The PharmSource Blog by Jim Miller

News from the bond markets this week may have some implications for Blackstone Group's plans to finance its acquisition of Catalent Pharma Solutions. The Wall Street Journal is reporting that investors are starting to insist on stiffer terms in bonds sold to finance leveraged buyouts by private equity firms. Investors apparently are balking at provisions that have allowed borrowers to pay interest by issuing additional debt to bondholders (so-called payment-in-kind provisions) and that have imposed minimal covenants on the borrowers. These provisions have not been typical in buyout lending in the past, but had become popular in the lax lending environment. Investors are starting to demand higher interest rates as well.

The WSJ reported on June 27^th that a $1.5 billion bond deal meant to finance the leveraged buyout of U.S. Foodservice by two major private equity firms had to be pulled because investors balked at the terms, while a $4.5 billion debt offering to finance the acquisition of ServiceMaster had to reduce its payment-in-kind provisions.

The WSJ article noted that the stiffening bond environment reflected the large volume of offerings coming to the market and the recent difficulties of two high-risk hedge funds managed by Bear, Stearns. It noted that a $60 billion bond offering to finance the buyout of Chrysler from DaimlerChrysler also hit the street this week.

The Blackstone acquisition of Catalent was completed in April and is not at risk; most of these deals are closed with bank financing to bridge the time until the debt can be raised. However, Blackstone and Catalent could be looking at more costly debt, which could change their strategy and plans for operating the company.

Hopefully, the changing environment won't change Blackstone's plans to do the deal with public bond debt. Companies issuing public debt must file reports with the SEC similar to what publicly-held companies must file. If Blackstone chooses to go an alternate route, we will miss out on a valuable window into Catalent's performance and plans.

Now that it has announced its new name, what should we expect next from Catalent Pharma Solutions, formerly known as Cardinal Health Pharmaceutical Technologies and Services?

Initial indications are that the new owner, the Blackstone Group, is looking for opportunities to pare down costs by reducing staff and shedding some facilities. This is consistent with the way private equity firms operate, and Catalent appears to offer ample opportunities for improved efficiency: with revenues of $1.7 billion, 35 sites and 10,000 employees, its sales of $170,000 per employee and $49 million per facility are on the low side.

We have heard from multiple sources that the company has put its Albuquerque, New Mexico, sterile manufacturing facility up for sale. The Albuquerque site, the former SP Pharma facility that Cardinal Health acquired in 2001, has suffered a number of regulatory and operating problems over the years, despite substantial investment in new lyophilization units and filling lines. According to mid-June reports in the Albuquerque media, the company recently laid off 100 people at the facility because of a decline in orders and said it was paring back operations from 7 days to 5 days.

Catalent has two brand new sterile manufacturing operations - one in Raleigh, North Carolina, with large scale lyophilization capability and the other in Brussels, Belgium, specializing in prefilled syringes - where it is focusing its new business development efforts.

In a number of its businesses, Catalent faces the prospect of making significant investments to build a more significant market position and greater financial contribution; where it chooses not to make those investments, divestiture would be a natural consequence. We speculate that candidates in that category might include the biomanufacturing business, formerly known as Gala Design; clinical supplies; and the analytical operations formerly known as Magellan Laboratories.

Patheon's announcement last week of its second quarter results was full of more bad news about its Puerto Rico operations. Generic competition for Abbott's Omnicef antibiotic, which is made at Patheon's Carolina, Puerto Rico, cephalosporin facility, has hit the market two years sooner than expected. That follows the loss of patent protection for Merck's Zocor statin product, made in Caguas, and the declining sales of Sandoz's version of generic levothyroxine product, which Patheon makes for Sandoz. Combined with the continued downturn in OTC products, sales of which fell 32% in the quarter, and it is to see the glass as being half-empty for Patheon.

It's just as easy to see the glass as half full, however. Revenues in Patheon's European operations jumped 22% in the quarter, and development services revenues were up 12%. Moreover, EBITDA was essentially the same as a year earlier, despite a 5% overall decline in revenues. The company outside of its Puerto Rico operations appears to be quite robust.

Most importantly, it is clear that Patheon's leadership is facing the realities of its problems and will do whatever it takes to put the company back on sound footing. It has announced plans to divest four marginal operations in Ontario and get out of the OTC manufacturing business. During the Q2 conference call executives said they will have a plan for dealing with the Puerto Rico problems by the end of the summer. It would not be surprising if that involves consolidating operations by closing at least one of the three manufacturing sites.

What has been critical for Patheon executives is the support of its financial backers. The recent financial restructuring not only raised equity and took out the commercial bankers; it brought in sophisticated and patient financial players with a high tolerance for risk. Undoubtedly JLL Partners, the private equity group that put the $150 million in new equity, and lenders GE Commercial Finance and J.P. Morgan Securities, were well aware of the issues facing Omnicef and the Puerto Rico operations. They appear to have judged that substantial pieces of the business are sound, and are enabling executives to deal with the unsound elements by providing a financial cushion.

© PharmSource 2007

Sundia MediTech and United PharmaTech are merging, a first in the Chinese CRO industry. The merger, announced June 6th, will combine the two companies' complementary expertise; Sundia focuses on drug discovery and development while United PharmaTech has strengths in process development and manufacture of small molecule APIs.

For quite a few years, Western pharmaceutical companies have been exploring China as a potential location for sourcing. Drawn by cheap, abundant labor, big pharma companies have already established some relationships with Chinese CROs for discovery services. The rise of WuXi PharmaTech, a Shanghai based discovery firm established in 2001, has proven that outsourcing to China can be profitable and successful. But outsourcing to China has primarily focused on discovery and developmental services and has only involved the few contractors that have developed major operations, such as WuXi and Shanghai Chempartner. Sundia and United PharmaTech's merger is creating another sizeable company that, with continued internal growth, should be able to attract more business from the West.