Merck & Company : Evaluating the Licensing Opportunity

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 LAB's 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

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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