62%
36%
40%
24%
26%
89%
55%
7%
24%
64%
ENPV
370
120
250
182
80
80
250
80
90
18
23
214
582
87
1,400
77
27
371
102
1,538
633
100
152
272
EIRR
535%
345%
318%
301%
230%
230%
210%
90%
83%
83%
76%
59%
58%
54%
48%
42%
41%
40%
40%
35%
34%
33%
31%
30%
Assets
Opportunity ID
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
PTRS
6%
48%
25%
10%
82%
63%
40%
14%
21%
21%
43%
14%
35%
45%
35%
46%
19%
60%
42%
8%
31%
7%
18%
38%
ENPV
3
411
129
71
837
288
12
116
137
132
183
80
151
12
8
230
28
3
123
15
52
22
7
6
EIRR
29%
29%
27%
27%
26%
26%
26%
24%
24%
24%
24%
23%
22%
20%
19%
19%
19%
19%
19%
18%
18%
17%
15%
13%
PTRS = probability of technical and regulatory success
eNPV = expected NPV
eIRR = risk-adjusted internal rate of return
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Source: Talk by Kazuo Ezawa, Bristol-Myers Squibb, “Pharmaceutical Portfolio Management”, DAAG, February 2004.
PROJECT RANKING
Bristol-Myers Squibb Ranking of Potential Licensing Deals
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
The approach that we will discuss today is very similar to that
used by Bristol-Myers Squibb.

In fact, almost every large pharmaceutical company uses the
same approach to deal valuation.

Consulting firms like BCG, Campbell Alliance, LEK, Mattson Jack
and McKinsey have standardized the industry in this way.

A key area of emphasis from us is to keep an eye on risk-adjusted
returns in transactions.

There are numerous fine points and ways in which firms differ in
approach.

We will discuss many of these but the key focus will be on the
“hands on” – how to approach to valuation.
TODAY’S DISCUSSION
Our Approach
ROI
(IRR)
Examples in Specialty Pharma
Small Project
Big Payoff
Big Project
Big Payoff
(The zone of shareholder bliss)
Small Project
Low Payoff
Allergan – Botox
Biovail – Wellbutrin XL
Cephalon - Provigil
ENDO – lidoderm patch
Forest – Lexapro
Gilead - Truvada
King – Altace
Reliant - Lovaza
Salix – Rifaximin
Viropharma - Vancomycin
Big Project
Low Payoff
Scale of
Project
The key to creating lasting value is to bet big and win.
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VALUE IS CREATED BY INVESTMENT FOR FUTURE PROFIT
General View: Go Big and Go for IRR / ROI to Create Value
13
Big Pharma
A, B, C
Sometimes employ real options tools in project assessment.
The idea is to look at a drug development project as a
sequence of choices or options. The most important insight
is the “option to abandon” a project is valuable. A further
insight involves the value of the option to expand
indications.
Biotech A
Focuses largely on “pie splitting” – the sharing of the rNPV of
a project. Other inputs like IRR are not looked at all. Have
historically used higher discount rates for risky projects but
without risk-adjustment.
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TODAY’S DISCUSSION
Some Key Differences Across Pharmaceutical Firms - Method
Big Pharma An organization called that carries out financial analysis of licensing and
M&A projects. They have prepared an internal manual on how to value
D
every aspect of a project which standardizes their approach. Tends to do
careful valuation work with reasonable discount rates. Always have at
least three scenarios. Organization tends to be intelligent but financially
conservative in looking at opportunities. Will occasionally look at real
options and offer option deals to biotechs.
Has created a management science group that engages in sophisticated
Big Pharma predictive modeling of pharma product performance. Their view is that
good forecasts are the most important and most difficult aspect of
E
pharma licensing. This group has been driving real options work but
hard for organization to grasp.
The focus is much more on simplicity, insight and medical soundness
Big Pharma than say Big Pharma E. Every projects gets summarized on two pages
(and not more ever) for either the head of commercial or the head of
F
R&D. Once there is a preliminary approval an AIF (autorissation
investiment financiere) is prepared (30 to 50 pages). This document
does not skimp on commercial analysis but uses basic rNPV models.
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TODAY’S DISCUSSION
Differences Across Firms - Process
VALUATION OF PHARMACEUTICAL PROJECTS
A: Profit = - $50 + $60
= $10
$10
Added Value
$50
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Initial Investment
NET PRESENT VALUE
Q: Suppose we can invest $50 today & receive $60
later today. What is our increase in value?
This is the definition of NPV
60
Profit = -50 +
 $4.55
1.10
$4.55
The idea of an expected rate of return or
discount rate reflect the time value of
money, otherwise known as the underlying
cost of capital in society.
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$50
Added Value
Initial Investment
NET PRESENT VALUE
Q: Now suppose we can invest $50 today and receive
$60 in one year. What is our increase in value given
a 10% expected return?
Ct
NPV C 
0 (1 r)t
For two
periods
With multiple periods
C1
C2
Ct
NPV  C0 


...

1
2
t
(1  r ) (1  r )
(1  r )
N
or
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Ct
NPV  
t
t 1 (1  r )
Where N=Number of years
t = year
C = cash flow
r = discount rate
Sigma = Summation Symbol
NET PRESENT VALUE
NPV = PV - required investment
Net Present Value Rule
If the net present value of a project is positive
then it creates value and should be carried out.
If resources are finite and there are more
positive NPV projects than time, money or
other constraints would allow then the group
of projects that maximize NPV should be
implemented.
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Risk Adjusted NPV
Pharmaceutical cash flows are risky and the
risk can be characterized based upon stage of
development.
Risk-Adjusted NPV or rNPV is a risk weighted
NPV and should be used in assessing risky
project.
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Revenues
Total Market
Prescriptions
Written
X
Penetration of
Product
=
Units Sold
X
Price
=
Revenue
-
Costs
COGS
+
Research and
Development
Expense
+
Selling Costs
-
Other Cash
Outflows
I
Net Cash
Flow
Capital
Expenditures
+
Change in
Working Capital
Cash Taxes
+
G&A / Other
Costs
+
Acquisition Costs
Risk Adjustment at Each Stage
21
=
rNPV
INPUTS TO RNPV MODEL
Elements of Risk Adjusted NPV Model
RNPV FORMULA
The rNPV Formula
N
R1Ct
rNPV  
t
t 1 (1  r )
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Where N=Number of years
t = year
t=1 (now)
C = cash flow
R1 = Probability of cash flow now
r = discount rate
Sigma = Summation Symbol
The risk-adjusted IRR is the discount rate that would give an rNPV equal to zero.
In other words, it is the expected rate of return on a project.
We refer to the rIRR as the risk-adjusted IRR.
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IRR ANALYSIS
rIRR
Issue
Equity
vs.
Partner
Drug
Both of the choices shown at left involve
bringing cash today by causing current
equityholders to give up future cash flow
(either by sharing the cash flow through
issuance of more equity) or instead by giving
away product cash flows to a partner.
There is an embedded opportunity cost
which is computed in the rate of return
given up in future cash flows for cash today.
This is the internal rate of return or IRR.
When derived from a probabilized model we
refer to this as a rIRR (risk-adjusted IRR).

Cash Received by Licensor t  
t 1
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Cash Flow Given Up to Licensee t
(1  r )t
The internal rate of return is the discount rate that is
impounded in the equation comparing cash received
to cash flow given up.
APPLICATION OF IRR TO LOOK AT TRADE-OFFS
An Example Trade-Off
ACCOUN
TING
TREATM
ENT
Accounting Considerations – EPS Impact
 How will the expense be amortized?
– Straight-line amortization
• Negative EPS impact in later years due to smaller profit share
payments
• Acquisition price set standard treatment
– Amortize based on profit share payments
• EPS accretive each year
• What happens if we don’t achieve projections? Write-down
– Amortize in full each until asset is gone, then recognize full benefit
• Most conservative approach
• Not EPS accretive in the beginning years
 Many pharma companies are highly focused on EPS management
• Will prefer to use investment dollars over R&D dollars whenever
possible
• Will prefer to push out spending into the future
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EPS
Example of EPS Impact in a Transaction to Restructure an Alliance
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
$0.02
$0.03
$0.05
$0.06
$0.07
$0.08
$0.04
$0.04
$0.01
$0.01
$0.01
Assumptions
Discount Rate: 10%
Amortization: Based on projected profit share payments
Tax rate: ~35%
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Revenue
Forecasting
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Cost
Assumptions
Tax and
Working
Capital
Risk
ACCOUN
TING
TREATM
ENT
Building an rNPV Analysis of a Project
Cash Flow
Estimates
Discount Rate
Selection
rNPV
Computation
REVENUE FORECASTING
Estimating Product Revenue Trajectory
Analyst
Bottom Up
Looking at
Reports and
Market
Similar
Research
Analysis
Products
Reports
We believe the best approach is to have a good bottom up model and
check the thinking by looking at external reports and similar product
revenues.
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THREE WIDELY USED METHODS FOR REVENUE FORECASTS
Approaches to Developing Market Sizes
Market / Valuation
Analysis
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Full Service Analysis / Consulting / Support
VENDORS ARE OFTEN USED FOR MARKET ANALYSIS
Commonly Used Research Vendors
Total Population, Population in Target Markets
Incidence/Prevalence
Potential
Market Size
Use 10 year planning
horizon: 2012-2022.
Assume 2012 launch
% Diagnosed
Addressable
Market Size
% Treated for Disease
% Prescription of Drug
Price per Day of Drug
Actual Ave Days Used
It is very
common to
build several
scenarios
(good, poor,
expected)
Penetration, Pricing
Studies, Competitive
Analysis, Compliance
Analysis, Reimbursement
Analysis and Utilization
Patterns
Revenue Estimates over the
Planning Horizon
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BUILDING A BOTTOM’S UP REVENUE FORECAST
Going from Market Size to Revenue Estimates (Bottom Up)
2000
2025
U.S. Patients are Not Controlled with ACE’s, ARBs and Beta Blockers
Trends in awareness, treatment, and control of high
blood pressure in adults ages 18–74
800
700
600
500
400
300
200
100
0
National Health and Nutrition Examination Survey
Percent
Developed
Market
Economies
China
India
1976–80
1988–91
1991–94
1999–2000
Awareness
51
73
68
70
Treatment
31
55
54
59
Control
10
29
27
34
Other
Economies
Source: JNC 7
Source: Kearney et.al., Lancet, 2005, 365: 217-223
Many Patients Poorly Controlled with Existing Treatments
ALLHAT Study: Distribution of Patients by SBP Before
and After Treatment with HCTs, CCBs and ACEi’s
40
Baseline
36 Months
30
Thin Pipeline of New Treatments
The only major recent innovation in
anti-hypertensive therapy on the
horizon is the direct renin inhibitor
class (e.g., aliskiren/Tekturn) from
Novartis.
20
Direct Renin
Inhibitors
ACEs, ARBs
10
0
<100 100- 110- 120- 130- 140- 150- 160- 170- 180+
109 119 129 139 149 159 169 179
SBP (mm hg)
Source: Cushman, et al. J Clin Hypertens 2002, 4:393.
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Diuretics, Beta
blockers,
Calcium Channel
Blockers
*Source: Sealey and Laragh,
American Journal of
Hypertension, May 2007
Renin inhibitors are not more
effective than ACEs and ARBs and
may be unsafe.*
EXAMPLE: NOVEL HYPERTENSION DRUG
Global Burden of Hypertension, Millions of Persons with Hypertension
Rationale for a Synergistic Effect with Current Treatments
There are four important ways in which the novel
drug can take share in the hypertension
market:
1. Better efficacy and/or safety than current
treatments
2. Synergistic with existing treatments (e.g.,
consider a triple ARB, HCT, novel combo)
3. Better outcomes in certain patient subgroups
4. Better marketing in the face of generics
 The Novel drug is a vasodilator that operates


Opportunity for Segmentation / Differentiation by Patient Subgroups
Better outcomes
in patients on
Cox-2’s and
NSAIDs
Better outcomes
in patients at risk
of nephropathy
Better outcomes
in nonresponders
to existing antihypertensives
Better outcomes
in salt sensitive
hypertensives
Novel Antihypertensive
Better outcomes
by genetic
biomarker
Better outcomes
in obese patients
Better outcomes
in cardiac
patients
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Better outcomes
in patients with
inflammation

independently of the RAAS cascade and is likely
to be synergistic with RAAS inhibitors.
It is likely that a many uncontrolled
hypertensive persons would be controlled with
the novel drug given its mechanism.
Likely to be synergistic in salt-sensitive
hypertension
• The drug appears more effective than
other meds in animals that are salt
sensitive.
• Salt sensitive patients are some of the
poorest responders to existing
medications.
Likely to be synergistic in obese patients
• The drug appears to be effective in the
presence of obesity.
• Obese patients are some of the poorest
responders to existing medications.
DIFFERENTIATION OPPORTUNITY
Taking Share by Differentiation
Key Assumptions
Daily Cost of Therapy
ROW as % of US Market
$4
80.0%
2010
2012
2014
2015
2016
2018
2019
2023
2028
2031
Begin Year Patient No.
Growth in Patients
80,000,000
84,872,000
3%
90,040,705
3%
92,741,926
3%
95,524,184 101,341,607 104,381,855 117,482,697 136,194,645 148,823,566
3%
3%
3%
3%
3%
3%
Diagnosis Rate
Treatment Rate
# of Patients Treated
Compliance Rate
50.0%
70.0%
28,000,000
50.0%
50.0%
70.0%
29,705,200
50.0%
50.0%
70.0%
31,514,247
50.0%
50.0%
70.0%
32,459,674
50.0%
50.0%
70.0%
33,433,464
50.0%
50.0%
70.0%
35,469,562
50.0%
50.0%
70.0%
36,533,649
50.0%
50.0%
70.0%
41,118,944
50.0%
50.0%
70.0%
47,668,126
50.0%
50.0%
70.0%
52,088,248
50.0%
0.0%
0.0%
0.0%
0.0%
0.0%
6.0%
8.0%
12.0%
12.0%
12.0%
0
250
4.00 $
1,000
$0.0
0.0
0
250
4.20 $
1,050
$0.0
0.0
0
250
4.41 $
1,103
$0.0 $
0.0
Hypertension - US
Penetration Rate
Patients on drug
Average Days of Therapy
Cost Per Day
Cost per Day * Days of Therapy
Total Revenues
Probabil. Adj Revenues
0
250
0
0
$0.0
0.0
5.0%
0
250
0$
0
$0.0
0.0
2,128,174
250
4.86 $
1,216
2,586.81 $
129.3
2,922,692
250
5.11 $
1,276
3,730.18 $
186.5
4,934,273
5,720,175
6,250,590
250
250
250
6.21 $
7.92 $
8.73
1,551
1,980
2,183
7,654.68 $ 11,325.56 $ 13,644.25
382.7
566.3
682.2
Hypertension - ROW
Begin Year Patient No.
Growth in Patients
64,000,000
67,897,600
3%
72,032,564
3%
74,193,541
3%
76,419,347
3%
81,073,285
3%
83,505,484
3%
93,986,158 108,955,716 119,058,853
3%
3%
3%
Diagnosis Rate
Treatment Rate
# of Patients Treated
Compliance Rate
50.0%
70.0%
22,400,000
50.0%
50.0%
70.0%
23,764,160
50.0%
50.0%
70.0%
25,211,397
50.0%
50.0%
70.0%
25,967,739
50.0%
50.0%
70.0%
26,746,771
50.0%
50.0%
70.0%
28,375,650
50.0%
50.0%
70.0%
29,226,919
50.0%
50.0%
70.0%
32,895,155
50.0%
50.0%
70.0%
38,134,501
50.0%
50.0%
70.0%
41,670,598
50.0%
0.0%
0.0%
0.0%
0.0%
0.0%
6.0%
8.0%
12.0%
12.0%
12.0%
0
250
0$
0
$0.0 $
0.0 $
0
250
4.00 $
1,000
- $
- $
0
250
4.20 $
1,050
- $
- $
0
250
4.41 $
1,103
- $
- $
1,702,539
250
4.86 $
1,216
2,069.45 $
103.47 $
2,338,154
250
5.11 $
1,276
2,984.14 $
149.21 $
3,947,419
250
6.21 $
1,551
6,123.74 $
306.19 $
- $
- $
- $
- $
4,656 $
6,714 $
13,778 $
Penetration Rate
Patients on drug
Average Days of Therapy
Cost Per Day
Cost per Day * Days of Therapy
Total Revenues
Probabil. Adj Revenues
Total Worldwide Revenue
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0
250
0
0
$0.0
0.0
5.0%
$
- $
4,576,140
5,000,472
250
250
7.92 $
8.73
1,980
2,183
9,060.44 $ 10,915.40
453.02 $
545.77
20,386 $
24,560
LARGE REVENUE FOR NOVEL HYPERTENSION DRUG
Revenue Forecast for Novel Hypertension Drug
• Prevalence:
• Total number of potential
customers at any one point in
time
• Best for products purchased
by same customer on a
recurring basis (chronic Rx)
• Incidence:
• Number of new potential
customers each year
• Best for products treating
onetime acute event (heart
attack)
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ACCOUN
TING
Estimate Incidence and
Prevalence
TREATM
ENT
Defining the Market
Identify Segments
Change Over Time
• All potential customers are not
alike
• Segmentation helps refine
penetration and share
forecasts
• It also allows you to refine
estimates and focus efforts by
identifying “early adopters”
• Example in RA
• Severely affected patients
(25% of the market)
• Moderately affected
• Mildly affected
• Customer base and
segmentation are influenced
by factors that change over
time
• Growth driver analysis provides
insight into changing and/or
emerging markets
Penetration is usually the main driver of revenue forecasts. There are a few
different means to estimate the peak penetration that a new product can be
expected to achieve:
1. Historical penetration of comparable products
2. Objective comparisons versus currently available treatments (efficacy, safety,
convenience)
3. Physician interviews to gauge acceptance and potential use versus competing
treatments (preference share analysis)
4. Analysis of likely reimbursement and factors related to achieving reimbursement
from key payor groups
5. Mapping of commercial effort into physician prescribing behavior (companies
often use IMS analysis)
6. Almost all “bottoms up” approaches to penetration analysis tend to overestimate
penetration in practice. Preference analysis tends to do a poor job of predicting
actual prescribing behavior in the face of detailing and sampling
7. Comparison versus pipeline products and relative timing to market
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Can then build low, expected and high penetration scenarios
(important to understand limitation of forecasts in practice)
IMPORTANCE OF MARKET PENETRATION SCENARIOS
Building Penetration Scenarios
Primary Market Research
(Structured Interviews)
Historical Analysis of Impact of
Order of Entry
Expected Product Market Share By Order of Entry
P&T
Committees
Physicians by
Segment
Payor
Research
Estimates of usage and
dependence on pricing
By Physician
Segment
By Disease State
(e.g., first line,
second line)
Build demand curve, make pricing
estimates
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Total
Products
on Market
1st
1
100
2
58
42
3
43
31
26
4
35
26
21
18
5
30
22
18
16
6
26
19
16
14
2nd
3rd
4th
5th
6th
13
12
Research Sources:
G. Kalyanaram,”The order of entry effect in prescription (Rx) and over-thecounter (OTC) pharmaceutical drugs,” International Journal of
Pharmaceutical and Healthcare Marketing, 2008, pp. 35-46.
Hans Bauer and Marc Fischer, “Product life cycle patterns for
pharmaceuticals and their impact on R&D profitability of late mover
products,” International Business Review, 2000, 703-725.
IT IS POSSIBLE TO TAKE AN EVIDENCE-BASED APPROACH
Research Methods for Market and Penetration Analysis
t
uc
od
Pr
w
Ne
ed
a t al
tim rci
Es me
m
Co s
ve
Li
T3
T3
T2
NF
T3
NF
T2
T2
T3
T3
NF
T3
T3
NF
T2
T3
T2
T2
ia
e
id
iz
T2
T2
T2
NF
T3
NF
T2
T3
T3
T3
NF
T3
T3
NF
T2
T3
T2
T3
d
an
Av
lip
G
T2
T2
T2
F
T2
NF
T2
T3
T2
T2
T2
T2
T2
T2
T3
T2
T2
T3
in
rm
fo
et
T3
T3
T3
T3
T3
NF
T3
T3
T3
T3
T3
T3
T3
T3
T3
T3
T3
T3
M
24,900,000
12,020,000
10,960,000
9,000,000
8,990,000
7,290,000
3,340,000
2,730,000
2,520,000
2,290,000
69,000,000
49,000,000
49,000,000
6,000,000
5,000,000
3,300,000
8,900,000
1,200,000
275,440,000
ia
National
National
National
Internal PBM
National
Regional
Internal PBM
Regional
Regional
National
PBM
PBM
PBM
PBM
PBM
PBM
PBM
PBM
PBM
v
nu
Ja
I
Target Payers*
WellPoint/Anthem
Aetna/US Healthcare
United Healthcare
Prime Therapeutics
Cigna
Kaiser
RxSol / PacifiCare
Coventry
HealthNet
Humana
Caremark
ExpressScripts
Medco
PharmaCare
MemberHealth Rx
Anthem
NMHCRx
Coventry
pe
Ty
38
an
Pl
Leads to suggested sales force sizing
and territory coverage with a managed
care strategy in light of a launch
budget. This facilitates building a
penetration forecast that is market
based. Typically such forecasts are
much lower than those derived from
physician preference share analysis.
T3
T3
T2
NF
T2
F
T2
T2
T2
T3
NF
T3
T3
NF
T2
T3
T2
T2
COMMERCIAL ANALYSIS AND PENETRATION
Penetration Analysis Should Understand Prescriber Concentration, Sales
Force Design, Prescribing Behavior and Reimbursement Positioning
Historical Ramp Speed Analysis
Bauer and Fischer (2000) show that Early Movers Ramp Slowly
Source: H.H. Bauer, M. Fischer, International Business Review 9, 2000, pp 703–725
39
I
COST ESTIMATION
ACCOUN
TING
TREATM
ENT
Estimating Costs
Research Costs / Clinical Development Costs
• Identify remaining steps to IND (Toxicology, PK, etc.)
• Estimate cost of remaining steps
• Evaluate anticipated time and numbers of patients per phase
• Examine patient enrollment issues, treatment length and cost, ease of
establishing endpoints, long-term safety, regulatory complexity, etc.
COGS
• Look at COGS estimates on comparable products
• Use expected dosing and treatment length to generate unit sales. Estimate COGS
at that sales volume
• Important to be aware of fixed / variable elements of COGS
• Review status and current data on scale-up issues
Sales and Marketing Costs
• Examine concentration of customer base: hospital or office based physicians, etc.
• Use IMS sales force sizing / penetration studies.
• Evaluate potential market issues: requirements for physician training and
education, patient education, direction to consumer marketing, etc.
41
I
Estimating Costs
Pre-Clinical Costs
Clinical Development Costs
From lead to IND: $5 to
$15mm
Number of Patients in Trials
From target to lead: $5mm to
$50mm
Complexity and Length of
Protocol
Pre-Clinical Cost Drivers
Time in Trial
Difficult of chemically reaching target
Existence of pool of potential targets
Existence of predictive animal models
Demand for Patients / U.S. vs.
ROW
Cost and complexity of pharmacology work
Need for extensive animal toxicity work
Drug supply costs
Need for formulation / scale-up work
A good rough benchmark is to assume $25,000
per patient and count the number of patients.
42
I
• Raw materials
• Inventories
• Small molecular
versus biologic
43
I
ACCOUN
TING
Input Costs
TREATM
ENT
COGS Factors
… and production
costs
• Batch size
• Production process
(complexity, steps)
• Storage and
inventories
• Delivery to
customers
Estimating COGS can
be based on a number
of factors
• Similarity to other
drug profiles
• Complexity
• Economies of scale
ACCOUN
TING
TREATM
ENT
Sales Force Costs: Example of Costing Grid
Number of
Personnel
Fully Loaded
Cost
Total Annual
Costs
Senior
Management
2
$380,000
$760,000
Regional
Managers
5
$260,000
$1,300,000
MSLs
8
$250,00
$4,000,000
Sales Reps
120
$180,000
$21,600,000
Support Staff
12
$80,000
$960,000
Total
$28.6 million
Level
44
I
ACCOUN
TING
TREATM
ENT
SG&A Typically is Typically Much Higher than Direct Sales Force Cost
Company
Pfizer
GlaxoSmithKline
Sanofi-Aventis
Novartis
AstraZeneca
Merck
Wyeth
Bristol-Myers Squibb
Eli Lilly
Schering-Plough
King Pharmaceuticals
Sepracor
Reliant Pharmaceuticals
Sciele
Revenues
2006 ($mil)
$ 48,371
$ 45,500
$ 38,934
$ 36,749
$ 26,475
$ 22,636
$ 20,351
$ 17,914
$ 15,691
$ 10,594
$
1,998
$
1,196
$
800
$
293
SG&A
Expense
($mil)
$ 15,589
$ 14,268
$ 10,641
$ 13,157
$ 9,464
$ 8,165
$ 6,501
$ 6,270
$ 4,890
$ 4,718
$
714
$
764
$
550
$
145
SG&A
Margin
32%
31%
27%
36%
36%
36%
32%
35%
31%
45%
36%
64%
69%
49%
Salesforce
Cost ($mil) Revenue / Rep
$ 4,140
$ 1,389,971
$ 4,375
$ 1,229,730
$ 3,342
$ 1,364,191
$ 1,940
$ 2,370,903
$ 1,950
$ 1,765,000
$ 1,900
$ 1,741,231
$ 1,575
$ 1,695,917
$ 1,348
$ 1,628,545
$ 2,175
$ 950,970
$ 1,618
$ 827,656
$
193
$ 1,816,364
$
333
$ 629,474
$
126
$ 1,111,111
$
114
$ 450,769
U.S. Reps
8,800
9,000
6,500
5,200
6,000
8,000
5,000
3,300
7,000
4,500
1,100
1,900
720
650
Worldwide
Reps
34,800
37,000
28,540
15,500
15,000
13,000
12,000
11,000
16,500
12,800
1,100
1,900
720
650
Source: Cowen Pharma, Jan 2007 and Torreya Partners Analysis
It is important to estimate variable cost components of a new drug introduction
beyond direct sales force costs.
45
I
ACCOUN
TING
TREATM
ENT
Illustration of a Launch Budget for a Primary Care Product
New Drug Launch Costs
Marketing
Travel
Advertorial Media
Patient Starter Kit
Launch Sales Aid
Launch Campaign Art
Small Science Flash Card
Patient Ed Booklet & Holder
Direct to Patient Concepts
Printing Sales Aids
Testing
Media to PCPs and GI docs
Launch Journal Advertising
Launch Media
Launch Convention Panels
MDAlert
PharmAlert
Pharmacy Sell Sheet
Managed Care Sales Aid
Formulary Stickers
Shelf Talker
Web site
Direct Mail
Product Website Development
Premium Item Give-Aw ays
Launch Meeting (does not include hotel and flight arrangements)
Marketing Plan -Consulting
Sales Training Modules
Promo Items
Rebate
Trade Show Booths
RCW Account service fee
Drug Med Ed
Sample packaging
Marketing Total
46
I
2011
1,000,000
6,000,000
30,000
86,500
100,000
43,000
98,750
58,000
250,000
12,000
1,500,000
2,000,000
40,000
37,000
32,000
27,000
37,000
15,000
20,000
250,000
205,000
60,000
107,000
1,000,000
120,000
20,000
150,000
630,500
3,000,000
568,000
17,496,750
Regulatory & Prod Developm ent
Surveillance system
800 number
Orange book costs
PDUFA establishment
Total
Personnel
Representatives (1500) including salary, benefits & fleet
Recruiting, Travel and Misc Personnel Expenses
Managed care organization (100)
Sales Management, MSLs, Outcomes Grp (80)
Total
Sam ples
Manufacturing, Packaging
250,000
20,000
100,000
50,000
420,000
262,500,000
75,000,000
15,000,000
20,000,000
372,500,000
50,000,000
Sales
Sales Incentive (trip/other)
Training
Inventory sample cost
Total
Shipping costs
3,000,000
1,500,000
1,000,000
5500000
1,000,000
Total
$ 446,916,750
RISK ESTIMATION
Phase 1:
Done Q3 2008
Phase 1b:
Done Q2 2009
Phase 2:
Done 2010
Phase 3:
Done 2012
Opportunity to show
range of doses
Opportunity to find
clear efficacy and start
to see safety profile.
Hopefully, primate tox
is complete and we
have a backup
compound in Phase 1.
Critical to get the dose
right, establish a safety
profile and begin to
write the label. Animal
carcinogenicity done.
Write the label, confirm
the safety profile and
dose. Consider head to
head trials vs. standard
of care, noting points of
differentiation. Get QT
study done.
Phase 3: Large
safety confirmation
trial / write label
I
48 48
Drug Safe and
Superior to existing
meds
Drug Safe, not
Superior but adds
to existing meds
Phase 3: Not Safe
Terminate /
Consider Other
Indications
Phase 1b: Not Safe
Terminate /
Consider Other
Indications
Terminate /
Consider Other
Indications
Terminate
Development
Terminate
Development
Terminate
Development
Phase 1b: Initial
Proof of Concept
Phase 1: Not safe
If we can beat on efficacy
and match safety we
have a giant drug.
Drug approvable
but inferior to
existing meds
Phase 2: Dose and
Safety Confirmed
AR9281 Phase 1a
Safety Trial
Drug Approval /
Label: 2013
KEY CLINICAL EVENTS AND POTENTIAL OUTCOMES
Important to Diagram Key Development Steps and Risks
100%
80%
100%
60%
80%
Cumulative probability
of success (percent)
40%
52%
20%
26%
18%
15%
0%
Pre-Clinical
Successful
IND
Submission
Phase I/IIa
Successful
Phase IIb
Successful
Stage of Development
49
I
Phase III
Successful
NDA
Successful
MOST DRUG CANDIDATES FAIL TO BE APPROVED
Using Industry Average Failure Rates to Handicap Risk (PTRS)
Probability of FDA Approval
Probability of FDA Approval for Products Entering (%)
STUDY
Lehman Brothers (1997)
Myers / Howe (1997)(1)
DiMasi / Manocchia (1997)
(1)
Kaitin (1995)
DiMasi / Hansen / Grabowski / Lasagna (1997, 1995)
Struck (1994 biotech)
Struck (1994 conventional NCE)
DiMasi / Seibring / Lasagna (1994)
Wenzel (1993)
Grabowski (1991)
Tucker / Blozan / Coppinger (1988)
Sheck / Cox / Davis et al. (1984)
Hansen (1979)
Recombinant Capital (o.D.)
Bienz-Tadmor / DiCerbo / Lasagna (1992)
Grosse / DiMasi / Nelson (1996)
Average
Average (excl. high and low)
Preclinical
Phase I
Phase II
Phase III
FDA
4
22
–
–
–
38
11
–
–
–
?
–
–
19
–
–
10
24
–
20
23
69
25
–
63
64
–
62
64
92
66
–
63
64
?
–
–
60
–
–
90
75
90
75
–
100
100
83
–
29
21
30
32
–
30
31
79
33
–
30
31
?
–
50
30
–
–
19
18
25
23
38
34
66
64
87
87
23
?
17
19
?
–
–
–
–
–
Notes
(2)
(3)
(4)
Source: "Real Option Valuation in R&D Decision-Making in Pharmaceuticals" by Dr. Gunnar Pritsch, Associate Principal, McKinsey & Co.
(1) No empirical study, but “conclusion estimates”.
(2) Gastrointestinal: 79%; anti-infective: 84%; cardio: 90%; oncology: 92%; antiviral: 93%; endocrine: 94%; neuropharmacologic + radiologic: 100%.
(3) Peptide hormone analogous: 24%; antiviral 29%; antineoplastics: 33%; cardiovascular: 34%.
(4) Data 1980-89; number reflects average expected success for all recombiment protein and monoclonal antibody drugs; all recombinants: 19-43%;
new recombinants: 15-39%; therapeutic MAbs: 4-29%.
50
I
WIDE RANGE OF SUCCESS RATE ESTIMATES
Studies of Drug Approval Risk
Avance published a study in November 2009 of over 200 companies listed on
public stock exchanges, tracking their clinical drug candidates from 2003-2009.
Cost ($ million)
Success Rate /
Transition
Probability (%)
Duration
(Months)
Phase I
5
71%
12
Phase II
12
44%
26
Phase III
68
69%
34
NDA
3
NA
18
Total
88
21%
90
Stage
In biotech the success rate was even lower, averaging 9% for NCEs and 15% for
biologicals.
51
I
OVERALL SUCCESS RATE OF DRUG APPROVAL: 21%
Success Rates from a Recent Study
Another Updated Study: DiMasi – March 2010
Source: JA DiMasi, L Feldman, A Seckler and A Wilson, “Trends in Risks Associated With New Drug
Development: Success Rates for Investigational Drugs,” Clinical Pharmacology and Therapeutics, March
2010, pp. 272-277.
52
I
Success Rates Depend on Therapeutic Indication
Source: DiMasi, J.A., 2001, “Risks in New Drug Development: Approval Success Rates for
Investigational Drugs”, Clin Pharmacol Ther, vol. 69, p. 297-307.
53
I
Transition Probabilities by Therapeutic Class
Source: JA DiMasi, L Feldman, A Seckler and A Wilson, “Trends in Risks Associated With New Drug
Development: Success Rates for Investigational Drugs,” Clinical Pharmacology and Therapeutics, March
2010, pp. 272-277.
54
I
Small versus Large Molecule
Source: JA DiMasi, L Feldman, A Seckler and A Wilson, “Trends in Risks Associated With New Drug
Development: Success Rates for Investigational Drugs,” Clinical Pharmacology and Therapeutics, March
2010, pp. 272-277.
55
I
THE DISCOUNT RATE
ACCOUN
TING
Nominal / Real
TREATM
ENT
Discount Rates Used in Industry
Discount Rate
Company
Actelion
57
I
Source
Nominal
13.2%
HY Report 2009
Large Pharma A
Real
10%
2010 Interview
Spec Pharma A
Nominal
12%
2010 Interview
Large Biotech A
Nominal
10%
2009 Interview
Spec Pharma B
Nominal
14%
2009 Interview
Large Pharma B
Nominal
12%
2009 Interview
AstraZeneca
Nominal
11%
Annual Rpt 2008
Range
10 to 14%
ACCOUN
TING
TREATM
ENT
Nominal Versus Real Discount Rates
Nominal rates include the effects of inflation.
Real rates have been adjusted for inflation.
It is important to match cash flows in the forecast to the type
of rate used:
Nominal cash flows with nominal rates and real cash flows with real
rates.
It’s an important distinction because many pharma revenue forecasts
are real whether stated or not. Price increases that are modeled in are
above and beyond normal inflation.
58
I
Discount Rate Should Reflect the Cost of Capital
What is the Cost of Capital?
 The cost of capital is a measure of the opportunity cost of capital in an economy.
A company’s cost of capital should equal the marginal return available to
investors in the next best investment opportunity of similar risk available in the
capital markets
 The cost of capital should reflect:

The return available to investors in the economy on risk-free instruments

The return that investors require for taking systematic risk over and above
the risk-free rate

Systematic risk is that which cannot be diversified away.

Traditionally measured as the weighted average of the cost of equity and
debt. Known as the Weighted Average Cost of Capital (WACC).
The Cost of Capital is the opportunity cost of money in a competitive market
economy and is a guide to the right discount rate.
59
I
Weighted Average
Cost of Capital (WACC)
Cost of Equity
Cost of Debt
Risk-Free
Rate
Credit
Spread
Country/
Political
Risk
Premium
Tax Shield
Risk-Free
Rate
Equity
Market
Risk
Premium
Equity
Beta
Business
Risk
Country/
Political
Risk
Premium
Financial
Risk
WACC is a weighted average of cost of equity and debt, where the weights for cost of debt
and cost of equity are determined by market values of equity and debt. Because a number of
inputs to WACC are of statistical nature, WACC is a range rather than a point estimate.
60
I
THE TRADITIONAL APPROACH TO WACC
Estimating The Cost of Capital using WACC Approach
Because equity is a long-term investment,
a risk-free rate representing a long-term
horizon is most appropriate.
Consequently, we utilize the 30-year U.S.
Treasury as the risk-free rate in the CAPM.
EQUITY MARKET RISK PREMIUM
The equity market risk premium is the
excess return expected for the equity
market relative to the long-term bond
market. The figure that is used normally
ranges between 4 and 8%.
EQUITY BETA(1)
The beta is a risk measure which
represents the non-diversifiable risk
associated with an equity investment
measured relative to the overall equity
market. It is a function of asset risk and
financial risk.
POLITICAL RISK PREMIUM
The political risk premium represents the
incremental return investors require for
use of their funds in international
investments and represents nonsystematic risks such as expropriation.
(1) When calculating the asset beta for high-levered, non-investment grade companies, it is important to utilize a “debt beta” in the calculation.
61
I
TRADITIONAL APPROACH TO WACC (CONT’D)
RISK-FREE RATE
Discount Rates in Practice
62
I
CAPM near useless
(betas on risky pharma
companies often very
low)
Industry betas are
better if you must use
beta
We prefer to pick a
fixed rate that reflects
the leveraged
opportunity cost of
equity
Another approach is to
look at industry wide
implied cost of equity
from actual market
prices.
VALUATION CONSIDERATIONS IN LICENSING
Illustrative
Value to
Original
Developer
Total Program Value
NPV= $30
License
Milestones
Royalties
NPV= $80
R&D
Sales
COGs
R&D
NPV= $50
Sales
S&M
License
Value to
Partner
COGs
Milestones
S&M
R&D
64
I
Royalties
PARTNERSHIP AND NPV
Partnering a Program Splits the NPV Between the Original Developer and the Partner
Negotiating and Valuing Licensing Deals
NPV Split
•
•
•
•
What percent of the rNPV goes to the licensor and licensee?
Generally the licensor can get more than 50% of the value
Generally the split is more favorable to the licensor on earlier deals
Generally the split is more favorable to the licensor when the licensee
is small or in financial difficulty
rIRR to the Licensee
• A key benchmark is what return on investment goes to the licensee
(risk-adjusted internal rate of return)
• A smart licensee avoids putting his capital to work in order to boost
the rIRR
• A smart licensor tries to get the lowest rIRR deal possible
• Surprisingly, many counterparties in pharma negotiations pay less
attention to this metric than they should.
65
I
66
I
PARTNERSHIP DASHBOARD
Partnership Economics in a Recent Torreya Advised Transaction
1. Pick deals with large scale and high rIRRs
2. Know your rIRR limit – generally in the 20 to 30% range.
3. Focus on putting largest payments after key risk points
have been passed
4. Focus discussion on precedent transactions (example at
right)
5. Focus discussion on key issues (e.g., reimbursement,
compliance, other related product revenues)
6. Focus discussion on fit and good job that can be done
7. Include equity as consideration if licensor is cash-strapped
(often is misvalued)
8. Understand liquidation preferences of licensor / seller
67
I
BARGAINING TACTICS WHEN IN-LICENSING
Bargaining Tactics when In-Licensing
1. Ask licensor to show what they can do for you. Get financial forecasts if
possible. Ask for a capabilities presentation.
2. Figure out the licensor’s financial modeling approach and assumptions
as best as possible.
3. Figure out the licensor’s hurdle rate on rIRR.
4. Solve for the licensor’s model and the rIRR as terms change.
5. Focus less on deal comparables.
6. Try to get payments made early in the collaboration.
7. Avoid including equity as consideration.
68
I
BARGAINING TACTICS WHEN OUT-LICENSING
Bargaining Tactics when Out-Licensing
Assume $20 million upfront, $160 million in milestones and a 22% royalty.
Cash Flows to BigPharma from Partnership Transaction - US
Items
Forecast Revenue
Cost of Goods Sold
Royalty payment to Biotech
BigPharma development expense
SG&A and launch cost
Milestone payments to Biotech
BigPharma Pre-tax cash flows
After-Tax Cash Flow
Probability of Success in Year
Probability of Payment if Deal in 2008
Probability Adjusted Cash Flow
EPS Impact with success
2008
0
0
0
5
0
20
(25)
(25)
10%
100%
(25)
$
(0.00)
BigPharma Tax Rate
22%
BigPharma Rate of Return on
Partnership
36%
Value created at BigPharma by deal:
2009
0
0
0
10
0
0
(10)
(10)
20%
50%
(5)
$
(0.00)
2010
0
0
0
20
0
40
(60)
(60)
40%
25%
(15)
$
(0.01)
2011
0
0
0
20
0
0
(20)
(20)
40%
25%
(5)
$
(0.00)
$6,104 million for an investment of
2012
0
0
0
50
(30)
60
(140)
(140)
70%
20%
(28)
$
(0.02)
$
2013
0
0
0
50
(30)
60
(140)
(140)
70%
20%
(28)
$
(0.02)
2014
0
0
0
10
0
0
(10)
(10)
85%
15%
(2)
$
(0.00)
$
2015
624
62
137
0
(156)
200
68
53
100%
10%
5
2016
1,686
169
371
0
(422)
0
725
565
100%
10%
57
2017
2,918
292
642
0
(642)
0
1,342
1,047
100%
10%
105
2018
4,339
434
954
0
(954)
0
1,996
1,557
100%
10%
156
0.01 $
0.08 $
0.15 $
0.22 $
(78) million in expected terms.
The deal on the table here is for a Phase 1b cardiometabolic drug. The
proposal made of 20mm upfront gives the licensor (big pharma company) a
generous return of 36%. However, the project is highly risky. The licensee
should keep bargaining to try to get the pharma’s return down to a sub 25%
area. This will require getting the upfront to be higher.
69
I
2019
5,972
597
1,314
0
(1,314)
0
2,747
2,143
100%
10%
214
0.31 $
2024
8,836
884
1,944
0
(1,944)
0
4,064
3,170
100%
10%
317
0.45 $
2029
12,450
1,245
2,739
0
(2,739)
0
5,727
4,467
100%
10%
447
0.64
ONE SHOULD ALWAYS TRY TO GUESS THE OTHER SIDES VALUE
Solving for the Other Side’s Model
THE M&A SETTING
M&A and Licensing Valuation Analysis are Conceptually Similar
Same exercise but now we are valuing a company rather than a drug.
Sum the rNPVs of the projects of the target company with adjustment
for overhead costs or model the company as a whole (will shown an
example for Eli Lilly).
This gives the target company intrinsic valuation.
Try not to overpay. Valuation is treacherous, particularly with terminal
value assumptions.
Problem is that most M&A deals involving later stage and marketed
assets are NPV negative.
Two ways to think about this:
1. Look at the IRR on your own company – what is your cost of cash?
2. Look at missing elements – particularly the target’s pipeline.
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OUR
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APPRO
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M&A Analysis Approach at One Pharma
•
•
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The Pharma has a well developed approach
– Step 1. Identify cash flows from identifiable products
– Step 2. Discount the cash flows at a rate in the low teens to get the DCF value
– Step 3. Compute the target purchase price as the equity value plus a premium of
30 to 50% (typically 40%) plus debt less cash
– Step 4. Compare the DCF to purchase price of the target
• The difference between enterprise value and DCF is known as pipeline or
science value
• If pipeline value is negative then the valuation test suggests acquire
• If pipeline value is greater than 50% then the valuation test suggests avoid
• If pipeline value is between 0 and 50% then study further and make a
business judgment
This approach leaves significant room for quantitative and qualitative judgment. It is
intelligent and designed to avoid situations where the pharma overpays for targets.
Consequences of a Hypothetical 2004 Acquisition of a Specialty Pharma
Operating Income (ex-Synergies)
Operating Income (ex-syergies)
Revenues
$3,966
$3,549
$3,163
Revenues
$3,072
$2,777
$2,725
$2,373
$2,199
$526
2005
$699
$772
$803
2006
2007
2008
Warner Chilcott
$996
$726
$625
$351
$377
2007
2008
$270
$216
2006
28.4% 41.1% 30.7%
30.6% 38.9% 32.5%
Allergan
Pro Forma
Source: Wall Street projections
$1,000
$856
$841
2005
Operating Margin
Allergan
$1,377
$1,207
30.8% 45.4% 33.9%
Warner Chilcott
31.6% 46.9% 34.5%
Pro Forma
Source: Wall Street projections
EPS
2003-2008 CAGR
19.9% accretive
18.8% accretive
14.1% accretive
$5.54
$4.62
$4.42
$3.28
$3.55
2005
$5.48
$3.87
2006
Allergan
2007
Pro Forma
Source: Wall Street projections
2008
2005-2008 CAGR
8.4% accretive
21.4% 22.4%
20.5%
$6.51
17.0%
15.2%
12.9%
17.9%
18.7%
13.3%
Revenue
Operating Income (ex-synergies)
Allergan
Warner Chilcott
Pro Forma
EPS
Factors to Consider in NPV Models of Pharmaceutical Companies
Model each drug in an additive manner.
• Revenues and cost curves for each drug.
• Use reasonable estimates to the curves for the models.
Take drugs out at least 10 to 15 years – past patent expiration dates
• Analyst reports generally stop too soon
• Pay careful attention to patent issues and associated cliffs
• Use analyst reports to get the estimates started
Carefully think about the role of R&D in the model.
• If you keep R&D in then you need a terminal value
• If you leave it out or scale it down then no terminal value required
Be aware of how your own company looks through the same lens
• For the purpose of a stock for stock merger it’s important to look at each party with the
same analytical approach
• If you ignore their pipeline, you should ignore yours etc.
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