Contract research organisations (CROs) with scale, multiple capabilities and geographical reach are best placed to benefit from the dominant trends of globalisation and strategic alliances in the sector, a new report suggests.

Meanwhile, the survival of mid-size and small firms “will depend on their ability to become market leaders within a particular geography or specialist research area”, says the M&A update from Catalyst Corporate Finance.

Both large and mid-size CROs will use merger and acquisition (M&A), as well as joint-ventures, to address sponsor needs, the report adds.

These strategies will serve to fill in therapeutic capabilities, extend geographical scope –especially in high-growth regions such as Latin America and China – and pick up different-stage services of interest to clients.

PE interest

At the same time, private equity (PE) firms will maintain their interest in a volatile CRO market, facilitating consolidation, strategic bolt-on acquisitions and investment in platforms, Catalyst believes.

This can pay dividends, the report points out. Recent successful PE exits to strategic buyers have included Avista Capital (£227 million sale to Sigma-Aldrich of BioReliance, acquired by Avista for £130 million) and Welsh, Carson, Anderson & Stowe (Catalent Pharma Solutions paid £249 million for Aptuit’s Clinical Trials Supply business).

Since global stock markets bottomed out in March 2009, the enterprise value to earnings before interest, taxes, depreciation and amortisation ratio (EV/EBITDA) of leading CROs has averaged 9.4 times, consistently outperforming the broader pharmaceutical sector, Catalyst notes.

While the largest CROs, such as Quintiles, can likely resort to initial public offerings as a source of finance, the biggest deal in the sector over the last few years has been Carlyle and Hellman & Friedman taking PPD private for £2.5 billion, or around 10 times EBITDA, the analysts observe.

Moreover, this transaction followed a number of other PE acquisitions of publicly traded CROs, including INC/Kendle and Nautic/Omnicare (now Theorem Clinical Research.

Double-edged sword

All of this is happening in a CRO market worth an estimated US$22 billion in 2010 and expected to reach US$33 billion by 2015.

Driving the market growth is increased outsourcing throughout the drug-development lifecycle, with a particular emphasis on late-stage trials, Catalyst points out. While this means near-term gains for CROs, in the longer run it could prove to be a double-edged sword.

More and more stages of the drug development process are being outsourced “as sponsors focus on reducing fixed costs, improving time to market and responding to increased global regulation”, the report says.

In particular, though, pressure to replace revenues threatened by impending patent expiries is intensifying the focus on late-stage development, along with the lucrative generics market and a search for novel revenue generation opportunities.

Positive environment

This is “a positive environment for CROs, which can expect to increase their share of R&D spend”, the analysts suggest.

Yet while prioritisation of investment in lower-risk and lower-cost late-stage drug development is delivering short-term volumes to CROs active in that field, the longer-term impact will be “a decline in novel therapeutics in the development funnel as drug discovery activities are neglected in favour of faster developments”.

What this implies for the CRO sector is “a period of fierce competition and reduced demand  … a catalyst for consolidation and diversification until sponsors shift their attention back to refilling the earlier-stage pipeline”.

Strategic alliances

One engine of consolidation is pharmaceutical companies rationalising their drug-development portfolios to focus on a smaller number of core therapeutic areas. In turn sponsors are whittling down their supplier base, “preferring deep relationships with fewer CROs”, the Catalyst report notes.

A total of 22 such major strategic alliances were announced by 13 large pharma companies between 2010 and 2012, including Bayer HealthCare’s long-term partnership with Covance and Pfizer’s two partner model, “which cut its functional services providers from 17 to partnerships with just ICON and Parexel”. 

Once again, this environment favours the larger CRO with a multinational footprint and broad capabilities/expertise. It is also fuelling more M&A.

Larger CROs that need to gain a particular strategic advantage are attracted to specialist providers, Catalyst observes.

It cites US-based QPS, which acquired a majority stake in Austria’s JSW Life Sciences, a full-service CRO specialising in central nervous system diseases and with operations in Central and Eastern Europe.

Increasingly vulnerable

The flipside is that clinical research providers lacking a distinctive proposition will find themselves “increasingly vulnerable”, the report warns.