Taking Over Big Pharma Plants

In the days when blockbuster drugs lined up like cherries on a slot machine, pharmaceutical firms didn’t know what to do with all the money they were raking in. So they parked some cash in manufacturing plants built in tax havens and in countries where they wanted to get products approved.

A few decades and many patent expirations later, these plants are often underused and no longer needed by the big drug companies that built them. Recent mergers are only compounding the overcapacity problem. Consequently, many drugmakers are backing away from manufacturing and looking to close or sell dozens of plants. They will gamble instead on outside suppliers.

AstraZeneca intends to outsource all its active pharmaceutical ingredient (API) production over the next five to seven years. Bristol-Myers Squibb, GlaxoSmithKline, Merck & Co., and Pfizer are scaling back the number of their plants by up to 50% and are planning to outsource as much as 40% of their API needs. “It’s 10 to 15 years too late, but better late than never,” Rob Bryant of U.K.-based Brychem Business Consulting says of the shift.

Custom chemical manufacturers have stepped up to the table as buyers of the unwanted plants. Over the past few years, companies as varied as Hovione, Evonik Industries, Aesica Pharmaceuticals, and Cherokee Pharmaceuticals have purchased pharmaceutical chemical plants once owned by big pharma firms.

The established firms among them say they need capacity, and midsized suppliers want to expand their capabilities. New entrants are creating entire businesses around former drug company assets. Yet after the hands have been shaken and the deals have been closed, all these new owners must turn previously in-house, often single-use plants into customer-focused, multipurpose operations.

Although nicely equipped and usually adorned with a supply deal, former drug industry plants are not always the right choice. Some API suppliers have effectively integrated big pharma facilities, and industry observers point to achievements in the formulation area. Nevertheless, even with lucrative contracts to produce legacy products for their new plants’ previous owner, other buyers have found success elusive.

Financial problems at now-defunct Inyx, which bought an Aventis plant in Puerto Rico in 2005, led the company to fold and ultimately renege on supply contracts. Likewise, consulting firm PharmEng Technology set up Keata Pharma in late 2007 around a former Pfizer plant in Canada and a three-year supply agreement. The company subsequently declared bankruptcy, and its plant is now in the hands of another new entity, Pillar5 Pharma, whose chief executive has managed the site since 1998.

For sellers, on the other hand, the transaction is almost a guaranteed winner. “There is always a benefit to the seller because it gets a plant off its books and improves the bottom line,” Bryant says. Sellers also avoid site closing costs and bad press from firing workers. Efforts to close plants can be hampered by environmental issues and labor laws, especially in Europe, that may involve union negotiations, pensions, and severance payments.

Still, Bryant would rather see plants closed than handed over. “If you look at the whole transaction, the pharma chemicals industry never benefits,” he says. “This spare capacity really should be taken out, but unfortunately there are people who think it would be a neat idea to buy a plant because it gets them into a stronger relationship with a pharma company.”

Two Indian companies have already abandoned two former drug company plants that were acquired in recent years in an effort to build relationships with customers. In late 2008, Shasun Chemicals & Drugs decided to shutter a former GSK API facility in Annan, Scotland, calling it “no longer viable” in light of customer demand. GSK had opened the plant in 1980 to manufacture the API in its big-selling acid-reducing drug, Zantac. Chirex bought the plant in 1997. Chirex later became part of Rhodia Pharma Solutions, which Shasun acquired in 2006.

Over the past 11 years, the different owners have invested more than $80 million at the Annan location. In September 2009, with help from the Scottish government, U.K.-based Phoenix Chemicals bought the site, eager to apply its continuous-processing technology to the large-scale regulatory-compliant production there.

“The site is open and getting ready to produce in March,” Phoenix Chief Executive Officer Colin A. Leece tells C&EN. The company has reemployed 35 people, or about half the previous staff, and will have more than 50 employees by year-end, he says.

In mid-2009, another Indian firm, Piramal, closed a former Zeneca drug plant in Huddersfield, England, and is now disposing of the assets to an as-yet-undisclosed party. Piramal has been moving projects from the plant to its facilities in India and Morpeth, England. It bought the Morpeth plant from Pfizer in 2006 in a deal that came with supply agreements worth up to $350 million. Pfizer recently renewed some of those contracts.

Indeed, supply agreements offered by drug companies can help make their unwanted sites attractive to buyers. The contract values vary, but they are usually enough to justify a deal, says Kenton Shultis, a partner in the Syracuse, N.Y.-based consulting firm Rondaxe. For the buyer, he adds, “it’s key to have a base load that can be relied on for at least several years from which to build a business.” Established companies get a quick boost in sales.

The challenge, however, is keeping a grip on this business by being an efficient and competitive manufacturer, Shultis says. Companies run the risk that if they don’t find more business to fill the acquired plant they will face a precipitous drop in revenues when the contract ends.

Evonik recently acquired Eli Lilly & Co.’s Tippecanoe Laboratories site in Lafayette, Ind. After assessing other potential targets, the German company was attracted to the high standards of the assets, a broad technology portfolio, and the skilled employees there, says Hans-Josef Ritzert, head of Evonik’s exclusive synthesis unit.

The main driver was Evonik’s need for large-scale API capacity to meet growing demand for outsourced drug production, he says. Along with 650 employees, the purchase gives the Evonik business a foothold in the U.S., where it will be supported by a nine-year API and intermediates contract. “Due to the size of the site and the large available capacities, the long-term contract with Lilly allows Evonik to smoothly grow into these large capacities,” Ritzert says.

Following a different strategy, Portugal’s Hovione acquired Pfizer’s Cork, Ireland, facility last year to “buy capacity, not a supply agreement,” Hovione CEO Guy Villax says. He admits the site may lose money for two years, but the rationale was to add large-scale capacity from which innovator drug company customers could launch products.

“The plant is a multipurpose one that was originally designed for custom synthesis, so it doesn’t have the drawbacks of a tailor-made plant,” Villax explains. Built in 1985 by Angus Chemical and later owned by Hickson International, the facility had been producing the API in Lipitor, Pfizer’s blockbuster anticholesterol drug, for more than a decade.

Hovione will initially operate the Cork site with about one-third the workforce that could be employed at full capacity. Within two weeks of the sale being completed, Villax says, former Pfizer employees once concerned only with Pfizer’s needs “had their sales hats on” to handle visits by Hovione customers. Since then, the company has worked hard to introduce its quality and computer systems and to train employees. Pharmaceutical chemicals have already been moved into production at Cork.

Almost by definition, drug company plants that are up for sale aren’t running at full capacity. So even with production contracts in place, it may take a few years before a plant generates significant revenues, says Adam Sims, commercial director at Aesica, based in Cramlington, England. A formulation facility may produce income faster, but either way it will take time to find customers.

“The drug industry is very conservative and quite slow to change, so you can’t take on a site with employees unless you have very deep pockets or you have got some business to help you cover the transition from big pharma to contract manufacturer,” Sims says.

To create a custom manufacturing business alongside its generic API operations in Cramlington, Aesica bought two drug company sites in the U.K.: an Abbott Laboratories formulation facility in 2007 and a Merck API plant in 2006. “Building strategic relationships with big pharma is a lot easier if you buy sites off of them,” Sims contends.

Aesica’s acquisitions have positioned it as a full-service provider to many large pharma firms, he points out. Since 2004, the company has nearly trebled in size, in part due to a $300 million multiyear agreement with Merck. Another reason the Merck deal made sense was that, as a small company at the time, it was “geographically within our grasp,” Sims says.

A similar next-door opportunity arose for France’s Minakem when AstraZeneca was looking to sell its plant in Dunkirk, France. Minakem CEO Frédéric Gauchet says he wasn’t keen on the idea of taking on a former pharma company site. But the plant was nearby and Minakem needed capacity, so Gauchet bought it in May 2009.

Minakem had invested in lab and pilot-plant facilities at its Beuvry-la-Forêt location a few years earlier. With Dunkirk, he says, “I had the opportunity to get more value out of my R&D resources by having an additional factory that I can manage from the same location.” Dunkirk’s large-scale reactors also complement Minakem’s smaller multipurpose operations.

Minakem has been an active buyer of fine chemicals businesses, but Gauchet waited until the company achieved a certain scale before adding the Dunkirk plant. “You need to already have a good team, and be sure you have enough R&D and commercial resources to manage the integration,” he advises. “You have to have completely filled your capacity before you welcome additional industrial capacity.”

Acquiring a former pharma site may be relatively easy; operating it is almost always harder. If the plant is designed to run a specific process or uses technology developed elsewhere, it may lack the multipurpose equipment and employee skills that custom chemical firms rely on for product development and process scale-up.

“Most of these plants are pretty inflexible, and even if employees wanted to improve a process, they haven’t been allowed to,” Bryant says. He does believe that contract manufacturers can find good investments by picking and choosing intelligently but suggests they should be skeptical about plants that change hands repeatedly, have become rundown, or have limited scope.

Established pharmaceutical chemical manufacturers are arguably in the best position to know what they are getting into and how a site shapes up. Judgments differ, though. When executives speak with C&EN off the record, they often mention studying but passing on a drug company plant that was later bought by a competitor.

Gauchet says Minakem was fortunate to find a plant that was designed for multipurpose use and required few equipment changes. “For us it is mainly a question of training people to do new chemistry” and to cope with quality assurance systems from many different clients, he says. “It’s most important to properly transition your human resources, share your strategy, and explain the difference between the merchant business and the captive business.”

As a merchant operation, “you become a supplier of services and products and have to fulfill many obligations that you do not really have when you are in a captive supply chain,” Gauchet explains. “We have to go to the open market for selling custom synthesis to many companies. The way to address the business is not the same, and you need to organize a transition between the captive business and the competitive business.”

Gauchet believes it will take three years to fully train all of the Dunkirk plant’s employees. Meanwhile, Minakem started its first new project in the facility last summer and plans on moving more projects there this year. The company will also produce the asthma drug budesonide and antiulcer drugs omeprazole and esomeprazole for AstraZeneca.

At Cherokee, President John Elliot is happy to get “world-class infrastructure” and an “empowered workforce,” but he acknowledges that changes were needed in the company’s former Merck site. The Riverside, Pa., facility can do sophisticated chemistry at a high level of quality and compliance, he says, “but there was limited flexibility, and cost was as defined within a major pharma operation rather than within a contract manufacturing operation.”

Although the site came with a five-year supply agreement worth up to $200 million per year with Merck, it had underutilized lab, pilot plant, fermentation, and warehouse units. Cherokee is expanding multipurpose production but leaving certain other aspects untouched. “Clearly you don’t mess about with quality, compliance, and environment, health, and safety,” Elliot says.

With its 2008 purchase from Merck, Cherokee emerged as a new entrant in the contract manufacturing arena. Elliot says it can offer services from bench-scale chemistry to full commercial production. It hired experienced managers to bring in business and build the organization beyond the Merck products it inherited.

Elliot believes that effective communication is critical when trying to transition from a relatively stable big pharma environment to a flexible contract manufacturing organization. A new player must inform external customers of its capabilities, he explains, and internal communications must ensure that employees buy in to the change in business strategy.

No one denies the differences in culture and mind-set between the entrepreneurs who buy a plant and its pharma company workforce. But change can be good. Cherokee plant manager Justin Noll believes that most of the former Merck employees, like him, are excited by the new sense of freedom and involvement that pervades the business.

“There is rigidity about how you do things in big pharma,” he says. “Being able to execute ideas and being asked to respond quickly gives a lot of people opportunities that they didn’t have before.” After many years with GSK, Elliot too senses an urgency and faster pace. He says he now must be more self-sufficient because fewer people in the organization are “looking after you.”

With the new freedom, though, comes unpredictability. “In the big pharma world, you have a very long planning horizon,” Noll says. At Merck, he and his colleagues had ample warning about what was coming down the pipeline into the facility. Each new drug was a major event, and work typically focused on long campaigns to make a single product. “Handling two products in parallel would be the exception,” he says. Now as part of Cherokee, employees must manage changing between multiple products from different customers.

According to Elliot, the Riverside plant’s site improvement program shows that employees are stepping up to the challenge through greater input. “People are very tuned in to the fact that eliminating waste, driving up productivity, and improving performance of the processes are not only cost-saving activities but also a route to growth for a small company,” Elliot says.

Making former pharma operations competitive is one change that custom chemical firms believe they can bring. Because contract manufacturers run facilities as profit centers, not cost centers, they say they can be significantly more cost-effective than the former owners were. “Even though we are aiming to make a profit, we’re still cheaper than the internal solution,” Aesica’s Sims says.

After product quality, a drug company’s foremost concern is security of supply. “Pharma-run facilities have a different purpose than a contract manufacturing organization,” Rondaxe’s Shultis says. “The pharma viewpoint is to get it done now and make sure there is never a problem. Any efficiencies that might interfere with certainty of supply are really not relevant, or even cost-effective, in the grand scheme of things in this view.”

In contrast, because contract manufacturers have an incentive to lower costs and improve capacity utilization, some executives see the pharmaceutical industry’s excess capacity as a problem of its own making. “The plants that actually need to shut down are still within big pharma,” Sims says.

Minakem’s Gauchet takes a broader view, putting responsibility for the industry’s excess capacity on any company—drug firm or contract manufacturer—that continues to operate facilities that haven’t kept up with the times. “There definitely is overcapacity in our industry, but I am afraid that there is also a lot of capacity that does not fit the standards of our business anymore,” he says. “We should expect to see these factories shut down.”

Elliot, meanwhile, offers his colleagues at other companies a word of caution. “Not every plant that becomes available is a good opportunity to enhance the contract manufacturing capability of either a new entrant or an established firm,” he says. “You have to do your due diligence and be very selective to ensure that the capabilities fit the business strategy you are taking forward.”