TUNKU ABDUL RAHMAN COLLEGE

School of Business Studies

Purinex, Inc.

Team members : Beh Saw Hwai 09WBA09229

: Heng Leong Wei 09WBA09952

: Hor Boon Hong 09WBA09227

: Jackson Lim Beng Shien 09WBA10241

: Leow Jia Ling 09WBA08735

: Lim Zhen Huey 09WBA09228

Group : 2AFI1

Programme : Advanced Diploma in Business Studies

(Finance & Investment)

Course : ABMF 5354 Case Study in Finance and Investment

Lecturer/Tutor : Mr. Samuel Lim

 Purinex, Inc. is a pharmaceutical company which has based in Syracuse, New York. It

has several clinically and commercially promising drugs in development. The main business of

the company is to discover drug that used for treatment purpose and develop that particular drug.

Based on the company purine drug-development platform, Purinex sought to commercialize

therapeutic compounds.

Purine, a naturally occurring molecule that played an important role in the numerous

biochemical processes. In order to use molecules to initiate physiological responses or block the

activation of receptors by endogenously produced signaling molecules, Purinex had create small

molecules that acted as selective agonists (activators) or antagonists (blockers) for specific

purine receptors in the cell membrane. The founder’s goal and vision of the company is to

develop products that evoked a receptor-specific pharmacodynamic effect and avoid from

producing undesirable outcomes that could result from interactions with other receptors. Besides

that, to address a broad range of potential indications, the company is taking the new receptor-

selective drugs into clinical trials. The most promising indications for the company compounds

were for the treatment of diabetes and sepsis, one of the deadliest diseases in the world.

Sources of Purinex Inc (PI) value can be classifies into several parts which are physical

building, intellectual property and labor forces of the company. Currently, there are 14

employees’ works under this corporation. Purinex Inc owns a chemistry laboratory which located

a few miles from the company’s main office. Intellectual property of the company is having a

portfolio which consists of more than 35 patents pending or issued in the purine field.

Purinex Inc. had a wide range of technology under development. Two of which are

antagonist and agonist programs. The drug-development process consists of seven stages which

are discovery, preclinical testing, phase I, phase II, phase III, FDA review and approval and the

last stage is postmarketing testing. The antagonist program which is developed purposely for

treatment of diabetes had currently processing in preclinical stage while agonist program which is
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developed purposely for treatment of sepsis had completed phase I clinical unit. Both of the

programs had applications appropriate for partnership deals with larger pharmaceutical company.

Regarding purine antagonist, Purinex Inc. had the patent of using it for diabetes treatment

purpose and its related condition within the United States. A series of proprietary antagonist

molecules that developed by the company has showed a great promise in preclinical studies of

diabetes and it is believe that the company can generate total annual sales of $4 billion by selling

this drug. On the other hand, the major problem in management of septic patients was the delay in

administering the right treatment after the sepsis had been diagnosed. Purine agonist is used for

sepsis treatment purposes, the company had implemented some testing in animals. Testing result

show a positive sign. This drug has limited side effects, to be fast acting and effective at treating

sepsis even if there are some delays for treatment after sepsis had been diagnosed. In phase I

clinical trial, this drug had been proved safe in humans. It is believe that the company can

generate total annual sales of $500 million by selling this drug. From company point of view, the

two products are likely to success.

However, it is not easy to successfully develop a drug as it had to go through distinct

stages which required extensive testing. Moreover, the drug-development process was overseen

by Food and Drug Administration (FDA) in the United States to ensure the drug efficacy and

make sure it brings no harm for human body. Safety of the drug is very important. Before

applying for regulatory approval, the drug manufacturer had to undertake three sequential sets of

clinical tests. During clinical testing, out of 20 drugs, FDA estimated that 13 or 14 drugs would

successfully completed phase I, followed by only 9 drugs would likely survive phase II out of 13

or 14 drugs. On average, only 2 would successfully completed phase III. After several attempts,

only 5 percent to 10 percent of drugs that undertake clinical testing were ultimately approved for

marketing.

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 In other words, likelihood of success for drug development is relatively low according to

FDA estimation. A company has to do some minor testing on the drug to ensure the drug is safe

and effective in treating a particular disease before enter into clinical test that overseen by FDA.

The approval process by FDA took a very long period and it required a very high Research and

Development (R&D) cost. According to Standard & Poor’s, R&D spending by biotechnology

firms was 40 percent of the industry revenues. This is because of biotechnology firms did not

generate revenues. Moreover, according to a study by the Boston Consulting Group (BCG) in

year 2001, it cost $880 million for company to develop a new human-therapeutic compound and

the drug-development failures accounted for 75 percent of the total R&D costs.

Problems of Purinex

The problem facing by Purinex Inc’s CFO Gilad Hapaz is expect to establish a

partnership with a major pharmaceutical company sometime in the next four to twelve months

where this partnership would enable the company to develop one of its leading compounds into a

drug for the treatment of one of the world’s most widespread diseases.

Purinex Inc is currently facing financial problems. The company did not generate sales or

earnings and had only $700,000 of cash in hand. The expenses of the company are more than

income. Monthly expenses of the company were about $60,000. Cash level that Purinex holds

would only enable the company to survive for another 11 months. Moreover, Purinex was a drug-

discovery and development company, it need to spent a huge amount of money on Research and

Development (R&D) in order to develop an antagonists and agonists program for the treatment of

diabetes and sepsis. Early-stage biotechnology firms needed excessive access to capital for R&D.

According to a study of Tufts University, in order to develop a new human-therapeutic

compound, it cost a company total of $897 million.

A successful deal of partnership between Purinex and a major pharmaceutical company

is crucial. If the company able to secure the partnership, it can solve the financial problem that

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company currently facing. Purinex will receive milestone payments, royalties, front fees and

copromotion rights and have enough access of capital for R&D funding. However, there are two

partnerships available, one wanted a deal for treatment of sepsis while another sought for

treatment of diabetes. The first deal which want a deal for treatment of sepsis enable Purinex to

receive $108 million milestones. Another one promised to give Purinex $80 million milestones. It

is believe that there is 60 percent probability that the first deal of partnership will occur. In order

for Purinex to go for initial public offering (IPO), securing one of the deals was practically a

prerequisite. In other words, the company has to retain at least one of the two partnership to

maintain firm’s viability as a strategic acquisition target as possible IPO candidate. Although the

successful rate remain high but the sepsis and diabetes partnership are still uncertain. This is one

of the problems that need to be considered by the CFO.

Besides that, the drug development and approval process was lengthy and risky. The

drug-development process consists of seven stages which are discovery, preclinical testing, phase

I, phase II, phase III, FDA review and approval and the last stage is postmarketing testing. On

average, it took 10-15 years to move a drug from preclinical testing to marketing approval.

Preclinical testing is the most challenging stage and it accounted for about 40 percent of the time

and resources required to bring a new compound to market. According to Food and Drug

Administrative (FDA), over the years, drugs that went through all the approval process and

completed postmarketing testing is only 5 to 10 percent. In other words, even if the company has

enough access of capital for the drug-development process, there are still some approval

problems that need to get rid by the company.

The urgency associated with the CFO concerns of is the financial problem that facing by

the company. Absence of partnerships and external financing might cause the company to give up

from developing the drugs that might bring potential annual sales to the company. Assuming the

company is able to retain one of the partnerships or able to seek for external financing, the

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company has to make sure the antagonist or agonist program can complete the testing process

which overseen by FDA. If the program cannot be approved during the approval process, the

money that invested on development will be wasted. The company might turn into bankruptcy

due to a very low level of sales or even no sales in the future time.

Comparison among the options and ranking in terms of risk and return

The CFO is planning to undertake external financing now in case the company fails to

establish any partnership which will then put the company into a big trouble. There are three

options that considered by Hapaz which are venture-capital round, angel round and wait for the

partnership deal in six months and each option came with its own risks. Hapaz need to make

decision on which options the company should go for and he need to choose the option that will

bring the highest benefits to the company.

First of all, venture-capital round could secure Purinex Inc $10 million in a one-time

round, which enables Purinex Inc to survive another 166.67 months or 13.83 years

(10mil/60000), and it just takes 3 months to complete the process. Still, $10 million is definitely

adequate for Purinex Inc to continue the research and development on diabetes and sepsis. In

addition, Venture capital firm would grant a premoney valuation of $15 million for Purinex Inc.

Therefore, Purinex Inc is still maintaining a good reputation or image. Besides, venture capital is

currently had showed its serious interested in biotechnology, and Purinex Inc showed great

promise as well. Nonetheless, there are still some risks which Harpaz (CFO) needs to concern

with. Since investing in an uncertainty business is highly speculative, venture capitalists will

basically come with a significant number of restrictions such as preferences for board

appointments, antidilution rights and so on. As a general rule, venture capitalists require

controlling about 30-40 percent of the equity in the company which they invested; hence it might

to bring a certain impact to the company structure and decision. Then, if either one of sepsis and

diabetes successfully launch in the future, Purinex Inc has to share its earnings with venture
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capital firm based on the agreement. On the other hand, Harpaz believed that round of venture

capital has the possibility to increase the value of pharma deal by 10 percent.

Do nothing and wait six months for the partnership deal is the second option of sources

financing. Purinex Inc could just do nothing and expect either sepsis or diabetes will be deal

within 11 months. Assuming Purinex Inc has partnership deal for sepsis, its partner for that drug

(larger pharmaceutical firm) need to pay the royalty to Purinex Inc as stated in the contracted

term, which is 10 percent of its earnings. Next, Purinex’s current owners still retain the control to

the company completely and preserve a $25 million for the company’s valuation, which is the

highest compared to another two options. On the other side, since Purincex Inc’s cash on hand is

just able to make them survive 11 to 12 months, but the company could just wait only six months

before securing additional financing. Then, if either the sepsis or diabetes has failed during the

following six months, it will put the company into trouble. Down round scenario would come to

Purinex Inc’s investors, which would dilute the value of existing investors and make it worth

much lesser or even nothing at all. By this, a premoney valuation for Purinex Inc possibly would

drop till just $8 million or even worse than, as low as $5 million. So, the most crucial component

is the short time period to seek for partnership. If no any partnership deal comes through, there is

no doubt that Purinex Inc will face a financial distress. However, regarding to the historical trend,

the success rate of partnership deal is increasing in these several years between pharmaceutical

firms and biotechnology firms. By referring to the table of Exhibit 2 “Recent Biotechnology and

Pharmaceutical Partnering Deals”, it shows that there are 10 companies successfully in the

partnership deal within 7 months.

The last alternative is angel round. The similarity between venture capital and angel

investors, which is the way they invest in the company. If the CFO chooses this option, the

company is not able to raise as much funds as it could from venture capital round. Angel

investors are just able to provide $2 million for Purinex Inc, which is just could making Purinex

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Inc survive to 33 months further, and about six months is needed to undertake this angel round.

Compared to venture capital, the funds raise from angel investors are much lesser and take longer

time to complete it. These are the risks in which Harpaz ought to take care seriously if he wants

to undertake angel round. Nevertheless, with angel investors, they may not demand too much

about the preferences, which mean current owners of Purinex Inc are still able to be in charge and

have the major power to control the company; the rights wouldn’t be diluted excessively as well.

Furthermore, a higher valuation of $17.5 million will be allocated to Purinex Inc with those angel

investors, slightly higher than venture capital but lower contrasted to partnership. Similar with

Venture investors, Purinex Inc has to share its earnings with angle investors after the product is

gaining the marketing approval and sell in the market.

In summary, based on the potential return and risk level, we rank wait six months for the

partnership deal as first, followed by venture capital and ended up with angel. The reasons we

ranked wait for partnership deal at the first is mainly due to the Purinex Inc does not have to share

its earnings with others party, but instead of receiving up-front fees, research and development

funding, royalty and so on. And, Purinex Inc just needs to distribute the marketing rights under

licensing arrangement for its partnerships. Additionally, Purinex Inc’s current owners still

maintain the absolute control to the company. These returns are definitely greater than venture

capital and angel round with no doubt. Furthermore, most of the companies in biotechnology

industry had partnership deal in year 2003 and 2004. There is just one thing that Harpaz needs to

take into considerations, which is the short period time of waiting for the partnership deal.

Although the potential return of partnership is high, but it comes with greatest risk among all the

options. The consequences of failed to undertake partnership dealing are down round scenario

and financial distress.

Second ranking based on the risk and return is venture capital round. Venture capital is

able to provide an optimistic figure ($10million) to secure Purinex Inc within 3 months time,

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make it able to survive longer and has more funds to conduct research and development for sepsis

and diabetes. Still, a strong interested of venture capital firm investing in biotechnology is

another reason we ranked it as second. However, the risks associated with venture capital are

Purinex Inc needs to share portion of its earnings with venture capital investors, a substantial

restrictions inject into company as well. Some restrictions are crucial because venture capital

investors able to appoint the new board and thus change the board structure and also the dilution

of the rights which will caused the CFO lose his job. As a result, current owners of Purinex Inc

will tend to loss significant control to the company. Still, it offers a lower firm premoney

valuation compared to angel investors.

The last ranking is angel round. Even angel investors are able to give a better firm

valuation compared to venture capital; however, it may not raise much fund for financing

purpose. Angel investors are just able to hand out only $2million, which is enable Purinex Inc

survives another 33 months only. And, $2 million is definitely not adequate to conduct research

and development. Although angel investors do not demand many preferences, but it doesn’t mean

there is zero involvement, there might be some changes on the company structure. The angel

investors may required for higher rate of return in the compensation of higher risk borne by them.

Moreover, it takes six months to complete angel round of financing, which is longer period

compared to venture capital round.

Financing options chosen by us

In our opinion, we will suggest to the CFO to finance the firm’s growth by choosing

venture capital as the first avenue after that only wait for 6 months to be partnership with other

company. The reasons we not directly choosing to wait for 6 months because it is very risky wait

for 6 months in the expectation that partnership deal will come through but at the end it failed.

The existence of uncertainty in partnership deal since there was only 75 percent chance that

Purinex would secure a partnership with pharmaceutical company.

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 Although the value of firm is high in the partnership ($25 million) however if the deal is

not success, Purinex has to search for other options like venture capital and angel round to

finance its growth. Purinex would be forced into a down-round scenario which investors

purchased stock from them at lower price than the one placed on the company by earlier

investors. From the case, it is believed that pre-money valuation for Purinex will drop to $8

million or as low as $5 million. It probably will caused dilution of economic value for existing

investors.

As a result, we would like to choose venture capital as our first choice since it takes three

months to secure $10 million from a Venture Capital firm. Currently Purinex had $700,000 in

cash on hand which allowed the firm to sustain for about 12 months. With the external financing

of $10 million, Purinex is able to sustain the monthly expenses cost of $60,000 (after taking into

account of federal research grants amounted $100,000) for about 14 years and avoid the firm

from having cash flow problem. As we know, total development time for drug was highly

variable and it took 10-15 years to move from preclinical development to marketing approval.

Currently, there is a preclinical stage antagonist program for the treatment of diabetes whereas

agonist program for the treatment of sepsis had completed a phase I clinical trial. The fund of $10

million raise from venture capital round is sufficient enough for the firm to complete the whole

drug development process either it secures a partnership with sepsis or diabetes.

After Purinex raise the fund through venture capital firm in 3 months time, it can wait for

6 months in order to complete a partnership deal either sepsis deal or diabetes deal. This will

reduce the risk of the firm from just simply wait for 6 months because once the partnership deal

fail, it will not affect the firm’s financial situation and the firm still have enough fund ($10

million) from venture capital to support their research and business.

From the research, it shows that many large pharmaceutical firms had moved

aggressively to partner with smaller firms in biotechnology sector in 2003 to 2004. 10 companies
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completed partnering deal within 7 months (Exhibit 2) and there is 36% of North American

Biotechnology Industry finance firm’s growth by partnering with other firms (Exhibit 4) so it is

important for Purinex to partner with other in order to remain competitiveness of the firm.

Venture capital firm had expressed serious interest in biotechnology investment. Moreover, a

round of venture capital funding could possibly increase the value of pharma deal by 10 percent

thus encouraging more firms to raise fund through venture capital firm before going for

partnership. As a result, Purinex has to go for partnership because it was practically a prerequisite

for initial public offerings in future.

One of the concerns of venture capital funding is Purinex will lose the control of

company and may have some restrictions including appointment of board members and

antidilution. The board structure may be changed according to their preference and high

probability that CFO may lose his job. As venture capital firm is part of the owner of the firm, it

greatly decreases personal cost of failure. Now CFO has divided the risk up between him and

outside investors, meaning if the venture fails, the loss is spread between him and his investors,

sometimes cushioning the blow to him personally. However, as long as the boards are performing

their job effectively and able to manage the company well, the board still can be maintain by

venture capitalist because their main interest is the earnings generated by the firm. Good

management team will help increase the value of firm and the current board structure will be

maintained.

Venture capital invests in Purinex because they believe that the high growth rate of

business will drive them high earnings and worthwhile to invest. Purinex has to share their

earnings with venture capital firm and every year. However, most of the venture capitalist is

short-termism and they will divest their investment once the firm is at the maturity phase and start

looking for other new business opportunities. In this case, Purinex will be able to retain the

control of firm after venture capitalist drop off the business.

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Qualitative factors under consideration

There are several qualitative factors that are under our consideration in structuring our decision

among various alternatives. Practically, our consideration is revolving around the financing

decision and the partnership option available. We have decided that the best possible decision is

to secure financing in the near term through venture capital and seek for partnership deal in

the sepsis drug. Our consideration can be divided clearly by the financing options and

partnership deal as stated in below:

Financing Options

1).Control and Restrictions Issue

The venture-capital round and angel round financing would both trigger the control

power issue and impose certain aspect of restrictions on the firm. Therefore, the choice between

venture capital and angel round financing are both detrimental in the sense that it might alter

existing owners share composition. In addition, both choices might also require the firm to adhere

to certain clauses inserted into the contractual term or face the eventual penalty. Nevertheless, we

must also weighing up the benefit that could possibly derived from those financing options-

namely a well capitalized firm. We believe that venture capital is the best option as it can offer

$10 million in 3 months as compared to $2 million in angel round financing. In essence, venture

capital can help to recapitalize the firm and help the firm possess more flexibility in selecting a

suitable partnership deal.

2). Possible Impact to Partnership Deal

Another major factor that we need to take into consideration in the financing options is

the possible beneficial impact from the resulting financing option. Based on Purinex CFO Gilad

Harpaz, he claimed that “a round of venture capital funding could possibly increase the value of a

pharmaceutical deal by 10 percent”. From our computation, we found out that the value of the
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partnership for sepsis could be boosted by $11.3 million to $124.3 million from the initial $113

million. In this sense, we believe that the potential improvement in partnership deal value could

help to offset the issue of dilution in control.

3). Uncertainty in Partnership Deal

We must also access the success rate or finding a partnership deal in structuring our

financing decision. Since it is more preferential in finding a partnership deal for sepsis, we need

to be more conservative in our financing decision. The success rate of finding a partnership deal

for sepsis is estimated to be lower as compared to diabetes. It is estimated that there are only 60

percent probability that it would be a deal for sepsis in the next four to twelve month and 95

percent probability that the diabetes partnership would occur a year later. The higher uncertainty

associated with the partnership deal (sepsis) lead us to be more incline towards a conservative

financial profile. We believe that having a well capitalized firm through venture capital ($10

million) will allow the firm to stand a better chance to cushion against unexpected events.

Partnership Deal

1). Potential Revenue and Financial Package

The determinant factors in our evaluation for the best possible partnership deal rely upon

the potential revenue that would be able to generate by the drug in the future. As illustrated in the

text, Purinex CFO Gilad Harpaz has estimated that the annual sales for diabetes and sepsis would

be $4 billion and $500 million respectively. In line with this, we believe that it is in the best

interest of the company to retain the right for developing diabetes drugs while dropping the right

for sepsis drug through partnership deal.

Furthermore, we also need to take into account the financial package that offered for each

partnership deal. The financial package offered for the sepsis partnership deal is $5 million up-

front, $108 million milestones, 10% royalty while the diabetes deal stand at $8 million up-front,

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$80 million milestones and 12% royalty. Since sepsis drug is on a more advanced development

phase, we believe that it is more likely to trigger the milestones payments in the near term. In

addition, there is also a restriction on diabetes drug in which the value of the current financial

package offered will be cut by half if the partnership for the diabetes occurs about a year later.

From the financial aspect, we believe that it is in the best interest of the firm to keep developing

the drug for sepsis while dropping the sepsis drug through partnership deal.

2). Biotechnology Development Risk

Uncertainty in developing new drugs was staggering and this has contributed to skyrocket

development cost, it was estimated by Tufts University that the cost to develop new human-

therapeutic compound was $897 million (in 2000 dollars). This clearly implies that there is

definitely a need to find a suitable partner to be able to develop the drug with a higher success

rate. A larger pharmaceutical company has more expertise and the economies of scale to develop

and market those potential drugs. In essence, we believe that having a partnership deal for sepsis

is beneficial for the firm as it can help to reduce burdensome development cost while offering

lucrative financial package in the long-term. Moreover, it also can help Purinex to redirect it

focus and its resources on developing single drug (diabetes) which will contribute to a higher

success rate in developing the drug in the future.

3). Potential IPO or Buyout Deal

A partnership deal for either drug was necessary as a means to instill much needed

confidence into Purinex. Based on the text, Purinex only has sufficient cash to fund ongoing

operation for the next 11 months, which clearly reflect the dire state of financial condition in

Purinex. In this context, we believe that embracing the partnership deal will inject much needed

fresh capital in Purinex while providing a springboard to Purinex as potential IPO or buyout

candidate. This can be attributed to the financial stability provided by the partnership deal which

will act as sweetener and help to entice potential investors into the company. In this context, we

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believe that partnership deal for sepsis will gather lucrative financial package which is vital to

provide financial solidarity required to get listed and help to enhance shareholder’s value in the

long run.

4). Long-term Development Cost

Another major concern is the long-term development cost of a drug as the cost of

developing new drug might be inflated in the long-run. According to the text, the Tufts University

has conducted a study and published in a 2003 report that it requires $897 million (in 2000

dollars) to develop a new human-therapeutic compound. On the other hand, Purinex burn rate

was about $60,000 a month (after 100,000 research grant from the federal government) and we

believe that this is an unrealistic projection and it does not reflect the true cost of developing new

drugs. Moving forward, we believe that once Purinex drugs move into a more advanced phase of

development, it might involve additional resources and the burn rate might increase substantially

along the road. Likewise, it is a necessary and imminent measure to secure financing thorough

venture capital and embrace the partnership deal for sepsis as it offers the most lucrative financial

package to the firm. The lucrative financial package will help the firm shield away from the

pressure of escalating development cost thus able to realize shareholder’s value in the long run.

In conclusion, we believe that Purinex need to act fast to secure substantial financing

through venture capital in order to recapitalize the firm and thus enable the firm to have a firmer

financial footprint. This would then allow the firm to possess a stronger position to negotiate a

better financial package in potential partnership deal for sepsis. Sacrificing the right to sepsis

drug is imminent as this measure would enable Purinex to divert all its resources on diabetes drug

which contain a higher revenue potential in the future. All these measure will help to open up the

window for IPO opportunity or potential buyout offer which will act in the best interest of the

shareholder’s.

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