Do you remember that 1984 advertising slogan for Wendy's, "Where's the beef?" And how it morphed into a catchphrase used by everyone from actors in TV comedy shows to a Presidential candidate? It's a question I've been considering as I've looked through the most recent financial reports of a wide variety of outsourcing firms.
In a very unscientific study, I examined the anticipated growth in revenue and EBITDA for 2010 (as noted in the Capital IQ database) for a few dozen firms in various segments of outsourcing. I expanded the list and ran the results again, just to be sure I could support the tentative conclusions that my first look had suggested. The results were the same:
-First half results and analysts' consensus forecasts suggest there will be little if any growth in revenue for the companies concentrating on clinical services. There are exceptions, but most clinical CROs are suffering from the weak growth in new business they recorded throughout most of 2009. As I have noted in other forums, it is difficult for these companies to generate strong profit growth without meaningful revenue growth. So it is not surprising to note the prospects for modest declines in profitability from most of them this year.
-Companies providing contract laboratory and manufacturing services are also experiencing weak
revenue growth. (How many times have you heard the phrase "flat is the new up" this year?) They serve the same biopharmaceutical customer base as the clinical CROs. So it should not be surprising to hear their managements point to the impact of project delays and cancellations. They also suffer from the sluggish pace of decision-making by their customers and the internal turmoil within large pharma that is affecting the nature of outsourcing decisions. Since most of these firms operate extensive networks of facilities and have high fixed-cost levels, it is not surprising to hear that low capacity utilization is having a very negative effect on profitability.
-Companies providing instruments and consumables to the drug development industry are reporting modest but solid increases in both revenue and profits. I have long considered them a part of the broad group of companies involved in outsourcing, but they really seem to be quite different. They serve a much broader customer base, including medical facilities not directly involved in drug research, and laboratories in various industrial settings. They have some ability to spur their own sales by introducing much-needed new products that increase the efficiency and productivity of their customers. And they serve the increasing demand for testing food ingredients and environmental contaminants, leading to greater sales of high-margin consumables.
For the bulk of the CROs and CMOs involved in pharmaceutical outsourcing, I'm labeling 2010 "The Year of the Hangover." The six quarters encompassing late 2008 and all of 2009 were unusually rough ones. The weak order flow during that period is the major culprit behind the weak revenue/profit flow of this one. So far in 2010, the flow of new business wins for the CROs and new manufacturing assignments for the CMOs are good indicators that 2011 will be a year of substantial revenue growth, as well as the profit growth that normally accompanies such a trend.
Company managements are loath to give 2011 revenue and earnings guidance until they complete the annual budgeting exercises that are only now just beginning. But analysts are already predicting rebounds in revenue growth and profitability for most of the firms I surveyed in this little exercise.
Here's hoping they don't get too far ahead of their skis,
and that investors and company managements alike enter
2011 with a realistic view of the financial rebound that seems likely to occur. I don't want to write a repeat of this column next fall!
Michael A. Martorelli is a Director at the investment banking firm Fairmount Partners. For additional commentary on the topics covered in this column, please contact him at email@example.com, or at Tel: (610) 260-6232; Fax (610) 260-6285.