Private Equity & CDMOs
Drivers of the CDMO Landscape – An Opportunity for Private Equity?
Shift towards Outsourcing
During the last decade, the pharmaceutical industry has been experiencing a significant shift towards outsourcing activities, with over 50% of pharmaceutical manufacturing now outsourced to Contract Manufacturing and Development Organizations (CDMOs) globally. This shift is driven by a range of well-known factors, including the demand for including the growing complexity of modern drug development and manufacturing, stringent regulatory requirements, and the imperative to manage costs efficiently. In this comprehensive review, we will characterize the CDMO sector, taking an in-depth look at its profitability and analyzing the opportunity for private equity (PE).
CDMO Market Potential
The global CDMO market was estimated at $94 billion in 2022, and it is expected to grow at an annual growth rate of around 7%. By 2032, it is projected to hit around $172 billion[1]. The CDMO sector’s unique positioning as a vast and still-emerging market has gone in parallel with a surge in PE investment. The biopharmaceutical industry’s potential for consolidation further elevates its appeal to investors, exemplified by an impressive number of deals during the first half of 2023 valued at a combined total of $71,1 billion[2].
Demand for Biologics
Several recent developments within the pharmaceutical industry have strengthened the case for outsourcing to CDMOs. The demand for biologics, in particular, has surged, with an expected annual growth rate of approximately 10% from 2023 to 2030[3], and a tendency by biopharmaceutical companies to engage CDMOs early in the drug development process. For CDMOs, biologics manufacturing offers the potential for significantly higher gross margins, ranging from 30% to 50%, in contrast to the 15% to 30% typically seen in small molecule manufacturing. Moreover, the cost per gram for biologics production exceeds $100, as opposed to the mere $0.10 seen in small molecules. Consequently, the revenue and profit generated per gram of material produced in the biologics sector are substantially greater[4].
Re-shoring to Europe
Supply chain reliability and sustainability considerations are driving the re-shoring of drug manufacturing to Europe. This trend is expected to further boost the CDMO industry in the region, capturing a significant share of re-shored manufacturing activities.
Diverse Service Portfolio
CDMOs typically offer a wide range of services, including drug development, manufacturing, formulation, and analytical testing. This diversity enables them to capture revenue at literally every stage of the pharmaceutical value chain, enhancing their overall profitability. Based on the number of deals within the CDMO M&A transactions from 2017 to 2021, investments were mainly equally distributed between the value chain steps of research and development services, drug substance manufacturing and drug product manufacturing, while packaging and other business were represented less[5].
Profitability and Efficiency
The profitability of CDMOs is a critical aspect of their appeal to investors and stakeholders. Key factors that influence profitability include diverse service portfolios, economies of scale, and efficient capacity utilization. Careful consideration of the following elements is crucial for investors and industry stakeholders evaluating the long-term sustainability of their investments.
- Economies of Scale: CDMOs benefit from economies of scale, particularly as they expand and consolidate operations. Larger CDMOs can spread fixed costs over a larger revenue base, which can lead to improved profitability.
- Capacity Utilization: Efficient capacity utilization is crucial for profitability. CDMOs must strike a balance between meeting client demands and maintaining cost-effective operations. Idle capacity can erode profitability, while overutilization can lead to quality issues and increased costs.
- Contract Structures: The structure of contracts with pharmaceutical clients can significantly impact profitability. Long-term partnerships and volume commitments can provide stable revenue streams and better profit margins.
- Regulatory Compliance: Maintaining rigorous regulatory compliance is non-negotiable in the pharmaceutical industry. CDMOs that excel in this area can command premium prices for their services, positively impacting profitability.
- Technological Innovation: Investment in cutting-edge technology and automation can improve efficiency and reduce costs, contributing to higher profitability. This is particularly relevant in industries like biologics manufacturing, where precision and speed are paramount.
- Operational Efficiency: Streamlining manufacturing practices and supply chain robustness, from sourcing raw materials to distribution, can reduce costs and enhance profitability. Efficient supply chain management can also mitigate the risks associated with disruptions.
- Quality Control: Stringent quality control measures not only ensure compliance but also reduce rework and recalls, preserving profitability. CDMOs with robust quality management systems are more likely to sustain long-term success.
- Global Expansion: Expanding into emerging markets can open new revenue streams, but it also entails navigating complex regulatory environments. Successful global expansion can drive profitability, but it requires careful planning.
- Sustainability Practices: As sustainability gains prominence, CDMOs that adopt environmentally friendly practices can attract clients committed to sustainability goals, potentially offering premium contracts.
- AI Integration: The integration of Artificial Intelligence (AI) can optimize processes, reduce errors, and enhance efficiency, all of which can positively impact profitability. AI can be particularly beneficial in predictive maintenance and quality control.
In summary, the profitability of CDMOs is influenced by a complex interplay of factors. CDMOs that strategically navigate these factors stand to enhance their profitability and cement their position as vital players in the sector. For PE firms with a keen eye on business, CDMOs represent a meaningful contributions to the ever-evolving pharmaceutical landscape. With a market value expected to hit $172 billion by 2032[1], the CDMO sector is poised for sustained growth, making it a prime focus for savvy investors.
[1] Precedence Research. Pharmaceutical CDMO Market. May 2023. Source.
[2] BioProcess International by Dan Stanton with Paul Manlapig. Biopharmaceutical Mergers and Acquisitions: Their Impact on the Services Industry. August 2023. Source.
[3] Grand View Research, Inc. Biologics Market Size, Share & Trends Analysis Report By Source (Microbial, Mammalian), By Product (MABs, Recombinant Proteins, Antisense & RNAi), By Disease Category, By Manufacturing, By Region, And Segment Forecasts, 2023 – 2030. Source.
[4] Mansfield Advisors by Victor Chua, Abhishek Patel and William Johnson. The Commercial Case for Investing in CDMOs. March 2023. Source.
[5] EY-Parthenon by Dr. Isabelle Heiber and Elias Eckert. How Contract Development and Manufacturing Organizations (CDMOs) are leading innovation for pharmaceutical partners. 2022. Source.