20-20 Insights and Outlook on the CDMO MarketBy
The stars are aligned for another strong year of performance for CDMOs. DCAT Value Chain Insights examines industry fundamentals and an outlook for pharma outsourcing in 2020.
Strong fundamentals but some risks
2019 proved to be a stellar year for the biopharma industry in general and the CDMO sector in particular. Many CDMOs experienced double-digit growth, and the key indicators of opportunity for CDMOs, although down from the blowout levels of 2018, performed well. The US Food and Drug Administration (FDA) approved 48 innovative products, the second highest number in the past five years, and translational science continued to produce more drug candidates. Emerging biopharma companies raised $5.7 billion in initial public offerings (IPOs) in the US and were on pace to raise $15 billion in venture capital, again an historical second best.
That’s impressive performance given that the year started out a little shaky thanks to a fourth quarter 2018 stock-market correction that, at one point, saw the NASDAQ Biotech Index drop 21% from its mid-year high point. There was also a lot of uncertainty around global trade policies, which depressed investment in many industries and could have been a risk for biopharma given the globality of industry supply chains. Fortunately, stock prices recovered, funding remained robust, and the industry remained relatively unscathed by the global trade uncertainty.
There is good reason to expect a strong 2020 since many of the conditions that made 2019 successful remain in place. On the approval front, biopharma companies are making broad use of the FDA’s expedited approval pathways, including the breakthrough and fast track designations, and the FDA remains committed to improving the drug-approval process through its New Drugs Regulatory Program Modernization initiative. On the financial side, the industry drug pipeline is robust, global biopharma companies are spending freely to acquire promising candidates, and investors, desperate for better financial returns, continue to show strong interest in IPOs and venture capital. In addition, many companies that have raised money in the past two years still have significant cash balances.
Risks to that outlook include events that are not specific to the biopharma industry, e.g., a stock-market correction, the upcoming US elections, or uncertainties surrounding trade. Efforts to control drug prices in the US could have a negative impact but are unlikely to have much impact near term. For most new drugs, a bigger challenge is gaining access to pharmacy benefit managers’ formularies for coverage eligibility. Clinical and commercial setbacks to major classes of drugs like those experienced for treatments for non-alcoholic steatohepatitis (NASH), Alzheimer’s and infection, could hurt funding for some segments of the pipeline.
Mergers and acquisitions: what may be ahead
Mergers and acquisitions continue to be a big part of the CDMO story. There were three blockbuster deals completed in 2019, and more big deals are likely in 2020.
The take-off of gene and cell therapies had major industry participants scrambling to secure a position. Thermo Fisher Scientific acquired Brammer Bio for $1.7 billion, and Catalent acquired Paragon Bioservices for $1.2 billion. Both deals were notable for their eye-popping valuations: 7x projected revenues for the Brammer acquisition and 6x revenues for Paragon, which reflected the tremendous growth (25% per annum) that industry segment is experiencing. The deals enabled Thermo Fisher and Catalent to catch up with Lonza and WuXi AppTec—their rivals in the $1-billion-plus CDMO club—which already had established positions in the gene and cell therapy space.
The other big deal of note was the $2.4-billion acquisition of Cambrex, a publicly traded CDMO with capabilities in small-molecule APIs and solid-dose products, by the private-equity firm, Permira. The deal was noteworthy, in part, because it was an unsolicited (but not unfriendly) acquisition of a public company by a private-equity investor at a valuation that was a 47% premium over the price the company’s stock had been trading at the day before it was announced.
The deal is also of interest because it highlights the strategic challenge facing mid-sized CDMOs: how to respond to the emergence of “mega-CDMOs” with broad service offerings and revenues well over $1 billion. Cambrex had taken on a substantial amount of debt to make acquisitions to gain scale and add drug-product development and manufacturing capabilities to its small-molecule drug-substance capabilities, but the weight of the debt made it vulnerable to a takeover. A similar scenario led to the acquisition of AMRI in a public-to-private deal in 2017.
There are at least 25 CDMOs with similar characteristics to Cambrex, i.e., revenues of $150–$750 million, with a single service capability; many are family-owned. All face the dilemma of whether to take the risk to grow through acquisition, sell the business, or risk falling behind competitors that are larger and have broader capabilities. Some of these companies will be acquisition targets while some may be buyers.
So, we can expect to see a number of significant acquisitions in the CDMO industry in 2020, either by private-equity firms or large strategic buyers. Private-equity firms are said to have as much as $1.5 trillion available for investment and are enjoying a very low interest rate environment. CDMOs have been an attractive sector for them in recent years, and that is likely to still be the case. In addition, the CDMO industry has attracted strategic buyers from adjacent sectors in recent years (e.g., Thermo Fisher Scientific’s acquisition of Patheon), and it would not be surprising to see more of that. Japanese corporations, in particular, have been active acquirers of CDMOs in recent years (e.g., Fujifilm, AGC, Ajinomoto, Hitachi), and there may be more to come.
Big Pharma restructuring
One of the major biopharma industry developments of recent years has been how the 20 largest drug companies have “re-risked” their business models by focusing almost exclusively on their most innovative products and candidates. In many cases, they have abandoned long-occupied therapeutic strongholds to focus on other disease areas, especially oncology and cell and gene therapy, and are increasingly dependent on their ability to acquire emerging biopharma companies or their candidates to fill their pipelines.
Further, most global biopharma companies have divested their non-innovator business units, including generics, consumer and animal health, as well as late-lifecycle products. Companies that have stayed in those businesses have reinforced their presence by acquiring what their competitors have divested and have created larger entities with improved cost structures.
These developments are significant for CDMOs because global biopharma companies have traditionally kept most development and manufacturing of innovator products in-house. They have invested heavily in manufacturing and laboratory infrastructure to support their innovator pipelines, and view in-house development as critical to acquiring knowledge, know-how, and experience necessary to develop and manufacture these products successfully. CDMOs are engaged to provide supplemental capacity as companies catch up with the backlog of internal capacity (as is happening now with cell and gene therapy), but the long-term strategy is to keep the most value-adding activities in-house. A compounding challenge is that business leaks out of the CDMO segment as global biopharma companies acquire emerging biopharma companies and their pipeline candidates.
This is not to say that there is a net loss of opportunity for CDMOs; rather it underscores that the nature and focus of the opportunity will be ever more concentrated on emerging and specialty biopharma companies, including the companies that are acquiring the non-innovator products from global biopharma. Those companies need the full menu of CDMO capabilities, from early development to commercial manufacturing, and often have a particular need for alternative formulation and delivery know-how.
Given the above, there is reason to be more confident about the outlook as the industry goes into 2020 than it was going into 2019. The financial markets seem solid, the FDA approval process seems to be in high gear, and global biopharma companies are very much in need of candidates to populate their development pipelines. CDMOs with capabilities in gene and cell therapy, mammalian cell culture, high-potency small-molecule APIs, and injectables, along with the vital analytical, development and logistical support, should do very well.
Still, not all CDMOs will participate in this robust environment because they lack the portfolio of capabilities the CDMO offers the market. This includes many CDMOs in Europe that are stuck with undifferentiated low-value capabilities for which there is an over-abundant supply in the market. As we saw in 2019 with the dismemberment of Famar, those CDMOs and their customers are at risk owing to their low margins and inability to participate in the fastest-growing, more profitable segments of the market.