Pharmaceutical Outsourcing Industry Update

CPhI Conference Highlights Strong Demand and Notable Fragmentation

Friday, December 7, 2018

In early October, healthcare analyst John Kreger attended CPhI Worldwide, the world's largest trade fair for pharmaceutical contract manufacturing. At the event in Madrid, he had the opportunity to meet with close to a dozen public and private players in the contract development and manufacturing (CDMO) space.

"The clear consensus at the event was that demand trends are overwhelmingly positive at present, with companies looking to take advantage of these trends by expanding via a mixture of greenfield investments and M&A," stated Kreger. Furthermore, pharma companies are looking to move toward strategic partnerships and reduce the number of outsourced CDMO vendors, benefiting those companies with a global presence and capabilities throughout the development process—whether in API, finished dose, or a combination of the two.

Demand is booming. Nearly every company he spoke with at CPhI described demand in various forms of being "very good." As a result, companies are building out additional capacity or looking for additional capacity via M&A. In particular, companies are looking to add capabilities and capacity in biologics, sterile fill/finish, and in technologies that address bioavailability challenges.

Specific to biologics, production by volume is expected to increase by roughly 14% per year over the next five years, according to CPhI's most recent annual report. Even following myriad capacity investments in the industry expected by both pharma companies and CDMOs, capacity utilization by volume in biologics production is expected to be at near-optimal levels—roughly 77%—in 2022, according to the same report. Given the current outsourcing trends, Kreger believes investments in capacity are warranted and unlikely to result in a supply glut, unless a significant demand slowdown occurs.

Outsourcing is on the upswing. It appears that outsourcing penetration is steadily increasing or steady. A few areas in particular that pharma has more inclination to outsource include highly potent production, pediatrics, and lower-volume drugs. Kreger heard directly from a large pharma company that it planned to shift from roughly 80/20 in-house/outsourced production today to 70/30 in the short to medium term, as a result of both site divestitures and increased usage of CDMOs generally. Commentary from the CDMOs confirmed this shift and apparent readiness to increase levels of outsourcing.

Pharma looking to reduce supply chain complexity. In addition to increasing outsourcing levels, pharma companies are looking more toward strategic partnerships with CDMOs and using fewer vendors. Kreger believes this trend should benefit the CDMOs with global operations (particularly in Europe and the United States) that can offer multiple services and minimize the number of touchpoints required for biopharma procurement/supply chain personnel.

Consolidation/M&A in the space will continue. Both pharma executives and CDMOs commented that the number of CDMOs would have to decline. Kreger estimates that there are roughly 650 CDMOs operating globally with a large majority exhibiting at CPhI. "We believe there are a number of CDMOs that still rely on legacy products and are likely underinvesting in their assets," he stated. "Eventually, we expect these CDMOs to exit the industry once legacy products go away, as they are unlikely to win new business." More importantly for both public and private investors: the market is still highly fragmented.

The "end-to-end" offering is becoming increasingly common—though it means very different things to different CDMOs. A majority of CDMOs Kreger spoke with discussed end-to-end offerings—"though we heard about a dozen descriptions of what this means in practice." In our opinion, the prominent discussion around end-to-end offerings is a clear indication that CDMOs are moving earlier upstream in the development process. He believes this is appealing both for CDMOs and for pharma companies as they attempt to reduce supply chain complexity. A number of companies remain focused solely on API or solely on finished dose or in small molecule only with capabilities in both API and finished dose, but the common thread is that services offered by CDMOs are now beginning at an earlier stage.

Bioavailability of molecules is a key concern for clients and opportunity for CDMOs. Estimates for the percentage of molecules in the pipeline with bioavailability challenges range from 60% to 90%—with 70% as the most common estimate in our discussions. It is clear that CDMOs with capabilities to address solubility and permeability challenges will be well positioned over the medium to long term. Techniques such as micronization and spray drying are appealing: micronization is a relatively inexpensive offering to address solubility challenges, and spray drying, while a more expensive alternative, lends itself well to a large portion of molecules in the pipeline. Considering the limited capacity industrywide in commercial spray drying. Kreger expects organic investments in this space, and potentially M&A for companies with commercial spray drying offerings looking to take advantage of elevated deal multiples.

Continuous manufacturing is gaining traction at a measured pace. Kreger believes that continuous manufacturing is an opportunity to produce pharmaceuticals at a lower cost, but the shift will take time considering the deliberate attitude of most big pharma companies. Some manufacturers are open to using continuous manufacturing lines from dedicated CDMOs, while other large pharma companies are taking a much more cautious approach to this efficiency tool. He believes the more gradual pace of this shift is a positive for the entrenched CDMOs, as a wholesale change across the industry would require significant immediate investment in continuous production capabilities and lessen the relevance of batch processing capacity. Kreger views continuous manufacturing as an interesting opportunity for margin and facility utilization improvement longer term.

For a copy of this report or for more information on the companies from John Kreger's coverage list, please contact your William Blair sales representative.


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