The second source and the qualification calendar

An active pharmaceutical ingredient is qualified into a finished product, not simply purchased. The dossier supporting a marketing authorisation names the supplier, the site and the process. Changing any of the three is a variation, and a variation is assessed by the authority that granted the authorisation. Sponsors have known this for years and have generally accepted single-source exposure because the alternative was expensive. Post-pandemic supply interruption changed the price of that exposure, and the boards that set it have revised their view.

The work our desk sees now is a qualification programme rather than a purchase. A sponsor identifies a second supplier, funds a technology transfer, runs comparability batches, files a variation and waits. Two years from selection to first commercial batch is a reasonable planning assumption in the markets we cover. During those two years the sponsor carries duplicate inventory, duplicate testing and a supplier producing at a loss. Somebody has to finance that period, and the financing is the transaction.

Three structures recur. The first is a prepayment against future supply, secured on qualified inventory and repaid through a discount per kilogram. The second is a minority equity investment in the second supplier, sized to fund the plant modification the transfer requires. The third is a joint venture that owns the qualified line and sells capacity to both parties. Each allocates the qualification risk differently, and each is priced off the same question: what happens if the variation is refused.

Market structure in ingredient supply is more concentrated than most sponsors realised. For a large share of the molecules our desk tracks, two or three sites worldwide hold the current qualification. Concentration of that kind is durable, because a new entrant faces the same two-year calendar with no customer paying for it. The sponsors funding second sources are, in effect, buying entry for suppliers who could not buy it themselves. That is an unusual and temporary condition, and it is where advisory fees are being earned.

Geography follows the customer. Sponsors in the largest markets want a qualified site inside their own regulatory perimeter, or in a jurisdiction whose inspections their own authority recognises. That pushes capital towards a small number of manufacturing countries with long inspection records and away from suppliers whose only advantage is cost. The firm's coverage of Mexico and Japan rests on that observation. Both hold qualified capacity and owners approaching succession, and neither is a market a generalist adviser reads quickly.

Advisory income from this work funds research capacity elsewhere. The pharmaceutical desk exists because the sector is difficult to enter and rewards the reader of an inspection file, not because a pharmaceutical franchise is an end in itself. Fees earned in 2020 and in the first half of this year are being applied to financial systems and data coverage, where the barriers now being built are of a different kind. Find the advantage, capture the value, and reallocate the capital somewhere else.

Published 2021-02-16 by the Investment Banking division. Research is prepared for eligible counterparties and does not constitute advice.