Pharmaceutical companies are looking to outsource manufacturing as they focus more on drug development, marketing and filling product pipelines with emerging biotech companies, says Paul Levy, founder of middle market private equity firm JLL Partners. This leaves an opening for private equity firms to get involved on the manufacturing side, which is what JLL is doing with a deal that gives the New York firm majority ownership of one of the largest pharmaceutical manufacturing companies in the world.

In a transaction that closed in March, the firm took Canadian specialty-pharmaceuticals maker Patheon Inc. private and combined it with the manufacturing assets of Heerlen, Netherlands-based Royal DSM NV, creating DPx Holdings BV in a $2.6 billion deal.

DPx, headquartered in Durham, N.C., will provide services to large pharmaceutical, biotech and specialty pharmaceutical companies under the direction of CEO Jim Mullen, who previously served as CEO of Patheon. Levy says more deals that leverage the fragmented drug-making industry are on the horizon.

Why is JLL interested in pharmaceutical manufacturing?

JLL is very interested in the pharmaceutical outsourcing business, and that business consists of being a service provider to the pharmaceutical industry. The pharmaceutical industry is extremely dynamic - there is a lot of change underway. One of the things that is going on is some of the global players are doing less manufacturing and production of drugs in house than previously. They are putting their energy into drug development and marketing, and also into buying emerging biotech companies to fill their pipelines and remain crucial players in the industry. We help produce the product and then we get it back to the manufacturer for them to distribute.

Do you think we'll see more consolidation of the pharmaceutical manufacturing industry?

We're going to see an enormous amount of activity. The industry is very fragmented, and there will be a couple of companies that will get really big. The other reason is that pharmaceutical companies want to simplify their supply chains and they want to deal with bigger, stronger companies.

How did JLL invest in Patheon initially?

We are contrarian investors. We are willing and anxious to work in complicated and difficult situations, and we are very price-conscious. We got involved in Patheon back in 2007. It had grown through acquisition and never fully integrated the businesses that it bought. The company bought three facilities in Puerto Rico for debt, thinking they had bought $40 million in cash flow, but by the time they woke up, the $40 million in positive cash flow was roughly $40 million in negative cash flow. They were overleveraged and they did not have the internal ability to fix the business, so in 2007 they held an auction. Our proposal was to put in a piece of senior preferred stock and use the proceeds to pay down the debt. They kicked us out of the auction, but then the auction failed and they invited us back. We wound up doing the deal as we proposed. When the market crashed in 2008 and 2009, we were able to buy more stock more cheaply and wound up with 56 percent of the company.

Why did you decide not to sell Patheon?

We took the Ebitda from $70 million to $190 million in two and a half years. We were getting ready to sell the company. We had every major buyout shop call Patheon to try to buy them. It turned out that management had a dialogue with the people at DSM, and they had an $800 million division in pharmaceutical manufacturing that was a perfect complementary fit with what we had at Patheon. We came to the conclusion that this was too good to pass up. We got DSM to contribute their assets to the new company in exchange for 49 percent and bought Patheon in a going-private transaction.

What will the combined company do?

With the merger of Patheon and the pharmaceutical manufacturing assets of DSM, we are now the largest player in the industry. We have the broadest product offering, meaning we go from taking the active pharmaceutical ingredient and working with the drug company through the creation of the API to the production and packaging of the final product.

Do you expect that more PE firms will invest in pharmaceutical manufacturers?

Some of the large buyout shops are very interested by virtue of the fact that they all called us trying to buy the company.

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