Clustering: A Time to be Skeptical?
Hidden Opportunities within Exaggerated Headlines
For those that are new here, this substack is all about finding imbalances, or “gaps”, in the supply and demand between a company’s current real estate assets and their actual, longer-term need— providing an opportunity to act on that imbalance via development, investment (sale-leaseback/acquisition for the cash flow), divestment (acquisition for the real estate), or construction.
It begins with a simple framework:
Expectations + Operating Performance - Current Capacity = Supply Gap
Now, although it’s been some time since my last post, something I talk about constantly (outside this page) is the fact that corporate real estate growth (and decay) follows the same consistent patterns at the company level. As I’ve written about before, the trick is recognizing those patterns, gaining an understanding of them, and then deciphering through some of the bullshit to help gauge expectations.
And as I’ve continued to progress and refine the Tactical Real Estate strategy over the last 4-years, my ability to ‘monitor the situation’ regarding opportunities has also naturally increased my recognition and skepticism toward certain “suspect” things. A skepticism that gets greatly ramped up when I notice a clustering of massive investment announcements from large, mature companies within the same industry within a short period of time (hence, clustering).
My skepticism around clustering is brought on because this typically means there are larger outside forces affecting the typical decision-making process. Outside forces causing reactionary or emotional one-upmanship rather than truer directional operating performance motives— which I believe have more substance (and I prefer to look for those).
For this particular instance, we’ll focus on the Pharmaceutical industry and the multitude of announcements made in direct response to President Trump’s tariff threats:
All these announcements sound great, right?
Expectations couldn’t be higher! But, when you dig deeper past the headlines, you begin to see what’s actually driving the big investment announcements. Such as Eli Lilly’s CEO saying the quiet part out loud about how their investment is completely dependent on tax cuts staying in place, “…we point out here today that, as a company, tax reform is the carrot. When that’s not in balance, I don’t think they’re going to get the outcome they want” (1). Or that Johnson & Johnson will announce their manufacturing locations “at a later date” (2). Eerily similar to the Novartis’ sites that “haven’t been determined yet” (3). Of course, these decisions all take time, and site selection can be a fickle exercise, but I know I always like to declare I’m spending $50B with no idea where it’s going… I mean come on… These read more as responses to something, or as “threats”, not as initiatives.
Personally, my favorite thing about these announcements is the game-within-a-game that’s played to see who can be the most American— appealing to President Trump no doubt. Lilly announcing $50B, just six days after meeting with President Trump; Roche announcing $50B; then J&J coming from the top rope with $55B of announced investment. In simpler terms: it’s a pissing contest. (Who's announcing $55.1B??) It’s a game of who doesn’t want to be the one left out. Continuous outside pressure from politicians, investors, and pundits, along with the slow trickle of your competitors making announcements will more likely than not, force management to put in place their own ‘exciting investment initiative’. It’s human nature to not want to be left out, and it’s a career risk/job security reaction for some executive officers to want to prove to others that they are on top of the ball and can make quick decisions. So they play follow the leader and promise big dollar investments— even if there’s no tangible plan in place.
In reality, these announcements and the grandiose pageantry that goes along with each press release are a public form of corporate lobbying. That’s what you get with large mature companies who can swing dollar amounts like this around. You should see it for what it is: appeasement, negotiation, politicking. It’s headline-grabbing of course, but that’s the goal.
We’ve seen this before— very recently actually— when the Biden administration enacted their own form of economic “forcefulness” with the Inflation Reduction Act, government subsidies, and state-level mandates. This spurred it’s own marvelous set of investment announcements and expectations— which provided some ‘boom’ in clean energy manufacturing and development, that ultimately hasn’t lived up to the hype.
The point is, similar to the Biden-era, these administrations sometimes do not outlast the time it takes to spend these “hundreds of billions of dollars”. Once the administration moves on, these companies will pivot— similar to what GM continually does every administration change. This leads to investments never actually being made, canceled projects, and empty buildings.
What I will always continue to harp on is that big buildings take years to build. Bigger buildings take even longer to build. And, depending on where you're located, some buildings may never be approved to be built. Although President Trump, being a developer himself, does understand this hindrance and is trying to help. (reminder: all developers love local government processes).
I know this has sounded maybe a little negative up until now— and trust me, I don’t mean it to— it’s just supposed to show what I believe is a more rational approach. My skepticism over these announcements, and the motivations for them, will undoubtedly amount to investment that doesn’t reach the stated levels— or even come close for that matter (in my opinion).
However, this is not to say that some projects won’t go forward, that money won’t be spent wisely, and that somebody will make a good return on invested capital. You just have to keep your expectations at the right level and in the right places.
So…
Let’s play out the most likely scenario and what we can expect:
Let’s say that only 1/4 of these announcements actually pan out, and we move from hundreds of billions down to tens of billions, or maybe even just a couple billion. This is still a significant investment and development of much needed US-based drug manufacturing— which is great! That investment, in turn, creates a significant amount of ancillary opportunities for corporate real estate investors and developers— which is really the point of this entire Substack!
If just $10B gets spent building new drug manufacturing buildings, then the total addressable market for suppliers and service providers in the US pharmaceutical industry will go up by some multiple of that. And that’s the type of exciting opportunity we look for— TAM adjustments. Also, just to cover my bases here, even if foreign plants are shut down and global TAM remains the same, that manufacturing work is still moving to the US and increasing the TAM for a localized US supplier pool (tradeoffs). This is similar to some of the reasons we touched on with Zyn, but it’s especially important because if suppliers don’t build here, they too will get hammered with import tariffs. The math starts mathin’ a lot better when the US Pharmaceutical market grows for them to be co-locating.
While the manufacturing sites from the big players mentioned above (whenever they find those sites) are highly-specialized facilities that will most likely be company-owned and depreciated (bonus-ly). What about down the supply chain? What about those companies who will occupy the 400,000 square foot, 36’ clear buildings for distribution of products, or the manufacturing of lab equipment and supplies to be used?
These are the bread and butter assets— the highly tradable and adaptable type asset that money flows to. And I can bet that it’ll take more than a single building to service each manufacturing center.
So who will fill them?
Well, did you know that 90+% of the US medical distribution market is handled by just three companies: Cardinal Health, McKesson, and Cencora (prev. AmerisourceBergen)? I would assume this oligopoly is currently budgeting and scouting sites, or at least, they will be if these projects move forward.
What about the Lab equipment that will be utilized within these new manufacturing facilities? Thermofischer Scientific is a powerhouse (and has already announced), as well as Danaher, Agilent Technologies, Bio-Rad, PerkinElmer, Bruker, and Waters, among others.
What about bottles for the medicine? Amcor, Berry Global, Gerresheimer, Aptar, and Schott would most likely be increasing US-based production to service their increase in US-based business.
Don’t forget about labeling those bottles— Avery Dennison, CCL Label, and HERMA should expect an uptick in their revenue breakout section for US clients.
We’ll purposely skip the raw material supply side of things. As this is still mostly sourced from China and India— again eerily similar to the battery supply chain (probably an overlooked and significant long-term risk, but I digress). Also, those buildings are probably even more specialized than the drug manufacturers’.
All in all, I see clustering as a bluff to politick, with inflated numbers tossed around haphazardly. But, just because I’m skeptical of the sincerity, doesn’t mean we don’t move the ball down the field. Once you understand this, and can think rationally about expectations and the most likely scenarios, you can act to find opportunity.
As I’ve witnessed firsthand, bad companies get caught chasing headlines— better opportunities arise when you apply a tactical approach
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Thanks for reading.