Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report.

Jim Miller

Long-term strategic planning must always contend with uncertainty about future business conditions, but the current bio/pharmaceutical industry environment makes forward planning especially difficult. Macro-economic conditions are changing; long-established business practices are being disrupted; and political instability is widespread. It is increasingly difficult to have confidence in one’s assumptions about the context in which any industry must operate.

	In such a volatile environment, contract development and manufacturing organization (CDMO) executives must test how their strategies will hold up in the event that long-held assumptions about the external environment are upset by new realities. They need to play out “what-if ” scenarios that test the robustness and appropriateness of their strategic initiatives and investment plans in the event actual business conditions diverge from their expectations.

	Here are five what-if developments that CDMO executives need to consider carefully as they prepare and implement their business plans.

	What if payers in the US crackdown on drug prices?

	Expenditures on drugs account for just 10% of all healthcare expenditures in the United States, but they draw inordinate attention because consumers must pay a significant portion of drug costs out-of-pocket.

	CDMO executives need to consider multiple scenarios if US drug prices are attacked by government and private payers. Bio/pharmaceutical companies could respond by insisting on better pricing from their suppliers, including CDMOs, and by bringing contract manufactured products back in-house to absorb more fixed manufacturing overhead. Alternatively, they could decide to pare down their manufacturing networks and reduce capital expenditures, which could be a boon for CDMOs.

	The greatest and most negative implications are likely to be for R&D spending. Companies that self-finance R&D spending will likely reduce costs by shrinking the number of candidates they have in their pipelines.

	For emerging bio/pharma companies that depend on CDMOs, the impact would be more severe. Lower or uncertain drug prices would reduce valuations of in-licensed and acquired drug candidates, and the emerging bio/pharma companies that develop them. That would reduce the flow of external funds available for their R&D activities, most of which get spent with discovery and clinical contract research organizations (CROs) and CDMOs.

	What if funding for emerging biopharma slows down?

	There is now a symbiotic relationship between CDMOs and emerging bio/pharma companies: because there is a robust CDMO sector to serve the development needs of emerging bio/pharma companies, those companies can be set up on a virtual model that requires much less financing than if they had to invest in their development infrastructure. That means that the fortunes of CDMOs are now tied closely to emerging bio/pharma’s access to external financing. That financing has historically been cyclical, and the industry has benefited from the current, historically-long run of funding availability. When the cycle dips down again, as it did in 2007, the consequences could be devastating for the CDMO industry: a number of CDMOs may go out of business and others may have to impose deep staff cuts and postpone capital investments to ride out the downturn.

	CDMO executives preparing for this eventuality will need to be aware of several factors. One is the nature of their offerings: CDMOs dependent on early development projects, which tend to have short timeframes, will feel a slowdown more quickly than CDMOs that have a strong mix of Phase II and III projects. Secondly, they should monitor the financial health of their major clients to determine if they have sufficient cash on hand to complete the program they are working on. Finally, CDMO executives will want to keep a close eye on their company’s spending, which can get out of hand when the business is growing rapidly.

	What if trade in pharmaceuticals becomes a victim of the trade war?

	The uncertainty surrounding international trade should be a matter of great concern for CDMO executives. Bio/pharmaceutical ingredients and products are among the most actively traded goods in the global economy.

	Responding to the imposition of tariffs and non-tariff barriers would be difficult for the bio/pharmaceutical industry, whose supply chains are particularly inflexible. In the best of circumstances (i.e., when spare capacity is readily available), it takes several years to qualify new production sites. But spare capacity is not readily available, especially for small- and large-molecule APIs and injectable drug products, and especially in the US. So, if bio/pharmaceuticals get caught up in a trade war, costs will likely increase to reflect tariffs and bio/pharma companies will expect their CDMOs to absorb some of the higher costs.

	Longer term, bio/pharma companies could redesign their supply chains to localize more production, giving up economies of scale to avoid the tariffs. That could be favorable to CDMOs as contract manufacturing for a particular market could be more cost effective than building a captive facility.

	But companies would have to believe that the restricted trade environment was a fixture before undertaking the massive capital expenditures and effort that such a redesign would require. Bio/pharma and CDMO executives would likely be reluctant to move ahead with such a plan given the risk and uncertainty it would entail.

	What if new processing technologies become widely adopted?

	CDMOs have generally been followers in adoption of new technology as they lack the resources available to global bio/ pharma companies to do technology R&D. As bio/pharma companies develop products incorporating new technologies such as continuous manufacturing, CDMOs will have to figure out how to underwrite the capital expenditure and develop the expertise to implement them. This is likely to require skills in partnering with clients to co-develop and co-invest in the technologies. It is also likely to favor financially-sound CDMOs that can provide assurance that they can be reliable long-term partners in innovation.

	What if industry restructuring dumps capacity into the CDMO space?

	Large global bio/pharmaceutical companies of all stripes are restructuring their manufacturing networks and supply chains. The CDMO industry has gained most of its capacity as a result of plant divestitures by large bio/pharma companies, but the result has been a large amount of undifferentiated available capacity and a number of CDMOs facing financial difficulties, especially in Europe.

	CDMO executives must consider the implications of a large amount of new bio/pharma capacity coming into the market on top of the capacity that CDMOs are investing in themselves. A market already awash in capacity for low-value solid and liquid dose forms is likely to be pressured as more capacity becomes available. There are still investors new to the industry that are looking for a way into the CDMO market, and political pressures to maintain marginal facilities remain high. Even a small amount of incremental capacity from bio/pharma companies could severely impact profit margins and cause the contract services industry a lot of pain.


	Supplement: Outsourcing Resources
	Vol. 42
	August 2018
	Pages: s6, s8

	When referring to this article, please cite it as J. Miller, "What Ifs in the Five-Year Plan," 

Pharmaceutical Technology Outsourcing Resources Supplement

Articles

Heightened uncertainty means CDMO executives need to play out planning scenarios.

What Ifs in the Five-Year Plan

	Emerging bio/pharmaceutical companies are going through an unprecedented period of opportunity and growth and have contract development and manufacturing organizations (CDMOs) to thank for much of their good fortune.

	Bio/pharma companies that are dependent on external funding have never enjoyed such a sustained period of funding support as they are now. Analysts who track the industry expect 2018 to be the sixth straight year of substantial new investment in emerging biopharma companies from venture capital, public markets, and partnering. Funding for emerging bio/pharma companies has traditionally been cyclical, with the positive portion of the cycle lasting three-to-four years at most. This continuous funding streak is nearly twice as long as is typical for emerging bio/pharma companies.

	A number of factors have contributed to the explosion in funding for emerging bio/pharma companies, including:

		A plethora of new disease targets thanks to genomics and a better understanding of disease process 

		An increased arsenal of weapons to aim at those targets with traditional small molecule and monoclonal antibodies being augmented by highly potent small molecules, antibody drug conjugates, and gene and cell therapies

		A favorable regulatory environment that offers faster routes to new drug approval

		A robust equity investment environment across the economy

		Aggressive partnering, in-licensing, and acquisition by global bio/pharmaceutical companies.

		A mature network of contract services providers that can get new drug candidates into clinical trials and end markets relatively quickly.

	Individually and in combination, these factors have greatly changed the risk/reward equation for new drug development. Relative to what they could expect 10 or more years ago, investors in emerging bio/pharma companies today can put up less money and get proof of concept more quickly, for the following reasons:

		Most new drug candidates are highly targeted at narrow diseases, meaning that clinical trials can be smaller and faster, with less commercial infrastructure.

		Regulatory pathways such as the breakthrough therapy designation enable smaller clinical programs and faster approval times, while the 503(b)2 pathway for new formulations of older products may mean that only bioequivalence studies are needed.

	While scientific research can discover targets and ways of attacking them, those discoveries are only valuable if they can be converted into physical products that can be safely and effectively administered to patients, and if that safety and efficacy can be demonstrated in clinical research. For that reason, CDMOs and contract research organizations (CROs) are the real enablers of success for emerging bio/pharma companies.

	By relying on CDMOs, emerging bio/pharma companies can get a product into Phase I testing for $2-5 million and in one to two years from when they commence GMP-compliant development. Without the access to CDMOs, companies would need to invest at least $10 million in facilities and a similar amount on manufacturing, analytical, and quality professionals. It would take at least two years before that infrastructure could start making product, and much of that capacity would be underutilized. In short, the presence of a robust CDMO industry probably reduces the cost of making the product by 50-75% and shortens the time to the clinic by half.

	Those time and cost savings accrue to the venture capitalists and public investors who back emerging bio/pharma companies. The amount of funding put at risk for any given company is much less, and the money and time expended on a product or company that is ultimately unsuccessful are much less. That means there is more funding available to back more companies with less risk.

	The relationship between emerging bio/pharma companies and the CDMO industry is truly symbiotic: one could not exist without the other. Thanks to the economics cited previously, the emerging bio/pharma sector depends on CDMOs for at least 80% of its development and manufacturing requirements and is similarly dependent on CROs for their preclinical and clinical testing needs. CDMOs have enabled the formation of virtual companies with just a few staff overseeing a network of service providers.

	On the other hand, the availability of funding for emerging bio/pharma drives the fortunes of the CDMO industry.  Following the sharp decline in funding for emerging bio/pharma in the wake of the global financial crisis, many CDMOs hung on by their fingertips and some went out of business altogether. By contrast, in today’s environment, most are growing at double-digit rates and are sought after by private equity firms wanting to acquire them at valuations as high as 15 times earnings.

	Emerging bio/pharma companies are much more important to CDMOs than they are to clinical CROs. The ability of CROs to reduce clinical research costs by absorbing large numbers of clinical staff from company payrolls and implementing advanced information technology made them valuable partners for global bio/pharma. By contrast, global bio/pharma have been much less willing to outsource their manufacturing operations.

	The two biggest risks to the emerging biopharma and CDMO industries would seem to be a downturn in macroeconomic conditions that would make investors more skittish about investing and a major change in the willingness and ability of the US healthcare industry to pay for expensive new drugs. Both of these risks are real. Many economists see the likelihood of a recession in the United States in 2019 or 2020; the Trump administration campaigned on the promise to bring down drug prices; and US corporations look to be getting more aggressive in managing healthcare costs, including the cost of drugs. 

	Nevertheless, CDMOs look well-positioned to ride the wave of emerging bio/pharma success into the foreseeable future. The year 2018 has started off well for new financings, and public companies have often been able to raise sufficient funding to last them for a number of years into the future. Further, while global bio/pharma companies have dominated new product approvals in recent years, thanks largely to their acquisitions and in-licensing, pipeline data suggest that more emerging bio/pharma companies are willing and able to remain independent entities.


	Vol. 42, No. 5
	May 2018
	Page: 63–64

	When referring to this article, please cite it as J. Miller, "CDMOs Driving Emerging Bio/Pharma Success,"

CDMOs can claim credit for the robust growth of emerging bio/pharma financings.

CDMOs Driving Emerging Bio/Pharma Success

	It was a great year for much of the bio/pharmaceutical contract manufacturing and development (CDMO) industry in 2017. Research organizations continued to generate hundreds of new candidates, while venture capitalists and private equity investors maintained a robust flow of new funding to emerging bio/pharma companies, which are highly dependent on CDMOs. An active deal environment provided rich exits for CDMO founders and investors.
	
	The momentum from 2017 looks like it will continue into 2018, but one should never extrapolate today’s trends inexorably into the future. Here are five industry themes to watch closely for their potential impact on the CDMO industry. 

	The demand for CDMO services has historically been tied to funding cycles for emerging bio/pharma companies, and 2017 was the fifth year of the upward slope of the funding cycle that began in 2013.  The capital raised by emerging bio/pharma in 2017 should certainly maintain demand for CDMO services through 2018. Indeed, new business bookings by clinical contract research organizations (CROs), a bellwether for development activity, remained quite strong through 2017.

	CDMO executives should keep a close eye on the fundraising environment, however, especially the public equity markets. Availability of capital can be impacted by factors external to the industry that change investor psychology, even when underlying industry fundamentals are unchanged.  Those factors include a general economic slowdown (which many economists are predicting for 2019), rising interest rates (a reality), and political uncertainty (2018 is an election year in the United States). On average, emerging bio/pharma -companies have only 12-15 months of cash of hand, and they are likely to slow their spending at the first sign that raising new capital could be difficult.
	
	CDMO executives should keep a close eye on the fundraising environment, especially the public equity markets. 

	There were some very large deals in the CDMO industry in 2017, and a lot of smaller ones. Private equity firms continue to be drawn by the high level of drug development activity and the opportunity to roll up small CDMOs into larger entities. Larger CDMOs continue to pursue strategic acquisitions that add technical capabilities and provide entry into new market segments.

	The industry will see more M&A activity in 2018, but the pace may slow down. Valuations have gotten quite high, even for smaller properties that require investors to fund substantial additional capital for capacity expansions and upgrades. Financing will get progressively more expensive as interest rates rise during the year; that could force valuations down but potential sellers may balk at taking lower valuations than their competitors got just a few months ago.

	One development to watch for is a very big deal involving an industry leader, along the lines of Thermo Fisher’s acquisition of Patheon and Lonza’s acquisition of Capsugel in 2017. The largest CDMOs need to do deals to deliver on promises to investors and to increase their ability to service global bio/pharma companies with their billions in manufacturing and R&D expenditures. It would not be surprising to see another large private equity firm or strategic buyer from outside the industry make a game-changing entry into the CDMO industry.

	New treatment modalities such as gene therapy, cell therapy, and antibody drug conjugates are becoming a bigger part of the new drug pipeline. Most of the candidates are early stage, with a high percentage still owned by academic institutions, but some initial clinical successes in actually curing once-incurable diseases is stoking investor interest, and established bio/pharma companies are actively buying up advanced-therapy companies.

	Advanced therapies present a challenge for CDMOs because their business model and technology often don’t fit the traditional CDMO model. Many of the candidates are autologous (i.e., they involve taking cells from a patient, processing them with the sponsor’s technology, and re-injecting them into the same patient). That is very different from the CDMO model of producing multiple units of a single product.

	Still, a number of entrepreneurial CDMOs have positioned themselves for advanced therapies, and several established CDMOs have built positions that are expanding with acquisitions and internal investment. Demand for these services appears strong, and the industry can expect to see further M&A activity in this sector during the year, as major CDMOs look to add advanced therapies to their portfolios.

	Pricing and margins for generic drugs continue to spiral downward, and regulators and payers are determined to keep the pressure on. In the US, the FDA commissioner has promised new procedures and regulations to speed approval of generic drugs, and the nominee to head the Department of Health and Human Services has promised to focus on bringing drug prices down. In Europe, the turn from branded to commodity generics has undermined the industry’s profitability as governments use tendering to purchase pharmaceuticals.
	
	CMOs will do well to follow developments in the retail supply chain, because they could create new opportunities and challenges. 

	The pressure on generics has significant implications for the bio/pharma CMO industry. Much of the industry has been dependent on branded generics, especially the European CMOs. Lost volumes and narrowed margins, compounded by overcapacity in solid dose manufacturing, are forcing CMOs to restructure, including facility shutdowns.

	The problem could be compounded by the restructuring efforts of the large generic-drug companies themselves. Some, like Teva, are committed to downsizing their sprawling and inefficient manufacturing networks. Others, like Sandoz, are reportedly preparing to exit the solid dose portion of their business, which is also likely to result in plant closings. The risk to CMOs is that some of the closed or divested manufacturing facilities will end up becoming CMO operations themselves, worsening the overcapacity problem.
	 

	CMOs will do well to follow developments in the retail supply chain, because they could create new opportunities and challenges. The pharmaceutical industry was rocked at the end of 2017 when the retail and mail order pharmacy giant CVS announced that it intended to buy health insurer Aetna. If the deal were to go through, it could drive a lot of changes in the healthcare delivery system, concentrating more market power in the hands of a few large integrated providers. 

	The CVS-Aetna announcement came in the midst of speculation that Amazon is preparing to enter the drug distribution business. The online retailing giant threatens to disrupt the way patients get their drugs today thanks to its large customer base, skill in app-based ordering, warehousing and distribution scale, and willingness to take low profit margins.

	The kind of market power that might be accumulated by CVS/Aetna and Amazon could create new demands on drug sponsors and manufacturers over issues such as price, inventory maintenance, just-in-time delivery, and packaging. CMO executives should probably devote some time to understanding the implications of those downstream changes and begin thinking about how they should respond.  

	When referring to this article, please cite it as J. Miller, “What to Watch for in 2018," 

The industry will see an impact from financing, M&As, advanced therapies, generic drugs, and the retail market in 2018.

What to Watch for in 2018

	This has been another big year for acquisitions in the contract development and manufacturing organization (CDMO) industry. In the first three quarters of 2017, there have been 25 deals in which a CDMO was the acquisition target (see 

). With just three months left in 2017, the final number of deals is likely to trail 2016 (34 CDMO acquisitions), but the total value of the transactions is likely to exceed $20 billion, which will far exceed 2016’s total. Average deal multiples look to be about 13.5x EBITDA (earnings before interest, taxes, depreciation, and amortization), a big premium above the 10x multiple at which private equity investors typically value acquisitions; a number of deals have come in at multiples in the 15x-25x range.

	Aside from the sheer size of the transactions, deals in 2017 are most notable because they may have finally created some CDMOs with the scale, breadth, and financial wherewithal to be strategic manufacturing partners to global bio/pharma companies. Global bio/pharma companies represent the last frontier for CDMOs: they outsource only approximately 25% of their drug product manufacturing requirements, compared to 70-80% for small and mid-size bio/pharma companies, and they use CDMOs to manufacture fewer than 15% of their biologics products. 

	CDMOs are fighting ingrained culture and deep pockets when trying to get global bio/pharma companies to outsource more of their manufacturing requirements, but they are also handicapped by scale and scope. An average size global bio/pharma company (top 25 by revenue) has approximately $20 billion in revenues and $3.5-4.0 billion in cost of goods, plus as much as another $1 billion for developing and manufacturing clinical candidates. That means the manufacturing requirements of that average global bio/pharma company are two to three times the revenues of the three largest CDMOs, which all had revenues of $1.5-2 billion prior to the latest round of acquisitions. Even those largest CDMOs had limited capabilities (only API, no dose; or strong solid oral dose, limited injectable, and API), and companies in the next tier of CDMOs ($500 million-$1 billion range) had even more limited capabilities and/or significant financial issues.

	Global bio/pharma companies are struggling to manage complex supply chains with hundreds of vendors, but the limited scale and scope of most CDMOs left the global companies with few choices for consolidating their supply base without becoming too big a piece of a given CDMO’s business. Thanks to the latest round of acquisitions, however, the industry now has some participants that, either on their own or in concert with their parent companies, have the scale, scope of capability, and financial sophistication to be taken more seriously by global bio/pharma companies. Consider the implications of some of the major deals in 2017.

	Capsugel’s $1 billion in revenues pushes Lonza’s total revenues past the $5-billion threshold, giving it manufacturing scale equivalent to a $25 billion bio/pharma company. It also expends its scope by bringing dose form capabilities, including softgels and solubility-enhancing technologies such as spray-drying, and its market-leading hard gelatin capsule business; all of those are key inputs for prescription pharmaceuticals and nutraceuticals and a big part of any bio/pharma company’s procurement spend.

	Combining Patheon with Thermo Fisher’s clinical supplies business fills a major gap in Patheon’s service portfolio and creates a CDMO with $3 billion in revenue, comparable in size to Lonza’s pharma and biotech segment. Patheon is now better-positioned in the market for clinical development, manufacturing, and packaging services, which is becoming more important as a feeder into a CDMOs commercial manufacturing pipeline. As importantly, Patheon is now a significant part of a $20-billion supplier of life-sciences products and services to the bio/pharma industry, rather than a $2-billion standalone CDMO. 

	Acquisitions by private equity firms aren’t usually viewed as strategic, but a deal with a firm of the size and reputation of Carlyle could be transformational for AMRI. Carlyle will bring more financial savvy and operational focus to the company, which should strengthen it for the long term. The transformational opportunity will come about if Carlyle is able to bring in an executive team of significant stature and experience to drive the company to the next level, as Blackstone did for Catalent and JLL Partners did for Patheon.

	Catalent’s acquisition of Cook Pharmica, despite its nearly $1-billion price tag, is not as transformational as some of the other recent deals: the company already has a growing biomanufacturing business, and the near-term revenue increment is much smaller than in the other cases. However, the deal makes Catalent a more complete provider in the biopharmaceuticals market as the addition of North American injectables and biomanufacturing capacity complement its existing biomanufacturing and analytical capabilities. 

	Eurofins is worth noting not because of any one large deal but because of the way it has built a CDMO offering through a series of small acquisitions. Eurofins built its GMP analytical services capability around its acquisition of Lancaster Laboratories in 2011, but in the past two years, it has broadened its chemistry, manufacturing, and controls (CMC) portfolio into process development, formulation, and clinical manufacturing services by acquiring companies like Sinesis Life Sciences (Netherlands), Advantar Laboratories (USA), Alphora Research (Canada), and Amatsigroup (France and Belgium). Eurofins, with revenues exceeding $2.5 billion, may be able to leverage its strong position providing analytical and bioanalytical services to global bio/pharma companies to get more of its clients’ development business.

	The current financial market environment has been favorable to large-scale acquisition activity, and one might expect to see a few more large deals that consolidate the top end of the CDMO industry. However, the number of large and attractive acquisition targets is limited, which will limit the number of transformational deals in the near term. There is no doubt, however, that creating large-scale suppliers will be crucial to cracking the global bio/pharma market. 

	When referring to this article, please cite it as J. Miller, “CDMO Acquisitions Build Strategic Supplier Base," 

Recent acquisitions are creating CDMOs with scale that rivals global bio/pharma.

CDMO Acquisitions Build Strategic Supplier Base

Acquisition activity has created some CDMOs with facilities and capabilities that rivals global bio/pharma companies.

CDMOs Add Capabilities to Build Strategic Biopharma Capabilities

	Mergers and acquisitions (M&A) are a central feature of the contract development and manufacturing (CDMO) industry today. Several new deals are being announced every month, some of them quite substantial, and these deals are reshaping the industry. 

	CDMOs are in great demand by both strategic buyers (i.e., companies in the CDMO business or a related business) and financial buyers (i.e., private equity firms). Valuations of companies acquired in M&A deals are reaching high levels as buyers compete to win the prize. While private equity investors typically use a “rule of thumb” to value businesses at 10 times earnings before interest, taxes, depreciation, and amortization (EBITDA), some deals have gone as high as 20x EBITDA. One small CDMO that recently went through a process reported that they had received nearly 10 offers from potential investors.

	The interest in CDMOs as acquisition targets is driven in large part by the demand for contract development and manufacturing services from emerging bio/pharmaceutical companies. Those companies generally lack internal development capabilities and are highly dependent on CDMOs and contract research organizations (CROs). Emerging bio/pharma companies themselves have attracted large amounts of investor capital as they have become a major source of new product candidates for global bio/pharma companies. Thanks to growing demand from emerging bio/pharma companies, CDMOs have enjoyed high double-digit growth rates in recent years, and investors in CDMOs are betting that those rates of growth will continue into the next five years at least.

	Therein lies the rub: today’s high valuations are based on current market conditions, but history tells us that extrapolating today’s market well into the future is dangerous. External financing for emerging bio/pharma companies is notoriously cyclical: a boom in the late 1990s collapsed along with the bursting of the dotcom bubble in 2000. After several poor years, the market rekindled again in 2004 but collapsed with the global financial crisis in 2008. Public financial markets did not really open again for emerging bio/pharma companies until 2012-2013, and the industry is now four years into the current financing rebound. While an imminent collapse in bio/pharma funding is not predicted, history suggests that caution is warranted. The challenge for the industry is illustrated in 

	R&D spending by publicly-traded emerging bio/pharma companies has risen rapidly since the beginning of 2015, although it has been flat in the first few quarters (blue columns). However, most of those companies have cash on hand equivalent to just over four quarters’ of R&D spending (red line). If external financing becomes more difficult to raise, as it did in 2016, companies will slow their rate of spending in order to conserve their cash until they can raise more. With just four quarters’ of cash on hand, spending could slow quickly if conditions worsen.

	The implications of making acquisitions in an overheated market will differ depending on the motivations of the buyer, and the way the buyer finances the deal. Strategic buyers have a long-term perspective, and measure success in terms of market share, revenue growth, and enterprise value. The motivations of financial buyers, however, are often more complicated. They typically make acquisitions with defined investment horizons of about five years, and their focus is on how to optimize their cash return on investment over that period. While concerned with enterprise value at the end of the holding period, private equity investors may also seek a faster return by using the company’s cash flow and debt capacity to finance dividends. Their take on what makes an acquisition attractive is often different from that of the strategic buyer.

	The conflict between near-term cash returns and long-term investments can be particularly severe in the case of pharmaceutical manufacturing and development. A substantial capacity investment can take two-to-three years to design, construct, and validate, and ramping up utilization of that capacity increment will take several more years after that. For a financial investor with a five-year horizon, an investment that is cash-negative for most of that period may not be attractive, even if it enhances the long-term value of the business.

	This is not to suggest that private equity firms are not welcome buyers of CDMOs. Often the businesses private equity buyers invest in are short on the capital, know-how, financial discipline, and executive skills necessary to take their businesses to the next level. The best private equity firms are very good at providing the resources to enable business growth and maturation. In an environment of frothy valuations, however, investors in debt-financed acquisitions may be challenged to feed businesses all the resources they need to grow.

	But using a lot of debt to buy a business at the top of a cycle can be dangerous. As revenues flatten out or fall on the downside of the cycle, debt-laden businesses will struggle to make the necessary investments as well as service their debt. A number of CDMOs experienced financial challenges in the wake of the downturn in the late 2000s and were forced to restructure or close down altogether. Bio/pharma companies should do careful financial due diligence when qualifying CDMOs, especially for commercial requirements.

	Another concern is the impact that M&A activity has on customer perceptions, especially global bio/pharma companies. On the one hand, M&A creates companies with broader capabilities and scope, which enables bio/pharma companies of all sizes to simplify their supply chains. 

	However, the M&A activity also creates uncertainty around the supply chain. Given the current rate of activity, there is no assurance that the CDMO a biopharma company contracts with today will be the same company that is fulfilling its order two years from now. The business model, objectives, culture, and operating skills of a new owner may be different from the owner the CDMO originally contracted with. 

	Global bio/pharma companies may be particularly concerned about changes in ownership. Already reluctant to outsource and keenly attuned to supply chain security issues, too much churn in the supply base can make those companies wary about working with CDMOs.

	Overall M&A is a positive for the CDMO industry. The current activity attests to the industry’s robustness and long-term prospects, and rewards the entrepreneurs who have built admirable businesses. But buyers and sellers need to be wary of the downsides of the overheated market. 

Investors are betting on the current growth of CDMOs; but history reminds us that extrapolating today’s market well into the future is dangerous.