At Lacerta Bio, we see a lot of financial models and valuations. Some of these are prepared internally, obviously. But many are prepared by management teams as part of an out-licensing or fund raising campaign.
One area where we see errors committed is with respect to Peak Year Sales, or PYS.
There are three general considerations for arriving at a PYS:
Amount– How high of a PYS will the product achieve?
When– When will PYS be achieved?
Shape– What is the shape of the curve from 0 to PYS?
Let’s take these one at a time.
Amount
There exists a fallacy that every out-licensing or fundraising presentation must describe a billion-dollar product opportunity.
And, in a sense, there is some truth to that.
Large commercial opportunities with clearly underserved medical needs and a drug candidate which fills that need are what everyone is looking for.
But there are geographies to consider as well.
A $100 million opportunity may not interest a global multinational, but it might interest a regional or country-focused company.
Regardless, creating a model which is forced to hit or exceed an arbitrary billion dollar PYS value is asking for trouble.
Companies and investors naturally want to invest in opportunities which might achieve these lofty levels. However, Sales is only half of the story. Those sales may not be very attractive unless:
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The product is developed as efficiently and as rapidly as possible; and
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The product is marketed, sold, and distributed as efficiently and as cheaply as possible.
This suggests that PYS is only half the story.
Revenue is obviously important, but only if it can be generated efficiently.
This suggests that project return on investment (however that is expressed) is the way in-licensing companies/investors ultimately evaluate opportunities.
Think of a licensee as a bank.
They are making an investment in exchange for a return on their capital. For some companies, small investments with large returns could be very attractive, even in the absence of a billion-dollar PYS.
So when it comes to PYS amount, there is nothing wrong with the creation of a scenario which is aggressive. But that aggression has to be balanced with realism, both on the revenue side and, critically, on the expense side.
Lesson: Drive Revenue forecasts upward using reasonable assumptions, but think carefully about returns.
When
When will PYS be achieved? Three years? Five? Six?
Highly innovative products which serve clearly defined unmet needs have the potential to peak fairly quickly.
But as companies push the pricing envelope, some of those models assuming PYS in Year 3 (or sooner) will be blatantly wrong.
Conversely, early innovators in conservative, highly genericized markets can peak relatively slowly, i.e., in Year 7 or 8. This is especially true in indications where the standard of care is well established with many generic alternatives, such as many cardiovascular conditions.
It simply takes time for standards of care and prescribing habits to change, and this should be reflected in the relevant models.
For an academic treatment of these ideas, check out Bauer and Fischer, 2000.
Lesson: Not all products, even innovative ones, will peak quickly. Study the market characteristics and determine if this market tends to be a fast or slow adaptor. Physician and payer interviews can influence this line of thinking.
Shape
What is the shape and slope of the uptake curve? Straight line? Convex? Concave?
More importantly…how do we decide?
Again, this is where studying product histories (i.e., prescription data) in your particular market can guide your thinking.
The more challenging aspect of the shape question is the marketing and sales investments to influence that shape.
For example, if your market tends to accept products via a slower (concave) adoption curve, can you accelerate that adoption via more aggressive marketing? If so, how will that impact project ROI?
Lesson: This is a great opportunity to get input and advice from Sales and Marketing, both internal colleagues and external consultants. There is no shortage of expertise available.Take advantage of it.
Does PYS even matter?
Good question.
In our view, PYS is like a headline. It can be eye-catching if it’s built on a foundation of solid assumptions and logic.
But any individual experienced in due diligence will drill down into these assumptions and look for holes.
More advanced stages of due diligence will find prospective partners constructing their own models, weaponizing them to deconstruct your models (and drive asset valuation downward).
Ultimately, the PYS is but one number…a product of many others. The true value is realized when both parties agree on the “many others” bit, and a contract is actually signed.