US-based contract research organisation (CRO) Charles River Laboratories has taken the trend for outsourcing of drug development to more cost-effective emerging markets to its logical conclusion by agreeing to pay around US$1.6 billion for WuXi PharmaTech, the CRO with headquarters in Shanghai, expertise in drug discovery and operations in both China and the US.

The deal, believed to be the largest foreign takeover of a Chinese company in the pharmaceutical sector, will result in what Charles River calls “the only global contract research organisation … to offer fully integrated research and drug development services from molecule creation to first-in-human testing”. It sees the acquisition as “a transformational transaction that sets a new standard in the outsourced drug development services industry”.

The combined company will retain the Charles River name and will be led by James Foster, current chairman, president and chief executive officer (CEO) of Charles River. Dr Ge Li, chairman and CEO of WuXi PharmaTech, will become corporate executive vice president at Charles River and president of a new reporting segment, Global Discovery and China Services. Dr Li will also join the Charles River board along with two other WuXi directors.

Charles River already has a presence in China, where it opened a 60,000 sq ft preclinical research facility in October 2008. That in turn sprang from a joint venture agreement with local preclinical specialist Shanghai BioExplorer - Charles River Preclinical Services Greater China - that was announced by the US CRO in March 2007.

WuX PharmaTech is listed in the US, where it acquired laboratory testing, contract R&D and manufacturing services provider AppTec in January 2008. The Chinese company shed AppTec’s US biologics manufacturing capabilities in December of that year, refocusing the WuXi AppTec facility on biologics testing, cell banking and cell therapy services. Some analysts questioned the wisdom of the AppTec acquisition and there have been reports of difficulties integrating the US operations.

In September 2008, WuXi and US-based CRO Covance decided not to proceed with a planned joint venture for preclinical research services in China, with neither party giving a reason for the decision. The deal fell apart only three months after Covance and WuXi announced they would set up a 50:50 joint venture centred on a 323,450sq ft purpose-built facility under construction by WuXi in Suzhou.

Last March, WuXi announced an agreement with Johnson & Johnson Pharmaceutical Research & Development (J&JPRD) to collaborate on preclinical services and associated training. It involved WuXi providing toxicology and other non-clinical services to J&JPRD, while its partner would supply training and other services to establish a Good Laboratory Practice (GLP) quality system and the technical capabilities to meet international standards at the Suzhou facility.

Cash and shares

Under the definitive merger agreement between WuXi and Charles River, each WuXi American Depositary Share will be exchanged for US$11.25 in cash and US$10.00 worth of Charles River common stock, as determined by an agreed exchange ratio. Based on WuXi’s closing share of US$16.57 on 23 April 2010, the transaction gives WuXi stockholders a premium of 28%. The premium increases to 38% if based on WuXi’s 30-day average closing price of US$15.45.

The deal, which is expected to be “neutral to slightly accretive” to Charles River’s earnings per share on a non-GAAP (Generally Accepted Accounting Principles) basis, and “increasingly accretive thereafter”, is subject to approval from both company’s shareholders as well as regulatory clearances and the usual closing conditions. It is expected to be completed by the fourth quarter of 2010.

WuXi and Charles River said they would form a joint integration team, as soon as was practicable, to “fully assess the logistics of the combination and optimisation of our resources”.

With WuXi on board, both existing and potential Charles River clients will for the first time “be able to obtain support for their early-stage drug development needs from one company with unparalleled scientific depth and breadth in chemistry and biology”, Foster said.

“We will be a more valuable strategic partner to our clients by offering both upstream and downstream support for their efforts to bring new drugs to market,” he added. Moreover, “we will be able to provide our integrated portfolio of products and services globally, affording clients the opportunity to work in the locale which suits them best: North America, Europe or China”.

Dr Li characterised the deal as “a true win-win scenario that significantly expands the global reach and growth opportunities for both companies”.

It meant Charles River could “immediately expand its presence in China and avail itself of WuXi's expertise in chemistry services, while simultaneously, WuXi will be in a position to accelerate its Good Laboratory Practice toxicology capabilities. Together, we will offer our clients unparalleled support to meet their early-stage drug development needs”.

Based on the two companies performance last year, the combined entity will have sales of US$1.5 billion, with 44% of that total coming from Research Models and Services (RMS), 41% from Preclinical Services (incorporating WuXi’s US-based Laboratory Services) and 15% from Discovery Services (including Charles River’s Discovery and Imaging Services).

The new company is expected to be a leader in discovery chemistry services, with a leading position in non-GLP efficacy testing and a developing position in chemistry-based manufacturing.

In the RMS segment, it will be the market leader in research model production and a leader in endotoxin detection, WuXi and Charles River said. On the preclinical services side, the consolidated Charles River is being slated as a leader in GLP safety assessment in both Western markets and China, as well as a leader in worldwide biopharmaceutical services.

Geographically, the merger chimes with the view among pharmaceutical multinationals that China is “the new frontier” for drug development, the two companies noted. These multinationals are taking advantage of cost leverage by moving their chemistry activities to China, while there are further opportunities in safety assessment and manufacturing services as clients build on their development operations in China.

Some degree of safety assessment is also expected to migrate to the country, although China’s limited preclinical capacity will restrict the amount of work that can be done there “for some time”, WuXi and Charles River believe. At the moment, there is more than 8 million square feet of preclinical space in North America and Western Europe, compared with around 500,000 sq ft in China.

First-quarter results

Charles River also announced its financial results for the first quarter ended 27 March 2010. Net sales dipped by 1.4% against the first quarter of 2009, to US$297.3 million, with higher sales in the RMS segment (+6.6% year on year) offset by a 10.6% decline in Preclinical Services (PCS). Operating income for the latest quarter was US$29.5 million, down by 26.0% year on year.

WuXi PharmaTech achieved revenues of US$270.0 million in 2009, 6.5% more than in the previous year. Revenues for this year were projected at US$310-320 million, with the bulk of that coming from China-based Laboratory Services.

Adjusted earnings before interest, taxes, depreciation and amortisation (EBITDA) were US$92.3 million last year, 23.1% ahead of 2009 and beating WuXi's own forecast of US$86-$90 million.