Macro Matters

Print 15 February 2016
Jim Miller / BioPharm International

Heightened global uncertainty could slow bio/pharma development activity.

Bio/pharmaceutical companies, and the companies that serve them, tend to think they are immune from broader macroeconomic and political developments. As populations age, emerging middle classes expand, and scientific knowledge progresses, research on new drugs and demand for new therapies seem to follow an inexorably upward trend.

However, the global financial crisis of 2008 demonstrated that the industry is not isolated from macro events. Early-stage companies, which drive the early development engine, had great difficulty raising money as the availability of venture capital declined and the window for initial public offerings (IPOs) closed altogether. It took nearly five years for drug-development funding to become readily available again, and for the pharmaceutical services industry to once again thrive.

It’s worth reminding industry participants of the vulnerability of the bio/pharmaceutical industry to macro events because memories tend to be short, and the global environment is becoming uncertain again. The coincidence of two events, in particular, threaten the global economic equilibrium: the collapse of commodity prices and the resumption of interest rate hikes by the central bank of the United States, the Federal Reserve. 

Most people are keenly aware of the steep decline in oil prices, but prices have also collapsed for a broad range of commodities including industrial metals such as copper and agricultural products such as soybeans. The falling prices are a result mainly of increased supply (thanks to fracking for oil and robust harvests) coming at a time when demand, especially from China, has slowed considerably. In affected economies, government tax and royalty revenues have decreased sharply, as have employment, foreign currency reserves, and investment.

The decision by the Federal Reserve to begin raising interest rates is exacerbating the problem for emerging markets. Many businesses in those countries had borrowed US dollars heavily to fund investment because the Federal Reserve had kept interest rates so low. Those companies, and some governments as well, are now facing a financial crisis brought on by rising interest rates, declining revenues, and rising repayment costs caused by the depreciation of their local currencies against the US dollar.

Bio/pharma implications

So what do these macroeconomic developments have to do with the prospects of bio/pharma companies, CROs, and CDMOs? There are at least three negative implications of the deteriorating global financial outlook for the bio/pharma services industry.

Bio/pharma industry growth has been hurt by the problems in emerging markets. Expansion in those countries, with their rapidly growing middle classes, was a major element of the post-patent cliff strategy of many global bio/pharma companies. Now, declining government revenues, skyrocketing debt service, declining foreign currency reserves, and depreciating currencies will severely limit the ability of those countries to import and distribute all but the lowest-cost generics.

CROs and CDMOs have not been major participants in the emerging market expansion plans of their global bio/pharma clients, so their exposure to these developments will be limited. They could see lower product volumes, however, as emerging market countries limit imports and encourage more local production.

A bigger concern is what happens to investor confidence. The banking and investment communities will take a big hit as the financial condition of companies and countries around the world deteriorates. Further, there is increased uncertainty surrounding even the strongest economies, as evidenced by the turmoil in world stock markets at the beginning of 2016. While few financial observers expect a crisis as severe as the 2008 financial meltdown, investor nervousness could reduce willingness to invest, negatively impacting company valuations, and the ability of companies to float IPOs and otherwise raise capital.

That could be a big problem for the CRO and CDMO industries. Freely flowing investment capital for early-stage companies has been a huge driver of demand for CRO and CDMO services in the past three years. As seen in 2007–2008, just the fear that finding new capital could be difficult can make early-stage companies slow their spending (e.g., by reducing the number of candidates in active development).  

US-based CROs and CDMOs have an additional concern as the US dollar has appreciated considerably against most currencies. The euro has lost 17% of its value relative to the US dollar in the past year and that can considerably alter the comparative advantage of CDMOs in the US and Europe. It means that a €1 million contract with a European CDMO, which would have cost a US client $1.3 million in 2014, will now cost that US client just $1.1 million. On the other hand, a European client considering a $1 million manufacturing or development contract with a US-based CDMO will be facing a €909,000 expense today versus €750,000 just a year ago. Moreover, the situation could get worse for US-based CDMOs in the next year or two as the euro is expected to depreciate to parity (€1= $1). US-based CDMOs that have benefitted from a weak US dollar for nearly 10 years are now facing strong foreign exchange headwinds.

The point here is not to wallow in doom and gloom about the macro environment. CRO and CDMO executives should not take for granted the robust market conditions they have enjoyed during the past three years. They need to be fully cognizant of the macro environment in which the industry operates and the risks it presents. As learned in the 2008–2012 period, the bio/pharma industry is not immune from global economic and political developments.

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