For everyone, entering the market late carries a price. Biopharma market dynamics have shifted focus from fermentation and cell culture to plasmids and viral vectors. There are few assets to buy, and only large-cap private equity (PE) firms and strategic buyers can afford the outlandishly high multiples they come with. Big CDMOs are electing to build, while middle-market PE firms are looking at new options in the form of emerging specialty biotechs and suppliers of specialty materials and equipment.
Passed the Inflection Point
When biopharmaceutical manufacturers want to access new production capacity, whether a small biotech preparing for the launch of their first drug, a large international pharma company with several new impending launches or growth in demand of existing products, or a CDMO looking to expand production or enter new sectors, the choice is to build or buy (excluding the option of outsourcing).
Companies looking to add capacity by purchasing existing facilities are having a hard time today. The build-or-buy equation, in fact, passed through an inflection point a few years back. Today, it isn’t possible to buy a company without paying exceedingly high multiples — up to a hundred times earnings in many cases. And there just aren’t many to find, either.
The buy market is, in fact, 100% overcooked. This has created challenges for lower-middle-market and middle-market PE firms. Their investments are dictated by their fund sizes, which for lower and upper-middle-market PE firms participating in the mammalian and the microbial space range from $300 to $600 million. These companies are geared toward deals with multiples in the teens. While larger-cap PE firms can afford to pay the current very high multiples, they prefer not to. As a result, strategic investments/acquisitions are dominating the market today. A typical PE fund will allocate 10% of the fund size to one transaction and then ask the Limited Partners (LPs) for additional investment capital or partner with a larger fund.
Shifting Investments
The focus of investments has also changed from traditional biotech — mammalian and microbial — to next-generation cell and gene therapy. Capital investments in the mammalian cell culture space were announced primarily in 2020, while investments in 2021 were pushed into the new modality space.
2021 also saw a series of acquisitions in the viral vector space. To name a few, AGC Biologics bought a commercial manufacturing facility from Novartis Gene Therapies, Thermo Fisher Scientific acquired Novasep’s viral vector manufacturing business, and Charles River Laboratories purchased two cell/gene therapy CDMOs: Vigene Biosciences and Cognate BioServices, which owned Cobra Biologics.
The Vigene deal is pretty interesting. It wasn’t the biggest deal and didn’t involve breaking-edge technology. Nonetheless, the multiple was very high — probably 50% more than what they would have been before the market experienced explosive growth. It is a clear example of how much entering into a market late can cost.
Paying for Time
Entering a market late carries such a high cost, because the companies for sale have been investing in themselves for years, and any buyer will be expected to pay for all of that investment over the time that has passed. In addition, once a market has experienced explosive growth, all the attractive targets have already been acquired, and there are few assets left to buy, the simple supply-versus-demand equation comes into play.
The end result is whole companies, carved-out businesses, or even individual facilities being sold at multiples ranging from 40-plus times earnings before interest, taxes, depreciation, and amortization (EBITDA). That is doable when buying a company for $20 million that has a profitability of $500,000. A reasonable level of CAPEX put toward growth can boost that business to $100 million. However, it is not so easy when buying a company with $30 million in sales and $3 million in EBITDA to face paying 40–100 times the latter. In that case, success hinges on forward projected earnings, which is quite risky, even in a hot market like cell and gene therapies.
Biotech Stock Decline
Acquisitions at crazy multiples is affecting biotech stock values. Up through March 2021, biotech stocks were increasing in value; some stocks increased as much as five times. Since then, however, there has been a continued decline, with a massive sell-off starting in September 2021 that is still occurring today. On average, biotech stocks are now down 30-40%.
And unlike the impact of the delta variant of COVID-19, which when it surged led to a temporary run-up in biotech stock prices, and particularly those of BioNTech, Moderna, Novavax, and other vaccine developers, when the omicron COVID-19 variant started to spread in Q4 2021, it did not result in a subsequent rise in stock prices and still hasn’t, despite the tremendous surge that is taking place today.
Indeed, those vaccine developers have experienced 40–50% drops in their stock values. Similarly, the large CDMOs supporting COVID-19 vaccine manufacturing, such as Catalent and Lonza, have also experienced a 15–20% selloff in their stock value in Q4 2021.
Big Companies Can Build
The big CDMOs, however, represent a good example of companies that have the wherewithal to build when they cannot buy additional capacity. Lonza, for instance, which already has a global Asian, European, and North American footprint across mammalian and microbial capacity, is investing massively — on the level of billions of dollars — at its Visp, Switzerland site to dramatically increase its capabilities in viral manufacturing.
Lonza isn’t the only one. The top four CDMOs — Lonza, Samsung, WuXi, and FUJIFILM Diosynth Biotechnologies — are not only driving the majority of the top-line large volumes, but they are also all making large investments in their existing sites: Lonza in Visp, Samsung in Incheon, Korea, WuXi in the Pennsylvania Navy Yard and in Dublin, and FUJIFILM in College Station, Texas and a new site in North Carolina, each at the $2–5 billion level.
Some PE Firms Are Deploying Risker Models
PE firms, of course, can’t build when they can’t buy. Although middle-market PE firms generally invest larger amounts in established companies and management teams based on scalability, capacity upside, and market growth matching, some are starting to act more like venture capital (VC) companies, investing in new companies with as little as $10 million EBITDA. Many smaller specialty companies — small plasmid DNA and viral vector companies in particular — that are reaching $3–12 million in sales are now being targeted for investment by middle-market PE firms.
Other PE firms, such as Dynamk Capital, are expanding beyond traditional biotech companies into the life science industrials space, investing in suppliers to the biopharma industry rather than just focusing on manufacturers of drug substances and drug products. They are looking at suppliers of unique starting materials, including antibody fragments and mesenchymal stem cells, advanced chromatography solutions, state-of-the-art laboratory equipment, and so on.
These component organizations each have hundreds or thousands of customers, with each individual sale being relatively small. VC companies do not invest in these types of firms, because there is high risk in growing a startup to a sufficient size. They need a lot of volume, people, and manufacturing space to transition from a mom-and-pop organization to something properly structured, which must happen before they can be really profitable.
With buying the only option and the available traditional biotech assets extremely limited and generally out of reach, middle-market PE firms must be creative. Investments in emerging specialty cell and gene therapy companies and in suppliers of specialty materials and equipment to the biopharma market are two opportunities that carry more risk than these PE firms are used to — but will keep them in the game.