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European Pharmaceutical Contractor

The CRO Scene

I first produced an annual report on contract research organisations (CROs) for this magazine in 2006. At that time I noted that the industry was dynamic, vibrant and growing at a healthy rate. In 2013, the situation appears to be similar; although the structure of the market in terms of large companies has changed significantly, smaller companies – of which there may be as many as 2000 – leave it fragmented. Seven years ago, of the top 16 companies, three were private, 10 were publicly quoted and three were subsidiaries of other large healthcare corporations.

CRO Analysis

Table 1 lists the nine companies listed by Centerwatch as the leading CROs in 1995. Now let us review the CRO scene in 2006 and 2013, and see how the situation has changed (see Tables 2 and 3). Starting with the subsidiaries over the latter period of time, all three have either been acquired or, in the case of MDS, been spun off. In 2013, of the three private companies, Quintiles has once again become a public company with an initial private offering having raised $947 million, with a market capitalisation of $5.65 billion.

In the public sector today the only significant players are Covance, PAREXEL, Icon, Charles River, and now Quintiles, with total annual revenues of over $10 billion. As seen in Table 2, the other six public companies have been acquired by private companies or private equity.

In 2004, the Washington Post headline read “PRA Raises $68.4 Million in its IPO”; in just nine years, the company has increased its value by a factor of 20. It is little wonder then that the private equity sector has shown such an appetite for investment in CROs, even if there have been some (but not many) spectacularly bad investments in the sector. In 2013, a number of private equity companies not hitherto involved in the CRO market have taken the plunge. Thus, investors in CROs – apart from those mentioned in Table 3 – include groups such as Temasek (Singapore), Bain, TGP Capital 3i, Audax, Kilmer Capital, Mercury Capital (Australia), Northstar and Water Street. In addition, there have been new entrants into the market, such as the consultancy firm Accenture.

Investment

Private equity and other stock market investors clearly see the CRO market as attractive – apart from the prospect of big capital gains exemplified by PRA. We might ask why. Outsourcing is the flavour of the month – if not the year. On a recent trip to Germany, I noticed two interesting things about freight traffic: there were virtually no vehicles belonging to major manufacturing companies and, by a quick count of 200 trucks, at least 50 per cent of these came from eastern Europe, notably Poland. The pharmaceutical industry has come to the decision to outsource – at least for drug development – rather late. It has outsourced other so-called core activities, such as manufacturing, for many years.

In 2013, we have seen a continuation of the trend towards what the industry calls strategic outsourcing. Centerwatch reports that in 2013, 87 per cent of the top 30 pharmaceutical companies had entered into at least one strategic alliance, compared with 63 per cent four years ago. This has led to major upheavals in the market; in particular, the publicly quoted companies have benefited, even if in some cases their bottom lines have suffered due to lowpriced competitive bidding to obtain the contacts, and the subsequent staff recruitment activities needed in order to fulfil these contracts.

Clearly, pharmaceutical companies will continue to outsource. Industry observers see clinical research organisations expanding their offering into other areas of research and development such as non-clinical, regulatory, commercial and even discovery. I wonder if the once vaunted but now rather discredited concept of the ‘one-stop shop’ is due to regain some credibility. Jamie McDonald, CEO of INC Research, has said that he expects more innovative strategic partnership models to become standard as pharmaceutical companies look for partnership structures that consistently produce more long-term value. He expects that the cost-cutting of recent years will be replaced by more innovative approaches to bring new drugs to the market, while still enhancing value to shareholders. The CEO of Chiltern International, one of the larger non-public CROs, has commented that the world has become smaller: both large and small global CROs now have a place at the table. He feels that service and relationships continue to be key to CROs’ success. One of the changes that has occurred in recent years has been the embedded solution, whereby a CRO provides staff which are integrated with the employees of the sponsor company. The pioneer in this area among large companies is Research Pharmaceutical Services (RPS). RPS grew to become a $400 million company, but has recently been acquired by Kohlberg Kravis Roberts (via private equity) and will be merged into PRA.

The alignment of large pharmaceutical companies with global CROs has, to some extent, put pressure on mid-tier CROs. Investment bankers believe that these mid-tier CROs will find it increasingly difficult to maintain their independence and may be squeezed out, since they cannot compete with the larger players in what has become an extremely competitive market. Bankers doubt that the mid-tier CROs have the resources to win these contracts. However, mid-sized companies are not small or specialised enough to provide the really personalised services that others can provide, especially those that focus on particular therapeutic areas. The mid-tier CROs are now beginning to see their opportunity to gain contracts with mid-sized pharmaceutical companies. There may be a natural alignment of large CROs with Big Pharma, and mid-tier CROs with mid-sized pharma. This could lead to some of the mid-sized CROs merging, most likely with those with smaller than $100 million annual revenues.

Private Equity

As we have seen, private equity is playing an increasing role in 2013 in the reshaping of the CRO industry. The general view is that a private equity company will acquire or invest in a CRO for three to five years, and then pull out. The investment of private equity companies using debt to finance acquisitions has, according to Mike Martorelli of Fairmount Partners, come under criticism from many CRO employees. This use of debt is often obtained by using the assets and creditworthiness of the company that the private equity is investing in as collateral. However, the problem with clinical CROs in particular is that they have few fixed assets, such as laboratories, and thus the debt may be at risk.

Changing Markets

One area of change in 2013 has been the Phase 1 or healthy volunteer area. For several years, particularly in the US, there was a very significant shortage of capacity in this area which prompted an explosive growth of CROs, especially for those offering services to generics companies conducting bioequivalence studies. This under-capacity led rather rapidly to an over-capacity, and in the US and Europe a significant number have been closed.

As the market has become saturated, several companies have indeed closed down entirely while others, such as Novum Pharmaceutical Research, have grown through expanding their services and client base to include not only generics companies, but also speciality companies on the periphery of pharmaceuticals, such as nutraceuticals or dietary companies. Novum, for example, is currently running a study for a company that specialises in health supplements. The movement of bioequivalence studies offshore to India and China has not helped the domestic North American or European markets.

As private equity companies look to realise their investments, it is thought that CROs may well begin to consolidate, especially as the market becomes increasingly competitive, and companies see economy of size and global coverage as a necessity. Consolidation, of course, is nothing new in the CRO industry, and in 2013 we have seen numerous acquisitions and mergers. This has mainly been in small deals, although the RPS deal with KKR is an exception to this. We are on track to see some 60 or 70 deals – on par with previous years. Much of this acquisition activity has been with mid-tier CROs such as Synteract, Trial Forms Support and Accelovance. Whether a merger between two of the major players is on the cards remains to be seen over the next two or three years.

Trial Sites

One of the areas of activity that was expected to grow in a major way has been India. Unfortunately for CROs and pharma companies, there have been major upheavals in the legislation surrounding clinical trials in India. This has led to a limitation of the number of trials taking place there, and it is yet to be seen whether the bribery scandals involving some of the major pharmaceutical companies in China will have a similar knock-on effect. This may mean that companies with activities and capabilities in other areas such as Indonesia, South Africa or Brazil will become preferred partners for conducting clinical trials. There has been speculation that companies with capabilities in North Africa and the Middle East would also be favoured, but this seems increasingly unlikely due to the political unrest in these areas.

Conclusion

In previous years I have attempted to estimate the overall size of the CRO market, noting how difficult this had become. In any area where private companies dominate, estimation of market size is a formidable task. Earlier I mentioned consolidation and concentration of business in the upper tier of CROs. There are still, however, at least 1,500 CROs worldwide, the vast majority of which do not publish figures on their annual revenues. There is also a difficulty in defining what the CRO actually is. Some consultants consider that any company which is the recipient of an outsourcing contract in the drug development area is the CRO. This inflates the total market in that it includes contract manufacturers, regulatory consultants, business and recruitment consultants, as well as the traditional clinical CRO. Suffice to say, the market in the CRO sector now comfortably exceeds $20 billion and may well exceed $30 billion. With growth rates at 5-10 per cent, this could reach the $40 billion mark in the not too distant future.

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