This year’s CPhI conference was held in Madrid where Kevin Bottomley, Partner at Results Healthcare chaired a panel discussion on the M&A outlook for the pharma industry. Panelists included executives from some of the world’s leading pharmaceutical and contract manufacturing companies (CMOs); Gérard Bellettre (Senior Director, Sanofi Industrial Affairs), Tim Tyson (CEO, Avara), Mark Quick (EVP, Corporate Development, Recipharm) and Tim Kent (VP Business Development, Pfizer).
Given the background of the panelists the discussion focused on the contract manufacturing sector and pharma’s divestment of non-core assets. Kevin highlighted the incredible amount of activity that had been witnessed in the past decade. The CDMO market is currently sized at $92 billion and is expected to continue to grow at a compounded growth rate of 8% over the next five years. We have observed an increasing amount of deal activity especially above $100m+ value and have seen valuations reach all-time highs; Patheon, Capsugel, Cook Pharmica and Halo Pharma were cited as examples of mega deals, and in some cases pushing acquisition multiples beyond 20x.
Kevin pointed out several factors that he felt were underlying drivers of inorganic growth strategies in the deals that Results Healthcare had worked on; diversification of service offerings to create a “one-stop-shop” solution, early stage product capture by way of vertical integration, geographical expansion to meeting the demands of global clients, adding high value capabilities across all stages of development and commercialisation, and achieving critical mass to achieve economies of scale.
When the question turned to the future, the panelists agreed that the market remains incredibly fragmented and this will be one of the key drivers for consolidation. Approximately 15% of the market is controlled by the top 5 players with the vast remainder staying in the hands of small to mid-sized companies. Tim Tyson highlighted that there are currently between 500-600 CDMOs generating revenues above $5 million revenue. He expects to see this number filter down to 100 over the coming years. Tim Kent noted that Pfizer currently has a vast supplier base of 300 companies and this presents some obvious challenges. He would like consolidation to lead to a simplification in the supplier base, which will help to reduce costs and lead to a formation of strategic partnerships with a handful of suppliers, much in the same way that we have seen in other industries, such as the automotive industry.
Consolidation over the next decade will continue to be driven by a need to increase the utilisation of assets and improve performance. They envisage a consolidation of smaller CMOs which are often dependent on legacy contracts for pharma’s tail-end products. As the economy experiences turbulence (which they agreed is now long overdue), these smaller companies will struggle to invest, and this will create the stimulus for further consolidation. The panelists also acknowledged that there is a wealth of talent which exists at sites which also need to be re-positioned and utilised effectively.
On the topic of site integration, panelists agreed that this was never an easy challenge as emotions naturally run high due to the uncertainly of the eventual impact on site workforce jobs. Where opinions differed was the approach to manage these organisations once they are integrated – there were two different camps. Mark Quick believes that the integration challenge often stems from changing the mindset of an organisation into understanding that they are evolving from cost centre into a profit centre. In his experience most people are usually up for this challenge and therefore believe operating under a decentralised model is optimal, where the site is responsible for managing their own P&L. Manufacturing units often perceive themselves as non-vital organs of the pharma organisation, overshadowed by R&D functions, but they soon realise that they are the most central part of a CMO and critical to its success. Tim Tyson agreed that it is important to empower people to make decisions and let them know that they have a meaningful role where they can make an impact. However, it is crucial that this is delivered under a paternalistic culture, where there is the existence of coherent corporate culture and symmetric systems and governance framework across the site network.
Deal structures in pharmaceutical site carve-out transaction are usually based on two principal economic components; upfront purchase price and supply contract. In transactions where there is a high degree of potential liabilities being transferred onto the buyer, the level of consideration being paid is a low nominal value and in fact economic value is transferred to the buyer through the supply agreement to provide “cost coverage” as product volume at the site falls. These types of transactions have become the norm in recent years. The CMO panelists agreed that cost coverage is required to support these transactions and to ensure that the site is a going concern in the long run. The process of bringing new product volume to site is not easy and can take multiple years, especially when factoring in the tech transfer process. In today’s market we are seeing cost coverage being provided for 3-5 years and at varying degrees of the total cost base. When the deals take place, it is assumed that the legacy business from the pharma sponsor will eventually disappear, however on the positive side it rarely ever does.
When the topic turned to the M&A process, Gérard Bellettre and Tim Kent both agreed that the amount of time it takes to run internal processes is sometimes overlooked. Negotiating with the buyer is one side of the coin, but the corporate development teams ultimately need to sell the deal terms internally and this can mean getting various stakeholders and the executive committees on board. This is not a painless process.
The session ended with the customary topic around global macroeconomics. The panelists agreed that there needs to be open boundaries for trade to happen optimally; no one really knows what will happen with Brexit even as we edge close to March 2019, and the uncertainty is dampening business confidence regardless of which side of the fence one sits on. We have enjoyed a relatively stable economic environment over the past several years and the expectation is that this is likely to turn in the short term, precipitated by an increase in interest rates and ultimately the cost of capital.