A biotechnology company’s (IBB) value is comprised of two main factors: assets in place and growth assets. Assets in place, or drugs currently being sold in the market, are indicators of the present cash generation capacity of the biotechnology company. Growth assets involve drugs in a company’s research and development (or R&D) pipeline as well as future licenses and collaborations with other pharmaceutical and biotechnology companies.
The above graph shows the current enterprise value (or EV) to forward earnings before interest, taxes, depreciation, and amortization (or EBITDA) of leading biotechnology players Gilead Sciences (GILD), Amgen (AMGN), Biogen (BIIB), and Celgene (CELG).
Many biotechnology companies carry substantial debt on their balance sheets. EV-to-EBITDA value can be used to determine the attractiveness of a mature biotechnology company. Low EV-to-EBITDA ratios may signal that the market is undervaluing the stock.
Since a large portion of a biotechnology company’s value is derived from its R&D assets, discounted cash flow valuation (or DCF) proves to be a more effective valuation technique. However, this method is extremely sensitive to inputs related to future riskiness and returns of the company. So wrong inputs can lead DCF in returning erroneous company values.
A biotechnology company’s forward EV-to-EBITDA multiples depend both on current EBITDA margins and the company’s future growth potential. Biogen displayed a sudden increase in EV-to-EBITDA multiples in May 2012. Shares of the company reached a 52-week high in this period. A healthy research pipeline coupled with three to four years of patent protection for established drugs led to Biogen’s high valuations after 2012.
The sudden jump in valuation metrics was attributed to better-than-expected results for the clinical studies of its new multiple sclerosis drug BG-12, which was found more effective than Copaxone, the drug currently in the market. This signaled the possibility of higher revenues in future years. Biogen’s valuations rose dramatically once again in 2015 on expectations of another blockbuster drug, Aducanumab, for Alzheimer’s disease.
Gilead Sciences’ valuations rose after 2012. The company’s revenues grew on account of the company’s drugs Sovaldi and its improvised version Harvoni for the treatment of Hepatitis C. However, valuations dropped in 2015, as AbbVie launched Viekira Pak, a much cheaper Hepatitis C drug, in December 2014. Gilead Sciences then announced it will have to offer substantial discounts on its drugs as a result of the price war with AbbVie.
Celgene has traded consistently at relatively high valuations. This is mainly due to its blockbuster drugs for cancer as well as its collaborations with other biotechnology companies to develop new drugs. Amgen valuations have been steadily rising, as the company has several promising drugs in its pipeline. An investment by hedge fund Third Point has also raised investor interest in the company.