Buying A Manufacturing Facility And Turning It Into A CMO

By Alan Horowitz

Real estate has a variety of ways of being valued: original cost, replacement cost, and market value being examples. Real estate valuation plays a role in the pharmaceutical industry when one is considering buying a manufacturing facility. Today, such facilities are often sold by pharmaceutical companies and bought by CMOs with the plan to turn them into contract manufacturing facilities.

Original cost may not play much of a role in today’s market, but replacement cost and market value do. In the current market, the market value of a facility (the intersection of the price the seller is willing to take and the offer the buyer is willing to make) is typically much less than the replacement cost (the cost to build a similar facility from scratch). Which helps explain why many CMOs are interested in buying existing facilities — though maybe they should not.

“No one pays full dollar for these manufacturing facilities. You pay cents on the dollar,” says Nick Davies, principal in Nick Davies & Associates, a pharmaceutical and biotech consultancy. Ten years ago, he says, few facilities were on the market. But with the consolidation that has taken place within the industry and continues to this day, many facilities are now for sale. “The big pharmaceutical companies have written off much of the factory, and the price the purchaser pays will be a fraction of what the seller paid to build it. It’s a buyer’s market,” says Davies.

The Benefits Of Speed And An Immediate Stream Of Income
The appeal of buying an existing facility is not only initial cost. Many of these facilities are up-and-running, making the time to get the facility operating very short. Stuart Hinchen is cofounder and president of JHP Pharmaceuticals, which bought a facility in 2007 which now manufactures products for itself and others on a contract basis. He notes that construction of a new facility can take two to three years. Add another year or two to get one’s products approved, and the time frame for a new facility from start to operations can run as much as four to five years. “It takes years and years before you can produce income with a new facility, and all the time you are shelling out money,” says Hinchen.

Says Davies, “If you build a new factory, you’re going to pay hundreds of millions of dollars. Then you have to recruit and train people. It will probably take three years or more. You can buy a factory today with all the equipment and products and employees and have it working tomorrow. And then you can bring in your own products over the next 6 to 12 months. That’s substantially faster, and you don’t have the depreciation that comes with building a new facility.”

And then there’s the fact that existing facilities are often staffed and producing product, which means the new owner has a stream of revenue coming in immediately. This is definitely appealing, too.

Cheap, But Fraught With Risks
Speed to market, low up-front costs, and an instant revenue stream are big pluses. But before you rush to buy, recognize you may be running some serious risks.

One is that, though the facility has passed muster with the U.S. FDA, the European Medicines Agency, or other regulatory body, it may be out-of-date. “I am aware of facilities that have been grandfathered in for a long time and that have old pieces of equipment that still function, but are not up to the standards of modern facilities,” says Peter Calcott, president of Calcott Consulting. “So, they are not as modern and efficient as they should be, and they pose a compliance risk.”

In addition, while the purchase price of the plant might be relatively low, its ongoing expenses might be high. “A lot of these facilities change hands at little or no cost. You take on the ongoing costs, and you can have the facility for little or nothing. But very rarely do you find a facility for sale that’s cash-flow positive,” says Hinchen.

One more negative to ponder: Why would someone want to sell a plant that was a good plant? Be wary of any facility that is put up for sale. “Sometimes, you get a very straightforward answer of why someone wants to sell, and sometimes it is oblique,” notes Calcott. Internal issues with the plant might be a reason, such as regulatory personnel problems, and if you buy the plant, you will be buying those issues.

Other times, the issues might be internal to the parent company, but external to the plant. The company might have excess capacity because of a merger or because it built the plant for a product it expected approval for, only to find the product was never approved. Calcott is aware of a company that sold “a fantastic facility” at a bargain price. Why? Because the company was being pressured by hedge fund investors to raise money.

Due Diligence
Certainly, buying an existing plant for the purpose of turning it into a CMO entails risk, but it also presents opportunities. To make sure you get what you want, thorough due diligence is essential.

First, gather a knowledgeable due diligence team. Davies says he’s seen buyers rely heavily on their attorneys for due diligence. Sure, the legal and contractual aspects of the purchase are important. But so are many other aspects. The due diligence team needs to include those experienced with human resources (if taking on employee liabilities), technical processes, engineering (to understand the facility’s capabilities and condition), manufacturing, environmental regulations, and regulatory compliance, among others. “Quite often you find people turn up with just a lawyer, but the lawyer doesn’t have the breadth of experience that is required,” Davies warns.
Sellers will likely provide an extensive due diligence package. This of course needs to be thoroughly vetted. But go beyond what the seller tells you if you want to learn about any potential problems or shortcomings.

An example is a plant that has ongoing operations where you think you are buying a complete package, only to find out differently when you become the owner, warns Calcott. Procurement for the plant may have been centralized at the former owner’s headquarters, and only receiving was done at the plant. When you take over, you will need to put a procurement process into place. He’s seen situations where the quality control staff was partially at the plant and partially at headquarters. Again, that means you will need to expand the plant’s existing internal personnel capability.

In fact, if you are buying a plant with ongoing operations, personnel issues are a major consideration. Employees are, after all, one of the plant’s major assets that you do not want to lose. For example, as a newcomer, you might think you know the facility’s strengths and weaknesses, but to really know where the problems are, you need to go to the people who know from experience — the plant’s current employees. They also know the systems and have the institutional memory, which makes them important contributors to your success. Calcott has seen new owners come in and fire everyone the first day they take over and then hire back whom they want. “That way you lose good people. It hurts morale. It’s just not a good working strategy,” he says.

Of course, pay close attention to how well the regulators like the plant. Clive Bennett, president and CEO of Halo Pharma, bought a plant from a large pharmaceutical company in 2006. He warns against buying a plant that is “damaged goods.” “It must have a good regulatory history,” he says, and “you need experienced people at the site.” And if you are planning to ship product to various countries, the plant needs to have the regulatory approvals for those countries.

You could just buy a vacant building and do with it as you want. This was the strategy used by Harmony Labs, which bought a 130,000-square-foot vacant shell of a building. “Outside of the building’s four walls and ceiling, the architecture firm had carte blanche to design each manufacturing suite, each filling line, dedicated kitting areas, warehouse space, etc.,” says Roger Martin, the firm’s vice president of sales and marketing. “This forethought shows when clients tour the facility.” In fact, the company just added 15,000 square feet.

Create A Retention Strategy
Calcott recommends immediately putting in place strategies to retain key personnel. This includes creating a positive work environment, a commitment to stability, and opportunities for advancement and growth. Do not make promises you cannot or will not keep. “If you fool them once, they will never trust you again,” says Calcott. And do not think money will salve all injuries. “You can give people money, but if you create a bad work environment, your people will be looking for work elsewhere,” Calcott notes.

As you make decisions regarding the plant, keep the plant’s senior people in the know and involve them, so they have ownership in the decisions. Remember that it is the good people who will leave first, so if you do not immediately put into place a retention strategy, you may be left with low-performing employees.

If the plant is located outside the United States, be sure you know what you are getting into employee-wise. Europe, for example, has very strict legislation regarding transferring and firing employees, says Davies. Even in the United States, location can matter. If the plant is in the Bay Area, New Jersey, or other another location where other pharmaceutical plants exist, the chances of your good people leaving is relatively high because their opportunities are likely plentiful. If the plant is in a place that offers few opportunities, your chances of retaining employees is better.

Be Realistic About CMO Opportunities
Be realistic. Do not think that because you now have a facility, business will come knocking at your door. As noted, a lot of capacity is available, which means you will likely face considerable competition. When Hinchen bought his plant, he brought his own products and had some CMO products already there but, he reports; there had been no investment in the CMO pipeline for a number of years. He spent money refurbishing the plant and drumming up business. He reports, “It literally takes years to fill the product pipeline. You have to have a solid financial foundation that allows you to invest while you wait for the new business to generate.”

His investment included new equipment to bring the plant up-to-date. “We invested in a brand new lyophilizer. There is no sense bringing in new business and put it in a lyo that will be out of compliance in a few years’ time. Every year we put millions into the facility, and that’s not just spent on maintenance,” he says. “You have to reinvest in the building to stay ahead of where the trends are going.”

Hinchen says he has three goals with his investments: 1. to make the plant compliant, 2. to make it attractive to customers, and 3. to make it where he thinks it needs to be. If you buy a manufacturing plant, you will probably have similar goals and need to make substantial investments above and beyond the cost of the purchase price.

While manufacturing may be going hightech, finding facilities is still done the old- fashioned way. Observers say there is no central listing service that lets everyone know what facilities are available. The pharmaceutical community is a relatively small one. Use your network to help spot potential plants to buy. Suppliers are another potential source of leads.