biotech investing basics
Bay Bridge Bio
reading + resources
- drug valuation calculator
- a paper on Understanding Biopharmaceutical Venture Capital Performance and Behaviour
- https://www.pharmagellan.com/blog/how-to-learn-about-biotech-and-pharma
- personal notes / related
- equity research
1 — value
resources
-
SEC EDGAR
- forms/files: 10-K, 10-Q, 8-K
- google finance https://www.google.com/finance/?hl=en
- can input ticker into google spreadsheet using =GOOGLEFINANCE()
- more formulas https://support.google.com/docs/answer/3093281?hl=en
value of a company is the sum of all the cash a company will generate in the future
value is not equal to price
what are stock prices driven by?
what moves price in biotech?
2 — measuring value
methods to measure
- market cap = no. outstanding shares X price per share
- measures value of equity
calculating market cap using SEC filings (SEC EDGAR)
- primary filings to look for shares outstanding
- 10-Q quarterly
- 10-K yearly
procession
market cap BEFORE data: outstanding shares X price per share = market cap
market cap AFTER data: outstanding shares X price per share = market cap
value created by study results: market cap after data - market cap before data = value created by data
new data changes the perceived probability of a company’s success.
value AFTER data (solving for x): probability of FDA approval after good phase 3 data × market cap if approved (x unknown value) = market cap after good phase 3 data
- 90% probability, general industry data of transitioning to FDA approval after phase 3
- solve for x (if drug is approved)
value BEFORE data (solving for y)
- y is the proability of FDA approval before good Phase 3 data
enterprise value
- market cap is the value of a company’s stock, BUT it doesn’t reflect the value of a company as a whole. enterprise is therefore relatively more a holisitc metric.
- enterprise value = equity value + debt - cash
- enterprise value is kind of like worth of acquisition - if somoene were to buy out existing stakeholders.
- reading: https://mergersandinquisitions.com/enterprise-value-vs-equity-value/
measuring enterprise value – Balance Sheets
- balance sheet is one of three core financial statements (others r cash flow and income statements)
- law of BS: total assets = total liabilities in stockholders equity
questions / unsure / to explore
- c diff
3 — valuation
- which assumptions are you / the market betting on?
- valuation allows you to understand the TERMS and the ODDS of the bet
- risk tolerance dictates how much risk you can take on, and therefore, how much you can invest.
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- just saying a company is undervalued is NOT a reason to invest
- need to start with a differentiated view on science, market view, or management team
- then, does this different view on something about the company move the stock price?
- if i’m right about this divergent view, how much might i make if i’m correct, and how much would i make if i am wrong? (odds of the bet)
- the strength of your assumptions are far more important than the robustness of your evaluation models. (hence the need for scientists and doctors in biotech investment. everything is driven by this differentiated view, the clinical profile, or the market opportunity)
3.2 common valuation techniques
valuation techniques fall under two large buckets: fundamental-based versus multiples-based (‘comps’) methodologies.
broadly, the former pertains to future cash flows, then determine company value – in so doing, developing an understanding of fundamental underlying assumptions that drive cash for the business. and the latter method cares about what others are willing to pay for assets.
DCF (discounted cash flow analysis)
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- \[DCF=\Sigma ^t_{n=1} \frac{cash flow_{n}}{(1 + discount rate)^n}\]
- basic premise of discount rate: the time value of money, pertaining to how a dollar today is worth more than a dollar tomorrow (== a dollar tomorrow is worth less than a dollar today). why? because you can invest that dollar and generate a return in the future
- discount rate is known as the opportunity cost of an investment. it varies by company, because you also need to take into account return if you were to invest in something else.
comps-based valuation
- takes away most assumptions (and therefore complexities) from a DCF model (such as patient number, revenue, rev growth, costs of business etc.)
- instead, it uses a one specific financial metric as your variable of interest called ’the multiple’ that, in some sense, pools together and represents all the above assumptions made in a DCF
- how to do it?
- pick a set of similar companies, known as a ‘comp set’. then calculate the relevant metric:
- numerator is some way used to measure the value of a company (such as enterprise value)
- denominator is a specific financial metric that is usually related to earnings, profit, or revenue
- equations list (bolded is those typically used in biotech)
- P/E = market cap / net income
- EV/EBITDA
- EV / revenue
- EV/peak sales
- Discount to M&A value
- got a bit confused here… “calcualte a valuatuion range for your comapny: relevant revenue or profit metric * multiple from comp set”
using this in practice questions to consider: 1) why might one company have a higher revenue multiple than another? 2) why use a revenue multipel in early stage biotech, as opposed to an earnings multiple (commonly used in other industries)? 3) why use peak revenue, as opposed to next year’s revenue, last year’s revenue, or a projected value in 3 years?
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- y-axis shows the time it takes to conduct
- x-axis