Pharma Outsourcing Outlook for 2021: The CDMO Industry Scales Up

By Jim Miller, Content Advisor/Consultant, DCAT

January 13, 2021

The CDMO industry enters 2021 in the strongest position it has ever been in. The industry has reaped substantial benefits from government responses to the COVID-19 pandemic, especially those measures meant to maintain economic activity, but size and access to capital are more important than ever.

Impact of the COVID-19 pandemic

The contract development and manufacturing (CDMO) industry enters 2021 in the strongest position it has ever been in. The industry has reaped substantial benefits from government responses to the COVID-19 pandemic, especially those measures meant to maintain economic activity.

Jim

Jim Miller
Consultant and Content Advisor, DCAT

Once the pandemic struck Europe and North America in March 2020, the biopharmaceutical industry and governments jumped into action to develop therapies and vaccines to mitigate the harmful effects of the virus and ultimately stop its spread. Much of the available biomanufacturing and injectable capacity at CDMOs was reserved for the pandemic response, and funding was made available to underwrite even more capacity investment. A number of CDMOs were direct beneficiaries of the government and industry efforts via demand for development services and take-or-pay contracts for manufacturing capacity, and they have delivered on the expectations placed on them.

Vaccines and therapies have only been a fraction of the opportunities unleashed by the COVID-19 response, however. Macroeconomic measures to maintain economic activity and prevent business failures has benefited CDMOs well beyond those directly involved in the pandemic response. In particular, the reduction of interest rates to record-low levels has set off a frenzy of investment in risky assets, including equity investments in emerging biopharma companies, as investors seek higher financial returns. The central bank actions have also substantially lowered the cost of capital for CDMOs needing to invest in new capacity.

Priming the CDMO pump

The level of new investment in biopharma companies has been truly staggering. According to data compiled by the investment firm Jefferies, biopharma companies raised $88 billion in new equity in 2020, including venture capital, initial public offerings (IPOs), and secondary offerings by already-public companies. That represents a stunning 76% increase over the amount raised in 2019. Much of that new funding flowed to emerging biopharma companies and will get channeled to CDMOs and clinical contract research organizations (CROs) to develop the candidates in their pipelines. Many of those companies have taken advantage of the favorable financial market conditions to raise funds, well in advance of their needs, so they should have sufficient funds to support development two-to-three years into the future.

The new funding is spread around the pipeline. Nearly 50% of the companies floating IPOs have small-molecule pipelines while 20% are developing cell and gene therapies, and another 20% are focused on monoclonal antibodies and recombinant proteins. So, while biologics get most of the headlines, CDMOs serving the small-molecule pipeline should see plenty of opportunities.

Capacity commitments

With demand high and the cost of capital low, CDMOs are committing to substantial increases in capacity. In the injectables space, at least 36 expansion projects costing well over $2 billion have either opened in 2020 or been announced with completion planned in the 2021-2023 timeframe.

In the cell and gene therapy sector, there are at least 14 expansions underway with expected completion in the 2021-2024 period, representing a total investment of nearly $1.5 billion. In the traditional large-molecule segment of the industry, at least 19 expansion projects have been announced with a combined value of nearly $4.5 billion. That total includes Samsung Biologics's fourth biomanufacturing facility, in which it is investing $1.7 billion, and three site acquisitions by CDMOs from major biopharma companies. And that doesn’t include Fujifilm’s recent announcement that it will spend $1.9 billion on a new biomanufacturing facility, for which a site is still being determined.

There has been a large number of investments announced in the small-molecule space as well, but generally at a smaller project scale than we have seen in biologics. CDMOs acquired four oral solid-dose facilities and an ophthalmics facility from major pharmaceutical companies, and more such deals are likely as major companies such as Viatris (the result of the merger between Mylan and Pfizer’s Upjohn unit) look to restructure their operations.

The huge investments are clearly a response to the increased demand brought about by the record fundraising activity. With so much money on the balance sheets of biopharma companies, a major source of uncertainty has been lifted, and CDMOs appear comfortable in pulling forward investments rather than waiting for further proof of demand. Still, with so much capacity in the pipeline, the industry risks experiencing an overcapacity situation in the three-to-five year time horizon.

Modest M&A

CDMO merger and acquisition (M&A) activity was modest in the first half of 2020 but picked up in the second half. Fifteen deals were either closed or announced; 11 of those involved a buyer that was either a private-equity (PE) firm or a company owned by a PE firm. Development services companies, including clinical manufacturing and packaging and analytical testing, accounted for 40% of the deals while dose manufacturing and cell and gene therapy accounted for 20% each.

The biggest deal of the year was announced at the end of the year (2020). PE firm EQT will take publicly traded Recipharm private in a deal valued at $3.2 billion (equity plus debt). This is the third take-private deal in the CDMO industry in recent years, following the acquisition of AMRI by Carlyle and GTCR in 2017 and the acquisition of Cambrex by Permira, which was closed in December 2019. Those deals have a common theme: a mid-size publicly traded CDMO pursues an acquisition-driven strategy to increase its competitiveness against the industry’s largest players, only to struggle to maintain profitability as it tries to realize synergies and manage a highly-leveraged balance sheet.

The level of M&A activity in the CDMO industry may pick up in 2021, now that companies have learned how to operate in the pandemic environment. While low interest rates reduce the cost of financing deals, they also drive up valuations, so that could make some potential acquirers hesitate. We could also see one or more privately owned CDMOs go public by way of a special purpose acquisition company (SPAC), an investment vehicle that has been extremely hot in the IPO market of the past year.

Scaling up

The CDMO industry entered 2021 with six companies with revenues in excess of $1 billion, and 11 companies with revenues of $500 million to $1 billion, of which three may cross the $1-billion mark by year-end. By comparison, at the beginning of the last decade, only two CDMOs had revenues greater than $1 billion and no more than five were in excess of $500 million.

But the industry can hardly be said to be mature. With the explosion of the drug-development pipeline, record funding of emerging biopharma companies, and vast new opportunities such as gene and cell therapies, the industry can look forward to continued rapid growth. Further, it can’t really be said to be consolidating, as some of its largest and fastest-growing participants, such as Samsung Biologics and Fujifilm Diosynth, didn’t even exist 10 years ago.

Still, size is becoming of increasing importance for companies trying to compete and be successful as CDMOs. And with size comes the challenge of how to maintain the high rate of growth necessary to maintain high valuations; after all, CDMO stocks trade on their growth expectations, not on their ability to generate free cash flow. It’s that growth imperative that drives the massive investments in new capacity, especially in emerging fields such as cell and gene therapy, and it has implications for M&A, as any target with revenues under $100 million hardly moves the needle for a $1-billion-plus buyer.

The need to invest in large increments, whether for internal capacity expansion or by acquisitions, means companies must have access to deep sources of capital. Large public CDMOs, such as Lonza, Catalent and Thermo Fisher Scientific, have direct access to public equity and bond markets, as well as major bank financing while companies such as Fujifilm Diosynth and Minaris (a unit of Hitachi) have publicly traded parents with direct capital market access. For the rest of the industry, having the backing of a financing entity such as a PE firm would seem to be critical for sustained competitiveness, the larger the better.

The size challenge creates a special problem for mid-size CDMOs, which are defined as those with revenues of $250 million up to $1 billion. Mid-size companies can struggle because they lack the economies of scale of larger companies and the nimbleness and specialty depth of smaller ones. Some mid-size companies have stumbled in recent years when they tried to close the scale gap, overpaying for ill-conceived acquisitions and failing to integrate them properly to harvest economies of scale. Robust demand may stave off the strategic challenges of mid-size companies for a while, but mergers between mid-size companies may be an attractive option in the future.

The other big challenge facing fast-growing CDMOs will be human capital. The availability of qualified staff has been getting increased coverage in the industry and business press. Clinical CROs have been tackling this problem for years; they have spent heavily to recruit and train clinical research professionals, but continue to face high turnover as experienced people are recruited away. CDMOs will face similar challenges, and for CDMOs in rapidly growing segments, such as cell and gene therapy, competition from global biopharma companies is likely to compound the problem and be expensive.

The CDMO industry is coming into the most exciting period I have witnessed in my 25 years following the industry. While opportunities will be ample, every industry participant will have to be on its game to thrive in the long term.