Portfolio Risk Analysis Kimber Hardy November 2012

1. Portfolio Risk Analysis Kimber HardyNovember 2012

2. The Flaw of Averages Sam L. Savage John Wiley & Sons, Inc., 2009

3. Pipeline values and risk… … single, average values can be misleading…. “plans based on average assumptions are wrong on average”

4. Company Strategy Role of Portfolio Management Total R&D Investment Total R&D Investment Company Strategy R&D investment allocation TA3 NME Dev TA1 TA2 LCM Res Pipeline-derived sales Value and Risk • Portfolio Management • Align portfolio with Strategy • Maintain portfolio balance • Maximize portfolio value Portfolio Value Change Project Prioritization & Optimization Resource supply and demand, by project and Department Resource Management

5. eNPV: often used for (late-stage) project valuation Cash Flows by Year Probability of Success NPV* eNPV* 0 4 7 10 Success –50 90 100 100 100 50% 25 Failure –50 0 0 0 –50 50% *at 10% discount rate eNPV: to account for timing and technical risks, NPV and probabilities are combined

6. Project values: range of possible outcomes Fails in Preclinical. Project stopped Fails in Clinical. Project stopped 0.05 0.05 Mean value by itself doesn’t capture enough about the value and risk of the project 0.04 0.04 Mean value €80m 0.03 0.03 probability probability Successful Development & Registration. Generates sales 0.02 0.02 0.01 0.01 -250 -50 0 +200 +400 -250 -50 0 +200 +400 project value (€m) project value (€m)

7. Many ways to present project values and risks e.g. Decision trees and scenarios Sensitivity analysis Monte Carlo simulation Value change over time

8. How to analyse and present pipeline values, ranges and risks?

9. Typical portfolio analyses Pipeline-derived sales Project value and risk Pipeline value change Project prioritization

10. It can be very useful to show an analysis of potential sales with ranges … Pipeline-derived sales * *indicates that there is a 10% probability that sales will be greater than the value shown and 90% probability that it be less

11. … or an analysis of portfolio values with an indication of confidence limits 5’600 1’500 4’500 -800 400 Pipeline value (€ millions) Pipeline value change: + €1’100m (+24%) 2010 2011

12. An analogy with Financial Portfolios Probability analyses increasingly used: e.g. assessing downside risk in pension portfolios *Illustrative only! Adapted from www.ProbabilityManagement.org

13. Pipeline Value as the sum of project mean eNPVs Total pipeline value = €5’600m 13

14. Pipeline Value as the sum of project eNPVs This is a mean valueHow to show more information about the portfolio: values and risks?For example, what’s the probability that the value is less than €2’000m? Total pipeline value = €5’600m 14

15. Defined scenarios for projects

16. Scenarios vs. Sensitivity analysisBoth useful, but prefer scenarios as more clearly defined Sensitivity analysis NPV given Technical Success, Rebif in Colorectal Cancer Base 0 50 100 150 200 250 300 350 400 450 500 Case Product Profile  MAP TPP EU Market Share 30% 20% 40% US Final Market Share 30%   20% 40% EU Annual Launch Costs  25 40 7 EU Price Growth Rate  -2%  -3%  0% EU Initial Price $6,500/yr $5,800 $7,100 US Annual Launch Costs $20MM $28MM $5MM EU Launch Year  2016  2015  2017 Material cost per mcg Base High Low US Initial Price  $6,500/yr $5,800 $7,100 Base Value: $170 million

17. Sales forecasts & costs defined for each scenario e.g. for sales... 20% = scenario probability 60% 1036 819 20% Global peak sales (€ millions) 519 High Base case Low

18. Project probability of success • CMR & KMR benchmarks • Useful background information when assessing project probabilities • However, benchmarks for certain therapeutic areas have insufficient data • And certain types of project differ markedly from benchmark • E.g. phase III projects from small vs. large Pharma companies Phase III Oncology trials: 2000 to 2009* Company size Positive Phase III <$300m 0/21 (0%) >$1’000m 21/27 (78%) *A. Feuerstein & M.J. Ratain. J. National Cancer Institute.103(20):1-2. Nov 2nd 2011

19. Commercial and Technical Risks: project data needed for Monte Carlo simulation of portfolio value NPV Phase III Filing Scenario Outcome Probability 750 11% Launch Scenario 1 20% Succeed Launch Scenario 2 32% 400 54% 60% 90% 60% Scenario 3 Launch 11% 200 20% Succeed 10% Fail 6% -240 60% Fail 46% 40% -220 Fail 40% Fail

20. Portfolio value: Monte Carlo simulation 10000 Proj A Proj A 9000 Proj B Proj B 8000 Proj C Proj C 7000 6000 € millions 5000 4000 3000 2000 1000 0 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Cumulative distribution

21. Portfolio Value Ranges 10000 9000 8000 7000 6000 € millions 5000 4000 « Value at Risk » 22% of median value 3000 2000 1000 0 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Cumulative distribution

22. Portfolio Value Ranges The shape of the curve describes the value – risk profile of the portfolio

23. 9'000 8'000 7'000 6'000 5'000 Portfolio value (€ millions) 4'000 3'000 2'000 1'000 0 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% -1'000 Cumulative distribution Portfolio values: “the flaws of averages” Portfolio A Mean value: €500m Low Risk/ Low Reward Portfolio B Mean value: €500m High Risk/ High Reward

24. 4 projects. 70% correlation Impact of correlation on portfolio risk/reward profile Four phase II projects: 70% correlation vs. no correlation 14'000 12'000 10'000 70% correlation 4 projects. No correlation 8'000 no correlation Value (€m) 6'000 4'000 2'000 0 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% -2'000 Cumulative distribution

25. But a final word on keeping presentations to the Board simple. At most this…

26. … or this to show confidence limits 5’600 1’500 4’500 -800 400 Pipeline value (€ millions) Pipeline value change: + €1’100m (+24%) 2010 2011

27. The Flaw of Averages Sam L. Savage John Wiley & Sons, Inc., 2009