How to Read Deals
Press releases
announcing license agreements in life science in general disclose little
information on how much money flows from the inlicensing to the outlicensing
company. Usually, the amount of the upfront payment and the total sum of potential
milestones – if all are triggered – are disclosed. In some cases
the companies also mention whether the royalty payments are one or two digits
high. As an outsider it is not trivial to get an understanding of how these
deals are financially structured. Nevertheless, having an idea about the deal
terms is essential when valuing a company that depends on its license revenues
or when benchmarking an own deal.
Avance
presented an analysis of earlystage deal terms in its December 2007 newsletter.
The displayed milestone weights offer a particularly interesting insight in the
way deals are structured (Fig. 1).
Figure 1: Milestone
weights
These milestone
weights allow extrapolating the size of future milestones knowing the upfront
payment. If in a preclinical deal the upfront payment has been stated with USD
4 Mio, then this would mean that the NDA milestone would amount to four times
the upfront payment, i.e. USD 16 Mio. In theory, all milestones should sum up
to the total amount of potential milestones as announced in the press release.
For a preclinical deal this would mean that the total amount of potential milestones
should be 0.7+1.3+2.3+4.0+18.4=26.7 times the upfront payment. Often these numbers
do not match exactly. First, the displayed milestone weights represent an
industry average. Second, companies tend to artificially increase the launch
milestones, and to some lesser degree also the approval milestones. They add
significant milestones for the approval of a second or third indication, even
if such an extension is unlikely. Of course, this increases the milestone
figure excessively and makes it somewhat less representative. In some deals
backup molecules are included which double the potential amount of milestones
to be paid.
Another
method to reach an impressive headline is to include sales related milestones.
The inlicensing company must pay a milestone payment if it exceeded for the
first time e.g. USD 200 Mio sales on a cumulative (or sometimes annual) basis.
These payments are linked to welldefined goals, i.e. sales figures. But in
fact the figures are royalties disguised as milestones, which help increasing
the total milestone figures.
We
will now see how we can apply the knowledge of these milestone weights to a
press release of a deal.
“Jerusalem,
Israel, and Lund, Sweden, June 14, 2004: TEVA AND ACTIVE BIOTECH ANNOUNCE
AGREEMENT FOR LAQUINIMOD POTENTIAL ORAL THERAPY FOR MULTIPLE SCLEROSIS.
(…)
Teva has agreed to make an upfront payment of 5 million USD to Active Biotech and to conduct and fund the further clinical development of laquinimod. The contract between the two companies also calls for Teva to make payments to Active Biotech upon the achievement of various milestones, which include sales targets. If such milestones were all to be met, payments
to Active
Biotech would aggregate to 92 million USD. Active Biotech will also receive
tiered doubledigit royalties on sales of the product, once marketed. (…)”
(source: www.activebiotech.com)
In
addition to the USD 5 Mio Active Biotech receives another USD 87 Mio if all
milestones will be reached. Laquinimod was in phase II at the time of licensing.
If we
assume the weights displayed in figure 1 and assume the phase II milestone to
be an upfront payment, then the subsequent milestones are weighted as displayed
in table 1. The data sets for preclinical and discovery deals are slightly
different, we can therefore derive two sets of milestone weights; but they
remain pretty similar:
Table 1: Milestone
weights for phase II
Dataset

Discovery

Preclinical

Upfront

1.0

1.0

Phase
III

1.5

1.7

NDA

2.0

3.0

Launch

9.3

13.8

TOTAL

13.8

19.5

In the
press release the ratio upfront/total milestones is 5/92=1/17.4. Applying more
or less the weighting arising from the preclinical dataset we therefore obtain
the following deal structure for the TEVAActive Biotech deal:
Table 2: Forecasted
milestones
Milestones

Calculation

USD Mio

Upfront

5*1.0

5.0

Phase
III

5*1.7

8.5

NDA

5*3.0

15.0

Launch

remainder

63.5

TOTAL

92.0

92.0

In 2007 Teva
initiated the phase III:
“…net sales for the corresponding period in the preceding year included an initial milestone payment of SEK 51.2 M from Teva Pharmaceutical Industries (Teva) relating to laquinimod…” (source: Active Biotech, yearend report, JanuaryDecember 2007)
Active
Biotech received another milestone of about USD 10 Mio upon reaching phase III.
This is pretty much in line with the predictions from table 2. We can slightly
adjust the milestones predictions, because we now also know the phase III
milestone. We can also assume that the launch milestone will be about USD 30
Mio (distributed over different geographical areas) and the rest will be paid
upon reaching sales targets. To our experience launch milestones are only
excessively larger than the previous milestones if several indications or
commercial milestones are involved. We can expect that the milestones figure of
USD 92 Mio is not artificially blown up because no company mentioned any other
indication than multiple sclerosis. Excluding other indications we assume that
about half of the remaining milestones, i.e. USD 32 Mio, will be paid as launch
milestones. The new, revised deal forecast is presented in table 3.
Table 3: Forecasted
milestones (2)
Milestones

USD
Mio

Upfront

5

Phase
III

10

NDA

15

Launch

30

Sales
Milestones

32

TOTAL

92

We
still do not know the royalty structure. The
royalties are said to be doubledigit. In order to divine the royalty rate
(disregarding the tiered structure for a moment) we refer to the companies’
press releases that stated the multiple sclerosis market to be 4.2 bio in 2004
with TEVA being a major player commercialising Copaxone® with 2003 annual sales
of USD 720 Mio (in 2007 TEVA reported Copaxone® sales of USD 1,713 Mio,
excluding SanofiAventis’ Copaxone® sales). We can therefore assume that
Laquinimod will reach blockbuster status, above all because of its oral
administration. Assuming USD 1 billion sales and 15% royalties we get a 67%33%
value share between TEVA and Active Biotech (calculated at 12% discount rate).
If the sales potential is USD 2 billion then the value share becomes 77%23%. A
phase 2 deal is said to have a value share between 25% and 35% percent,
depending on the industry standard. A
tiered royalty structure of 15% up to maybe 20% seems therefore realistic.
In review USD 5
Mio upfront seem little for a potential blockbuster drug. One reason is
certainly the low success rates for CNS drugs in phase II, which reduce the
value of such compounds significantly. A second reason might have been Active
Biotech’s will to retain as much upside as possible, putting more weight to
sales milestones and royalties.
This
method of estimating future deal terms is essential when valuing companies
whose revenues stem essentially from license agreements. For an analyst it is
virtually impossible to value such a company without having an idea of the deal
terms. The outlined method should serve as a guideline to divine such deal
terms.