Merck & Company -Evaluating a Drug Licensing

Opportunity .Doc
INTRODUCTION
Merck & Company : Evaluating the Licensing Opportunity
Various recently-born biotech companies sell their technologies in either
finished or early stage to bigger companies in need of financing capital
to preceed business, while those bigger companies acquire technologies
to scout for promising profitable business. This sort of process needs
numbers of decision makings and agreements from both parties on the
valuation methods is crucial here. The valuation method being used has
to hold objective validity and generality.
For the managers to make accurate forecast of future profitability in
managing companies, quantified decision making process is needed.
Here we are dealing about whether Merck should give financial support
to the R&D project of Davanrik offered by LAB, and about the process of
valuation and the final decision. First we are to make brief of LABs
business proposal and practice detailed valuation functions to decide if
the proposal is profitable or not. And finally we will make a decision
based on the valuation process in perspective of Rich Kender, Vice
President of Financial Evaluation & Analysis of Merck.
Brief introduction of Merck and its agenda regarding Davanrik project
As a world-class pharmaceutical company concentrated on R&Ds,
Merck is performing various researches and developments upon medical
supplies for human and animals. Merck is providing Pharmaceutical
Benefit Management (i.e. PBM) through a company called Merck-Medco
Managed Care. Apparently it is a giant pharmaceutical company with
more than 15 blockbuster medical supplies, revenue of $3270 million
and net profit of $590 million, ever since 1995. One constraint of Merck
is that most of its profit is over-concentrated on the major top 4 items,
and in order to diversification of profits Merck is facing a pressure to
launch a new business item or take another complementary strategy
through biotech and internal R&D.
LAB Pharmaceuticals has already finished developing Davanrik, an
antidepressant. Even though it carries substantial medical/economical
feasibility for being effective on both hypochondria and obesity, LAB
cannot afford the capital to proceed clinical demonstrations ahead the
actual sale to acquire licensing. This is the reason why LAB offered
Merck of technical affiliation.
At the following step, we are to evaluate the profitability of Davanrik
based on the expected length of time and expense, chances of success
that LAB has suggested.
1. Expectaion of costs and chances of success for each phase
Phase I
1. Take 2years
2. Cost $30millin, including an initial $5millin fee to LAB
3. 60% chance of success
Phase II[1]
1. Take 2years
2. The efficacy test
-10% probability for depression only
-15% probability for weight loss only
-5% probability for both depression and weight loss
3. Cost $40million, including a $2.5million licensing milestone payment
to LAB
Phase III
1. Take 3years
2. The Costs and probabilities of success
- For only depression : cost $200million including a $20million payment
to LAB(85% chance of success
- For only weight loss : cost $150million including a $10million LAB
payment(75% chance of success
- For both depression and weight loss : cost $500million including
$40million licensing payement to LAB(70% chanceof success)
And 15% chance of a successful outcome for depression only
5% chance of a successful outcome for weight loss
10% chance of failure
2. Cost of launches and Potential profits[2]
1. For only depression : cost $250million to launch and PV of $1.2billion
2. For only weight loss : cost $100million to launch and PV of
$345million
3. For both depression and weight loss : cost $400million and PV of
$2.25billon
3. Decision Tree & Calculation
[pic]
1. Cash Flow : 1200-250-200-40-30=$680mil
Expected Value:680x0.051=$34.68mil
(0.051=0.6x0.1x0.85)
2. Cash Flow : 0-200-40-30=-270
Expected Value:-270x0.009=-$2.43mil
(0.009=0.6x0.1x0.15)
3. Cash Flow : 345-100-150-40-30=25mil
Expected Value:25x0.0675=1.6875mil
(0.0675=0.75x0.15x0.6)
4. Cash Flow : 0-150-40-30=-220mil
Expected Value:-220x0.0225=-4.95mil
(0.0225=0.25x0.15x0.6)
5. Cash Flow : 2250-400-500-40-30=1280mil
Expected Value:1280x0.021=26.88mil
(0.021=0.7x0.05x0.6)
6. Cash Flow : 1200-250-500-40-30=380mil
Expected Value:380x0.0045=1.71mil
(0.0045=0.15x0.05x0.6)
7. Cash Flow : 345-100-500-40-30=-325mil
Expected Value:-325x0.0015=-0.4875mil
(0.0015=0.05x0.05x0.6)
8. Cash Flow : 0-500-40-30=-570mil
Expected Value:-570x0.003=-1.71mil
(0.003=0.1x0.05x0.6)
9. Cash Flow : 0-40-30=-70mil
Expected Value:-70x0.42=-29.4mil
(0.42=0.7x0.6)
10. Cash Flow : 0-30=-30
Expected Value:-30x0.4=-12
If we plus all of Expected Values from to , we can get
+$13.98million.
And it will good for Merck.
CONCLUSION
The method we have mainly used here to evaluate the forecasted future
performance of the project is Net Present Value (NPV). The NPV is the
sum of the present values of all the expected incremental cash flows if a
project is undertaken. The discount rate used is the firms cost of capital,
adjusted for the risk level of the project. For a normal project, with an
initial cash outflow followed by a series of expected after-tax cash
inflows, the NPV is the present value of the expected inflows minus the
initial cost of the project. A project with a positive NPV is expected to
increase shareholder wealth, a negative NPV project is expected to
decrease shareholder wealth, and a zero NPV project has no expected
effect on shareholder wealth.
A key advantage of NPV is that it is a direct measure of the expected
increase in the value of the firm. NPV is the theoretically best method. Its
main weakness is that it does not include any consideration of the size
of the project.
Regarding the evaluation we presented above in the body part: The fact
that the expected value of $13.98million is greater than 0 shows this
project is likely to increase profit and shareholders value. So we suggest
Merck to accept LABs offer as the expected value from Davanrik Project
is positive.
Merck & Company
Evaluating a Drug Licensing Opportunity
INTRODUCTION
Merck & Company : Evaluating the Licensing Opportunity
Brief introduction of Merck and its agenda regarding Davanrik project
1. Expectaion of costs and chances of success for each phase
2. Cost of launches and Potential profits
3. Decision Tree & Calculation
CONCLUSION
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[1] All cash flows are expressed ad after-tax present values discount to
time zero, including papital expenditures.
[2] This PV was calculated as the after-tax present value of 10years
worth of cash flows from the drug discounted back to today(a terminal
value of zero was used in the calculation)