Buyers in Short Supply

As expected, last year's wave of megamergers among global pharmaceutical companies has unleashed a follow-on wave of impending facility closings. Pfizer (New York) announced its intention to shut manufacturing operations at eight sites and close six research and development (R&D) facilities following its merger with Wyeth (Madison, NJ). Merck & Co. (Whitehouse, NJ) plans to close eight manufacturing sites and eight R&D sites in the wake of its acquisition of Schering-Plough (Kenilworth, NJ). Roche (Basel, Switzerland), which acquired full ownership of Genentech (South San Francisco, CA) in 2009, recently announced a strategic review of its operations that is likely to lead to closures.

Jim Miller

Historical perspective

Past waves of pharmaceutical plant consolidation helped spawn the birth of the contract research and manufacturing (CRO and CMO) industry. For instance, most of Patheon's (Research Triangle Park, NC) current manufacturing network was assembled from divested facilities, and major European CMOs such as Famar (Athens, Greece), Recipharm (Jordbro, Sweden), and Fareva (Paris) are made up mostly of facilities once owned by global bio/pharmaceutical companies.

CMOs often have been able to acquire these facilities for only a token investment and have received contracts to manufacture legacy products that have guaranteed them an initial revenue stream. However, it has been the sellers that have been the big beneficiaries of the sales to CMOs. The sellers have saved millions of dollars/euros in severance payments, taxes, and environmental remediation costs that they would have faced if they had closed the facilities and terminated the employees.

Changing times

Facility sales are now going to be more difficult. The contract development and manufacturing market is improving, but the new product pipeline is not as robust as it was in the middle of the last decade and competition among CMOs for the available opportunities is intense. Established CMOs don't need or want additional capacity for the most part. New market entrants that lack name recognition and a track record will have an especially difficult time gaining significant new business.

Also, financing for deals to acquire legacy manufacturing facilities is difficult to obtain because banks in North America and Europe have tightened lending standards, and private equity investors have become more selective. In the best of circumstances, it can take five or more years for a new CMO to build a decent portfolio of contracts from nonlegacy clients, and there are few investors willing to take the chance that the effort will be successful.

The difficulties facing CMOs trying to make a success of a manufacturing site once owned by a global bio/pharmaceutical company were highlighted recently when it was announced that Merck is buying back its active pharmaceutical ingredient (API) manufacturing site in Riverside, Pennsylvania, from Cherokee Pharmaceuticals (Riverside, PA). Cherokee, a subsidiary of the outsourcing-services provider PRWT (Philadelphia), acquired the facility from Merck at the end of 2007.

PRWT acquired the Cherokee operation for total consideration of $22.2 million, most of which was in the form of a promissory note to Merck. In addition to the assets on the site, PRWT received a five-year supply agreement from Merck, which it claimed would generate $100–200 million in annual revenues annually from producing antibiotics and chemical APIs and intermediates.

Based on a regulatory filing made by PRWT in 2008, Cherokee generated revenues of $84 million in its first year, of which almost 90% came from Merck. However, overall facility utilization was low: less than 25% for the two pharmaceutical API synthesis plants on the site and almost zero for the fermentation facility. A third plant manufacturing a crop-protection ingredient had high utilization, however.

Aside from the Merck legacy business, the only other contract announced by Cherokee over the three years in which it owned the facility was with DuPont (Wilmington, DE) for a crop-protection product. The company tried to make fuller use of its assets by entering the chemical distribution business and announced a contract with Sigma Aldrich (St. Louis) to distribute specialty chemical products. It's not clear whether this arrangement ever got off the ground.

The Riverside buyback highlights another problem for bio/pharmaceutical companies trying to sell or divest redundant facilities: namely, that large legacy pharmaceutical manufacturing sites may not be financially viable for a CMO to operate, especially in today's business environment. Large sites such as Riverside have a lot of fixed assets that must be maintained and operated whether or not they are being utilized. Cherokee had to maintain a 340-acre site that includes three commercial-scale synthesis plants, two good-manufacturing-practice kilo laboratories, a fermentation facility with 43 fermentors, 10 warehouses, and laboratory space; little of that capacity was utilized. At almost $100 million in revenues, Cherokee would have been considered a substantially sized API manufacturer, but the cost of maintaining all of these facilities probably overwhelmed the revenue generated by the legacy Merck contracts.

Cherokee is certainly not the first pharma-to-CMO deal not to work out well. Keata Pharma, a Canadian dose CMO, filed for bankruptcy within a year of buying its facility in Arnprior, Ontario, from Pfizer. Inyx, a UK-based CMO, went into receivership soon after buying a facility in Puerto Rico from sanofi-aventis (Paris); sanofi-aventis had to retake the facility much like Merck has. Elaiapharm (Nice, France) went through receivership and is now owned by the Danish pharmaceutical company Lundbeck.

This is not to say that there will be no pharma-to-CMO/CRO deals in the near future. There are often good strategic reasons to complete these transactions, including filling a hole in a company's service offerings or extending a strategic relationship with a key client. In fact, in several recent deals, companies were able to achieve both of these objectives simultaneously. When Covance (Princeton, NJ) acquired Eli Lilly's (Indianapolis, IN) site in Greenfield, Indiana, it gained a 10-year services contract and some critical discovery-related technologies. Similarly, in its recent acquisition of the R&D site in Verona, Italy, from GlaxoSmithKline (London), Aptuit (Greenwich) gained discovery capabilities while enhancing a key client relationship.

These deals show that a bargain price is no longer an adequate incentive for acquiring a redundant facility from a major bio/pharmaceutical company. There must be a strong strategic rationale and an adequate revenue stream for the facility to achieve standalone viability. Executives we spoke with say they have walked away from many offered facilities because the economics and strategic rationale were missing. The global bio/pharmaceutical companies may get offers from small and mid-sized bio/pharmaceutical companies for their redundant facilities, but CMOs and CROs are not lining up to buy them.

Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, info@pharmsource.comwww.pharmsource.com.