Consolidation in Outsourcing
Reviewing 2007's transactions and the trends they portend
By Michael A. Martorelli
Every year we note at the beginning of this annual review several themes that characterized the consolidation activity among outsourcing providers in the prior year. As always, we suggest that we did not select those themes a priori, but instead developed them after surveying the relevant activity in the industry. The themes noted below may sound familiar, but they reflect the nature of the consolidation activity in 2007.
Private equity (PE) firms again were very active in the outsourcing arena
We suspect there may have been even more completed or announced transactions had it not been for the significant changes in the cost and availability of bank financing to support such deals, a fallout of the problems with sub-prime lending.
We noted more divestitures last year than in the recent past
As we predicted in our review of 2006, more management teams and boards have been willing to jettison operations no longer considered key components of growth. Many divestitures involved operations that had been performing satisfactorily, not just the laggard performers that had usually been involved in such sales in previous years.
Cross-border transactions accounted for a disproportionately large share of all transactions
As was the case in 2006, many of these acquisitions were tactical and small; only a few were headline-grabbers with important strategic significance. Nonetheless, we think it's significant that so much activity did occur and that it again involved participants of all sizes and in all business segments.
Overall Consolidation Activity May Have Peaked for This Economic Cycle
The pace of consolidation across the various segment of the outsourcing industry has usually been somewhat related to the overall pace of merger and acquisition activity, especially as it involves the interest of the PE firms, so it's worthwhile to look briefly at overall activity.
Overall merger activity rose again in 2007, although the year-to-year increase in the value of all transactions was closer to 8% than to 2006's historic increase of more than 30%. According to the ZEPHYR database maintained by Bureau van Dijk, the value of all transactions totaled about $4.1 trillion in 2007, versus $3.8 trillion in 2006 and $2.9 trillion in 2005.
The pace of activity was down across the board in terms of industries and geographic territories. Among the 10 groups tracked by ZEPHYR, only two (Basic Materials and Financials) saw an increase in the number of transactions. The presence of mega-mergers in the Financial sector resulted in the value of transactions in that area rising by the unusually high rate of 50%.
Geographically, deal volume decreased in both North America (down 6%) and western Europe (down 10%). Several mega-mergers caused the total value of transactions to rise 28% in western Europe as compared to a 17% decline in the total value in North America.
Consolidation: A Permanent Theme in Outsourcing
It's worth noting again that the outsourcing industry has many characteristics that make it a perennial area of consolidation activity. It is highly fragmented, with hundreds of small and mid-sized companies that can make attractive acquisition candidates for both strategic and financial buyers. Firms of many sizes and descriptions continue to offer their pharmaceutical and biotechnology customers products and services that help make the drug development process faster, better or cheaper. Those research-based customers are facing unprecedented challenges in transforming laboratory discoveries into commercial drug products; most are increasing their use of outsourcing service providers in order to improve the efficiency and efficacy of those efforts.
In 2007, the companies we track closely were involved in almost the identical number of mergers or acquisitions (about 120) as in 2006. Various databases can help one trace the number of such transactions announced or completed month-by-month throughout the year and compare that activity to the pacing of transactions in 2006. Even without such details, however, we can report a noticeable slowdown in the pace of deal-making in the second half of 2007 compared to the prior six to 12 months. In particular, PE buyers needed to react to changes in the cost and availability of debt to help finance their acquisitions. Since all negotiations occur behind closed doors, we can't identify any particular transactions in the outsourcing industry that were directly affected by a go-slow approach from the PE community. However, we suspect that there would have been more announced and closed deals during the summer and fall months had credit conditions not tightened as they did.
There were some changes in the make-up of transactions that did occur in outsourcing. The following table shows the percentage of deals in various categories:
|Crossed an international border||27%||27%|
|Involved a PE group||23%||20%|
|Involved a divestiture||9%||11%|
|Involved participants in a different industry segment||8%||15%|
This table suggests that most consolidating transactions involved two companies in the same industry segment and the same country. As was the case in 2006, many transactions involved a combination of the above-named factors. In the rest of this article, we comment on some of the most noteworthy deals.
Private Equity Firms Remained Active
We noted above that 23% or 28 of the 120 acquisitions we catalogued in 2007 involved a PE buyer. In the following 13 cases, a PE firm bought complete control of a company.
|Acquiring PE Firm||Target Company
|The Blackstone Group||Cardinal's PTS segment|
|Platinum Equity Partners||Cardinal's HMS segment|
|Riverside Partners||J-Pac LLC|
|Vector Capital Corp.||Tripos' Discovery Informatics|
|AXA Private Equity||Synerlab|
|Finama Private Equity||Laboratoire Delpharm|
|ICICI Venture||Radiant Research|
|LDC Ltd.||Penn Pharmaceutical Services|
|AFI Partners||OSG Norwich Pharmaceuticals|
|CVC Capital Partners||Taminco|
|Genstar Capital||PRA International|
There were another 12 instances of PE firm making a substantial investment in an outsourcing firm. The largest investment was a $150 commitment made by JLL Partners in Patheon Inc. Investments ranging from $15 million to $35 million were made by Telegraph Hill Partners in Althea Technologies, Three Arch Partners and others in Gentiae Clinical Research, Granite Global Venture and others in Bridge Pharmaceuticals, Sequoia Capital in GVK Bio, and TPG in ShangPharma. Companies ranging alphabetically from Access Communications to Xceleron Limited received lesser amounts of funding. Additionally, Aptuit Inc., Cambridge Major Laboratories, Cetero Research and United BioSource all tapped existing PE owners to fund more of their own acquisitions.
Divestitures Took Center Stage
We were struck by the number and nature of corporate divestitures announced and/or competed in 2007. Several seemed particularly noteworthy.
The largest divestiture by far, and the single largest transaction in outsourcing, was Cardinal Health's sale of its Pharmaceutical Technologies and Services segment to The Blackstone Group. Blackstone paid $3.3 billion for this collection of companies that generated $1.8 billion in revenue and an estimated $300 million in EBITDA for Cardinal in 2006. The multiples of revenue and EBITDA were higher than both management and investors seemed to be expecting in late 2006 when Cardinal announced its intention to divest that unit. Analysts were pleased with the planned divestiture of both this segment and the much smaller Healthcare Marketing Services segment. However, 2007 did not turn out to be one of Cardinal's best; at this writing the stock is about 7% below its year-end 2006 level and more than 21% below its April 2007 high.
Evotec AG completed three divestitures in 2006-2007, and agreed to make a meaningful acquisition. Evotec had been a diversified company with both drug discovery and development services components. In mid-2006 it sold the core of its Single Molecule Detection Technology and a related intellectual property portfolio to Olympus Corporation. At the end of that year it sold its entire division producing high-performance tools and technologies for cellular research to PerkinElmer for $29 million. In September 2007, it completed the sale of the Chemical Development business to Aptuit Inc. for $64 million. With its service components jettisoned, the company then augmented its discovery/development efforts by agreeing to purchase Renovis, Inc. for $152 million worth of stock. Upon the completion of that transaction, Evotec expects to be listed on NASDAQ. By the end of 2008, the combined company expects to have at least five compounds in clinical trials. Evotec AG's stock has been quite volatile during this two-year transition period; after peaking at almost 4.5 EUR in March 2007, it now sells close to the 2.50 EUR level it maintained through the second half of 2005.
Using two divestitures during the past 12 months, Gene Logic Inc. also accomplished a major transformation. That company had been attempting to blend preclinical research with genomics knowledge in order to help drug companies develop new products and reposition existing ones. In December 2006, it sold its Preclinical Division to Bridge Pharmaceuticals for $15 million, and announced its intention to explore strategic alternatives for its genomics Resources . The intent was to raise funds to focus its efforts on its promising drug repositioning efforts. At the end of the year, it sold its Genomics Assets to the genomics services company Ocimum Biosolutions for $10 million. The renamed firm Ore Pharmaceuticals Inc. plans to engage exclusively in repositioning stalled clinical drug candidates that its partners have chosen not to return to development. During the past two years, Gene Logic shares have continued the decline they started several years ago.
Invitrogen Corporation lists 47 press releases on the Investor section of its corporate website. For the first time this decade, none of them told of an acquisition. However, a late April announcement disclosed the completion of an important divestiture -- that of BioReliance Corporation. That contract biologicals safety testing and manufacturing unit had proven to be a poor strategic fit and had been a drag on the performance of this diversified supplier of products and services to support disease research and drug discovery. Invitrogen had purchased BioReliance for $470 million plus assumed debt in early 2004; it received $210 million for its sale to Avista Capital Partners, thus recording a loss of more than $250 million on the transaction. Investors were nonetheless pleased with the divestiture, and apparently with the company's pursuit of organic growth only throughout 2007. The stock has risen almost 40% in the past twelve months.
Finally, we note the sale by Covance Inc. of its centralized ECG business to eResearchTechnology in November 2007. It's important not to overstate the importance of this sale; Covance generated an estimated $15 million of its estimated $1.54 billion in 2007 revenue from this business unit. Those incremental sales could become much more meaningful to eResearch, whose own 2007 revenue level has been estimated by analysts at about $98 million. Analysts appear pleased with both the Covance decision to sell this unit and the eResearch decision to buy it. Neither company has been particularly active in the M&A arena during the past few years. One wonders if we'll be hearing more from them in 2008.
While we've focused on certain transactions that seem to say a lot about the intentions of the various managements involved, we should also note the presence of other divestiture activity in 2007. Biocon, Bioveris, Curagen, Harvard Bioscience, MDS Inc., Patheon, Solvay and Tripos all completed transactions that their managers believed would be beneficial to the companies' long-term success. One more observation seems appropriate: Most of the firms that made a significant divestiture -- and that seemed to do so while responding to investors' clamor for such action -- did not enjoy any stock market benefit. Obviously, there were many factors that influenced the stock performance of Cardinal Health, Evotec and Gene Logic besides the impact of the aforementioned divestitures. However, in addressing investors and corporate executives who may be advocating selected divestitures, we can't help noting the well-worn phrase that begins with the words "be careful what you wish for. . ."
Achieving Global Reach Remained n Important Consideration
The outsourcing business and the business of drug development are among the most international activities in the corporate world. Firms of all sizes and in most business segments consider it important to offer global capabilities to their customers. In 2007, there were several transactions that represented the first significant cross-border expansion by a company that had been prominent in its home country. By the way, it's pure coincidence that the acquirers we've chosen to highlight all begin with the letter C. We think.
Cegedim SA acquired Dendrite International. It paid that firm's shareholders $750 million in cash, which represented a 25% premium over Dendrite's then-current stock price. The French-based Cegedim became the international leader in providing sales, marketing, clinical and compliance solutions to the pharmaceutical industry. Analysts expected it to generate a healthy 29% of pro forma revenue from its home country; they also expected the U.S. to represent as much as 26% of total revenue.
Cambridge Major Laboratories (CML) acquired ChemShop B.V. (CS). In making this purchase, Wisconsin-based CML added a facility in the Netherlands; that 12,500-sq.-ft. complex includes R&D labs, GMP kilo labs, and a GMP pilot plant. CS provides intermediates and APIs from gram to hundreds of kilogram scale. CML itself has been using the financial resources supplied by PE firm Arlington Capital Partners to expand its integrated API delivery system, consisting of synthesis, formulation and consulting. It operates two facilities near Milwaukee.
Cross Country Healthcare (CCH) acquired AKOS Limited. CCH has long been a leading provider of healthcare staffing services in the U.S. Travel nurse staffing accounts for about 70% of revenue. During the past 18 months, it has used the acquisition route to expand its clinical research staffing and service businesses. The AKOS acquisition was its first move overseas; that suburban London-based firm is active in the UK and Europe. CCH is now better-positioned to help international clients cope with regulatory requirements in the world's largest markets.
CMC Biopharmaceuticals A/S acquired a biologicals manufacturing facility from Eli Lilly. The facility is in Bothell, WA; it had originally been operated by ICOS Corporation, which Lilly purchased in early 2007. Based in Copenhagen, Denmark, CMC has long provided custom services for the scale-up and GMP production of protein-based therapeutics for preclinical, clinical, and commercial use. It has had only sales offices in both the UK and the U.S. Having this West Coast facility should enable the company to enhance its revenue from the development and production of more customers' biopharmaceutical products.
Last year, there were several acquisitions of larger scale or importance that enabled companies to expand an already-strong overseas presence. Prominent among those were acquisitions made by Albany Molecular Research (a facility in India), Aptuit (a joint venture in India), Intertek Group (Alta Analytical), Jubilant Organosys (Hollister-Stier), NextPharma Technologies (Bioserv), and Publicis Groupe (advertising agencies in India, China, Italy and France). The merger of Manipal AcuNova and ECRON to form ECRON AcuNova looked like a true merger that expanded each company's presence abroad. As usual, many companies made what we would call tuck-in acquisitions in order to expand their presence around the globe. Transactions closed by AAIPharma, Bio-Imaging Technologies, Eurofins Group, Holmes Biopharma/ Qualia, Huntsworth PLC, ICON, Medpace Inc., and Synchron Research were representative of that trend.
What About the Others?
The reader may be wondering why we haven't commented on some other acquisitions that generated a good deal of interest in 2007.
- General Electric acquired the biodisposable manufacturer Wave Biotech. In that same industry segment, Parker Hannifin acquired Mitos Technologies and Sartorius acquired Stedim.
- Bio-Rad paid more than $475 million to expand its product line with acquisition of the majority of DiaMed Holding AG.
- There was much activity in the “e-research” world. Clinphone acquired Datalabs, Octagon Research Solutions acquired Ninanza, and Entelos expanded by acquiring Iconix Biosciences.
- MDS Inc. expanded its instrument business by acquiring Molecular Devices.
- INC Research added the business of Advanced Biologics to its clinical research services.
- Sigma-Aldrich entered the biologicals manufacturing business by acquiring Molecular Medicine BioServices.
- inVentiv Health made seven acquisitions in areas related to its healthcare communications business.
- The bioanalytical lab company QPS LLC added a Phase I testing capability with the acquisition of the Bio-Kinetic Clinical Applications.
There were more. As we noted earlier in this article, most acquisitions were made by a company extending its business in its established area and its existing geographic territory. Most did not fit into the three themes we noted as emblematic of much of the consolidation activity that occurred during the past twelve months. And most were considered fairly routine activities by the people that engineered them -- not that there's anything wrong with that!
It's hard to be extremely optimistic about the potential for a more rapid pace of consolidation in the outsourcing industry this year. We still expect more activity, but wonder if the incremental increases in the number and value of transactions will match recent levels.
- The economic tea leaves seem to be suggesting a slowdown in the U.S. economy in the early part of the year.
- The unsettled nature of the debt markets should keep PE buyers rather cautious with their commitments.
- The weakness of the U.S. dollar should impact the pricing if not the feasibility of certain cross-border transactions.
- Uncertainty about which party will win control of the White House and the Congress in November will color executives' views of their own business prospects and those of their drug development customers in the near-term future.
We suspect that many companies will continue to make acquisitions, and that they will continue to find a plentiful supply of willing targets for their attentions. But the devil is in the details; and the details are what will make the difference between a fairly robust period of activity and one that disappoints buyers, sellers, investors, and their investment banking advisors.