The last five years has seen the pharmaceutical contract development and manufacturing organization (CDMO) and contract research organization (CRO) sectors blossom in terms of value and significance of merger and acquisition (M&A) transactions. There are many drivers for this, including increased use of pharmaceuticals, retrenching of supply chains to regional and national manufacturing hubs, and novel innovative medicines driving strong investor interest in these business sectors.

CDMO business sector outlook
The CDMO sector benefits from strong growth fundamentals with the increased use of pharmaceuticals in growing and aging populations.

Covid-19 has been the most significant factor in the life sciences industry in the last 24 months. The industry has been seen as a major source of innovative solutions for this pandemic, quickly developing and deploying several highly effective novel vaccines. This has enhanced the public perception of this industry and particularly the pharmaceutical companies. Investors have followed, and life sciences have attracted investment and are viewed as a safe-haven investment in these challenging times. 

For example, the Chinese government has very recently led a regulatory assault on internet platforms this year, hitting those in food delivery, ecommerce, fintech, gaming and education. This has tempered investor interest in the Tech sector globally. However, the Chinese Communist Party’s desire to advance technologies such as high-end manufacturing has boosted other companies and industries including life sciences, underpinning life sciences as an attractive investment. 

Specifically, this has had a profound impact generally on pharmaceutical manufacturing, and specifically on vaccine manufacturing, both traditional adenoviral vector and validating novel mRNA-based vaccines. The importance of vaccine production and the ability for countries to have the capability to control the manufacturing has driven manufacturing strategies, which has been highlighted by investor interest and executed transactions including M&A.

Strong investor interest in life sciences generally and the pharmaceutical manufacturing industry is reflected in both the number and relative value of recent transactions. In the CDMO sector, deal activity in the first half of 2021 has been incredibly strong. Fourty-eight deals were completed in the first half of the year with the expectation that momentum will continue for the remainder of 2021, compared with an average of 50 deals per year for 2017-2020. The second quarter of 2020 saw the lowest level of deal making in the past 5 years with only 5 deals completed. However, deal activity picked up strongly and the year overall was still in line with previous periods thanks to strong first and third quarters. In parallel there has been an increase in valuations from 10-times EBITDA 10 years ago, to 12-times EBITDA 5 years ago and to around 15.5-times EBITDA over the past approximately 2 years. It is possible with the recent deal making frenzy that these values are even greater on current deals.

These numbers do however hide significant sector and technology differences. Valuations tend to be driven by technical differentiation of the company and fundamentals of the underlying market—mainly growth, margin potential and market size. For instance:

• Viral vector manufacturing for vaccines and cell and gene therapies (CGT) as well as other CGT manufacturing offerings are currently the most highly valued—we’re seeing multiples in the 20-30-times EBITDA range;
• Biologics API manufacturing is the next highly valued capability—multiples are in the high teens up to 20-times EBITDA;
• Injectables manufacturing is similarly valued in the high teens EBITDA multiples—mid-teens for smaller or less differentiated players. Valuations have been lifted by the exceptional demand for vaccine sterile fill facilities arising from the strong demand for Covid-19 vaccines;
• Exposure to the small molecule medicinal chemistry market leads to overall lower multiples:

– Oral solid dose (OSD) and liquids, ointments, creams (LOC) manufacturers tend to currently be valued in the low to mid-teens, depending on scale and differentiation (e.g. HPAPI handling, specialty formulation); and
– Small molecule API manufacturers are valued in the same range.

Scale is a major contributor to valuation across the sector due to the scarcity of scale assets. Companies with an enterprise value (EV) greater than $200 million command a premium over smaller players. We don’t see a significant difference in median valuation between pureplay API versus drug product CDMOs. There appears to be an investor premium for full-service CDMOs—development services, API and drug product—who on average receive a higher valuation compared with pureplay API or drug product CDMOs.

Deal activity in this sector is strongly driven by private equity. Over 60% of deals in 2020 and 2021 year-to-date (YTD) have been executed by private equity (PE) or PE-backed companies.  The sector is currently highly fragmented with the biggest players only having approximately 15% of the market, so in addition to the good fundamental business drivers, there is the potential opportunity to grow in this sector through consolidation.

CRO business sector outlook
The CRO business sector has flourished over the last 5 years driven primarily by the increased sophistication of service offerings provided by CROs—in the past they would provide basic chemistry and screening services, now more and more they are collaborating and contributing to the IP generated on these drug discovery programs. The leading players such as Evotec, Curia, WuXI AppTec and Charles River Laboratories are companies of scale offering comprehensive research and pre-clinical development services to the pharma, biotech, not for profit organizations (e.g. the Gates Foundation) and academic institutions. They are buoyed by the surge in interest in pharmaceutical innovation.

Behind these larger CROs are a larger number of smaller but growing companies which PE and investors are taking a strong interest in. Two recent transactions of note are the Symeres acquisition¹ and Sygnature Discovery deal,² which are both rumored to value these companies in the high teens/low twenties EBITDA multiples, confirming strong investor interest in this rapidly developing business sector.

Conclusion
For the next couple of years life sciences will retain the “safe haven” endorsement from investors.

Looking further ahead, life sciences is a business sector which we predict will continue to attract strong investor interest and this will drive transactions—both numbers and valuations. 

With respect to the CRO sector we expect to see this grow and consolidate driven both by investment in outsourced pharmaceutical research by large pharma, charities, governmental organizations and biotechs. Over the next five years we anticipate deal frequency and value will remain strong. 

For CDMOs this will continue to be a sector of interest for investors keeping transactional activity and valuations high. Within this we expect areas which relate to cell and gene therapies, biologics and high value secondary drug products, such as sterile fill and pharmaceutical device combinations, to be of premium interest and valuation. 

In addition, the repatriation of manufacturing from Asia to Europe and the U.S. arising from both manufacturing inflation in the Far East and a desire for strategic pharmaceutical products to be manufactured closer to their markets, will result in a buoyant CDMO business sector with good quality assets and people in limited supply. 

References

1. https://symeres.com/symeres-a-leading-european-cro-and-cdmo-joins-forces-with-keensight-capital/
2. https://www.sygnaturediscovery.com/news-and-events/news/five-arrows-invests-in-sygnature-discovery/