Tuesday, June 05, 2007

R&D: Worth It Only When You Don’t Pay for It

The late Michael Sorrel, one of biotech’s most perspicacious analysts, had a few basic rules for investing, one of which was the call option. Did the biotech have not merely a lead program, which could anchor the company’s valuation, but something else the stock buyer could get for free.

Same holds true with pharma. Analysts are now so skeptical of early-stage Big Pharma R&D that they want it for free. Or at least that’s the implication of some intriguing calculations from Craig Maxwell, European equity research analyst at JP Morgan.

Maxwell summed the estimated value of the six major European pharmas based solely on their current products plus their Phase III pipelines – the “embedded value” -- and then compared it to their current share prices (see chart). The closer these values came to the share value, the less the market—theorizes Maxwell—is valuing research. And that means the less the investor is paying for R&D.

Conversely, the bigger the gap between product value and share value, the greater the value the market is putting on research. No free R&D option—and a poor deal for investors.

Best value on the European market: Novo Nordisk (products equal 104% of share price). Worst deal: GSK (products equal just 74%).

Now, you can disagree with Maxwell’s estimates of product value. Maybe he’s discounting the value of GSK’s products and inflating Novo’s. But the fact that he won’t pay for R&D—that he wants it for free, and apparently can get it—seems about as damning an indictment of the value of R&D as we’ve heard in a long time.

1 comment:

MichaelRS said...

You can also come to the similar conclusion if you follow Lehman's PharmaPipeline's Valuation of the intrinsic value of large Pharma. Whereas 10+ years ago 50-80% of the value of a company was in the pipeline (NPV of pipeline vs. NPV of market products), now 50-80% of the entreprise value is substantiated by marketed products.
Maybe this explains why biotech (largely pipeline) is not doing so well in the financial markets (compared to other industries, especially when looking at the IPO market).