Why Discounted Cash Flow Analysis Reigns Supreme Amongst Valuation Methods in the Life Sciences Sector?

In the pharmaceutical, biotechnology and other life sciences based sectors, valuation is used in numerous decision-making processes such as new product planning, opportunity assessment, business development, licensing, partnering and in-house investment or investment by private equity and venture capital investors. Valuation using discounted cash flow (DCF) method employing NPV (net present value) analysis incorporates most appropriate business metrics and is also aligned with the interest of the owners of assets. In purist terms, decisions based on the valuation usually avoid the ‘principal-agent’ problem.

Valuation often happens to be the most widely discussed topic in several conferences and forms many research theses. Currently, DCF and comparables based methods are mostly employed valuation methods. Like any evolving discipline, new methods of valuation emerge and proponents of new valuation methods invariably highlight the drawbacks of the DCF methodology.  In real biopharmaceutical business scenarios, employing most DCF alternatives usually leads to higher value estimations. Is this good or bad? The answer is - it depends. Specifically, it depends on which side of the transaction you are on.

• If you are a seller of assets, then you would prefer DCF alternatives that give you high value. However, a savvy buyer is likely to disagree with you and would most likely put methods, structure and options to contain your value.
• If you are a buyer of the assets, then you would like to employ a method to compute lower value as you want to buy inexpensively.
• In a corporate setting, for example, in new product planning and commercial assessments, you might want to show the higher value of an opportunity using other valuation methods versus DCF/NPV based method. However, this does not exonerate you from conducting DCF based valuation.
• Similarly, in business development and licensing scenarios, if you are out-licensing, you might want to use DCF alternatives, but if you are in-licensing, you would prefer DCF valuation.

The simplicity of the DCF method lies in the additive property of NPV. If a company undertakes a new value creating, i.e. one with positive NPV project, the NPV of the project adds to the total value, the NPV of the company. This makes it easy to justify the project and investment and to assess the ex-ante contribution of the project to the company and its stock price. Since capital market values a company and its stocks using DCF based methodology, we believe adopting a market aligned method is the most pragmatic approach for practitioners and decision makers.

BiopharmaVantage is a boutique healthcare consultancy that specializes in providing valuation services specifically for the pharmaceutical, biotechnology and wider life sciences sector. If you would like to explore how we can assist you, please contact us.