Merger and Acquisition Drivers Remain in Place for 2007

2006 was a busy year for merger and acquisition (M&A) activity in the pharmaceutical services industry, and all signs point to 2007 being at least as active. The resulting consolidation and changes in ownership are altering the face of the industry.

Jim Miller

PharmSource counted almost 60 deals completed in 2006, with a total value of nearly $2 billion. The deal sizes range from the $2 million that Canadian contract laboratory company Warnex (Montreal, Canada) paid for the Blainville, Quebec analytical operations of MDS Pharma Services (Montreal, Canada) to the $567 million that a consortium of private-equity firms is paying for pharmaceutical chemical manufacturer Groupe Novasep (Pompey, France). The number of deals was almost equally divided between clinical and nonclinical development and manufacturing services.

One deal alone promises to make 2007 an even bigger year than 2006: Cardinal Health's (Dublin, Ohio) Pharmaceutical Technologies and Services (PTS) business, which Cardinal Health announced it intends to divest by mid-year, is expected to bring nearly $2 billion on its own. The industry also is waiting to learn whether the board of directors of dose manufacturer Patheon (Toronto, Canada) decides to sell all or part of its operations. If it does, assets worth hundreds of millions of dollars could change hands. Add to those two events the normal flow of small, tactical deals and the likelihood of a surprise announcement or two, and 2007 should be quite a year for investment bankers representing contract-services clients.

Hot environment

Even if the Cardinal Health and Patheon transactions were not looming over the industry, 2007 would probably be a busy year because the factors that drove contract services M&A activity in 2006 are still very much in place: a set of compelling business rationales and readily available financing.

The business rationales for deal-making reflect market trends in the pharmaceutical services industry.

Private-equity firms that own contract research organizations (CROs) and contract manufacturing organizations (CMOs)

Early-development boom. The number of early-stage candidates in the drug development pipeline has grown markedly this decade—Phase I candidates are up 50% according to data from IMS, Inc.—and service providers want to make sure they have the capacity to serve them. Companies that support the development of early-stage compounds, including Phase I research, formulation, and analytical services, have been in strong demand by acquirers.

Demand for Phase I beds has far outstripped the supply, making Phase I capacity a hot commodity in 2006. Covance (Princeton, NJ) added 11 sites and 500 beds to its network with its acquisition of the Radiant Research Phase I facilities. PRA International (Reston, VA) gained a Phase I foothold in Europe with its acquisition of Pharma Bio-Research, adding to its existing facility in Lenexa, Kansas. SGS (Geneva, Switzerland) bought a major Phase I presence with its acquisition of aster.cephac early in 2006.

The early-development opportunity also has been driving activity in process development and manufacturing for small-molecule active pharmaceutical ingredients (APIs). Notable deals in 2006 were the acquisition of EaglePicher Pharmaceutical Services by Aptuit (Greenwich, CT) and the purchase of Iropharm by Sigma Aldrich Fine Chemical (St. Louis, MO). Several Indian fine-chemical companies positioned themselves for the development market by buying European and US assets: Dishman Pharmaceuticals and Chemicals (Ahmedabad, India) with its acquisition of Carbogen-Amcis from Solutia, and Shasun Chemicals and Drugs, Ltd. (Chennai, India) via its deal for Rhodia Pharma Solutions.

Supply-base consolidation. The globalization of clinical research and the efforts by major pharmaceutical companies to consolidate their vendor base are major driving factors for M&A activity. Clinical trials are going global in an effort to broaden the pool of patients from which to recruit, and in anticipation of launching approved products in more markets. At the same time, major pharmaceutical companies are reducing the number of vendors they work with to gain more leverage in price negotiations and to reduce costs. These trends favor large companies with global capabilities and a broad range of services, and acquisitions are a prime vehicle for bulking up.

Company Web sites

The size factor was spotlighted in Kendle International's (Cincinnati, OH) acquisition of the Phase II–IV business of Charles River Laboratories (Wilmington, MA) and in Premier Research's (Crowthorne, UK) acquisition of IMFORM and Scirex. The acquisition of the Charles River business increased Kendle's revenues by 65%, pushing it onto the list of the top 10 largest CROs.

The acquisitions of IMFORM and Scirex allowed Premier Research to nearly double its size twice within a year. Although Premier Research is still small compared with the industry leaders (at about $75 million in revenues and 800 employees), the increased size and capabilities should help stabilize its financial performance and make it more competitive.

Corporate portfolio management. As companies have refined their corporate visions, chief executives have been aggressive in divesting businesses that they no longer consider strategic, or that they feel cannot compete profitably. This active portfolio management has put some major business assets in play.

For instance, Cardinal Health's decision to sell the PTS business reflects the company's growing focus on the downstream pharmaceutical supply chain (from the warehouse to the bedside) and the recognition that manufacturing was not critical to its mission. Charles River sold its Phase II–IV clinical research business to Kendle because its executives realized that at just $130 million in revenues and with a limited international footprint, they would have a difficult time competing with the larger CROs for Big Pharma contracts.

In the pharmaceutical chemical sector, similar considerations drove Rockwood Holdings to sell Groupe Novasep, DSM (Heerlen, Netherlands) to sell its South Haven, Michigan operations, and Rhodia and Clariant to sell their pharmaceutical chemicals businesses.

Private-equity role

The strong impetus to make deals has been supported by the readily available financing to pay for them. The cost of capital for acquirers is relatively cheap as corporate profits are strong, stock valuations high, and interest rates low.

The financing environment has benefited private-equity firms, which have been major players in the pharmaceutical services M&A market. They have been especially active buyers of pharmaceutical chemical businesses, and are expected to be major bidders for the Cardinal Health PTS business. They also have shown keen interest in attractive niches within the industry (see sidebar "Private-equity firms that own contract research organizations and contract manufacturing organizations").

The pharmaceutical services M&A boom is a reflection of the industry's growing maturity. The industry has demonstrated its staying power, and pharmaceutical business trends indicate steady growth in the years ahead. With the business case made, there is a need for stronger, more professionally run corporations and executive teams to drive companies ahead in the manner that industry leaders such as Quintiles, Covance, and PPD have demonstrated. M&A is a prime vehicle for achieving the next level of industry sophistication.

Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, info@pharmsource.comwww.pharmsource.com.