|Ryan Starkes, partner and Life Sciences Practice Leader at BDO USA|
By John Kwon and Ryan Starkes
In light of recent intellectual property transactions, life sciences companies have grown increasingly aware of the importance of understanding their IP portfolio value. That realization is not limited to life sciences. In July, an Apple-led ($AAPL) consortium purchased a portfolio of about 6,000 patents from a bankrupt Nortel for $4.5 billion. At the same time, Google ($GOOG) bought more than 1,000 patents from IBM, and then acquired Motorola Mobility and its estimated 24,500 patents for $12.5 billion. Although these transactions relate to the broader technology industry, they highlight the growing importance of understanding the value inherent in a company's IP portfolio. For life sciences companies, ascribing value to an IP portfolio is magnified as a result of two factors: first, the disaggregation of the life sciences value chain over the past decade, and second, the binary nature of drug discovery and development.
Although big biopharma is still spending considerable R&D dollars on drug development (see FierceBiotech's April 25 special report, "The Biggest R&D Spenders in Biopharma"), there is broad acknowledgment that the drug discovery process is broken at many of the larger companies, not delivering the volume of new drug approvals expected for the level of spending involved. In addition to manufacturing, R&D is increasingly being outsourced. IP is being sourced through partnerships with smaller, innovative biotech companies or being acquired altogether with big biopharma contributing presumably its most valuable asset, its sales and marketing infrastructure.
With respect to the binary nature of drug discovery and development, there are few industries where the risk-reward ratio can be so significant. Like the oil and gas industry, where billions of dollars can be spent in exploration with a low likelihood of success, biopharma companies are burdened with a stark statistic--only one drug from an initial 40,000 compounds will make it through the discovery and development process including Phase I, II, and III FDA trials. On top of that, drug discovery and development for a single compound can take more than 10 years (Phase I, II, and III trials can take 5 to 7 years) and cost in the hundreds of millions of dollars. In budget-constrained environments, and with relatively empty pipelines, big biopharma has had to manage its risk through selective partnerships, joint ventures and acquisitions.
From an investor's perspective, "value" is the perceived present value of future benefits associated with a company's products or potential products. Estimating the present value of future benefits requires considering not only the magnitude of the payoff but also the level of the risk involved. Value and risk are inversely related and risk is largely driven by uncertainty. For life sciences companies, there are many risks throughout the drug discovery and development process including clinical testing as well as the uncertainty of market acceptance once the product has gone through regulatory approval and reached commercialization. In addition, the implementation and impact of recent patent and healthcare reform legislation adds another level of uncertainty to an already complex process. Again, as many of these risks are event-driven or binary in nature (i.e., succeed or fail), estimating the present value of future benefits is not a straightforward task, often being addressed from an analytical perspective with event/scenario analyses, probability trees, Monte Carlo simulation, and other financial tools.
Finally, to highlight the importance of IP in the transactions taking place in the life sciences industry, the following is a table that shows the value attributable to IP in a number of recent transactions.
Click here to see the table
The data reveal that about 75% to more than 90% of a transaction's value can be attributed to the underlying IP. Here, IP is defined to include IP rights related to product/brand rights for commercialized products as well as rights to compounds in the development pipeline. GlaxoSmithKline's ($GSK) recently announced acquisition of Human Genome Sciences ($HGSI) was predicated on essentially three drugs/compounds. Benlysta (GSK and HGS had previously formed a 50/50 development and commercialization joint venture for the compound), the first new drug addressing systemic lupus erythematosus in more than 50 years, was approved by the FDA in March 2011. Raxibacumab is a human monoclonal antibody drug being developed for the treatment of inhalation anthrax. Although not approved by the FDA, the drug is generating revenue for the company through its contract with the U.S. government. HGS also has novel drug discovery technology that has been used by GSK in its discovery of new compounds including darapladib, which is in Phase III FDA trials to evaluate whether the drug can reduce the risk of adverse cardiovascular events such as heart attack and stroke.
Many life science companies do not have the revenue streams and advanced technology that HGS possesses and, therefore, the "value" is based on potential. With the majority, if not substantially all, of a company's value based on estimates and contingencies, the importance of how the "value" was determined is critical. Understanding the composition of and uncertainties related to an IP portfolio, along with the strategies available to execute a plan that enhances value upside and mitigates risk as uncertainties are resolved will assist in supporting the "value." The greater a company's ability to identify and communicate the benefits of its IP, the more it will be able to leverage this information and realize a financial benefit.
John Kwon is the managing director at BDO Valuation Advisors and Ryan Starkes is a partner and head of the Life Sciences practice at BDO USA.