Valuation Vs. Geographic Location in the Life Science Industry

March 2011
T3 Advisors

As far as most people are concerned, Biotech equals Cambridge and Cambridge equals Biotech.  I’m sure it comes as no surprise that many of the Massachusetts Life Science companies we work with have a strong desire to set-up shop in Cambridge. There are a multitude of logical reasons for the large cluster of Biotech companies in Cambridge: collaboration, recruitment, convenience, access to universities, etc. However, is there a way in which to quantify those intangibles?

During a recent conversation, a client (“Client”) asked our team “is there any correlation between our Valuation and our Geographic Location?” The question has been informally raised before but it wasn’t until now that we felt compelled to tackle this beast. The Client  was tired of being bled dry by Cambridge rents but was afraid that their company’s valuation would take a hit without the “sex-appeal” of a Cambridge address. For arguments sake, in just a fifteen minute commute from Kendall Square you can find the same quality of lab space for half the price.

Cambridge Map$-resized-600

My left brained mentality (Mr. Math) instantly thought “Nope, Client  aren’t you supposed to be the Genius?” My quick and cavalier explanation would be that valuationis based on some form of cash flow analysis. Rent is a cash outflow which would have a negative impact on your overall cash flow, therefore paying higher rents in Cambridge would actually make you less profitable. Return on Investment (ROI) divided by the capitalization rate (CAP rate) equals lower purchase price…Blah Blah Blah. Easy answer!

Suddenly, the small amount of my usable right sided brain (Mr. Artsy) kicked in. If this were the case then why does historical data show such a lopsided trend of biotech companies in Cambridge?  “You are soooo wrong Mr. Math!”

“Darn you Mr. Artsy” I thought to myself. “Life was much more black and white without your hippie influences!” Although I guess I have to thank Mr. Artsy for my enjoyment of Picasso, Shakespeare and Lava Lamps.

Quickly, I emailed a few of my friends currently in private equity for some form of validation. “Guys, you do this for a living, tell me what the secret recipe is for valuation.” The common theme across every response was “it’s all about the numbers. Numbers are KING!”

If the answer was truly that simple then why is the empirical evidence so conflicting? What makes Cambridge so appealing that it defies the standard logic of mathematics?  Historical data of exits illustrates that companies are acquired everywhere from Worcester, east to the South Shore, up to the North Shore, back to Worcester and everywhere in between. One could argue the pure quantity of Cambridge life science exits is higher but they would be failing to take into account any density factor.

So what is my final conclusion, do I side with Mr. Math or Mr. Artsy? I guess it comes down to a good old fashioned cliché…Beauty is in the eye of the beholder. Companies are acquired for an infinite number of reasons; the acquisition is strictly financial, it’s cheaper to buy the technology then build it, a proactive move to eliminate a competitor, a strategic move to be to expand a company’s operations, maybe to secure a presence in arguably the biotech hub of the world. The list goes on and on.

At the end of the day, great technology is great technology. The Client could be acquired for any of the reasons listed above. If the technology is truly groundbreaking then maybe all of the reasons for acquisition listed above could apply to the Client . Most of us learned in Economics 101 that at a truly macro level, higher demand equals higher price. My advice to the Client , wherever you need to be and whatever you need to pay in rent to make your technology as unique and desirable as possible will ultimately be the catalyst behind your valuation.