Publication

Valuation of Medical-Device Projects in a Changing Regulatory Landscape

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Thesis for Certified Financial Engineer at the European Institute for Financial Engineering und Derivate Research, Germany, Jan, 2017

Authors:

Dirk Müller

Summary

This thesis addresses the valuation of development projects in the medical-device industry. A variety of valuation models are deployed in a hypothetical, yet realistic, case of the development of an invasive catheter.

The following methods were utilized and compared to each other:

  • Discounted Cash Flow Method (DCFM)
  • Venture Capital Method (VCM)
  • Real-Option Method (ROM)
  • Possibilistic Real-Option Method (PROM)

They were assessed with respect to the worthiness of investment in two distinctively different situations: before and after the transition from the current Medical Device Directive guideline within the European regulatory environment to the more stringent Medical Device Regulation (MDR) expected to come into effect in 2020. Minimum, best-guess, and maximum cash-flow scenarios are established as an input for each model built with VBA Excel.

Despite the difference in the input and model parameters, the models yield fairly similar results with regards to a dichotomous decision to invest in the project or to reject it. ROM gives higher valuation figures than Net Present Value (NPV) and PROM.

The advantage of ROM is manifested in its granularity and its capability to address staged investments, PROM in its simplicity and comprehensiveness to incorporate all scenarios concurrently.

The penalty in financial terms of the new MDR is heavy. Only the long-term corporate investor with a 15-year time horizon can achieve an close-to-zero NPV in the best-guess, and a clearly positive NPV in the maximum scenario. Small medical-device companies will shirk innovative projects, and will rely on incremental improvement of existing products. Only corporations with cash reserves and the lobbying power towards the insurance companies to pay premium prices will consider risky projects.

Pressure will be exerted by (university) hospitals having to handle complex cases, requiring higher reimbursement for best-of-class treatment. Start-ups with no track record of cash flows will be neglected by VC under MDR, as their investment horizon is confined to 5-8 years.

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