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

Jim Miller

2006 was a busy year for merger and acquisition (M&A) activity in the pharmaceutical services industry, and all signs point to 2007 being at least as active. The resulting consolidation and changes in ownership are altering the face of the industry. 

 counted almost 60 deals completed in 2006, with a total value of nearly $2 billion. The deal sizes range from the $2 million that Canadian contract laboratory company 

 (Montreal, Canada) paid for the Blainville, Quebec analytical operations of 

 (Montreal, Canada) to the $567 million that a consortium of private-equity firms is paying for pharmaceutical chemical manufacturer 

 (Pompey, France). The number of deals was almost equally divided between clinical and nonclinical development and manufacturing services. 

 One deal alone promises to make 2007 an even bigger year than 2006: 

's (Dublin, Ohio) Pharmaceutical Technologies and Services (PTS) business, which Cardinal Health announced it intends to divest by mid-year, is expected to bring nearly $2 billion on its own. The industry also is waiting to learn whether the board of directors of dose manufacturer 

 (Toronto, Canada) decides to sell all or part of its operations. If it does, assets worth hundreds of millions of dollars could change hands. Add to those two events the normal flow of small, tactical deals and the likelihood of a surprise announcement or two, and 2007 should be quite a year for investment bankers representing contract-services clients. 

Even if the Cardinal Health and Patheon transactions were not looming over the industry, 2007 would probably be a busy year because the factors that drove contract services M&A activity in 2006 are still very much in place: a set of compelling business rationales and readily available financing. 

The business rationales for deal-making reflect market trends in the pharmaceutical services industry. 

Private-equity firms that own contract research organizations (CROs) and contract manufacturing organizations (CMOs)			

 The number of early-stage candidates in the drug development pipeline has grown markedly this decade—Phase I candidates are up 50% according to data from IMS, Inc.—and service providers want to make sure they have the capacity to serve them. Companies that support the development of early-stage compounds, including Phase I research, formulation, and analytical services, have been in strong demand by acquirers. 

Demand for Phase I beds has far outstripped the supply, making Phase I capacity a hot commodity in 2006. 

 (Princeton, NJ) added 11 sites and 500 beds to its network with its acquisition of the 

 (Reston, VA) gained a Phase I foothold in Europe with its acquisition of 

 adding to its existing facility in Lenexa, Kansas. 

 (Geneva, Switzerland) bought a major Phase I presence with its acquisition of 

The early-development opportunity also has been driving activity in process development and manufacturing for small-molecule active pharmaceutical ingredients (APIs). Notable deals in 2006 were the acquisition of 

 (St. Louis, MO).  Several Indian fine-chemical companies positioned themselves for the development market by buying European and US assets: 

 (Ahmedabad, India) with its acquisition of 

 The globalization of clinical research and the efforts by major pharmaceutical companies to consolidate their vendor base are major driving factors for M&A activity. Clinical trials are going global in an effort to broaden the pool of patients from which to recruit, and in anticipation of launching approved products in more markets. At the same time, major pharmaceutical companies are reducing the number of vendors they work with to gain more leverage in price negotiations and to reduce costs. These trends favor large companies with global capabilities and a broad range of services, and acquisitions are a prime vehicle for bulking up. 

's (Cincinnati, OH) acquisition of the Phase II–IV business of 

. The acquisition of the Charles River business increased Kendle's revenues by 65%, pushing it onto the list of the top 10 largest CROs.  

The acquisitions of IMFORM and Scirex allowed Premier Research to nearly double its size twice within a year. Although Premier Research is still small compared with the industry leaders (at about $75 million in revenues and 800 employees), the increased size and capabilities should help stabilize its financial performance and make it more competitive. 

 As companies have refined their corporate visions, chief executives have been aggressive in divesting businesses that they no longer consider strategic, or that they feel cannot compete profitably. This active portfolio management has put some major business assets in play. 

For instance, Cardinal Health's decision to sell the PTS business reflects the company's growing focus on the downstream pharmaceutical supply chain (from the warehouse to the bedside) and the recognition that manufacturing was not critical to its mission. Charles River sold its Phase II–IV clinical research business to Kendle because its executives realized that at just $130 million in revenues and with a limited international footprint, they would have a difficult time competing with the larger CROs for Big Pharma contracts.  

In the pharmaceutical chemical sector, similar considerations drove Rockwood Holdings to sell Groupe Novasep, 

 (Heerlen, Netherlands) to sell its South Haven, Michigan operations, and 

 to sell their pharmaceutical chemicals businesses. 

The strong impetus to make deals has been supported by the readily available financing to pay for them. The cost of capital for acquirers is relatively cheap as corporate profits are strong, stock valuations high, and interest rates low. 

The financing environment has benefited private-equity firms, which have been major players in the pharmaceutical services M&A market. They have been especially active buyers of pharmaceutical chemical businesses, and are expected to be major bidders for the Cardinal Health PTS business. They also have shown keen interest in attractive niches within the industry (see sidebar "Private-equity firms that own contract research organizations and contract manufacturing organizations"). 

The pharmaceutical services M&A boom is a reflection of the industry's growing maturity. The industry has demonstrated its staying power, and pharmaceutical business trends indicate steady growth in the years ahead. With the business case made, there is a need for stronger, more professionally run corporations and executive teams to drive companies ahead in the manner that industry leaders such as Quintiles, Covance, and PPD have demonstrated. M&A is a prime vehicle for achieving the next level of industry sophistication.  

 is president of PharmSource Information Services, Inc., and publisher of 

Articles

Sixty deals were completed in 2006, with a total value of $2 billion.

Mergers and Acquisition Drivers Remain in Place for 2007

Merger and Acquisition Drivers Remain in Place for 2007

Contract dose manufacturing has hundreds of participants, but two have dominated the industry in this decade: 

 (Toronto, Canada). With revenues of $1.8 billion, Cardinal Health's Pharmaceutical Technologies and Services (PTS) business unit is by far the industry's largest player, with capabilities spanning a broad array of technologies and dosage forms. At $700 million in revenues, Patheon is the second largest player, and an innovator of now-standard industry strategies such as using development services to drive new commercial manufacturing business. 

It is remarkable, therefore, that we enter the new year with both companies facing somewhat uncertain futures. Patheon's board of directors is considering "strategic and financial alternatives," including the possible sale of all or part of the company, in the wake of disappointing financial results and operating problems at several of its facilities. Cardinal Health announced in November that it would sell the PTS business because of disappointing performance and because it is no longer a strategic fit with the corporation's focus on the downstream healthcare supply chain. 

The uncertainty surrounding the industry's two highest profile participants has raised concerns among both buyers and sellers of contract manufacturing services about the long-term prospects of the industry and the viability of the CMO business model. After all, if the two biggest companies in the industry can't make a go of it, how can the many smaller CMOs expect to generate profits and attract the capital investment necessary to remain successful? 

It would be wrong to jump to conclusions about the entire industry based on the Patheon and PTS experiences. Their acquisition-driven business strategies are unique in the industry, and the challenges of organizational complexity and voracious capital consumption posed by such rapid expansion are not faced by the majority of CMOs, which have chosen a more conservative approach to growth. 

The mid-1990s seemed to be an ideal time to build a global contract manufacturing business through acquisitions. Contract manufacturers in the electronics industry were doing it, and their revenues and stock valuations were soaring. Furthermore, the pharmaceutical research and development pipeline seemed full, and there was much talk of the expected growth in outsourcing as both major and small bio/pharmaceutical companies scrambled for more capacity to manufacture the expected flow of new products. That was the environment in which Patheon and Cardinal Health initiated their acquisition programs. 

Their earliest deals were right on the mark. Cardinal Health's first acquisitions, including 

 remain the core of the PTS business and the principal sources of its revenues and profits. Patheon's initial strategy of acquiring redundant manufacturing facilities from major pharmaceutical companies was both cost-effective and strategic. It was able to buy assets at just a fraction of their replacement value while gaining long-term contracts and building important relationships with some of the largest drug companies. 

Nonetheless, later deals ran into problems almost as soon as the ink was dry on the purchase documents. Cardinal Health's 2002 acquisitions of contract analytical laboratory 

ran into problems soon after their acquisitions due to the loss of major clients. In late 2004, Patheon borrowed heavily and issued equity to acquire 

 (Caguas, Puerto Rico), but an FDA warning letter and a variety of smaller but significant problems quickly eroded profitability and undermined the strategic and economic rationale for doing the deal. 

Now, ten years after launching their acquisition-driven strategies, results at PTS and Patheon have been disappointing at best. Cardinal Health has invested $5 billion in building PTS, but its estimated $300 million in earnings before interest, taxes and depreciation mean it is yielding less than an ultrasafe US Treasury security. At Patheon, after nearly $1 billion have been invested, financial performance indicators have fallen short of levels required in its loan agreements, and the company has been forced to consider more radical restructuring moves to ensure its long-term viability. 

As experience has shown, the acquisitions entailed business and regulatory risks that often could not be foreseen or were easily overlooked. But, those risks were compounded by the challenges of operating such complex organizations. Integrating and operating these global manufacturing networks successfully requires a broad range of technical and business skills and systems and a cadre of experienced people. These are assets that take years to build. It can be argued that that the architects of Patheon and PTS failed to appreciate fully the operating complexity of what they were building. 

A further complicating factor has been the fact that the vision of the market that provided the underlying rationale for PTS and Patheon has not been borne out. Major pharmaceutical companies have not embraced outsourced manufacturing to the degree that was expected ten years ago. Furthermore, the secondary role of contract manufacturers has meant that size and global capabilities have not proven to be the competitive advantages they were expected to be.  

In today's CMO market, companies that offer a limited range of capabilities from a small number of sites appear to be enjoying the best results. They have grown organically by understanding their markets well and responding quickly to new opportunities. Focused offerings enjoy several advantages, including far less complexity in operations and a clear business development message. In addition, they can target their capital spending and innovation efforts to add cutting-edge capabilities that provide real competitive differentiation and advantage. Examples of focused manufacturing and packaging companies include 

 (San Antonio, TX) in semisolid and liquid manufacturing and 

The large clinical CROs figured out the power of focus and simplicity years ago. Revenues and profits at 

(Princeton, NJ) blossomed after it shed its clinical packaging and biomanufacturing businesses early in this decade. 

 (Wilmington, NC) has grown to $1 billion in revenues and strong profits by focusing on excellent delivery of plain-vanilla clinical research services. 

 (Wilmington, MA) divested its Phase II–IV clinical research operations earlier in 2006 to focus on its core strengths in research models and preclinical toxicology. 

Of course, any given business model does not remain successful forever; companies must continually adjust to the changing demands of their customers. Over the next few years, as major pharmaceutical companies seek to consolidate their vendor bases to gain savings in cost of goods, it may be that multicapability suppliers will have advantages over vendors that can offer only a single service. But, that advantage will be sustainable only if the business model makes financial sense and companies deliver excellent performance across all service offerings.

The recent struggles of Cardinal Health's and Patheon's contract dose manufacturing businesses offer a lesson on good business practices.

Simpler is Better

Simpler is Better...

Out of bankruptcy and focused on its contract research business again, 

 (Wilmington, NC) is investing in its traditional core strength: chemistry, manufacturing, and control (CMC) development services. 

Bolstered by a $30-million equity infusion from its current private investors, the company will make significant upgrades to its analytical, formulation, and manufacturing capabilities. AAI-Pharma's recently appointed senior vice-president for operations, Lee Karras, provided an update about the plans during November's AAPS Annual Meeting. 

AAIPharma will make a major investment in its Charleston, South Carolina parenteral manufacturing facility, spending $1.3 million on various upgrades. Planned projects will improve people and material flow, provide better engineering controls, and add GMP warehouse space. The improvements, says Karras, will enable the Charleston facility to meet  the compliance standards of the Medicines and Healthcare products Regulatory Agency (MHRA, the UK regulatory body) and European Union (EU) compliance standards, so that clinical-trial materials manufactured at the facility can be exported to EU countries. The 48,000-ft

  Charleston facility, which has two filling suites and a 54-ft

  lyophilization unit, already has FDA approval. 

AAIPharma also is making investments in its formulation and analytical-services capabilities, service areas where it was once an industry leader. Karras says that the company has managed to retain the scientific talent in those areas from the prebankruptcy days. Nonetheless, AAIPharma suffered from under-investment during the years when it tried to remake itself as a specialty-pharmaceuticals company. The company is planning to invest at least $500,000 to update instrumentation, including ultra HPLC and GC–MS capabilities. Formulation and analytical-chemistry services are provided from the company's Wilmington, North Carolina facility, which also manufactures solid-dose clinical trial material (CTM). The company also has a small laboratory-services group in New Ulm, Germany. 

Along with upgrading its existing capabilities, AAIPharma will be expanding its CMC development services offerings, according to Karras. The company recently launched a physical-chemistry practice. Physical Chemistry is a hot area in which opportunities are underscored by the recent acquisition activity in that area, including 

 (Cambridge, UK). Karras said the company is likely to add clinical packaging and distribution in the coming year.   

As it reorganizes, AAIPharma is pursuing an integrated services model, packaging together clinical and nonclinical capabilities to target specific market segments. It is currently promoting packaged services under the brand names "AAIGeneric," "AAIBiotech," and "AAIOncology." The latter offering was created following the recent acquistion of 

, (CAC) a Paris-based CRO specializing in oncology drug development. CAC has experience in running early-stage clinical trials as well as large, international Phase II/III trials for oncology drugs. 

A tour of the exhibit hall at this year's AAPS Annual Meeting showed that the integrated services model is the "next big thing" in CMC and early-development services. One of the biggest proponents is Aptuit, whose model calls for integrated API and dosage-form development and manufacturing capabilities tied together with a sophisticated project-management system. Aptuit recently announced two major acquisitions to fill out its service offerings: the API manufacturing operations of 

, a provider of solid-state analytical-chemistry services. Aptuit already had preclinical, formulation, CTM manufacturing, and packaging services as a result of its acquisitions last year of 

' (Research Triangle Park, NC) nonclinical operations and clinical packager 

 (Miami, FL) are other examples of CROs offering an integrated services package. 

The emergence of sourcing options in the low-cost countries of Asia has provided a learning experience for both buyers and sellers of contract services. Nowhere has this learning process been more evident than in the discovery services arena. A year ago, North American and European providers of discovery services were under tremendous pressure as major pharmaceutical companies seemed intent on pushing down everyone's prices to Asian levels. A year later, Western discovery CROs are more optimistic. While the flow of discovery, chemistry, and biology projects to Asia continues to grow, Western CROs are learning to compete more effectively.  

Part of the improvement stems from the fact that pharmaceutical companies are becoming more sophisticated in deciding where to place their projects.  They are differentiating their projects and providers with criteria such as speed, experience, innovation, and intellectual property (IP) considerations, as well as cost and matching requirements and capabilities more closely. 

"It seems like cost was a major driver," says Mike Trova, senior vice-president of discovery services for 

 (AMRI, Albany, NY). "I think the pendulum is swinging back to a middle ground now where it doesn't have to be one or the other."  Pharmaceutical clients are growing more comfortable placing projects in locations that best match the project's requirements, he notes. 

 "We have had to react to the developing Asian CROs," says David Phillips, senior vice-president of sales and marketing for UK-based 

 (Mechelen, Belgium). "Not by competing head-to-head, but rather by trying to position our unique selling points to be more competitive." 

Phillips says BioFocus DPI has become more targeted in its business development efforts. "We are much more selective about the type of work we pitch for," says Phillips. "We'll tell a pharmaceutical company, 'This may not be the right project for us.' We try to help them position projects with us more effectively." 

Going global has become an important strategy for the larger discovery CROs. BioFocus expanded beyond Europe by acquiring the remnants of 

 (San Diego,  CA), a US-based discovery company, and initiated collaborative arrangements for chemistry services with two Indian companies. 

AMRI recently opened its second facility in India, focused on early-stage drug discovery research, including custom chemical synthesis and medicinal chemistry. The company opened a facility in Singapore in 2005. "Diversification and globalization of our business are key," says Trova. "We can offer differing expertise and a variety of cost models around the world, and it allows us to expand our customer base." 

Projects that require speed frequently stay in the United States. "Timing is everything, especially for small companies,"  says Deborah Minor, whose company, 

 (Bath, NC), represents approximately 40 small- to mid-sized CROs and CMOs in the United States. "Communication is another factor. If you want information about your API real-time, that's not always easy to get with the time differences." 

Western CROs also may find that developments in the Asian markets may close some of the cost gap. The supply of key resources, including staff, energy, and water, is often unreliable, and their costs seem to be escalating. Phillips from BioFocus DPI notes that Indian salaries have risen, so the comparative advantage has narrowed there. Trova at AMRI sees some price pressures already beginning to surface in China, with escalating salaries and the cost of doing business there. That could lead to other countries becoming bases for discovery work. 

"Big Pharma began exploring options around the world years ago," Trova says. "I would suggest that there will be developing markets in other parts of the world." 

The integrated services model is the "next big thing" in CMC and early development services.