Mohamed Mitha – Investment Analyst

Aspen Pharmacare began trading in 1997 from a converted suburban house in Durban. 25 years on and through sheer ambition and bold deal-making, this company is now the largest pharmaceutical manufacturer in Africa, operating in 150 countries across six continents. Aspen’s rise is one of South Africa’s foremost corporate success stories, with co-founder and CEO Stephen Saad still at the helm.

As Africa lags well behind much of the rest of the world regarding COVID-19 vaccination rates (partly due to a prolonged period of vaccine supply shortages), Aspen has been identified as a potential role player in solving this need. We explore the business model and COVID-19 vaccine opportunity.

The pharma cycle
Pharmaceutical companies typically invest heavily in research and development (R&D) for new drugs. If the drug passes clinical trials it can be sold at a relatively high price – free from competition, while being patent-protected – to recoup the R&D costs and to make a suitable return on the capital deployed in its development. Upon the expiry of the patent, the price of the drug tends to drop steeply as generic manufacturers enter the market and replicate its formulation – selling it for much less. The original pharmaceutical company would then aim to replace the lost revenue with a new patented drug from their R&D pipeline, thereby continuing the cycle.

Aspen differs from this in that they perform very little in-house R&D. Instead, they have chosen to position themselves solely as a manufacturing company rather than a development-based business. To refresh their product portfolio as older drugs reduce in profitability, they rely on: the purchase of older niche drug formulations, the rights to distribute them in particular markets and sometimes existing manufacturing facilities. They purchase (from other large pharmaceutical companies) the commercial and production rights to “tail-end” products that have fallen off-patent, with the intent to manufacture these products more cost effectively to enhance profitability and to distribute them more widely via their existing network. They achieve this by in-sourcing production to their own cost-efficient facilities (cost synergies) and using their existing sales force to market the products (revenue synergies). There is also value added at times by efficient tax planning and lower financing costs.

Diverse lines of business
Aspen groups its disclosed revenue into the following categories and territories (charted below):
• Sterile brands: incorporates the anti-coagulant (blood clot prevention) franchise and anaesthetic products, of which Aspen is now the second largest supplier outside of the USA.
• Regional brands: is a portfolio of consumer, prescription and well-known over-the-counter products, such as Flutex and Mybulen.
• Manufacturing: comprises raw inputs used in the production of pharmaceutical products and contract manufacturing on behalf of other pharmaceutical companies.

Opportunity from the pandemic
Currently, only 15% of Africa’s population has received a COVID-19 vaccine versus over 70% in the rest of the world. Despite the promises made to supply Africa with sufficient vaccines during 2021, better resourced nations hoarded the initial surges of supply for their own use during the height of the pandemic, leaving Africa to wait.

Recognising this, Aspen reached a deal with Johnson and Johnson (J&J) to manufacture the J&J COVID vaccine under a licensing agreement, using their own brand called Aspenovax. The deal¹ is significant in that it enables Aspen to control the manufacturing process, selling price and distribution of the vaccine – with supply reserved exclusively for Africa’s population of 1.3 billion people. In addition, the company aims to increase the production of Aspenovax to 700 million doses per annum by December 2022 (from an initial 300 million doses).

As Aspen began speaking about the vaccine licensing opportunity in September 2021, their share price increased materially (up by 38% at its peak). It therefore appears that investors began to ascribe significant value to this opportunity.

¹_{Aspen previously had an agreement with J&J to complete the final stage of manufacture (fill-and-finish) only. They would have had no control over the selling price and distribution, receiving a fixed fee per dose for manufacturing the vaccine on J&J’s behalf.}

Not the only players in town
While Aspen could play a role in addressing the vaccine requirements of the African continent, we have reservations about the potential size and profitability of the opportunity. There is likely to be substantial alternative vaccine supply reaching Africa from elsewhere, and new vaccine manufacturing capacity installed on the continent.

With populations already substantially vaccinated in many of the wealthier nations, a new round of vaccine supply is scheduled to arrive in Africa. The USA, China and India have pledged a total of 3.7 billion vaccine doses to support lower income countries, including those in Africa. Supply has already begun to arrive. Furthermore, post the emergence of the Omicron variant, China has committed to donating an additional 600 million doses of vaccines to African countries. Relative to Africa’s population, this is material and will likely dilute the opportunity for Aspen as they ramp up their own production by the end of 2022.

Additionally, African nations are not obliged to purchase Aspenovax and pricing, availability and politics would undoubtedly be factors that will influence what is actually purchased.

The addressable market in Africa may be lower than the current population as 41% of people are below 15 years of age². Together with the prioritisation of older, more vulnerable citizens, this implies a smaller addressable market for the vaccine over the short term. Also, vaccination efforts may be further curtailed by Africa’s low rate of urbanisation³ (47%), undeveloped health systems and pervasive levels of hesitancy and apathy towards the vaccine among certain groups of people. There is a low vaccination take-up rate in South Africa, despite no supply constraints being experienced at present.

²_{Studies have shown that children are less likely to contract severe illness with existing COVID-19 strains and are therefore a lower priority for being vaccinated.}
³_{Studies highlight low rates of urbanisation as a key barrier towards childhood immunisation in Africa.}

Boosting the long-term opportunity
A key reason for the initial shortfall in vaccines was due to global pharmaceutical manufacturing capacity constraints. As indicated below, global vaccine manufacturing capacity is expected to increase exponentially, potentially reaching close to 41 billion doses per annum – up from just 8.5 billion doses in 2021. Theoretically, with a global population of around 8 billion, this suggests sufficient capacity to vaccinate the world many times over.

Africa has long lagged other developing nations regarding having their own mass-scale pharmaceutical production capability, however this is not being addressed by Aspen alone. Several initiatives have been announced to improve the overall manufacturing capabilities on the continent, over and above Aspen’s newly built facility in Gqeberha. Developments may push the market into oversupply, for example:
• Egypt plans to manufacture 1 billion doses per annum of China’s Sinovac COVID vaccine at their state-owned facility (potentially becoming the Middle East and Africa’s biggest vaccine producer);
• Moderna has announced their intention to open a plant in Africa to manufacture up to 500 million vaccine doses per annum; and
• BioNTech (who collaborated with Pfizer to develop their COVID vaccine) aims to build a vaccine manufacturing facility in Rwanda in mid-2022, followed by a second facility in Senegal.

While there is much uncertainty around how COVID-19 will play out over time, the possibility exists that ongoing booster shots will be required, which should absorb some of this new production. Costing will remain a pivotal factor for the success of sales volumes and ultimate profitability for Aspen. They will compete against formidable global suppliers. One example is the Serum Institute of India (the largest vaccine producer in the world), which has among the lowest costs of production of any pharmaceutical manufacturer due to economies of scale and access to low-cost labour.

Given the above, we do not believe very material economic value will flow to Aspen from vaccine production.