# Monte Carlo -Simulation in drug development and licensing Petteri

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```							Monte Carlo –Simulation in drug development and licensing
Petteri Hirvonen, CEO
August 2003
Content

•   Overview on Monte Carlo -simulation
•   Monte Carlo –simulation method in financial modelling of drug development and licensing
•   Replicon’s service
•   Replicon Contact Information
Overview on Monte Carlo -Simulation

•   Monte Carlo Simulations are statistical simulation methods where statistical simulation is defined as
any method that utilizes sequences of random numbers to perform the simulation.
•   Monte Carlo simulation randomly generates values for uncertain variables over and over to simulate
a model.
•   For each uncertain variable (one that has a range of possible values), you define the possible values
with a probability distribution. The type of distribution you select is based on the conditions
surrounding that variable.
•   Distribution types include:

•   A simulation calculates multiple scenarios of a model by repeatedly sampling values from the
probability distributions for the uncertain variables and using those values for the cell. Simulations
can consist of as many trials (or scenarios) as you want - hundreds or even thousands - in just a few
seconds.
•   Monte Carlo Simulation is now regularly used in many diverse applications, from the simulation of
complex physical phenomena such as radiation transport in the earth's atmosphere and the
simulation of the esoteric subnuclear processes in high energy physics experiments, to the simulation
of drug development process.
Monte Carlo –simulation method in financial modelling of drug
development and licensing

•   Traditional discounted cash flow (DCF) analyses combine single “point” estimates of a model’s
variables to predict a single result. Often, on top of these point estimates, some alternative scenarios
are calculated to take into account e.g. “high” and “low” demand or pricing etc.
•   In reality, however, there normally exists more than one important uncertainty and all these uncertain
inputs vary simultaneously (and they even correlate with each other). This kind of analyses is
impossible to conduct with traditional DCF-models.
•   Replicon can develop a Monte Carlo simulation model where one can simultaneously analyse
licensing situation from the point of view of both licensor and licensee. This very useful analysis for a
drug developing company that is preparing itself for licensing negotiation.
•   In our analyses we calculate even thousands of different scenarios for the drug developing company
•   In each scenario up to eight uncertain variables or inputs will be randomly chosen from carefully
defined probability distributions. These distributions as well as other assumptions will be constructed
in close consultation with the management of the drug development company.
•   If needed, we can test the revenue model of the company and the licensee with different royalty
stream assumptions

•   With a proper Monte Carlo –simulation modelling one can analyse complicated situations by
simulating hundreds or thousands of situations from the modelled reality. All individual calculations
represent a single DCF-model point estimate.
•   Thus one could argue that Monte Carlo –model should be as easy to understand as traditional DCF-
models. At the same time the joint probability distribution from which the values of input variables
are randomly chosen makes Monte Carlo-modelling as a whole much more sophisticated estimation
•   In addition, building of the Monte Carlo -model is much more cumbersome compared to DCF-model.
•   The biggest practical advantage of this kind of an approach is that it gives the whole range of
possible outcomes and their respective probabilities as a result. The analysts can obtain all the
relevant information from the Monte Carlo -simulation results. With this information it is easy to
pinpoint relevant input variables and the expected value of the business model.
•   The results can also suggest completely different approaches to the business situation that has been
a priori thought.
•   Multiple sources of uncertainty are especially evident in drug development where structured
regulatory process and relatively well defined markets make the setting very suitable for modelling
purposes.

•   Technically the biggest advantage is that Monte Carlo –method allows us to use lower discount rate
because the uncertainties (failure possibilities) are incorporated into the valuation model.
•   One cannot stress this point too much especially in cases where the relevant cash flows are far away
in the future.
•   As an example let’s assume that relevant revenues for certain drug development project are from
year 7-10 from today. When we discount the same cash flow to the present either by 20% or 40%
discount rate the present value using 20% rate is approximately three and a half times larger than
using 40%!
•   With Replicon Monte Carlo –modelling the drug development company will gain important
information and insight for the licensing negotiations. It is even possible to customize the model for
different types of licensees in order to estimate the negotiation power with various licensees.
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Replicon’s valuation service

•   In a normal model development project with Replicon there are approximately five half day
meetings with relevant management of the company.
•   Two first meetings are for development of the model, third meeting for fixing of all the parameters
and distributions, forth meeting for fine tuning and fifth meeting for presentation of the results and
recommendations arising from the model.
•   Currently we provide valuation and financial advisory services inter alia for:
– Pre-clinical and clinical stage drug development projects;
– Partner screening strategies;
– Intellectual property and other intangibles; and
– Public and closely held equity securities of biotech companies
•   Our greatest strength is in our methodology and proprietary set of tools for analyzing the current
state of technology, market trends, competitive issues, technological impact, and strategic moves.
•   On one hand, valuation assignment can be a comprehensive report or plan prepared using and
analysing market trends, company information, assessment of scientific quality, technological
leadership, intellectual property status and soft factors such as quality and experience of
management and overall company expertise to assess the fair market value of a given company or
R&D -project platform. At the same time the report helps to highlight critical factors, which will drive
company value in the long term.
•   On the other hand, assignment can be a monitoring instrument tailored to venture capital funds who
wish to have an independent and comprehensive comparative assessment of their portfolio
companies. Each company in the fund's portfolio is assessed using different quantitative
methodologies and common criteria. This allows funds to monitor portfolio value using a common
valuation assessment. Valuation can be effectively employed singly or on an ongoing basis.
Replicon Corporate finance Oy

•   Replicon group is independent Finnish corporate finance and consulting house based in Helsinki.
•   Replicon provides highly specialized and quality-oriented corporate finance and consulting services for growth
companies and their potential partners as well as venture capital and private equity funds.
•   Replicon’s special focus area is Life-Science -sector including:
–     Biotechnology;
–     Medical Technology;
–     Pharmaceuticals / Biopharmaceuticals;
–     Diagnostics;
–     Bioinformatics; and
–     IT-Solutions.
•   Regardless of the service or transaction, we offer flexible, cost-saving execution process combined with deep
knowledge of the industry and private equity market, based on education, experience, established network and daily
contact with leading companies and private equity investors
•   The fundamental objective of Replicon Corporate Finance and Consulting is to provide services of unrivalled quality with
a deep commercial and legal understanding and a practical, constructive and innovative approach.
•   Our team is fully committed to each client and to achieving professional excellence in every assignment

OUR INNOVATIVE FEE STRUCTURE TARGETS TO CLOSING, NOT MAXIMIZING CONSULTANCY HOURS
COMBINATION OF FINANCIAL, STRATEGIC, SCIENTIFIC AND LEGAL KNOWHOW MINIMIZES OUR CLIENTS COSTS
AND RISKS IN EVERY GIVEN TRANSACTION
WE HAVE INHOUSE LAWYERS TAKING CARE OF ALL DOCUMENTATION RELATED TO PRIVATE FUNDRAISING;
THIS MEANS NOTABLE SAVINGS IN TRANSACTION COSTS OF PLACEMENT PROCESS.
Replicon Corporate Finance Oy, Contact

Replicon Oy