Value creation through M&A has long been plagued by lackluster returns. McKinsey & Co. highlighted the difficulties of achieving long-term shareholder returns by analyzing more than 15,000 M&A deals over a 10-year period. The outcome was startling: large M&A deals tend to fail more often than succeed. But some M&A deals burst with goodness: they demonstrate strategic intent, a fit, are  reasonably valued, and are built with an after-thought for integration. Aspen’s deal with Merck & Co. (MSD outside the U.S.) exhibits all four characteristics:

Strategic Intent
Aspen does not have API manufacturing. MSD does and wants to get rid of it. In fact, Aspen gains two technology platforms in the deal: chemical as well as biochemical manufacturing.

Perfect Fit
Aspen’s generics business is strong in South Africa. It intends to strengthen its franchise in other emerging markets such as South America and Asia. Merck has a well-established product portfolio in those emerging markets and is happy to dispose of it. Aspen also gets niche products, which is a way to diversify away from a pure generic play.

Valuation
The price tag for the manufacturing assets: approximately €36 million, likely a fraction of the book value tied to the sites. Pro-forma revenues generated by the sites amount to approximately €284 million, yielding a transaction value of 0.13 times sales. In profitability terms, the picture may be different, but regardless, this type of volume catapults Aspen into the top five API CMOs globally, for a bargain price.

As to the option on the product portfolio, it was negotiated at 2.4 times sales, reasonable by some current valuations which are north of 4 times sales.

After-thought for Integration
Aspen structured a $600 million option for a portfolio comprising 14 products, rather than buying it outright. It allows for a phased approach to the integration work required and matches the limited number of corporate staff available at Aspen.

But beyond the technicalities, the Aspen/Merck deal is trend-setting in one respect: it unlocks an innovative consolidation model for the pharmaceutical contract manufacturing industry (CMOs). Indeed, the industrial ecosystem for CMOs has always been limited in its ability to consolidate, due to government regulations. Simply put, one could not shut down an under-utilized or inefficient production site and consolidate manufacturing into a more efficient one. Regulations require a stringent regime of validation and studies that make such drug product transfers prohibitively expensive. Adding shutdown costs to the mix, most consolidation projects become economically unworkable.

For many years, the industry found a loophole: Big Pharma companies would offload drug manufacturing sites — along with their liabilities — to their CMO partners with long-term supply agreements. As long as the agreements were in place, the concept held. But many transactions imploded (and are likely to continue to) once supply agreements were up. Lonza, a leading player in the industry, mothballed and subsequently sold a site it acquired from SmithKline Beecham in 1992. Piramal, one of the largest Indian players, closed a site it acquired from Avecia in 2005, while Shasun, another large Indian company, closed one of the plants it acquired from Rhodia in 2006. Merck had to buy back a site it sold to PRWT in 2008 and subsequently closed it down in 2012. Other deals such as Evonik’s acquisition of Eli Lilly’s Tippecanoe manufacturing site in 2009 are still running under the blanket of a supply agreement.

Aspen structured a deal that is both backward and forward integrated:

• Backward integration: The Merck site manufactures, among other things, heparin, which is needed to produce another drug, Fraxiparine, which Aspen intends to acquire from GSK.
• Forward integration: Aspen negotiated to acquire a portfolio of 11 drug brands. The APIs for those drugs will be manufactured in the sites currently being acquired.

The blueprint comes with another major benefit: it is compatible with current regulations and does not require policy changes. Regulations have kept the pharma industry on the right track, enforcing a level of quality that is necessary to fully meet the expectations of public safety, enabling swift tracking of offenders and their banishment from the ecosystem.

But a challenge remains: most CMOs do not have the flexibility to forward-integrate into drug products, as they typically focus only on manufacturing. This may set the stage for a reshaping of the industry, encouraging CMOs to move up the value chain, blurring even further the lines between them and their pharma clients.

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Andrew Badrot is the chief executive officer of CMS Pharma, an M&A and corporate strategy advisory firm serving the pharmaceutical, chemical and industrial sectors. Prior, he was the vice president of Strategy at Lonza. He can be reached at [email protected].