As the industry re-evaluates how to conduct business in the midst of a global pandemic, new trends have emerged. In addition to a shift in how M&A is conducted, valuations are through the roof, and even depressed assets are sought after — That’s Nice Managing Director Nigel Walker explains what’s changed and offers his predictions for the rest of the year.
Reflecting on 2020’s M&A Activity
If you take a look at the beginning of 2020, a high volume of deals were projected to go through, with valuations at all-time highs. We saw perhaps a bit of softness with regards to the viral vector space and contract development and manufacturing for cell and gene therapy following some significant M&A activity in 2019, and as a result, there wasn’t really a lot to acquire that had real commercial value.
What’s left in the market right now is further consolidation. One such example would be Recipharm’s acquisition of Aesica and Consort Medical to create another ~$1.5 billion, fully integrated small molecule CDMO. Fareva acquired assets from Pierre Fabre for manufacturing monoclonal antibodies (mAbs) and for aseptic fill/finish, adding to their operations and making Fareva a fully integrated small and large molecule drug product and drug substance CDMO — joining only Thermo Fisher Scientific in that category group — and taking Fareva over the $2 billion mark. Similarly, Dow Pharma acquired assets from Famar, resulting in another $1 billion CDMO, and Piramal Pharma Solutions, a mid-tier CDMO with a global footprint focused on small molecule manufacturing, acquired a depressed OSD drug product facility from G&W Laboratories.
We can definitely find a pattern in these deals. More generic CDMOs are acquiring low-value assets, and mid-tier CDMOs, like Recipharm, are buying higher-value assets. The very top tier of the CDMO space is occupied by integrated, multi-technology companies like Thermo Fisher Scientific, who just acquired Qiagen (for more than 13 billion!) and thus additional assay and bioinformatics technologies and R&D expertise. It is notable that, among these three tiers of CDMOs, there are companies in each valued at $1 million or more. This is an exciting new phenomenon and a real 2020 change, in spite of the challenges that this year has brought to the industry. Although these were all deals initiated before the COVID-19 pandemic hit, communication following through to execute them continued during the lockdown period.
Kicking Off The M&A Process During a Pandemic
The usual process for acquisitions starts with interactions between the sell-side advisor working on behalf of the company looking to be acquired or to divest assets and the buy-side advisors representing parties interested in the acquisition. For a typical deal, the sell-side advisor would line up somewhere between 10 and 30 buyers for each one of their sell-side assets, and they would socialize the deal using a confidential information memorandum (CIM). A CIM is an overview of the key investment highlights, products and services, market sales and marketing, management team, financial results, projects, risk factors, and appendices; which would be distributed in a digital format.
Following the signing of a nondisclosure agreement (NDA) and receipt of the CIM, there would be a management presentation, which is driven by the sell-side advisor and involves the sell-side management, as well as venture capital or private equity firms, if applicable. These presentations have historically been conducted in person but, in 2020, they are mostly arranged via Zoom or another teleconferencing interface. Although we’ve all become accustomed to communicating this way over the last few months, it creates some unique challenges to deal-making: body language, the fidget factor, eye-line, general deceit, or honest body language communications are more difficult to determine in a teleconference.
This change complicates things on the buy-side. The buy-side needs serious scrutiny to determine whether there is any deception happening in those management calls to identify whether what they’re communicating is true or not. Conversely, this creates a clear advantage on the sell-side, whose objective is to focus on all of the positives and diminish any of the disadvantages of the assets — particularly among sellers who are less than forthcoming about issues with their assets.
That’s Nice has developed protocols for these virtual tours, where the buyers join via a Zoom call and are shown around the site via video by a site tour engineer.
Virtual Site Visits and Audits
The management presentation is followed by site visits, which are very typical right after a management presentation; this is another stage in the process that has been seriously complicated by the COVID-19 pandemic. If the buyer is investigating a site within the same state, this could be done in person, but that situation is highly unusual. Interstate travel remains challenging, and international travel is all but impossible. As a result, site visits have, by necessity, transitioned into a virtual site tour. That’s Nice has developed protocols for these virtual tours, where the buyers join via a Zoom call and are shown around the site via video by a site tour engineer.
While we continue to optimize how these virtual tours are conducted, they will inevitably fail to be as comprehensive as in-person site tours. The value is really in the details, and on a virtual site tour, it’s highly challenging to determine whether a piece of equipment shown is truly operational or has been properly validated. To actually feel the fiber of the company and get a feeling of whether the construction is solid, and if the equipment is in perfect condition, old and clean, or new and dirty is difficult. Obviously, you can ask those questions, but it’s a huge disadvantage to the buyer to not be able to enter the facility. As a result. the information about the engineering and the water for injection (WFI) system and all of the utilities — including when they were installed and how often are they validated, updated, and cleaned — becomes a lot more important with regards to a virtual site tour than it does on an actual site tour. Conversely, however, you can have 30 or 40 people from the sell side on the Zoom call, which is far more than would typically perform the site visit. We’ve seen some challenges with our customers on both sides of the equation.
Every site is typically audited by its customers annually. In 2020, however, audits can’t be performed because auditors can’t enter the facility. Our clients are becoming more advanced and savvier in how they approach virtual site tours because they have learned from conducting these virtual audits, whether they are just quality audits or full FDA audits. An FDA audit is needed to move through different stages of an approval and to get to a pre-approval inspection (PAI). So, the shift of audits has been a really big driver of change.
Under normal circumstances, the buy-side would send in their own audit team to do an audit before an acquisition, but today we are seeing customers looking more at previous audits from an external third party validation company like Lachman Consultants, as well as from the EMA, the FDA, or other global regulatory bodies. This serves as a validation of quality and regulatory standards and reveals if there are any patterns, systemic issues, shortcomings in data recording.
Because there are fewer deals in the marketplace, there are fewer opportunities to acquire, which means less supply, which drives the price up in every market.
Indicating Interest and Due Diligence
Following the site tour and audit, the buyer would issue an indication of interest (IOI), which is a non-binding expression of interest in moving forward toward the acquisition. Normally, an organization won’t spend outside money before an IOI, so it is at that point that they bring external consultants or big four accounting firms on board. This is where due diligence (DD) begins, which historically involves examining heavy volumes of documentation in a data room, sometimes with as many as buy-side advisors, 40 sell-side advisors, consultants, and the management team in a room for a period of 1–4 weeks.
Obviously, we aren’t seeing that scenario in 2020, but we are witnessing the virtual equivalent. While the sharing of documents can be handled well virtually, miscommunication can occur quite quickly. If you’re not doing daily conference calls between each side’s counsel, accounting firms, and quality teams, there will be a delay in the DD process.
That’s Nice runs both exclusives and non-exclusives — in non-exclusives, there might be four or five different buyers doing DD simultaneously, which means that you can easily have up to a thousand questions, with minimal duplication, which have to be allocated to either internal staff management or external advisors.
For a good-size exclusive deal, the DD period can be anywhere between two and four weeks, but on some of the larger deals, it can last up to 60 days. International deals always take a little bit longer, because you have to address different regulatory bodies. This year, we are seeing this process slowing down considerably, with DD taking twice as long because it is much more challenging for everyone to access the information and then virtually return it to the data room.
Because there are fewer deals in the marketplace, there are fewer opportunities to acquire, which means less supply, which drives the price up in every market. We are seeing surprisingly high prices, even for assets that are not lucrative or leading-edge technology. On the manufacturing side, which is where we focus, there are far fewer biologic assets on the market for sale. There are a lot of depressed, old big pharma old facilities sale, with 3- to 5-year supply agreements, some take-or-pay contracts. There are still some less entrepreneurial, privately-held businesses for sale.
Regardless, deals are still closing. Firms from outside the CDMO market — including PE and VC firms — are entering the market just to see what’s available because of the limited amount of companies. The classic adage holds that “Every company is for sale;, if the price is right.” From a realistic perspective, small molecule CDMOs are selling for 12–15 times EBITDA and large molecule CDMOS are selling for 18–25 times EBITDA, based around a robust previous 12 months and for 12 months pro forma.
We are seeing some new deals that are the direct result of COVID-19 and the industry’s response. With so many companies working on the development of COVID-19 vaccines, we have seen nearly all of the aseptic sterile capacities being bought up by Big Pharma and quite a lot of COVID-19 drug substance projects that are being started by companies that really have no experience in the vaccine space. My presumption is that you’re ultimately going to see a lot of botched batches and bad quality, because people are working on these projects with no experience in vaccines. You’re also seeing tremendous pressure, not only from the U.S. government, but from almost every government, asking “When are we going to have our vaccine?” This only increases the pressure on quality control, perhaps leading some companies to produce vaccine drug substance and drug product without the usual quality testing and attention to detail. I think we will definitely have some major headaches concerning quality, hopefully not impacting anyone’s health, but perhaps artificially giving people safety and solace prematurely.
Going forward, I predict that companies that are involved in vaccines will be valued at a much higher level. We’ve seen some of our clients that are publicly traded go to all-time highs in the stock market, with huge trading volumes and stock price increases of 1000–2000%. I think these outrageous numbers are going to stay with us until the definitive vaccine and producer(s) have been identified. I think that tremendous stock market values will push through to the end of the year and into early next year for companies associated with promising vaccines.
On the therapeutic side, I predict organizations with cash on hand will make some significant acquisitions that are probably going to be overvalued through next year. You have organizations that were maybe valued at 500 million or one billion that are now being valued at two, three billion or more. There’s been a wave of confidence on the consumer level that the pharmaceutical industry does have value, perhaps a re-evaluation of the public’s perception of the industry that I hope will stick around. And finally, I think we’re going to see an increase in investment portfolios that are more focused in on pharma acquisition and pharma investments.