Huang Xiaolin: Is the value of biomedical enterprises "overvalued"?

■ This article is selected from Fudan Financial Review.

■ Author: Valuation Partner, PricewaterhouseCoopers Trading Consulting Department, Huang Xiaolin

■ WeChat official account: Fudan Financial Review

Hermia

Valuation Partner, PricewaterhouseCoopers Trading Consulting Department

It is the first anniversary of the opening of science and technology innovation board, which is a milestone in the history of China's capital market. Science and technology innovation board's success reflects the enthusiasm of the capital market to embrace "hard-tech" enterprises. Among many enterprises that have landed in science and technology innovation board, the strength of biomedical enterprises should not be underestimated. In the era of encouraging innovation, biopharmaceutical enterprises that have not yet obtained revenue can choose to go public with the fifth set of standards to realize docking with the capital market and help their own development.

The valuation of biomedical enterprises "opens higher and goes higher"

Since the beginning of 2020, with the global spread of the COVID-19 epidemic, the counter-cyclical characteristics of the medical and health industry have become prominent, and it has once again become a market gathering point. Among them, COVID-19's vaccine research and development and related vaccine industry are important sub-industries in the biomedical field. The birth of new vaccine varieties is an important driving force for the vaccine sector, and the birth of new heavy varieties is often closely related to the need to curb the prevention and treatment of diseases that spread rapidly and cause great harm. Since 2020, the time trial of vaccine research and development in COVID-19 has been launched all over the world. According to the data released by the World Health Organization (WHO), as of August 6, 2020, six vaccine varieties have begun to deploy phase III experimental clinical trials, including three from China.

The progress of vaccine research and development in COVID-19 has also affected the fluctuation of the capital market. According to the public information released by China Vaccine Industry Association in February, 2020, there are 18 companies in China developing COVID-19 vaccine, including many listed companies. It is worth noting that after the epidemic, the valuation of the overall pharmaceutical sector has increased, especially for listed companies related to vaccine research and development in COVID-19. Taking the multiple of the marketing ratio (i.e. share price/earnings per share) of some listed companies involved in vaccine research and development in COVID-19 as an indicator, we can see that their valuation levels have been improved to varying degrees before and after the outbreak (Figure 1), which fully reflects the expectation of the capital market for the vaccine research and development process in COVID-19 and the huge market after commercialization.

Note 1: The source of data S& is S&'s capital IQ and PricewaterhouseCoopers analysis.

Note 2: The time points of data analysis are 20 19 12 3 1 and June 30, 2020.

Figure 1 Changes in Marketing Rate of Some Vaccine R&D Listed Companies in COVID-19.

Looking around the world, while several international giants continue to lead the market, vaccine research and development enterprises in the field of biotechnology, such as Moderna, are also highly anticipated by the market on the road of vaccine research and development in COVID-19. Comparing the scale and marketing ratio of these companies, we can find an interesting phenomenon: many emerging vaccine R&D companies are still highly valued in domestic and international capital markets, although their current income is very small. This has also caused new market thinking: how to understand this marketing rate of hundreds of times? Facing the booming biomedical industry, how to grasp the reasonable investment value? How will the business decision of the enterprise affect the valuation?

Note 1: Data samples are from Wind database and S&; P Capital IQ and PricewaterhouseCoopers Analysis

Note 2: The date of data analysis is June 30, 2020.

Figure 2 Emerging vaccine R&D companies at home and abroad generally have high valuations.

The author believes that this phenomenon of extremely high valuation multiple appears because the market adopts a forward-looking "end-point" valuation perspective, that is to say, product pipelines and related enterprises with great R&D and commercialization potential will be highly valued by the market, and the current valuation level is linked to the expected commercial value of the market, focusing on "the future can be expected". This forward-looking valuation perspective breaks through the traditional valuation system and reflects the high tolerance of the capital market for "high-tech" enterprises. The market encourages scientific and technological innovative enterprises to raise funds through listing. Therefore, using the traditional marketing ratio multiple to measure the valuation level from a new angle will lead to the phenomenon of "extremely high multiple". At the same time, high valuation also contains high volatility, and every step of enterprise development is closely related to the valuation level.

Return to the value origin of biomedical enterprises

How to treat the valuation of biomedical enterprises? First of all, we should understand that "valuation" is an estimate of market value, and the data of capital market will provide very important clues and information. A good valuation can stand the test of the capital market, and the fluctuation of the capital market itself will also convey important market expectations and attitudes. When a new thing appears in the market, different market participants often have different attitudes. This is like how to look at a half-full bottle of water. Some observers see half full, while others see half empty. Different people have different opinions. This in itself reflects the systematicness, complexity and predictability of valuation, and also challenges the appraiser's market acumen, industry accumulation, professional judgment and valuation experience.

The process of valuation is a reeling process, and it is also a process from beginning to end. Valuation is inseparable from the exploration of the industry characteristics of the valuation object. Take the biomedical industry as an example. Enterprises in the industry generally have the characteristics of long R&D cycle, huge investment in the early stage and concentrated economic returns in the later stage. They need a lot of financial support in the R&D stage, and their products can hardly generate income before they are approved for listing. Therefore, biomedicine is a high-input and high-risk industry. Corresponding to high investment and high risk is the high value at the end and the milestone value growth mode in the process. As we all know, new products go through a long and arduous process from research and development to listing. In the process of preclinical trial, clinical phase I, clinical phase II, clinical phase III and market application, the value of pipeline will increase by a milestone every time it enters a new stage.

How to grasp the value drivers of biomedical enterprises can be summarized as follows:

First of all, we are studying the pipeline-on which track. Products and pipelines under research are the core values of biomedical companies. The number of pipelines, corresponding labels and related intellectual property protection are the core guarantee factors of "gold content" valuation, and they have also been paid great attention to by the capital market.

Second, the market capacity-how high the ceiling is. Market capacity determines the ceiling of valuation, which is an important factor that enterprises need to consider when deciding the strategic layout of R&D pipelines, because the value of pipelines is ultimately realized through the commercialization of products. After the new drug goes on the market, the corresponding indication field, the number of patients, the awareness rate and the treatment rate determine the overall market capacity of the product, while the market competition pattern and the ability to reach patients affect the market penetration of the product, and finally determine the final sales scale and sales revenue curve of the drug.

Third, research and development costs-how much. R&D is the engine of biomedical companies, and clinical trials are the most expensive part in the process of new drug research and development, so the cost of R&D can reflect the R&D process to some extent. But at the same time, R&D cost is also related to R&D efficiency. The higher the efficiency of R&D, the higher the enterprise value.

Fourth, the success rate of R&D-the return on investment. The value of biomedical companies is affected by the research and development status and success rate of each pipeline. There are structural differences in the success rate of pipeline R&D with different R&D stages and indicators. At the same time, the success rate of R&D in China and the international market is also different, so the research and thinking of R&D success rate need to be carefully analyzed according to the national conditions, the specific situation of the pipeline and the degree of innovation.

Fifth, the time node-when to get the reward. Important time nodes are distributed in R&D stage and commercialization stage, involving indications, clinical cycle, approval and marketing, commercialization strategy and many other considerations. From the perspective of valuation, the later the time node is, the closer it is to the commercialization stage, and the higher the corresponding value is. For the product pipeline that has been successfully commercialized, how long it takes to reach the sales peak and the changing trend of the sales curve after reaching the peak have a direct impact on the valuation level.

Sixth, business model-how to distribute value. The business models of biomedical enterprises include joint development, authorization, independent production and sales. Its essential influence on valuation is the distribution mechanism of value. Under the entrustment mode, the income sources of biotechnology companies are mainly authorization fees, milestone payments, sales share income and so on. In the independent production and marketing mode, the valuation pays more attention to the commercialization ability of the enterprise, including whether there is a mature sales team and sales channels and whether there is rich marketing experience. Enterprises need to decide which business model to adopt according to their different competitive advantages, market positioning and development ability, and conduct multi-dimensional and multi-scenario analysis based on valuation model to facilitate business decision-making.

Exploring the China Road of Biomedical Industry Evaluation Technology

Biomedical enterprises have the characteristics of large pipeline differences, huge initial investment and long time span, and the applicable valuation technology is essentially different from traditional industries. Therefore, the valuation of biomedical enterprises should be long-term and forward-looking.

Measuring economic value is the core of valuation. When discussing economic value, we need to consider two dimensions: scientific angle and commercial angle. Scientific views include indications, number of patients, awareness rate, rate of medical treatment and other key factors; The commercial angle is also the commercialization strategy, including product pricing, competitive environment, life cycle, medical insurance policy and other important factors. Valuation is to comprehensively consider the disease model, business model and their key elements, and transform them into economic language that investors and capital markets can understand, thus forming a valuation model.

Figure 3 Valuation Model of Biomedical Enterprises

The specific application of valuation method can be discussed through two ways: relative valuation method and absolute valuation method. Around the valuation methods suitable for biomedical enterprises, both methods are applied in international valuation practice.

Figure 4 Valuation method of biomedical enterprises

On the one hand, the relative valuation method is a valuation idea of "keeping a close eye on the market" and needs to set a reasonable reference. Among them, the recent financing method can reflect the valuation level of biomedical enterprises in a certain period to a certain extent, and at the same time can well display and track the range of valuation changes; Comparable transaction case method or comparable listed company method is more suitable for mature enterprises, and commonly used benchmark multiples include market sales rate, price-earnings ratio and so on. However, the growing biomedical enterprises that still rely on financing to support drug research and development may not be able to directly use financial indicators for benchmarking analysis, and need to further decode and analyze from the perspective of core business factors and enterprise development milestones.

On the other hand, the absolute valuation rule is the valuation idea of "pegged model", and the "connotation" value of pipeline products is calculated by establishing the valuation model. In order to reflect the characteristics of biopharmaceutical companies' long research and development cycle and short-term profit, discounted cash flow valuation method based on project risk correction and discounted sales peak period method have become the most commonly used methods in this industry.

The basic idea of applying the revised discounted cash flow valuation method based on project risk is to introduce the key variable of R&D success rate on the basis of the traditional discounted cash flow method, so as to adjust the valuation. This method is rigorous and meticulous. Considering that there is a certain probability of failure risk in each stage of R&D, it is necessary to distinguish between products and R&D stages, consider the risk correction applicable to each R&D stage, and consider the basis of risk correction based on different cash flow properties at the product pipeline level and the overall enterprise level.

The discount rule of sales peak is a highly centralized valuation method in practice, which closely follows the four key variables of product pipeline: the time to reach the sales peak, the required rate of return, the peak return and the peak return multiple. This method still adheres to the idea of "connotation" valuation, but it is easier to operate in practice than the discounted cash flow valuation method, and also draws lessons from the idea of relative valuation method to some extent, which has a very broad application prospect in practice.

Fig. 5 Operation steps of peak sales discount method

At the same time, in more and more local valuation practices in China, the index of market value/R&D expenditure multiple is gradually introduced. In the case that innovation-oriented R&D has obvious expectations for future market sales, but the current financial indicators such as income, profit and cash flow cannot match the future expected scale, the R&D cost reflects the investment and accumulation of R&D value by biomedical companies to some extent. The application of this valuation multiple also belongs to the category of relative valuation method, which has certain China characteristics. The market is also discussing and exploring the positive correlation between the accumulation of R&D expenses and the growth of enterprise value and the application basis of this method. For example, the accounting treatment of capitalization or expensing of R&D expenses in financial treatment itself needs to be fully considered in the valuation process.

In my opinion, there is still a gap between the overall experience of domestic biomedical enterprises in valuation and the maturity of the capital market itself and the international market, but the development speed should not be underestimated. The listing boom of biomedical enterprises has promoted the technological development of the entire China valuation industry, and the valuation industry itself needs to fully consider the factors affecting the local environment in China and create new methods and new ideas suitable for the local environment in China. The origin of valuation is seeking truth from facts, which fully reflects market data and market participants' expected judgment on the future. Biomedical enterprise industry itself is a long-term and patient industry, and the promotion path of valuation can not be separated from development milestones, the realization of future economic benefits, and the risk and cost factors of realizing these economic benefits.

Assess the situation and embrace the capital market

Biomedical enterprises have a long research and development cycle and high risk of capital investment, so financing channels have become a major difficulty in the development of enterprises. Like all developing "hard technology" enterprises, biomedical enterprises need capital to achieve rapid development, and also need to choose appropriate financing channels according to their own development stages and characteristics.

Figure 6 Development and financing stages of biomedical enterprises

Since the introduction of science and technology innovation board, the biomedical industry has benefited a lot. As of August 2020, among the 17 and 163 listed science and technology innovation board enterprises, there are 26 biomedical enterprises, accounting for more than 15% of the market value. The launch of science and technology innovation board has provided biomedical enterprises with an important financing channel, and at the same time promoted the overall valuation level of the biomedical sector in the A-share market, especially providing "anchoring" reference for enterprises that do not have mature products, and also improving the liquidity of the market.

At the same time, Hong Kong stocks returned to the science and technology innovation board market, and listed companies of science and technology innovation board went public in Hong Kong. One more financing channel is to reserve more ammunition for enterprises and support more research and development. It remains to be seen whether the listing financing of the two places will be considered by the market as the standard for the listing of biomedical enterprises. It can be predicted that in the future, with the continuous opening up of science and technology innovation board and the provision of various types of listing options, a more open venture capital environment and other innovative financial products will bring more financing options to biomedical enterprises and help them seize the development opportunities given by the times.

Looking forward to the economic development prospect in the post-epidemic era, domestic demand is expected under the new development pattern of domestic macro-cycle as the main body and domestic and international dual-cycle promoting each other. Biomedical industry is not only a starting point for creating new kinetic energy for economic growth, but also an important direction for unswervingly implementing scientific and technological innovation.

"Never waste any crisis"-For the biomedical industry, the epidemic test is both a challenge and an opportunity. Under the background of the overall market fluctuation, the valuation level of biomedical enterprises, especially the vaccine and diagnosis and treatment sectors related to the COVID-19 epidemic, has risen in a new round. While biomedical enterprises are favored by the capital market, the capital market also places high hopes on biomedical enterprises. Facing the tide of the times, biomedical enterprises need to understand value, display value and enhance value from the perspective of capital market, base themselves on China, lay out the world, take product pipeline as the core, refine value factors, establish valuation perspective from the perspective of business logic and strategic decision-making, optimize development strategy and enhance innovation ability, so as to seize the opportunity of the times and create value for society.

On the other hand, in the favorable environment of science and technology innovation, including biomedicine, it is the important professional responsibility of valuation consultants who are at the forefront of the industry to recognize the characteristics of biotechnology industry and adopt "tailor-made" valuation technology to help the capital market deepen their valuation awareness of this industry, help enterprises optimize their decisions and accelerate their development on the road of growth. As the leader of domestic and foreign capital markets, PricewaterhouseCoopers is willing to make full use of the accumulated industry experience and data at home and abroad, and play an active role in the valuation and pricing of science and technology innovation board enterprises through professional trading and valuation services, so as to contribute its professional strength to the outstanding biomedical enterprises in China, which are running on the road of rapid development.

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