CRAMS REPORT

ACK Capital Management Pvt. Ltd.

June, 2010

CONTRACT RESEARCH AND MANUFACTURING SERVICES INDUSTRY

The R&D and manufacturing outsourcing market (CRAMS) has two major segments contract (custom) manufacturing services and contract research (drug discovery and development) services. Drug discovery and development outsourcing, also known as contract research, spans target identification and lead optimization to Clinical Trial IIa. Contract manufacturing, spans from clinical trial phase IIb to the off-patent stage and includes manufacturing of intermediates, APIs and formulations. CS forms an important business sub-segment of CRAMS. CS entails synthesis of compounds, as per customer specification/requirements. Thus, it involves supplying initial material, reference compounds, derivatives of lead compounds and intermediates, especially for molecules in the development stage or drugs under patent

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry

Increasing pressures in the pharmaceutical industry have resulted in the emergence of the networked model as companies seek alternative ways to drive revenue and profit growth. Outsourcing is a core part of this model and companies are increasing their reliance on third parties to deliver value across drug discovery, development and manufacturing, which have traditionally been considered as core functions. Over the past 20 years, pharmaceutical companies have become increasingly reliant on using third parties to improve efficiencies through in-licensing, out-licensing, collaborations and outsourcing moving toward a networked pharmaceutical operating model. The degree to which companies have embraced the networked pharmaceutical model to date varies extensively; with some heavily reliant on third parties, while others use third parties to a lesser degree. A networked model with reliable third parties not only enhances capital efficiency but also improves flexibility and the overall cost structure, maximizes access to novel technologies for increasingly complex molecules, optimizes time to market and releases internal capacity/resource for core tasks.

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June, 2010

The global CRAMS market (excluding clinical trials) is USD 51 billion in size and represents 19.3% of total global pharmaceutical R&D and manufacturing spend which amounted to USD 264 billion in 2008. Further, the outsourcing market is growing at a CAGR of 14.5% from 2007-2010P

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry

There has been a change in the reasons for outsourcing and an expansion in the scope of outsourcing. Over the past two decades, there has been a shift in the pattern of outsourcing of pharmaceutical companies from noncore functions to routinely outsourcing a number of core functions such as clinical trial management and manufacturing. Drug discovery is one of the more recent core functions to be outsourced.

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry

There is higher prevalence of outsourcing across the late lifecycle than at the early stages; Outsourcing in API manufacturing is around 55%, the highest across the value chain Utilization of outsourcing in the discovery and development space, as well as in dosage manufacturing, is low since they are considered as core. However, it also indicates the scope for future growth Further, pharmaceutical companies have indicated a preference for API development and dosage manufacturing along with the intention of increasing outsourcing spends in these are as

ACK Capital Management Pvt. Ltd.

June, 2010

Contract Manufacturing
Global contract manufacturing services market is valued at approximately USD 33 billion in 2008 and represents 24.4% total global pharmaceutical manufacturing spend which amounted to USD 135 billion in 2008. It is projected to grow at a CAGR of 13.1% for the period 2007 2010

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry

Drivers
1. Closure of assets: Big pharmaceutical companies have built huge capacities over the years, and with products moving to their late lifecycle, these companies are operating plants at only 20 30% of their capacity. As a result, more companies are looking at divesting such plants and outsourcing and retaining the marketing rights for the products, thereby reducing their fixed costs. Acquiring these assets gives Custom Manufacturing Organizations ( CMOs ) a new business opportunity and a relationship with such big pharmaceutical companies. 2.Increasing focus on controlling costs by large international/ innovator companies

due to the following reasons:

Increasing penetration of generics: Increasing number of drugs going off-patent will result in increasing number of new generic drugs entering market and eroding margins for big pharmaceutical players Government pressure to reduce healthcare costs: Rising healthcare costs in developed countries owing to ageing population is forcing Governments to cut prices of drugs and encourage use of generic medications. Presence of fewer blockbuster drugs and R&D costs, hence putting pressure on their margins Focus on core skills and capabilities: Increasing focus of innovator companies on their core strengths of developing and marketing new drugs and outsourcing non-core activities such as outsourcing Virtual/emerging biopharma/biotech: Many of these companies do not have the internal capacity for manufacturing, and outsource it, only retaining their marketing rights

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June, 2010

Challenges
Lack of integrated CMOs: Pharmaceutical companies are looking at collaborating with a
CMO, which offers end-to-end services spanning development services to packaging and managing logistics. However there are only a few CMOs that are able to provide such services. This is especially true for western CMOs that are present in either formulations or API, unlike some large CMOs in India

Increasing regulatory costs: The cost of complying with regulations contributes a high
percent of the fixed costs of CMOs. With technological advances taking place regularly, investments in upgrading facilities, to provide the requisite expertise to pharmaceutical companies to sustain business, is essential

Contract Research
The global pharmaceutical R&D spend amounted to USD 129 billion in 2008 of which USD 49 billion (40.0%) was spent on drug discovery and development. The outsourcing market (contract research) was valued at USD 18 billion in 2008 representing 36.7% of the global drug discovery and development market. The contract research market is growing at 17.0% annually

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry

The capabilities required across the value chain for contract research are Speed of Delivery: As the drug candidate moves from discovery research to development, the importance of speed of delivery becomes more important as a delay of even a few days can jeopardize millions of dollars in potential revenues Flexibility: Financial crises, high rate of failure of drugs in development stages, changing market dynamics all create an environment of uncertainty where customers value the ability to scale up/down or focus/de-focus in certain areas as and when needed Integrated Capabilities: Integrated capabilities, demonstrated by a one-stop shop offering endto-end services right from research biology to chemistry, scale up from laboratory to pilot plants across API as well as formulations are of paramount importance Cost Value Proposition: The margins of pharmaceutical companies are dwindling due to increasing genericization and rising R&D costs. With this background, one of the key themes of outsourcing is cost saving with no compromise on quality

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June, 2010

 Innovation: Innovation is the ability to deliver new value to the customer in a nondeterministic environment. As the drug candidate moves from discovery research to development, where both expectations and activities become more deterministic, operational excellence takes the place of innovation Process Safety: Implementation of a high level of safety standards are of paramount importance since the development of new drugs involves new reactions/chemicals, whose effect on the safety of people, equipment and facilities are not completely known The CRAMS industry is undergoing a paradigm shift with the rise of a number of new players from emerging economies who offer global capabilities and a substantial cost advantage. This is forcing big pharmaceutical companies and western CMOs to recognize the need to transition from the West to the East, to fully leverage the benefits outsourcing can offer beyond simple cost-savings to strategic benefits.

The Indian CRAMS Industry

India is emerging as one of the most attractive destinations for outsourcing of global pharmaceutical activities. The Indian CRAMS industry was valued at USD 1.7 billion in 2008. Despite Indias inherent advantages, it accounts for only ~3% share of the USD 51 billion global outsourcing market, indicating significant opportunity for growth in this segment

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry

Contract Manufacturing Indian pharmaceutical manufacturing outsourcing was valued at USD1.1 billion in 2008 and is growing at a CAGR of 43% (2007-2012), a rate that is thrice that of the global market. Indias share of the global manufacturing outsourcing market is estimated to increase from 2.8% in 2007 to 5.5% in 2010 API/Intermediate outsourcing is more prevalent in India than formulation outsourcing. Around 64% of total outsourcing is in the area of APIs and Intermediates Further, most Indian players participate in mid-late lifecycle products and in contributing to the N-2 state of APIs. Indian CMOs do not participate in the production of the final API/ formulation sourced for patented product launch / filing for submission

ACK Capital Management Pvt. Ltd.

June, 2010

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourci ng Industry

Contract Research
India is emerging as a hot spot in drug discovery and development outsourcing, growing at approximately 65%, i.e., at more than three-and-half times the global growth rate. Indias pharmaceutical outsourcing landscape is well positioned to provide services in the area of late stage discovery (research chemistry) and drug development services. The country has recognized the need to develop its early stage discovery (research biology) capabilities and has begun investing in this area

Strengths of the Indian Pharmaceutical Industry Cost Efficiency: On comparing India with some prominent manufacturing locations, it
is seen that India rates higher on cost efficiency than all the other countries. This has been possible due to the intrinsic nature of the Indian pharmaceutical Industry and its evolution. The three key factors that contribute to this efficiency include: 1. Manufacturing costs: The Indian market is highly fragmented with almost 8,000 manufacturers. This high competition has driven Indian companies to relentlessly drive their costs down over the life cycle of a product. The competency developed as a result also reflects in the manufacturing costs of USFDA plants in India, whose costs are 65% lower than that in the US and 50% lower than that in Europe 2. Installation costs: The cost of setting up a plant in India is 30% lower than that of establishing an FDA plant in the US. 3. Manpower costs: Indias pool of trained chemists and pharmacists is six times as large as the USAs and is available at less than 1/10th the cost In end-to-end research and development, India offers 61% cost savings vis--vis the US. Research chemistry and drug development are stages where close to 85% of savings can be achieved

ACK Capital Management Pvt. Ltd.

June, 2010

Manufacturing Capabilities:

Currently India accounts for 8% of global pharmaceutical production, making it the 4th largest pharmaceutical producer in the world. Its prowess is in API, where it is the third-largest player worldwide with 500 different APIs and in formulations where it manufactures 60,000 packs across 60 therapy areas. 1. Vertically integrated pharmaceutical companies: In India, companies have adopted a vertically integrated model to become more competitive in the price-competitive Indian market. This advantage has been leveraged by some leading outsourcing players who offer end-to-end services across development and manufacturing in formulations and APIs, unlike western CMOs which generally have a presence in either formulations or APIs, but not in both. 2. Highest Number of USFDA approved plants outside the US: India has the around 119 USFDA plants in addition to around 844 UK MHRA approved plants Many of these plants also have approvals from countries such as Canada, Australia, Germany and South Africa. These approved sites aptly demonstrate the ability of Indian companies to deliver quality products worldwide and act as a platform for CRAMs players

Source: OPPI E&Y Report on Taking Wings: Coming of age of the Indian Pharmaceutical Outsourcing Industry

3.Increasing number of drug filings: India accounts for one-third of the DMFs in the US and has filed the largest number of ANDAs from any other country apart from the US. Indian companies have been active in filing DMFs in the US since 2000 and had a 36% share of the total filings in 2007. Between 2000 and 2007, India filed 1,155 DMFs with the USFDA, a much larger number as compared to countries such as China, Italy and Japan during the same period

ACK Capital Management Pvt. Ltd.

June, 2010

Source: OPPI E&Y Report on Taking Wings: Coming of Age of the Indian Pharmaceutical Outsourcing Industry

R&D knowhow: Indias pharmaceutical industry is driven by cost competitive strong chemistry capabilities supported by talent pool of skilled professionals and R&D infrastructure. Indias R&D legacy has been focused on the development of generics for western markets, which involved developing non-infringing process- and cost-effective routes. It has been able to leverage this capability in research chemistry, especially in the areas of medicinal chemistry, analytical chemistry and compound synthesis. India has developed strong capabilities in process chemistry, medicinal chemistry and analytical chemistry. Further, process development and scale up capabilities for clinical APIs and formulation manufacturing across various dosage forms such as solids, semi-solids, liquids, powders (lyophilisation) and parenterals have also been undertaken India has developed pre-clinical services capabilities with a number of animal testing facilities (existing and under development) using dogs and primates India offers significant cost arbitrage in end-to-end research and development with potential savings of 61% as compared to US. Further, India offers an abundant pool of professionals in the area of drug development and research chemistry with ~ 50,000 pharmacists and 150,000 chemistry post graduates qualifying every year India has more than 200 Department of Scientific and Industrial Research approved inhouse pharmaceutical R&D units and 48 cGLP compliant R&D facilities Big pharmaceutical companies and global outsourcing service providers have started focusing on India for drug development and research chemistry. Big pharmaceutical companies have adopted different operating models such as captive off shoring, dedicated R&D unit in partnership, fee for services and collaboration / joint venture

ACK Capital Management Pvt. Ltd.

June, 2010

Government initiatives
The GoI on its part has taken various policy initiatives for the pharmaceutical sector: Fiscal incentives to R&D units in pharmaceutical sector: Units are eligible for weighted tax deduction at 150 % for R&D expenditure incurred under Section 35 (2AB) of the I.T. Act Steps have been taken to streamline procedures covering development of new drug molecules, clinical research, etc. Launch of two new schemesNew Millennium Indian Technology Leadership Initiative or NMITLI, and the Drugs and Pharmaceuticals Research Programme or DPRP - especially targeted at drugs and pharmaceutical research. Reduction in customs duty from 10% to 5% on select life-saving drugs. In order to further strengthen Indias position in the pharmaceutical manufacturing outsourcing market, the GoI has taken or planning to take several initiatives such as: Streamlining and reducing time frame for approvals involving NOC manufacturer and NOC export licenses from 812 weeks to 2 weeks. Providing infrastructure support such as building Pharmazones, a separate dedicated temperature and atmosphere controlled area to maintain the safety, efficacy, and quality of imported and export drugs / pharmaceutical products at international airports at Delhi, Hyderabad and Mumbai. Building capabilities through collaboration with western countries, such as the MoU with the USFDA, WHO, Health Canada, South Africa and the European Medicines Agency We initiate our CRAMS sector report with peer comparison of five companies likeJubilant Organosys (JOL IN), Biocon (BIOS IN), Piramal Healthcare (PIHC IN), Dishman Pharma ( DISH IN) and Divis Laboratories ( DIVI IN), who represents around 40% of the total Indian CRAMS market and have strong presence across the pharma life cycle.

Source: Bloomberg

Though the selected peer set has CRAMS operation in common, their presence in other business segments apart from CRAMS makes their business model unique to each other. In terms of absolute CRAMS revenue, Jubilant Organosys is the largest player in India with revenues over 21 bn and an order book of over $ 1 bn and hence stays our top pick as we expect valuation discount to peers given its rich cash flows, reducing debt payment concerns and demerger of low margin APP business

ACK Capital Management Pvt. Ltd.

June, 2010

ACK Capital Management Pvt. Ltd.

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ACK Capital Management Pvt. Ltd.

June, 2010