CDMOs: The Private Equity Investment Case

In this volatile economic climate, contract development and manufacturing organisations (CDMOs) continue to grow in influence. In our previous article covering the CDMO space, we discussed the many ways in which CDMOs are becoming more and more crucial to the functioning of the global healthcare system. Now, we turn our attention to the relationship between CDMOs and private equity (PE).

The CDMO market is now worth $80bn and is growing at a CAGR of 6.7%. To make things even more interesting, the top five players together control just 15% of the market. Given that 90% of healthcare markets are commonly seen as ‘highly consolidated’, the CDMO space presents a rare opportunity to deliver outsize returns in a gigantic and highly developed industry like healthcare.

The potential for consolidation in the industry is attracting significant interest from private investors, but with so much fragmentation in the CDMO sector, selecting the right opportunities can pose challenges. Key industry trends in drug development, onshoring or nearshoring, and incumbents’ asset divestments can guide private investors seeking to create value while helping CDMOs drive service innovation and make the market access process more efficient.

Chasing the high: Key drug development and technology trends

There are now more than 500 CDMOs around the world, each of whom are trying to carve out a specific niche for themselves in certain key markets. Traditionally, most attention and investment has been directed at cheaper small molecule drug treatments. In recent years the market share of small molecule treatments has declined while the volume of large molecule and biologic treatments has grown rapidly. The size of the large molecule and biologics market is expected to overtake the small molecule market in the next few years.

Large molecules and biologics are far more complex and expensive to manufacture, but have a lower rate of attrition compared to small molecules. CDMO consolidation has been especially pronounced in the biologics market: Catalent’s acquisition of Paragon and Brammer Bio’s sale to Thermo Fisher are just two examples from the last couple of years that have strengthened market leaders’ positions. Teaming up with manufacturing partners in this way helps biotech specialists do what they do best without overinvesting in assets and placing additional pressure on balance sheets.

Taking a broader look at the ever-hot CDMO market we observe a number of value creation opportunities. So, for PE firms interested in entering the market, which kinds of deal make the most sense? 

PE investments: ‘string of pearls’ or ‘step change’?

For sure, PE interest in CDMOs is high and will remain strong. Generally, private investments in the space fit into one of two categories: ‘step change’ or ‘string of pearls’ deals.

A ‘step change’ investment typically involves the acquisition of a whole company or group. A couple of important ‘step change’ deals from the past year or so include Ampersand’s purchase of Vibalogics (biologics) and Permira’s $2.4bn acquisition of Cambrex (small molecule).

Compared to ‘string of pearls’ acquisitions, these transactions are more complex to execute with greater due diligence required. Given the broader integration requirements, they can also be capital-hungry in their early stages. However, they offer transformative opportunities in terms of reaching a broader and often new customer base and leveraging innovative technologies.

In bolt-on scenarios, a clear plan for site consolidation and future product allocation is essential. In addition, it is important to prepare for product contracts to change as transitional service agreements (TSAs) expire.

A ‘string of pearls’ investment is an acquisition of specific assets, sites or licenses which can be integrated into existing operations. These deals are broadly simpler to execute with shorter, less intense due diligence demands, and they can require reduced capital investment upfront. Having said that, these deals can come with significant covenants and a higher risk of exposure to a single client or customer.

CDMOs and private investors looking for ‘string of pearls’ deals should be paying attention to the trend towards ‘big pharma’ companies divesting sites. Earlier this year leading CDMO player Catalent acquired a biologics and sterile products facility in Italy from Bristol Myers-Squibb. Last year Thermo Fisher acquired an Irish GSK site and ICIG-owned CordenPharma took over a Pfizer site in Colorado.

These deals show how CDMOs can take advantage of incumbent firms’ strategic planning and high-value infrastructure. Outsourcing is already a crucial part of the manufacturing mix and this trend is not slowing down. We can expect ‘big pharma’ to continue to divest assets where appropriate.

This is not to say that such transactions always result in positive outcomes. In 2019, Novartis retook control of a Canadian site that it had previously sold to contract manufacturing organisation Avara Pharmaceuticals, after it was revealed that the site was in danger of becoming financially and operationally unsustainable.

Nevertheless, it is interesting to observe that many acquisitions have happened in higher-cost locations like North America and Western Europe. COVID-19 has heightened pressures on governments to carefully manage domestic manufacturing and R&D. Going forward, pharma and life sciences companies could be encouraged to move production nearshore or onshore where possible to solidify domestic healthcare infrastructure. CDMOs that plan location acquisitions and footprint carefully will be in a position to help other pharmaceutical companies wishing to outsource as well as governments under pressure to bring manufacturing capabilities onshore.

If incumbents are investing in global relationships in emerging manufacturing centres, CDMOs could leverage this shift to cement advantages in developed markets and build close relationships with policymakers and regulators. Not that emerging markets are off the table: investing in physical footprint in locations like China could be an important strategic opportunity for larger CDMOs, making it easier to adhere to local best practices and providing a launchpad to build relationships in other Asian markets.

Summary: Pick a strategy carefully

The investment case for CDMOs is clear: a fast-growing market in a sector with a huge amount of innovation taking place. In addition, CDMOs’ relevance and centrality to the broader healthcare ecosystem has been proven beyond doubt in the COVID-19 response.

Leading CDMOs will continue to ‘roll up’ competition. The amount of consolidation in the sector means that private equity investors could add tangible operational and strategic value during this process. But the investment theses for additive ‘string of pearls’ deals or transformative ‘step change’ transactions are likely to be very different. With so much happening in the sector, careful due diligence and decision-making is required.

Frank Herrmann

Managing Director

Email: [email protected]

Phone: +41 79 550 9814

Markus Peterseim

Managing Director

Email: [email protected]

Phone: +49 170 334 2109

David McArtney

Managing Director

Email: [email protected]

Phone: +44 7799 470749