Pharmacyclics Final Case Study 223j18

Case Analysis VIII: Pharmacyclics Introduction Pharmacyclics is a pharmaceutical company that manufactures drug to improve existing treatment of cancer, atherosclerosis, and retinal disease. The president of Pharmacyclics, Dr. Richard Miller, was considering a $60 million private placement in February 2000. By 1999, the company had developed four new drugs that were in the process of approval by the Food and Drug istration. The four new drugs included are Xcytrin which is Pharmacyclics most promising oncology product and was at Phase III clinical tests which is the rigorous final phase before Food and drug istration approval for commercialization. The drug was developed to improve the effectiveness of radiation and chemotherapy treatment. The product was expected to gain approval late in FY02 and to be adopted slowly outside of the United States which is expected to realize profits equal to 30% of the revenues. Another product, Lutrin, was developed to improve the effectiveness of photodynamic therapy which is a new king of treatment used for cancer treatments. The third and fourth product, Optrin and Antrin, which can replace the photodynamic therapy for the treatment of age related macular degeneration and photoangioplasty. The analysts of the product thought that Optrin and Antrin’s revenue is still unsure. As for the Xcytrin, Experts gave the drug a rather much better than 50% possibility of success. The organization had more money than in the past but Research and Development expenses as well as marketing expenses is unexpected. The company spent $73 million on research and development from time the company was founded in 1991 through June 1999 which is by then the company’s most promising product, Xcytrin was at Phase III clinical trials by the Food and Drugs istration. The CEO preferred the private placements since it does not require a road show, a prospectus, or a discount from the market price. In order to meet the anticipated funding for each stage, the company had been continuously obtained funds to conserve cash to complete development stages. To conserve cash, the company outsourced the manufacture of the compounds used in testing. Miller believed that funding later would increase share price and funding less would limit dilution which can motivate employees. The decision of whether Miller should proceed with the funding needs depend on two factors: the funding needs and the company’s valuation. Miller has to decide whether Pharmacyclics should proceed with the private placement now or wait until the Phase III clinical trial for Xcytrin was complete.

Statement of the problem These are the problems presented in the case: 1.) Dr. Miller has to decide whether they should proceed with the private placement now or they could just wait until the completion of Xcytrin’s clinical trials. Why do they even need to consider issuing equity for financing their R&D? 2.) How does the cash flow of the firm change after the approval of Xcytrin and lutrin? What if they were not approved? 3.) What is the value of the company in either situation in #3?

Osial, Krystal Anne | General, Jan Michael | Padua, Blessy | Ybanez,Noemi Joy 1|P ag e

SWOT, TOWS, Porter’s

SWOT Analysis

Strengths

-

reduced labor costs skilled workforce barriers of market entry high growth rate High profitability

Weaknesses

-

Opportunities

-

growing economy

investments in research and development competitive market future competition costs small business units Threats

-

increase in labor costs

Strengths Pharmacyclics hired three scientists from Sessler’s Lab which is one of the owner that is why the labor costs in this company will not be a problem. Given that the owners are skilled and the scientists that they have hired are already in experience, then it is assured that there is a skilled workforce in Pharmacyclics. On the other hand, since entry in this kind of industry will need a high cost especially in research and development, threats for new entrants is very low. As they introduce new drugs, growth rate is increasing as well. Because of high demand and high potential of the new drug that they will soon release in the market, there is high profitability and revenue for the company.

Weakness Since this industry requires a lot of investment in research and development, costs on financing this is a major issue. They will need to invest in research and development constantly which is expensive for a small business unit like them. Also, since they are still a small business unit, high threats from giant companies is very serious, even they have come up with the best drugs but has no fund to put it in trial, then it will fall either on letting it financed by a larger company or sell its patents to them. Future competition costs is highly seen because of the competitive market that this industry has.

Opportunities This industry has a good economy which is good to invest in. Pharmacyclics should continue to finance their drugs since there is growing economy for them.

Threats There is an increase in labor costs in the future especially when Xcytrin is already approved by the FDA.

Osial, Krystal Anne | General, Jan Michael | Padua, Blessy | Ybanez,Noemi Joy 2|P ag e

Alternative Courses of Action 1.) In their 2000 balance sheet, the company had cash and cash equivalents at $61,164,000. And since they value funding needs and valuation, the company should know the effects of costs in their balance sheet figures. (See appendix 1.) If the company does not sell equity by 2000, their cash will be negative by the time of the approval decision of Xcytrin in 2002 because of too much development and Selling and istrative costs. I.

Proceed with the private placement now. -

II.

He may want to proceed with the placement now because he can establish a fund for other drugs and it would help with the completion of Xcytrin. Since he has good hopes the company being approved of the drugs by FDA, the projections made will likely to happen and it will be a good thing for the company because they will have their fund to their expenses.

Proceed only after phase III completion -

The approval decision is expected to come out in 2002 and cash flow will be better after the approval because of the inflows from the projections the company made. The value of the firm at this point in time may be attractive for investors and it may serve as a catalyst for them to buy shares of Pharmacyclics. Appendix 5 shows the value of the company after scenario that it is approved and rejected since it the drugs has 50/50 chance of getting approved. The cash flow with the approval showed a positive NPV because the inflows from the drugs affected the revenues so much. But unlike when it is approved, the rejected scenario made it so that the NPV is negative and it may prove to investors that it is not the right time to invest in this company which will definitely put Pharmacyclic in jeopardy.

2.) The cash flow of the company under the approval scenario greatly improved. They have positive cash flows and the value of the company us positive (See Appendix 5.) The Bottom line values of the income statement were improved to a level that it offset the losses of the company from year 2000. 3.) The value of the firm is positive when the drugs are approved and negative when they are not. The company is worth $7,124,161,370.0 when approved and ($1,974,561.06) when not.

Osial, Krystal Anne | General, Jan Michael | Padua, Blessy | Ybanez,Noemi Joy 3|P ag e

Recommendation Our team has come up with the following recommendations based on the alternative courses of actions. Dr. Richard Miller can opt to sell the $60 million of equity now, wait until Xcytrin finish the FDA approval, or sell the $60 million on a staggered basis for the next 3 or 4 years. If the $60 million of equity would be sold now, then they would not need to have provided a cushion for funding the Phase III Xcytrin trial. However, real options must also be taken in consideration because these greatly affect the valuation of the business investment. He can also choose to wait until the Phase III clinical trial for Xcytrin to be completed because this will benefit them since this will help Xcytrin to be more developed. The funds may also be used for the development of Antrin to further forward its progress towards becoming a potential revenue generator. PCYC should not proceed with the private placement now and wait for a few more years before selling the $60 million equity since it will provide the highest NPV among the alternatives shown which will serve as an advantage for the company’s stakeholder.

Osial, Krystal Anne | General, Jan Michael | Padua, Blessy | Ybanez,Noemi Joy 4|P ag e

Appendices Appendix 1 2000

2001 28,664,000 (57,500,000)

Cash & Cash Equivalents Projected cash flow

$

61,164,000 (32,500,000)

Ending Balance

$

28,664,000

$

Appendix 2 CAPM BETA RFR

(28,836,000)

beta(mrp)+RFR 0.824 6.55%

Market return

14%

Cost of Equity

13%

Appendix 3 Xcytrin and Lutrin Profit - US

Product Portfolio Xcytrin

Percentage use

Patients Cost per treatment course Contract Revenue COGS per treatment COGS per treatment Gross Profit US Percentage Use (non US)

Radiation patients

Approval rate 50%

2000

2001

170,000

2002

2003

2004

2005

2%

17%

26%

40%

3400 $ 10,000 $ 34,000,000 $ 2,000 $ (6,800,000) $ 27,200,000

28900

44200

68000

$

289,000,000

$

442,000,000

$

680,000,000

$

(57,800,000)

$

(88,400,000)

$ (136,000,000)

$ $ 0

231,200,000

$ $ 0

353,600,000

$ $ 0

544,000,000

$

8,500

$

25,500

$

42,500

Revenue (non US)

$

85,000,000

$

255,000,000

$

425,000,000

COGS (70%)

$

(59,500,000)

$

25,500,000

Gross Profit (non US) Total GP Xcytrin'

$ 27,200,000

$

256,700,000

$ (178,500,000)

$ (297,500,000)

$

76,500,000

$

127,500,000

$

430,100,000

$

671,500,000

$

20,000,000

$

450,100,000

Lutrin Pretax Income Total Profit - US

$ 3,000,000 $ 30,200,000

$ $

9,000,000 265,700,000

Osial, Krystal Anne | General, Jan Michael | Padua, Blessy | Ybanez,Noemi Joy 5|P ag e

Appendix 4 Paharmacyclics, Inc Income Statement Gross Profit from US Total Revenue Research and Development General And istrative Total Operating Expenses Loss From Operations Interest Income Interest Expense Interest Net Loss Before Income tax Provision for Income Taxes Net Profit (loss)

*In thousands of Dollars Cash Flow - Approved EBIT Tax rate 30% assumed After tax EBIT Terminal Value -10% Growth Cash Flow NPV - 13% *In thousands of Dollars Cash Flow - Not Approved EBIT Tax rate 30% assumed After tax EBIT Terminal Value -10% Growth Cash Flow NPV - 13%

Assume 30% tax *In thousands of Dollars 2000 1,303 1,303 (27,500) (5,000) (32,500) (31,197) 2,557 (8) 2,549 (28,648) 0 (28,648)

2001 1,303 1,303 (42,500) (15,000) (57,500) (56,197) 2,557 (8) 2,549 (53,648) 0 (53,648)

2002 31,503 31,503 (38,000) (35,000) (73,000) (41,497) 2,557 (8) 2,549 (38,948) 0 (38,948)

2003 267,003 267,003 (44,000) (53,000) (97,000) 170,003 2,557 (8) 2,549 172,552 -51765.6 120,786

2004 451,403 451,403 (54,500) (62,000) (116,500) 334,903 2,557 (8) 2,549 337,452 -101235.6 236,216

2005 672,803 672,803 (54,500) (62,000) (116,500) 556,303 2,557 (8) 2,549 558,852 -167655.6 391,196

2005 556,303 166890.9 389,412 14,278,444 14,667,856

2000 (31,197) 0.00 (31,197)

2001 (56,197) 0 (56,197)

2002 (71,697) 0 (71,697)

2003 170,003 51000.9 119,002

2004 334,903 100470.9 234,432

(31,197)

(56,197)

(71,697)

119,002

234,432

2000 (31,197) 0.00 (31,197)

2001 (56,197) 0 (56,197)

2002 (71,697) 0 (71,697)

2003 (95,697) 0 (95,697)

2004 (115,197) 0 (115,197)

(31,197)

(56,197)

(71,697)

(95,697)

(115,197)

$ 7,124,161.37

2005 (115,197) 0 (115,197) (3,490,818) (3,606,015)

($1,974,561.06)

Osial, Krystal Anne | General, Jan Michael | Padua, Blessy | Ybanez,Noemi Joy 6|P ag e