Globally, deal activity in 2017 was at a comparable level to 2016, and significantly lower than in 2014 and 2015. We counted 323 transactions (2016: 345), with cumulative deal values of $120 billion (2016: $95bn). In comparison, in 2014 and 2015, there were 440 to 490 transactions with cumulative deal values of approximately $225 billion. We believe that the earlier years were exceptional, and that the 2016/2017 level likely reflects normal rather than subdued merger and acquisition (M&A) activity.

While global transaction numbers remained stable, the pattern shifted. As shown in Figure 1 in the picture slides above, there were fewer acquisitions involving targets based in the U.S., but significantly greater activity from bidders in emerging markets, when compared to 2016.

The end of a long courtship for Actelion
The largest transaction in 2017 was J&J’s acquisition of Actelion for $30 billion (see Figure 2 in the slide), the Swiss-based specialist in pulmonary arterial hypertension (PAH), and Europe’s largest biotech company.

Back in 2011, activist investor Eliott tried to push Actelion’s management to initiate a sale process, when the company was trading at around 45 CHF per share. In January 2017, after a long and very public courtship in the second half of 2016—with Sanofi stepping in and out of the process—J&J agreed to pay CHF 280 per share.

The valuation is perceived as very high, corresponding to 12 times revenues and 30 times EBIT. But not only did Actelion’s founders, Jean-Paul and Martine Clozel, realize a very attractive price for their shareholders, they also managed to carve-out Actelion’s pipeline and R&D outside the PAH franchise indication into a new company, Idorsia. In June 2017, the new company was floated on the Swiss stock exchange, and at the end of 2017 already had a market capitalization of more than $3 billion.

Without doubt, Actelion is one of the most successful biotech stories in Europe to date.

Big bets on cancer
A substantial amount of available M&A funds in the pharma industry is spent on so-called “pipeline deals,” when large Pharma companies acquire small innovators with development programs or innovative products. The substantial prices paid in these transactions are based on the expectation of future profits which quite often are elusive; the deals are veritable billion-dollar bets.

And Pharma is betting on oncology. Gilead acquired Kite Pharma for $10 billion, just before the latter’s CAR-T cell therapy against a form of B-cell cancer was approved. In January, Takeda paid $5 billion for Ariad Pharmaceuticals to get Ariad’s blood cancer drug and its lung cancer drug candidate. In December, Novartis offered $3.7 billion to secure the rights for AAA’s endocrine cancer treatment. And just before the year-end, Roche purchased Ignyta for $1.8 billion to take on a program of drug candidates against specific solid tumors.

Continuing consolidation among CMOs and CROs
Interestingly, five of the transactions with deal values greater than $1 billion involved companies which provide services to the Pharma industry, rather than Pharma companies themselves.

In the contract manufacturing organization (CMO) space, former serial acquirer Patheon was taken over by ThermoFisher, the provider of R&D technology and Pharma services, for $7 billion. In the same period, Lonza completed the acquisition of Capsugel (announced in 2016, not in Figure 2) for $5.5 billion.

In 2016, the merger of IMS Health and Quintiles (now trading as IQVIA) created a company providing services from early-stage research through to commercialization. In 2017, INC and InVentiv Health followed suit in a merger valued around $4.6 billion, with the stated claim to become another “end-to-end” service provider for the industry.

Private equity groups (PEGs) drove the shaping of the CMO and the contract research organization (CRO) industries. PEGs seem to have continued confidence in the sector, increasing the value of the single bets. The CROs PPD and Parexel and the CDMO AMRI were acquired in billion-dollar transactions, a clear sign that financial investors believe that more consolidation is coming, and that operational improvements can be achieved.

Renewed deal activity in generics
Three transactions announced in 2017 with deal values greater than $1 billion involved generic drug firms. Akorn was acquired for $4.8 billion by Fresenius Kabi. With the deal, Fresenius expanded its portfolio of generics from sterile injectables to other difficult-to-make formulations. The other large deal in the U.S. was Amneal’s acquisition of IMPAX, a deal which was seen as a defensive step to the evolving crisis in the generics market in the U.S.

In Europe, STADA, one of Europe’s largest generic drugs providers, was bought out by a consortium of investors for $6 billion. The protracted and highly public transaction process involved some drama, including the involuntary departure of the CEO and CFO of STADA, and the alleged installation of electronic surveillance equipment in the car of the CEO.

More deals expected after tax overhaul
The end of 2017 brought a big tax overhaul in the U.S., and many financial advisors expect that this may lead to increased M&A activity involving U.S. companies as buyers, across all industries.

Against this backdrop, some observers expect that large deals amongst originators may be on the rise in 2018, particularly as pipeline deals become scarcer. Both Novartis and Sanofi are said to be under pressure to do large acquisitions. BMS is perceived as a potential target, and AstraZeneca’s survival as an independent company is often questioned.

Large deals building momentum in OTC
In OTC, three large transactions seem to be building momentum: In October, Merck KGaA announced the intention to sell its OTC portfolio business, with revenues of €860 million, which is expected to fetch €1.8 billion to €2.7 billion. This divestment was expected since February, as the German company then announced the preparation of the organization for a separation.

Shortly after Merck’s announcement, Pfizer announced that they are seeking a buyer for their consumer health business. With revenues of $3.4 billion and a purchase price of up to $15 billion, Pfizer’s proposed deal is much larger.

There are few obvious buyers for the portfolios. In March, GSK will have to decide whether to buy out Novartis from their JV. Bayer is still digesting its huge acquisition of OTC products from Merck & Co, and Reckitt Benckiser—keen to expand its OTC business—may first have to do a lot of homework.

CDMOs grow faster than the Pharma market
As Pharma companies refine their business strategy and market focus, Pharma manufacturing also undergoes a fundamental change. More and more, large Pharma “originators” view manufacturing as a non-core activity, unless the products involve proprietary technology. This is a boost for contract development and manufacturing organizations (CDMOs), and one of the key drivers for the consolidation of this industry.

CDMOs collectively generate approximately $40 billion in revenue, and the large players forecast a market growth of 5% to 6.5% per year over the next five years. Two growth drivers are stated: First, small innovators (“biotech”) do not want to commit capital to building manufacturing plants, but rather use CDMOs. Second, outsourcing by Big Pharma is expected to increase further, from an “outsourcing penetration” of 30% today to 40% in 2020. Following this rationale, we believe that the CDMO industry may expand even faster, given that growth of the Pharma industry as a whole is expected to be 5% to 7%.

Interestingly, the largest CDMOs grow faster than the largest Pharma firms, as can be seen in Figure 3 in the slider. Each bubble in this graph represents one company, with its size proportional to the company’s revenues. The position on the horizontal axis reflects the company’s growth in the last three years, while the position on the vertical axis reflects the profitability (EBITDA margin). The higher rate of growth of CDMOs reflects on one hand the consolidation in the CDMO market, and on the other hand the growing trend towards outsourcing in the industry. For comparison, Figure 3 also contains some of the large CROs, which also grew substantially faster than the Pharma market.

Big Pharma’s bias for large CDMOs drives consolidation
Despite a considerable number of M&A transactions, the CDMO market remains very fragmented. The top five players generate approximately 15% of the $40 billion total, and there is a long tail of medium-sized and smaller CDMOs—we count at least 300 companies offering CDMO services.

However, there is a strong bias by Big Pharma for large CDMOs: Big Pharma firms want few, long-term, reliable relationships, and favor large CDMOs, which also have the capacity and means to manage and cultivate complex niche technologies, over smaller ones. A similar “size affinity” exists between Pharma companies and CROs. 

Consequently, the CDMO industry is in a phase of intense consolidation, comparable to the CRO industry three to five years ago. As shown in Figure 4 in the slider, between 2013 and 2017 there were 30 to 60 transactions annually with C(D)MOs and manufacturing units as targets. The number of transactions peaked in 2015, but while the number of transactions decreased in the last two years, the deal volume (the sum of all published deal values) increased, mainly due to the very large deals: Capsugel/Lonza and Patheon/Thermo Fisher.

Platform builders and new entrants
Two particular type of M&A actors drive deal activity. First, several CDMOs made serial acquisitions to expand their platform and reach. Figure 5 in the slider illustrates the acquisition timeline of Catalent, Recipharm and Patheon which have used M&A to build up sizeable manufacturing platforms. These players use M&A as part of their business model to complement their technology footprint, geographic reach, and client portfolio.

Second, new entrants, attracted to the industry consolidation, being driven by fragmentation, growth and size bias. As mentioned above, private equity groups (PEGS) have played a strong role in building the CDMO industry—as well as for CROs—and last year again saw several transactions involving PEGs buying out CDMOs, most notably AMRI. In addition, firms in related industries such as Thermo Fisher, a lab instrument and consumables supplier, are attracted to the CDMO industry. Table 1 in the slider deck gives examples of recent acquisitions of CDMOs by strategic buyers and private equity groups.

Biopharma contract manufacturing
Manufacturing of biologicals, for example antibodies which are produced using very sensitive mammalian cell cultures, is highly complicated and requires large dedicated investments. Even some of the largest Pharma companies prefer to enter into strategic alliances with specialist CDMOs, rather than building manufacturing plants on their own, as exemplified by Sanofi’s €270 million alliance with Lonza announced in February 2017.

Due to the high barriers to entry, the biopharmaceutical CMO market is an oligopoly in which Samsung Biologics, Lonza and Boehringer have the lion’s share. However, some large new players are seeking to muscle their way in: Japanese Asahi Glass acquired CMC Biologics at the end of 2016, and KBI, subsidiary of Japanese group JSR, acquired two companies to expand its biopharmaceutical contract manufacturing capabilities.

Biopharmaceutical toll manufacturing and biosimilar development overlap, as the example of Samsung Biologics shows. This company offers contract manufacturing services and has developed several biosimilars, in partnership with large biotech companies. Samsung Biologics is also an example of a successful new entrant into the CDMO market—with anticipated volume of 362,000 liters for mammalian cell culture, it is currently the largest biopharmaceutical CDMO. The company went public in November 2016 and at the beginning of 2018 traded at a market capitalization of more than $24 billion.

The beginning of Pharma-CMO alliances?
Pharma companies have for many years been relying on the acquisition of, or in-licensing from, biotech companies for innovation. In 2011 McKinsey, a consultancy, suggested that like the automotive industry, other parts of the Pharma value chain may disintegrate, with few large brand-owners sourcing everything—from innovation to manufacturing—through a network of suppliers. Along these lines, in the first half of this decade, Big Pharma companies have entered into strategic alliances with CROs, establishing preferred relationships with few (two or three) CROs instead of deciding case by case (or trial by trial) with whom to work.

The same may happen in manufacturing. The large CDMOs are big, stable, and broad enough to cover substantially all manufacturing needs of Big Pharma companies, perhaps apart from biopharmaceuticals which may be covered by specialist CDMOs. We believe this is one reason for Lonza’s acquisition of Capsugel—complementing existing technical capabilities and gaining scale. Similarly, Patheon becomes part of a large group under Thermo Fisher and hence may be viewed as an even more compelling potential partner for Big Pharma companies.

Obviously, given the many technical and regulatory constraints, transformation of a manufacturing network takes much more time to implement than changing suppliers of services. However, the transfer of manufacturing units from Pharma company to its future CDMO, could accelerate the process—thus the future of the CDMO industry may resemble its beginnings in the mid-90s. 

---

Christoph Bieri is managing partner with Kurmann Partners, a Swiss-based M&A boutique focused on mid-market transactions in the pharmaceutical and medtech industries and adjacent segments. Christoph has led numerous buy-side and sell-side international transac-tions concerning targets based in the Europe and North America.