Ebola, Obama, and how Biotech is going to Benefit from A Senate Bill

One my favorite things in the market is finding obscure situations that elude conventional analysis. My latest interest is the pricing of Priority Review Vouchers.

A little background:  The 2007 Food and Drug Administration Amendments Act (FDAAA) created Priority Review Vouchers (PRV). The purpose of the vouchers are to incentivize drug development for neglected tropical diseases which can represent a limited commercial opportunity. 

These vouchers reduce the FDA review time for drug approvals from 10 months to 6 months, and are awarded by the FDA to a company that obtains approval for a treatment for a neglected tropical disease.

Things got interesting in November when Gilead Sciences (GILD) paid $125,000,000 to purchase one of these vouchers from Knight Therapeutics (GUD/CN).

How many of these vouchers exist? According to Evaluate Pharma, only four have been issued, with three being of the Neglected Tropical Disease type, and one being for Rare Pediatric Disease. The two programs currently have some important differences, so for the purposes of this article we are focusing on  Neglected Tropical Diseases. Below are the status of all four: 

Things got even more interesting when the Senate voted for the Adding Ebola to the FDA Priority Review Voucher Program Act, which would change three elements of the  Neglected Tropical Disease Priority Review Voucher program:

1. Add Filovirus, which includes  Ebola,  Marburg, and Lloviu to the program.
2. Shorten the notice period to use the vouchers from 365 days to just 90 days. 
3. Allow the re-sale of the vouchers an unlimited number of times. The current limit is once.

The bill has broad bipartisan support, and is expected to be passed by the House and  signed into law by President Obama. While the headline is about Ebola, we are interested in points two and three, which would bring the neglected tropical disease program more in line with the rare pediatric disease program.

The reason we are interest in the time frame shift ( from 365 days to 90 days) is because it impact the value of the PRVs. Simply put, the sooner a firm can see revenue from a drug, the more its worth today. This is especially true if one were to factor in a the competitive landscape, where the first mover advantage can be critical. 

To estimate the impact of this shortened time frame I ran the back-of-the-envelope calculations below:

The take away here is once the Adding Ebola to the FDA Priority Review Voucher Program Act becomes law, the Neglected Tropical Disease PRVs will be come more valuable based on the reduced time frame alone. As for the discount rate, I came to 15% via a sophisticated method known as "from thin air". Yes, I can already hear you CFAs saying "you should use the WACC". To that I say drug development is a risky business and you should be more conservative in your modeling assumptions.

An additional factor that will drive up the value of PRVs is the lifted re-sale restrictions. Previously, if you bought the PRV you had to use it, as only one re-sale was allowed. However, with no re-sale restrictions, the pool of capital that could potentially purchase a voucher is much larger. One could see a healthcare firm with a large amount of capital scoop one of these up with the intent of selling it later. The liquidity premium is a real thing, and in this case I'm going to give it a conservative 2.5% liquidity premium, bringing the value to $142.3M. 

This brings the total gain from the legislation to +$17.3M per PVR. While this amount isn't going to move the needle for giants like J&J or Gilead, it certainly is material for a firm like Knight Therapeutics, which has a market cap of just $540M (Canadian). Ask them if they would like another $17 million for the PRV they sold to Gilead.

It is no surprise the Biotechnology Industry Organization (BIO) has come out in support of the bill.

Of course there are additional factors at play here, as I said this a back of the envelope exercise. For example, from a drug developers perspective, much of the value is derived from the drug and indication for which the priority review will be used. Furthermore, as the FDA issues more PRVs over time, the increased supply may drive down prices. One could also Again there are many factors that firms buying and selling will consider next time these trade hands, but I digress.

Those who want to learn more about Ebola can check out the classic The Hot Zone: The Terrifying True Story of the Origins of the Ebola Virus.

One last thing, once Filoviruses (Ebola et al) gets added to the list of indications PRVs can be used on, what does that list look like? See below: