NUCLEON

1
NUCLEON

• The date is December 1990
• Nucleon is a small biotechnological company
  specialized in RD, no manufacturing capabilities
• Potential products CRP (cell regulating protein)
  and 2 other products
• In order to get to the market the drug must be
  approved by FDA-gtsuccessful clinical trials

2
DILLEMA

• Vertically integrate downstream into (pilot)
  production or buy the production on the market

3
Biotechnology

• Biotechnology a relatively new field
• Nucleon one of over 200 companies, most of them
  specialized in RD.
• Companies racing to be first to clone a gene
  (proprietary position)
• CRP attractive niche
• Burn wound treatment
• Kidney failure

4
Biotechnology

• Strategies of BT companies -gt most RD, some
  integrated into manufacturing, some also into
  marketing

5
Legal framework

• Competition was mostly in RD establishing a
  strong proprietary position was crucial
• Risks of establishing a strong proprietary
  position
• New legislation (difficult to predict court
  rulings)
• Time demanding to obtain a patent
• Most companies could not wait until patent was
  granted (time lag)

6
Drug development process

• Drug development process was very complex
  (growing genetically altered bacteria was very
  much an art)
• Nucleon currently produced quantities well below
  those needed for clinical trials (scale up 10x)
• Due to complexity of process scaling up was
  unpredictable

7
Human clinical trials

• To get FDA approval drug had to undergo three
  phases of clinical trials
• Phase 1 trials assessed basic safety -adverse
  reaction (6-12 months)
• Phase 2 (determining appropriate dosages on a
  small sample-gt1-2 years)
• Phase 3 trials assessed products efficacy
  (multiple hospitals and large number of patients,
  2-5 years)

8
Financial environment

• Poor capital availability (buyers market)
• Venture capitalists expected returns of 30
• Nucleon just about to receive another 6 mil
  from its venture capitalist
• With additional infusion (6 mil ) and cash on
  hand, Nucleon had about 6,5 mil .
• Market analysts expected that situation on
  capital market would improve in 1992

9
Manufacturing options for clinical trials

• Three different options for Phase I and II
• The new pilot plant
• Contract manufacturing
• Licensing product to another company
• Two options for Phase III
• V. I. into commercial manufacturing
• Licensing out manufacturing and marketing rights
  at Phase III

10
Phase I and II three options
Pilot production in the new pilot plant
Contract manufacturing outside the firm
Phase I and II
Licensing out in Phase I
11
The new pilot plant

• Pilot plant capacity (600 m2) would meet
  Nucleons requirements for Phase I and II
• Investment outlay can be found in exhibit 3
• The pilot facility could however not be used for
  Phase III (stricter requirements)
• It was beyond Nucleons financial capability to
  build such a plant at this time

12
Contract manufacturing

• Biggest advantage no major capital investment (if
  CRP failed contract could be easily terminated)
• Companies offering contract manufacturing had
  facilities and their personnel in place
• Contract manufacturing not inexpensive (see
  exhibit 4)
• Industry experts believed that excess capacity
  would accumulate in the future
• Much time needed to transfer process due to high
  complexity

13
Licensing out-Phase I

• Nucleon could license the product immediately
  (before human clinical trials)
• Get 3 mio cash on hand (immediately) and
  royalties equivalent to 5 of gross sales (upon
  FDA approval)
• Gross sales estimates (exhibit 5)

14
Phase III two options
Vertical integration into manufacturing
Phase III
Licensing out in Phase III
15
Vertical integration into commercial
manufacturing

• Before Phase III Nucleon could V.I into
  manufacturing
• 21 Mio required to perform scale up (provided
  by venture capitalist if intermediary results
  promising)
• If FDA approved the drug Nucleon received 5 mio
  upon FDA approval and royalties equal to 40 of
  the partners gross sales

16
Licensing out in Phase III

• Under this option Nucleon could expect to receive
  7 mio upon FDA approval of the drug and
  royalties equivalent to 10 of the partners
  gross sales

17
Back to the case Methodology

• Use decision tree for determining possible
  scenarios
• Number of factors has to be considered
• Qualitative arguments (pros and cons of every
  alternative)
• Organizational change
• Technology transfer costs and risks
• Long term strategic options
• Other
• Quantitative arguments (Financial returns-NPV)

18
Study question 1(work in groups of 4)

• Develop a proper decision tree

19
Scenario breakdown with a decision tree
V.I. into manufacturing
Pilot production
Licensing out
V.I. into manufacturing
Contract manufacturing
Licensing out
Licensing out
Licensed out
20
Study question 2(work in groups of 4)

• Develop a table with pros. and cons. for
• Phase III and
• Phase III

21
Pros and cons (Phase I and II)
22
Pros and cons (Phase I and II)
23
Pros and cons (Phase I and II)
24
Pros and cons (Phase I and II)
25
Pros and Cons (Phase III)
26
Pros and Cons (Phase III)
27
Pros and Cons (Phase III)
28
Study question 3(work in groups of 4)

• Based on the NPV make recommendations

• Assumptions
• Discount factor 30
• Gross sales represent after tax cash flows
• Sales after 2002 grow constantly at 5
• Depreciation tax shield CF and Phase III cost are
  approximately equal
• How do you feel about these assumptions?

• Calculating NPV
• Estimate operating CF (exhibit)
• Discount factor (30 )
• General approach (use different discount factors
  according to risk of each CF)

29
NPV calculation

• First calculate pilot manufacturing V.I.

30
Example of NPV calculation pilot manufacturing
V.I.
PV 1500001500001.05/1.3 1500001.052/1.32
.. 780000
31
FCF analysis
32
NPV of branches on the decision tree
Phase III Phase III
16.478
production
3.596
pilot
license
19.276
production
contract
license
6.372
license
11.518
license
33
Study question 4(work in groups of 4)

• Pilot plant might be used for other projects
  (products). Estimate how much can Nucleon save on
  variable expenses by investing in pilot plant

34
Real options

• Pilot plant might be used for other projects
• By investing we save on variable expense
• Investment outlay and variable expenses can be
  estimated from exhibits 3 and 4
• Calculate break-even point

35
Real options valuation

• Investment outlay 3,1 mio
• Variable cost savings 0,5 mio

• Break-even point 6 projects

36
REMARKS Financial considerations

• NPV represents expected value of many possible
  outcomes (in reality there is only one)
• Nucleon has only one project outstanding (no
  diversification)
• One aspect to consider is preference of venture
  capitalist

37
REMARKS Long term strategic options

• RD company
• RD with pilot manufacturing capabilities
• Integrated manufacturing enterprise