Pharma assets are a risky buy for fine chems

A nice piece of real estate?

12 February 2010 15:39  [Source: ICB]

Big pharma is selling off manufacturing assets, but history suggests buyers should proceed with care

ONGOING CONSOLIDATION and cost cutting in the pharmaceutical industry present contract manufacturers with new opportunities - not only to burrow more deeply into supply chains, but also to expand production capacity by acquiring underutilized manufacturing facilities. The cost to acquire an existing facility is typically a fraction of the cost to build it, and if the deal is sweetened with a supply contract, the acquirer can report an immediate contribution to the bottom line. But is the choice so simple?

Rex Features/Chris Eyles

The exact number of active pharmaceutical ingredient (API) facilities subject to sale or closure in recent years is uncertain, but clearly large. US-based pharma giant Pfizer, for example, has closed or sold 10 API manufacturing sites since 2005 (see table on page 32), while US rival Merck & Co. closed or sold five manufacturing facilities as part of a $1bn (€726m) restructuring program announced the same year.

More could be on the way. In the aftermath of its October acquisition of compatriot Wyeth, Pfizer announced plans to cut another 20,000 jobs, while Merck said it would make 16,000 job cuts once the acquisition of US-based Schering-Plough, announced in November, is complete.

Other major pharmaceutical companies are also cutting back. UK-based AstraZeneca, which cut 12,600 jobs between 2007 and 2009, said last month that it intended to cut another 10,400 by 2014.

LOOKING FOR A WIN-WIN
The reverberations from this latest round of cutbacks are already reaching the fine chemical sector. In September, US-based Eli Lilly announced plans to cut staff by 5,500 by the end of 2011; only one month later, the company announced the sale of its Tippecanoe Laboratories manufacturing facility, along with nearly 700 employees, to German fine and specialty chemical giant Evonik Industries.

"An empty plantwill be someone else's problem" Guy Villax, CEO, Hovione

Lilly had operated the facility, located in Lafayette, Indiana, since 1953, manufacturing APIs and animal health products. After a recent strategic review, however, the company concluded that it should be sold. Lilly cited imminent patent expirations on products manufactured there; a strategic decision to purchase, rather than manufacture, many late-stage chemical intermediates; and the evolution of the company's pipeline toward more biotechnology-based medicines.

"This strategic investment represents a significant step forward for the business by enlarging our market position in the global pharmaceutical industry," said Reiner Beste, head of Evonik's health and nutrition business unit, when the site was transferred to the firm in January.

Evonik last bought an API production facility from a pharma company in 1989, when ASTA Medica, the pharma business unit of Evonik predecessor Degussa, acquired Arzneimittelwerk Dresden (AWD). When ASTA Medica was sold in 2001, Degussa incorporated the API facility into its fine chemical unit, says Hans-Josef Ritzert, senior vice president, exclusive synthesis & amino acids at Evonik. Later, the API plant was transferred to Germany-based generics firm HEXAL.

"Unfortunately, most of the produced APIs came under price pressure due to the generic market focus of AWD," Ritzert explains.

Tippecanoe, however, will remain focused on patented APIs and their intermediates. It will also continue to supply Lilly through a multiyear contract awarded to Evonik as part of the facility's acquisition.

Ritzert notes that the quality culture instilled by Lilly will remain in place, a factor he considers one of the major benefits of acquiring a facility from a pharma company. "Quality management is a big issue when buying an API facility from another fine chemical company," Ritzert says. The supply contract is therefore not merely an inducement to the buyer but a "win-win," he says.

"The seller benefits from a continuing high-quality supply of APIs due to the vast expertise of experienced employees," Ritzert explains. "Evonik will have a very strong positive effect, because it allowed us to expand our technology base, and we also continue capacity utilization at the site. The deal fitted very well with our expansion plans."

As an inducement, however, a supply contract also has the potential to blind a buyer to the drawbacks of an acquisition, observes Guy Villax, CEO of Hovione, an API manufacturer based in Portugal. Villax notes that the API facility in Loughbeg, County Cork, Ireland, which Hovione bought from Pfizer in 2008, came "virtually empty."

"People will give you supply agreements to encourage you to take over the plant," he says. "But in three years' time, they won't give you the same terms, even if they need the product. And then you're faced with a few hundred people that you either have to make redundant or I don't know what."

As a privately owned company, Hovione is able to focus on long-term benefits, he notes. Public companies are distracted by pressure to deliver quickly on investments. "If what you're looking at is the next quarterly report, because doing well has a horizon of a year, of course you want to buy a plant that's full: your sales go up, everything goes up," Villax says. "Facing an empty plant is three years later, and that will be someone else's problem."

Peter Pollak, a fine chemical consultant based in Switzerland and former manager of fine chemicals at Swiss contract manufacturer Lonza, disagrees. "A 'continue-to-make' supply contract is a win-win situation," he says. "It assures continuing product supplies to the seller and provides a base load business for the acquirer. Even if product offtakes decrease over the contract period, it gives the acquirer a grace period for the introduction of its own products."

BUYER BEWARE
At the same time, supply contracts do not guarantee success, and Pollak points to several plant acquisitions that have yielded disappointment. "Lonza's acquisition of SmithKline's Riverside Conshohocken plant has been a flop," he says. "Pirimal [Healthcare's] and Shasun Chemical's acquisitions of Pfizer's Morpeth and Rhodia Pharma Solutions' plants, respectively, have not been overwhelming successes (to put it mildly)."

Lonza, which bought the Riverside API facility in Conshohocken, Pennsylvania, from the then US pharmaceutical firm SmithKline in 1992, announced last month that the site, as well as two others, would be closed this year. The move, said the company, "complements Lonza's existing platform in Nansha [China] and is the response to customer needs for mature regulated products at competitive conditions."

Piramal, a leading Indian API manufacturer, bought Pfizer's Morpeth, UK, facility in 2006, in a deal that included a five-year supply contract. The company already owned another UK manufacturing facility in the city of Huddersfield, which it obtained through the 2005 acquisition of Avecia Pharmaceuticals.

Last year, however, Piramal revealed that utilization at the aging facility Huddersfield had dropped to 35%, and it would therefore be closed, with production moved to the Morpeth site and sites in India.

Shasun, another major Indian player, acquired two ex-pharma API manufacturing facilities with the purchase of France-based contractor Rhodia Pharma Solutions in 2006. The two sites, located in Dudley and Annan, UK, originally belonged to UK-based Glaxo Wellcome (now global pharma giant GlaxoSmithKline), which sold them to US contract manufacturer Chirex in the 1990s. Rhodia bought Chirex in 2000 for $545m, a move it later regretted, writing off the acquisition before passing it along to Shasun in 2006. Shasun, which paid much less for the business, seems to have found itself in a similar position and last year closed the Annan facility, also citing underutilization.

Rob Bryant, director of the UK-based fine chemical consultancy Brychem, warns against acquiring API facilities from pharmaceutical companies. "The majority are rather unsuccessful," he says. "One indicator is the serial disposals of such units, for example, the Loughbeg plant, which has been badged as Isochem, Hickson & Welch, Angus Fine Chemical, Warner-Lambert, Pfizer and now Hovione."

They are, says Bryant, often difficult to retrofit for general purpose use. "A classic example is GSK's Annan plant, which made a single liquid product that was shipped out by rail. Chirex spent a lot of cash to turn it into a suitable fine chemical plant."

INTO THE UNKNOWN
Furthermore, the workforce at a pharma plant does not naturally have a fine chemical mindset, he says. "The people at a divested pharma plant are not used to worrying about where the next project will come from," Bryant points out. "They are not ready to become part of an independent group. They are also reeling at the shock of being sent out into the less comfortable world of being a 'supplier'."

Pollak makes a similar point. "Plants built by pharma companies are often 'gold-plated'," he observes. "As the sellers offer a big price discount for the acquirer, this is not a financial problem. However, it is very difficult to implement a culture of lean production." It is, he continues, this human element, more than any engineering problem, that makes it difficult to convert dedicated facilities to multipurpose use. "The whole supply chain, from raw material procurement, production scheduling, customer relationships, controlling, [to] regulatory compliance, is entirely different. Therefore, as a general rule, 'Hands off dedicated plants!'" The employees of pharmaceutical companies typically have more generous labor contracts, as well, which may need to be honored, he notes.

"The earlier you plan for potential closures, the better" Nick Compton, head of life sciences, CB Richard Ellis

Bryant advises buyers to ask several key questions: "What possible use will it be to your own company's operations? Is it useful capacity - will the workforce be retrainable? Does it really bring you closer to the pharmaceutical company that is selling the unit? Always suspect that the deal is being driven by individuals within your own company who will gain personally by it in terms of either cash or ego."

Rather than exacerbating the problem of overcapacity, pharmaceutical companies should simply "close [plants] down once and for all," says Bryant, although, he adds, they "often dither because of negative publicity." There is, he says, "little upside, [and] plenty of potential downside for the pharmaceutical company - what would you do in their shoes?"

As it happens, the majority of API facilities probably do end up closing. The manufacturing plants are dismantled, and the sites redeveloped, says Nick Compton, head of life sciences, EMEA, at CB Richard Ellis, a global real estate firm. The pace of disposals is picking up, he adds. In a recent survey of top-ten pharma companies, CBRE found that increased M&A, partnering and collaboration is making a significant impact on the real estate market. After mergers, real estate is being consolidated - first offices, followed by research and development (R&D) and manufacturing. Big pharma is also increasingly monetizing its real estate assets, with office space again the first to be affected, but extending to R&D and manufacturing assets.

"The survey endorses our experience that shareholders and business leaders in the pharma sector expect rapid advancement of these activities," says Compton.

Compton advises pharmaceutical firms to prepare their real estate strategy as far in advance as possible. "The earlier you plan for potential closures, the better, because it opens up a whole load of options that would not otherwise be available," he says.

"You can start talking about doing a lot of the tasks that take time after the event," he explains. "For example, you can sell sites and lease them back, so that the solution has already been delivered. When the lease expires, you close the site and walk away. The investor gets rent from you for five years [as well as] time to take the site through the rezoning or town planning process. By the time your lease expires, they are ready with their rezoning. They have their finance in place, and it hasn't cost them anything because you've been paying them rent, so it works well for both parties."

Accustomed to uncertainty, contract manufacturers can only hope the industry's transformation works out for them, as well.

CHEMICAL AND FERMENTATION SITES EXITED BY PFIZER, 2005-2009

Site	Location	Sold to	Technology
Arecibo	Puerto Rico	Closed	Organic synthesis and oral solid dosage
Augusta	Georgia, USA	Closed	Organic synthesis
Cruce Davila	Puerto Rico	Abraxis BioScience	Organic synthesis and aseptic DP
Feucht	Germany	Fareva	Organic synthesis and oral solid dosage
Groton	Connecticut, USA	Closed	Organic synthesis
Holland	Michigan, USA	Closed	Organic synthesis
Loughbeg API	Ireland	Hovione	Organic synthesis and spray dry dispersion
Morpeth	UK	Nicholas Piramal India	Organic synthesis and oral solid dosage
Sandwich	UK	Closed	Organic synthesis and fermentation
Val de Reuil	France	Fareva	Organic synthesis SOURCE: PFIZER

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By: Clay Boswell
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