Pharma Outsourcing Outlook: The Only Sure Thing About 2019 is Uncertainty

By Jim Miller, Content Advisor and Consultant, DCAT, and former President, PharmSource Information Services, Inc., a GlobalData company

January 15, 2019

What is in store for CDMOs in 2019? A myriad of issues could impact market fundamentals and the recent highly favorable environment in which they have operated.

The year 2018 ended with a dizzying array of developments in the macroeconomic and political environment in which the biopharmaceutical industry operates. The implications of the stock market correction, unresolved trade war with China, Brexit, and change in political control in the US Congress are far from clear, so executives of contract development and manufacturing organizations (CDMOs) will need “what-if” planning and nimble decision-making skills to manage their way through 2019.

 Jim Miller 2015 Headshot

Jim Miller
Content Advisor and Consultant, DCAT, and
former President, PharmSource, Information Services, Inc.,
a GlobalData company

Financing into emerging bio/pharma companies

The development with the greatest downside risk for the CDMO industry is the increased volatility in stock prices of emerging biopharma companies; the NASDAQ Biotechnology Index (NBI) fell 21% from its mid-year high in 2018, a bigger drop than the broader stock indices experienced before recouping half of its loss in the first two weeks of January (2019). If that extreme volatility continues, it could impact the ability of emerging biopharma companies to raise new financing through initial and secondary public offerings (IPOs and SPOs).

The bounce back in the NBI and the generally positive mood of this year’s JPMorgan Health Care Conference, held in January in San Francisco, suggest that fundraising should be good in the first part of the year at least. Further, cash is plentiful both in venture capital funds and at global biopharma companies, which depend on emerging biopharma companies to stock their pipelines. Many companies that were able to access the public markets when the window was wide open have stockpiled enough cash to maintain activity for several years.

Nevertheless, the financing environment in 2019 should be a primary concern for CDMO executives because emerging biopharma companies depend on external financing for nearly all of their development spending, and most of that spending flows directly through CDMOs and clinical contract research organizations (CROs). Emerging biopharma companies raised over $6 billion from IPOs in 2018, but If company executives fear for their ability to raise adequate new moneys to fund their pipelines, they could cutback spending to conserve resources for their most promising candidates as they did in the wake of the 2008 financial crisis. The experience of 2018 demonstrates that sentiment can change almost overnight.

What happens to CDMO M&A?

CDMO executives are more likely to feel the impact of the market correction on the value of their own companies. CDMOs were traded at multiples as high as 15 times EBITDA (earnings before interest, taxes, depreciation and amortization) in 2017 and 2018, driven by competition among private equity firms wanting entry into the rapidly growing market and strategic buyers wanting to extend their capabilities and gain scale. However, the market correction has set a new, lower benchmark for company valuations; stock prices of CDMOs dropped more sharply than the market overall, and more than clinical CROs and biopharma generally. That will be disappointing to current owners but potentially more enticing to new investors.

The lower valuations may also help maintain CDMO merger and acquisition (M&A) activity in 2019 despite the headwind of rising interest rates. Central bank actions and growing concerns about credit quality have been pushing interest rates up, impacting the ability of private equity firms and strategic buyers to finance their acquisitions. Lower asset prices will reduce borrowing requirements and make debt loads more manageable for acquired companies.

Valuation and interest rate concerns will also drive CDMOs to improve their performance. Look for CDMOs to shutter or sell marginal facilities in order to boost profitability; a number of major players, including Catalent, Recipharm, and Famar have already made such moves.

Trade concerns extend beyond Brexit and China

Another source of great uncertainty for the CDMO industry, and the world economy generally, is the outlook for global trade. Brexit and the US standoff with China are the big headline grabbers, but it’s not clear that either event will have that great an effect on the CDMO industry. The UK’s CDMO industry is more important as a provider of clinical development and supply services than it is for commercial manufacturing, and most of the major CDMOs with UK operations have other facilities in continental Europe and in the US from which they can serve their customers. While China’s significance in the active pharmaceutical ingredient (API) supply chain has grown, many of its contributions are still at the low end of the value chain, including starting materials and generic APIs. The greater concern for many biopharma executives is that a trade war could block their access to the large and rapidly growing China market.

CDMO executives should also be watching actions by the US Administration targeted at a broader array of US trading partners. A 2018 report from the Office of the US Trade Representative attacked the intellectual property protection and pharma pricing policies of a number of countries that are important parts of the biopharma supply chain, including India, South Korea, Switzerland, and Canada as well as China. Another concern should be that disputes over automobile tariffs could extend to other industrial sectors: Europe is the major source of custom-manufactured active ingredients for innovator products as well as a principal operating base for drug- product CDMOs that supply the US market.

Drug pricing in the crosshairs

Drug pricing will get even more attention thanks to political and industry developments in the past year. Reducing drug prices is an objective that is shared by both the Trump Administration and the Democrats that now control the US House of Representatives. The Administration announced proposals and concrete steps to address drug pricing in 2018, and House Democrats will no doubt have multiple hearings on the issue this year.

In the meantime, two critical players in drug pricing and supply have been consolidated in a series of mergers: pharmacy benefit managers (PBMs) and insurance companies. While the two industries have been somewhat at odds in recent years, their combination is likely to put drug prices under renewed pressure.

CDMOs may not immediately feel the effects of measures to reduce drug prices because many of the efforts to date have targeted generic drugs and their manufacturers rather than innovator products. This no doubt reflects the fact that generics account for the vast majority of prescriptions and drugs used in hospitals despite representing a small piece of total spend. Many generic-drug companies are struggling financially as wholesalers and hospital buying groups have driven down prices and must take actions to drastically restructure their operations.

Generic API manufacturers will feel the effects of this situation sooner than custom manufacturers although most active ingredient manufacturers operate in both segments of the market. Nevertheless, CDMOs could feel the pressure before long as insurers, who pay the bills, pressure innovator drug companies by using their new PBM operations to determine which drugs get on formularies and at what price.

Big Pharma restructuring adding uncertainty

Global biopharma companies are busy reshuffling their portfolios as new chief executive officers (CEOs) position companies for new opportunities as old product franchises come under pressure from generic competition. Most major biopharma companies have initiated restructuring programs in the past year that involve downsizing of staff, refocusing of R&D efforts, closing of manufacturing plants and sale of poorly performing or sub-scale businesses.

Restructuring can create opportunities for CDMOs, e.g., outsourcing of products from manufacturing facilities that are closing, but they can also cause disruptions and distractions that slow development programs. CRO stock prices declined after Bristol-Myers Squibb announced its acquisition of Celgene earlier this month (January 2019) out of concern that development programs would lose momentum during the acquisition and integration processes, as happened with large biopharma acquisitions in the past. Manufacturing network restructuring by both innovator and generic biopharma companies could dump a lot of capacity onto the market, which could depress CDMO pricing.

Cautious outlook

The bottom line for CDMOs and their customers is that while a drastic downturn in their market is unlikely, the highly favorable environment in which they have operated since 2013 may be starting to deteriorate. CDMO executives will have to be more attuned to the big picture and more cautious about expansion plans. Digesting a steady stream of insightful market intelligence and close contact with customers should claim a significant share of executive time in the coming year.