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CMOs/CDMOs: Challenges and Opportunities

By Gil Roth, PBOA | 10.11.17

Protectionism, consolidation, immigration, drug pricing and regulatory issues

“All predictions null-and-void if Trump wins the U.S. Presidential election.” That’s how I closed out last year’s ‘Looking Ahead’ piece. Suffice to say, my crystal ball is C-R-A-C-K-E-D, and my backup Magic 8-Ball’s answer to everything is, “Reply hazy. Try again later.” Since the election last November, the pharma industry and U.S. healthcare overall have been on a roller-coaster ride, learning how to work with an unpredictable new environment. I won’t say things are settling down now, but there seems to be less of a tendency by pharma to overreact to presidential tweets than in the first months after the election.

What does it all mean for the CMO/CDMO industry? Good/unanswerable question! Rather than go into “predictions,” I’ll highlight concerns and how they may play out. Sound good?

One of the biggest concerns about the new administration has been what its “America First” ethos would mean for the globalized supply chains of the bio/pharma sector. Will we see a push for economic protectionism that compels drug companies to bring manufacturing in-house and/or to move their production facilities to the U.S.?

The verdict is out on that one, but the Republican leadership in the House of Representatives recently conceded that one of the key tools to promote domestic production—a Border Adjustment Tax (BAT)—is off the table, after pushback from business interests. The BAT would have, in essence, taxed imported goods to the U.S. and removed taxes on U.S. exports, but could also have had serious consequences for consumers if currency appreciation didn’t follow a particular theoretical model of economics. There’s an array of policy tools that could stimulate domestic manufacturing, but they inherently involve penalizing ex-U.S. manufacturing, and would likely be challenged in the World Trade Organization (WTO).

Still, those considerations can be a factor in the CMO/CDMO space. In November 2016, Patheon acquired an active pharmaceutical ingredient (API) plant from Roche in Florence, SC. In an earnings call, Patheon chief executive officer Jim Mullen noted that the move would serve as a hedge if BAT was implemented, giving Patheon a domestic API facility with room to grow.

BAT would have been part of an overhaul of the U.S. tax code, which hasn’t seen a major revision since 1986. Given how tough it was to come up with a feasible replacement plan for the Affordable Care Act, it may not be realistic to expect enough interests to line up for a true overhaul, but we could still see a repeat of the 2004 American Jobs Creation Act, which gave a one-time tax holiday for U.S. companies to repatriate revenues that were kept overseas.

A massive influx of pharma dollars could cause those big companies to alter their supply networks and spend more on domestic in-house facilities, to the detriment of their CMO/CDMOs, but I think it’s more likely that the money goes to share buybacks, dividends, and acquisitions of U.S.-based targets. This could lead to pharma-layoffs, which is why I renamed it the American Jobs Destruction Act last time around.

Speaking of acquisitions, one of the perennial issues facing the CMO/CDMO sector is consolidation, under the principle that there’s too much capacity overall and that a winnowing out through mergers and shutdowns will lead to more efficient and effective outsourcing.

It hasn’t exactly worked out that way. Some of the biggest deals in the sector—and they were BIG—don’t exactly qualify as “consolidation.” AMRI Inc. was acquired in June 2017 by a pair of private equity firms—The Carlyle Group and GTCR—but neither one has a presence in the dosage form CMO/CDMO sector. A month earlier, Patheon Inc. was acquired by Thermo Fisher in a $5.2 billion deal that shocked the industry. But Thermo doesn’t have a CDMO unit to merge with Patheon—besides its Fisher Clinical Services segment, and I’ve found that clinical services can be a very different business than development and manufacturing services—making this more of an additive move than a synergistic play. So, while those were large deals in the CMO/CDMO space, they don’t represent consolidation as we know it. Rather, they’re a sign that these companies—and by extension this sector—have untapped potential. That said, I should note that AMRI was a serial acquirer prior to this buyout.

On the other hand, Lonza’s acquisition of Capsugel was both large (~$5.5 billion) and consolidation-y, as it served to build out Lonza’s one-stop outsourcing model with more integrated service offerings. CDMOs are certainly looking for synergistic deals, but that scale of acquisition is rare in this sector, where we’re more likely to see smaller scale buys and tie-ups. Significant but not break-the-bank, Apotex’ Accucaps unit was acquired by Catalent late in 2016, bolstering the super-CDMO’s softgel offerings and preventing competitors from adding it to their offerings, and Evotec made a larger move by acquiring Aptuit this summer.

I think the sector is still ripe for narrow-focused acquisitions of technologies, while ex-US CDMOs may look to boost their US presence by acquiring either an existing provider or an available pharma facility. CDMOs talk more about expanding their current facilities, adding services and building more integrated suites of services.

“America First” carries another concern for the pharma industry overall, and that’s immigration to the U.S. The new administration’s first major move was an executive order banning immigration and refugees from several countries. It was struck down in court, subsequently modified and is now working its way back through the U.S. legal system. The administration meanwhile sustained its campaign rhetoric about barring illegal immigrants and more recently endorsed a legislation that would cut legal immigration to the U.S. in half, partly based on a points system.

These initiatives may not be permissible or practical, but they could have the effect of making the U.S. appear unwelcoming to potential pharma-employees. This may shift the talent pool—for both in-house pharma and CDMOs—to other nations and create greater opportunities for companies with ex-U.S. operations, while impacting domestic wages.

Drug pricing
Here’s one of the issues where the administration’s approach is simply unknown. When he was a candidate, the President inveighed against the cost of pharmaceuticals and the pharma industry’s use of lobbyists. Leading up to his inauguration, he repeated the charge and implied he had a plan to reduce drug prices. But the administration hasn’t offered up any new strategies beyond getting more generics approved more quickly in order to bring prices down.

That’s an admirable goal, and we’re glad the administration hasn’t tried to lower prices by fiat, but at the same time, it’s an example of that roller-coaster I mentioned at the outset; pharma companies and the CDMOs who serve them seem in the dark about policy decisions that could cause major disruption to their business models.

One of the bright spots of 2017 was the FDA Reauthorization Act (FDARA), the bill that reauthorizes four of the FDA’s major user fee programs, Prescription Drugs (PDUFA), Medical Devices (MDUFA), Biosimilars (BSUFA), and—the one that’s nearest to me, because I spent 10 months yo-yo-ing on the Northeast Regional train between New Jersey and Maryland so I could negotiate it—Generic Drugs (GDUFA).

GDUFA will include numerous enhancements to improve review times for generic applications, and increase communications with industry regarding complex generics, which have bedeviled the sector and the agency for years. With a significant increase in budget—up 50%, but with a reduced share coming from CDMOs—GDUFA II will help improve predictability for generic companies and their manufacturing partners, while bringing lower prices to patients.

There are plenty of other areas where we’re waiting to see how the new administration will work with the FDA in the years ahead. The new FDA Commissioner, Scott Gottlieb, M.D., has both agency and industry experience, so he understands the role FDA can play in facilitating drug development—be it innovator, generic, biosimilar, drug-device combo, etc.

That said, he works within the parameters of the new administration. Prior to his appointment, the White House barred new federal hiring across the board, although FDA eventually received clearance to add staff. Another early executive order specified that federal agencies would have to rescind two regulations for every one they added, but we’ve yet to see how that will play out.

You see what I mean about not making predictions? 

Note: This article forms part of the CPhI 2017 Annual Report, which will be released during the CPhI Worldwide event in Frankfurt (October 24-26, 2017);

Gil Roth is the president of the Pharma & Biopharma Outsourcing Association (PBOA), a U.S.-based trade association representing regulatory, legislative and general business interests of the CMO/CDMO sector. He can be reached at