Valuation of ARCA Biopharma (ABIO)

A tutorial for the IntrinsicBio net present value calculator

Posted by Kyle on June 19th, 2018

Welcome to the inaugural blog post for IntrinsicBio! This blog will be used as an education resource for those interested in using the valuation tools the app provides and just general posts about investing and other musings that might come my way. This introductory post will double as a tutorial for the net present value calculator and a biotech stock valuation walkthrough.

For the sake of this post, I will not explain into the basics of net present value (NPV) or discounted cash flow (DCF). If you need a refresher, Investopedia has great articles on both. If you are new to applying these techniques to biotech, here is a great article on biotech DCF. For a deeper dive, I give a list of a few books that I used to build the calculator.

For this tutorial, I chose a company that has a single drug in their pipeline for simplicity. ARCA Biopharma (ABIO) has a phase 2B drug, Gencaro, that treats recurrent atrial fibrillation or flutter (AF/AFL) in heart failure patients.

NPV Calculator Overview

Valuing biotech companies is not too much different from valuing any company. You take a look at each potential revenue stream, each drug in the pipeline, and then perform a discounted cash flow analysis to determine how much the future revenue from the drug would be worth today. The DCF values for each drug are then summed to determine what the entire pipeline is worth. Optionally you can add in the cash on hand and subtract out the debts. This resulting value represents the market capitalization of the company. Dividing by the number of shares outstanding will produce your predicted price per share.

The NPV calculator will prepopulate most of the required values needed to perform the DCF. Let’s step through each of the parameters of the model.

dcf param overview

The clinical trial phase and drug name come from the clinicaltrials.gov website. The annual sales value is more of a placeholder to give you an initial basis for your calculation. This initial value is an industry average across all drugs. If you only change one value in the calculator, make sure this is it. The discount rate comes from several journal articles that study what rate is appropriate for each clinical trial phase. Using a 10 year sales runway is common in DCF calculations and makes sense considering most drugs are exposed to patent cliffs. The sales growth rate is the rate that your sales will increase year-over-year. The remaining parameters, success rate, duration, and average cost per year all come from various textbooks and journal articles. The success rate signifies a risk factor associated with each phase in clinical trial. The earlier the drug is in the clinical trial pipeline, the higher the rate of attrition. The months to completion is an average of how long each clinical trial phase lasts. The cost per year is the average annual cost for each clinical trial phase.

Determining Annual Sales by Using Comparables

Finding comparable drugs is the best way to estimate the annual sales of a new therapeutic. Our sample drug, Gencaro, is reported to be an active comparator to the existing drug Toprol XL. According to this press release, Aralez Pharmaceutical purchased Toprol XL from AstraZeneca in which it stated the drug brought in a revenue of $89 million in 2015. Assuming a 5% annual compounded sales growth, the annuals sales for 2018 would be $103,028,625.00 if the drug captured 100% of the market share. Since Gencaro is trying to capture a portion of these existing drug sales, the sales estimate would mostly likely need to be scaled down to accommodate a more realistic market share. Determining market share is a challenging task which we will not cover in this post. For now, let’s assume we could capture 25% of this market, resulting in an annual sales of $25,757,156.

dcf comparable overview

Plugging the resulting annual sales value into the calculator would return an approximate DCF value of $13,849,254 with a per share value of $0.99. Assuming our market share estimate was reasonable, this puts our per share valuation within error and market fluctuation of the actual share price.

Determining Annual Sales by Simulation

If the annual sales numbers are not known or cannot be easily estimated, they can be stochastically determined via simulation. By assigning random variables to the parameters that make up the annual sales formula(monthly drug cost X number of patients X months of treatment X market share X royalty rate.) with minimum and maximum value constraints to confine the values to realistic scenarios for this specific drug, a probabilistic distribution of likely annual sales can be generated if the calculation is repeated many times.

dcf simulation overview

To use the annual sales simulator, click on the blue calculator button next to the annual sales text box. For our drug, we will fill in the range of possible values using known info and educated guesses. For drug cost, we will base our numbers on this WebMD page reporting one months drug cost of our competitor Toprol. For market share, we will use the conservative to optimistic range of 10% - 25%. For months of treatment, we will set the min and max to 12 months to signify long-term treatment. For number of patients, epidemiology studies are great for this. According to this study, atrial fibrillation affects 2% of the population. Since we are focusing on revenue generated in the United States, we can estimate AF impacts 6,500,000 Americans. No partnerships or external royalties seem to be associated with this drug so we can set royalty rate to 100% to signify complete ownership. After running the simulation, select from the probability distribution which value you would like to use in your calculation. For this example, I picked the highest probability sales at $203 million.

dcf full valuation

Assuming we have confidence in the model and there aren’t external factors that have been neglected, this calculation would suggest the company is greatly undervalued.

Feedback

The development of this NPV tool is still in its infancy. If you have any suggestions or feedback, feel free to reach out to me at intrinsicbio@gmail.com.