Patheon is one of the leading contract development and manufacturing organizations (CDMOs) in the world, having come together through a merger of the same-named company (at the time privately held by JLL Partners) and the pharma manufacturing assets of Royal DSM N.V. in 2014. This past summer, it had a successful IPO, returning to the public-capital market and currently has a market value of around $4 billion. Both before and after the IPO, it has held discussions to acquire additional manufacturing sites; there are 24 sites in North America, Europe and Asia currently.
Jim Mullen, CEO, joined the company in 2011, coming from the CEO position of Biogen Idec, and SmithKline before that.
Pharmaceutical Commerce sat down with Jim to learn about the outlook for contract services to pharma; here’s what he had to say.
1) Patheon has recently successfully completed an IPO, becoming a publicly traded company again. What can you say about the IPO process, and what should Patheon clients expect from the company as a result?
There were two primary purposes for the IPO: First, as we get larger and have more strategic conversations with the large pharma companies, having transparency of financial health is increasingly important to those customers. Second, we still have significant ownership represented by the private equity firm JLL and by Royal DSM, which contributed significant assets to the company a couple of years ago. Both companies view this as a financial investment—that’s what private equity does—but also for Royal DSM, they need a pathway over time to monetize this asset. A tertiary benefit is simply the capital that is now available: we have been acquisitive in the past and we intend to continue to be acquisitive going forward. Being public gives us one more tool toward that end.
There was some luck in the timing of going public; in theory we were ready to go last fall, but it was a horrible environment, and not much better in Q1-Q2 this year. But this summer, we had the kind of company that investors were more comfortable with—there are earnings, there’s growth and a valuation that will trade on fundamentals such as earnings per share.
We started the process a while ago, educating potential investors about our story. The good news is, most of the people we were talking to understood that this story was not brand-new and were able to get their arms around it. We were met with enthusiasm; in the end our book was oversubscribed 12X, and that led to a successful IPO.
2) What is that ‘story?’ How does Patheon position itself in the industry today and going forward?
Our contention is that there ought to be bigger players in the pharma development and manufacturing space. One of the things that has hindered the industry growth of CMO space is that very few companies have the necessary breadth of offerings and scale. When we talk to customers, whether the big guys or the medium guys, a common refrain is, “My supply chains are too complicated and getting too hard to manage. I’d like to consolidate my supplier base.” But these customers run into a math problem: there are not enough big guys. We think two or three companies need to emerge out of today’s environment. We’re one of the bigger players, and we think the industry is at a tipping point. With the right kind of scale, pharma companies can now engage in a more strategic conversation about where they are going with their supply chains. In 2011, when I came to the industry, all the conversations were very transactional—product-by-product. Now it will make more sense to have a strategic conversation.
The legacy of the pharma industry is that it was a very vertically integrated business; outsourcing was a relatively new concept to the industry, although most of today’s companies are quite experienced now. So it’s time to look at the pipelines that pharma companies are working on today and what will be required to commercialize their products. The future doesn’t look like the past, and internal manufacturing networks are going to have to be significantly modified over the next number of years.
Second, the industry is seeing more pricing pressure and more pressure on the entire P&L statement—return on capital from manufacturing assets is about zero. Pharma doesn’t get paid for their manufacturing assets; they get paid for IP, clinical insights and great commercial capability. What I call an ‘asset heavy’ model is moving toward an ‘asset light’ model that is more capital efficient. Being asset heavy is what we have to be—that’s our business model—but do these guys really need the heavy assets that they have beyond R&D?
Here’s the big-picture perspective: our industry is around $40 billion today, very fragmented with many specialized players, and most successful companies growing in the low single digits. Our breadth of services is relevant to about $30 billion of that market. The contract research organization (CRO) space is about the same scale, with the leading players each owning 10-15% share of the market. Our long-term goal, if you will, is to be at that scale, which is 2-3 times what we are now.
3) If at least some of that growth will come through acquisition, what assets are you looking for now?
We have done technology acquisitions to fill in our portfolio. One area of interest is small molecule formulation and production. It’s pretty clear that a majority of products coming through pipelines will require specialized formulation technology. There are not too many simple white pills that you granulate, blend, compress and take to market. Having a full suite of formulation technologies is essential, so we’ve filled that in.
In biologics, we’re one of a few companies that runs every platform that’s used in biotech—perfusion, batch fed, a variety of formats, we have made strategic investments in this area. Biologics pipelines continue to increase both in absolute numbers and as a percentage of pipeline. And the sterile or aseptically filled parenteral products market is very tight. We continue to invest in our own facilities, but if we could find another parenteral or biologics facility that’s high quality, we’d be interested. Geographically, we’re strong in North America in oral solids, while in Europe we are not so strong in oral solid dose capacity. We’d like to expand our footprint in Europe.
4) Patheon has an unusual range of clients, from Big Pharma to small biotech startups. What can you say about the complexity of handling such a wide range—and globally—of clients successfully? What are the problems of working with emerging companies as opposed to established ones? What’s the typical onboarding process for a client?
Our clients range from Big Pharma to small startups, but there is a common theme to the onboarding process: tech transfer. While we have every one of the Top 20 firms as clients, a core part of our strategy is that 80% of new molecules are held by small and emerging companies. Our strategy is that if you get involved early, it’s a very sticky business. We like you to start here in the developmental phase and then commercialize for you—that’s a fundamental part of our strategy.
Onboarding starts by getting customers into a room with the people who are actually going to do the work, technical people who understand the business from the other side. If we can’t get them to come to us, we go to them. We pride ourselves in tech transfer, with business and project managers responsible for all the big-picture things and all of the details that go into tech transfer. We’ll do more than 100 of these this year, two-thirds from outside to inside, and the other third from our development scale to commercial. This is core to being effective in this business. We like to say, if you can draw the molecule, we can figure out how to make it—synthesis pathways, scale-up, process design.
5) Patheon promotes “OneSource” as a new and better way of engaging with a CDMO. Doesn’t this model go against the strategy of contracting with best-of-breed providers in distinct service stages?
This question comes up all the time. The history of the industry was that there weren’t companies from which you could obtain APIs, develop commercial services or provide finished dosage forms. We’ve chosen to build our business not where the industry is today, but where it is going to be. Our customers keep coming back to the problem of supply chain complexity, which we offer to reduce by putting the process in the hands of one company.
By the way, if we need to access specialized services from a third party, we do that too. We can manage that whole process. Take the example of an emerging customer that found an API supplier in China; well, fine, but why should they do that activity when they have only one or two products, and managing that sourcing is a distraction for them? We source API for 700 commercial products; we have relationships everywhere. We have the ability to manage import and export and all that it entails. They shouldn’t be bothered with the things that we do every day, all day for our clients.
Think of us as a general contractor in a construction project. Customers ask us, can you manage this for me? And we’re happy to do that.
6) You’ve commented on parts of Patheon’s business being capacity-constrained. What can you say about capital investment in Patheon going forward, in API, development or commercial production?
Our capital investments are aimed at areas that are growing rapidly and have strong future growth. Today, this is in aseptically filled injectables, whether in vials, lyophilized prefilled, cartridges or drug-device combinations. The good news for us is that we have a lot of ability to expand capacity in this area. To my surprise, capacity is very tight for small-molecule API capacity in North America and Europe. For years, this capacity has been moving to Asia; but as the chemistry has become more complex, and the production scale has shrunken, manufacturers are more at ease locating their capacity closer to home in the West. So we have made incremental investment here.
We are also expanding in what we call our “condo” capacity. This started with some sterile-fill products, and now is becoming popular with biologics. The concept is straightforward: every year, there are a handful of projects that require highly specialized equipment or manufacturing processes, and the drug owner wants a high degree of control over production. So, we offer to locate that equipment in one of our facilities. We can help build, validate and run it, and the owner can choose to manage the production himself, or to have us run it. The advantage is that the facility is surrounded by all the other infrastructure—utilities, warehousing, quality control—that needs to be validated and approved, which is already in place in our facilities.
Another broader approach is flexible manufacturing. Time and again, we sit down with a client to do a forecast of their product volume, and the forecast is inevitably wrong, but I know from my experience on the other side that these forecasts are inherently inaccurate. In the face of uncertain forecasts, Patheon has the facilities, equipment and process technology expertise needed for operations and risk management, in essence flexing to meet forecast fluctuations. We encourage some clients to, in effect, take out an insurance policy by reserving capacity, paying us the opportunity cost, and then benefitting if their forecast was too low. Conversely, if the forecast was too high, they pass the excess capacity back to us, and we put it to use elsewhere. A related aspect of this insurance is to address business continuity concerns. If you currently have a sole source production arrangement, you’re only one fire or flood away from a bad day.
A final aspect of how we look at capital and where we invest is the internal networks of our customers. At today’s Big Pharma firms, their internal networks are great for the products that they have, but not necessarily for the future. The question is, can we help them migrate their network in a responsible, cost-effective way that maintains business continuity? This could be everything from selling us some of their capacity, or having us optimize their capacity, closing some things down and moving products around, or any variation on that theme. I call this the “hotel model”: hotels like the Ritz-Carlton are typically not owned by them, but they manage the property for the actual owners.
Overall, we encourage our clients to look at their business in new ways, and to take what are fixed costs and variabilize them. For example, I’ve had a discussion recently with a client at a good-sized company with a dozen products in development, who was challenged on what resource levels and skill mix he needed. But on our side, we had 500 such development programs in 2015—for us, it’s not that much of a variable. With so many programs, we don’t have to deal with the peaks or valleys in commercialization. His problem of great volatility isn’t a problem at all in our network. This was a win-win situation for both of us.
7) I’m assuming downstream manufacturing—encapsulation, fill & finish, packaging, etc.—are lower-margin businesses for Patheon. Will you be investing in this area? In particular, does Patheon have a program for enabling serialization/traceability on its packaging lines?
We have a platform that makes it as easy as possible for a client to go from a developmental program to commercial shipments—draw me a picture of the molecule, and tell me what package you want, and we’ll take it from there. The fact is, for packaging alone we’re the No. 2 or 3 contract packager in the US today. It’s an important core service we offer. All of our capabilities have different margins, but if you can run them at scale, you can make an adequate margin.
It’s still early days on serialization; I think we are going to see a version 2.0 or 3.0 as everyone converges on the market. Nevertheless, we are actively putting serialization capabilities on more and more of our packaging lines. In global context, we had to be ready for early adopters like Turkey, where serialization is required today.
Serialization is an interesting data management problem. For us as a contract packager, the challenge is that each customer has a slightly different vision of what they think they need. I absolutely believe that eventually, it will be a source of insights into commercial channels, but that’s yet to be seen. Besides the compliance requirement, the value will be to tap into your computer and find out where your package is—that will be valuable for inventory management as well as field recalls and sales data.
8) You’ve seen many changes in the pharma industry overall, and the CMO business specifically, during your career. What do you see in the future, given the growing criticism of pharma profits and drug costs on healthcare systems and consumers?
I’ll cite three vectors of change that I see. One is the importance of innovation in pharma and the ability to create value. New products with patent protection, great clinical outcomes and the ability to support these products commercially is what will make pharma successful in the developed world. Pharma should focus on the things that create value, and outsource to providers like us, CROs and other world-class suppliers for the rest.
A second vector is what is happening in the developing world, where most of the market need is filled by products that we would consider to be generics here in the US. In those markets, pharma looks more like a consumer-goods industry, where brand is most important. For example, GSK is doing a great job in India today; many people there think of GSK as a domestic company. People there and elsewhere don’t look for product brands like, say, Tylenol or Advil; they look for the J&J or GSK corporate brand, and make their purchasing decisions accordingly. Here in the US, the opposite is true; the product brand is more important than the corporate brand. A third vector is the pricing pressure being experienced in most of the developed world. Really, the only free-pricing market left is the US, and I don’t know how long that’s going to last. New pricing models, based mostly on outcomes and value to payers and providers, are going to evolve. The availability of big data on the payer and provider side from data collection systems will drive this. That’s the route for pharma to get paid for innovation. We don’t need more fiascos like what’s been seen recently over price hikes for longstanding products.