Consolidation in Outsourcing

By Michael A. Martorelli, Fairmount Partners | January 22, 2014

Reviewing 2013’s M&A activity

Most retrospective articles discussing a year’s M&A activity cover the details of who, when, where, and how much. They might also mention the why in a quick reference to a phrase included in the press release announcing a particular transaction. However, it’s important to remember that the why can be the most important aspect of a good acquisition or divestiture. Before discussing the active pace of M&A activity across the pharmaceutical outsourcing industry in 2013, we think it’s important to examine the why of many transactions.

The textbooks suggest that the why of any acquisition or divestiture should be based on how that transaction will help a company achieve its strategic objectives. We couldn’t agree more. Some observers might have been surprised to see the handful of global, full-service CROs continuing to make acquisitions in 2013. Those actions suggest the companies are managed by executives who don’t believe all the words written about the dominant market position they enjoy. Indeed, those corporate leaders understand the need for their firms to continue expanding the depth and breadth of their service offerings so they can generate more revenue from more clients.

The rationale for making acquisitions may seem more obvious for the mid-tier outsourcing firms that are trying to expand their presence in the market. Even in these cases, however, it is just as interesting to understand the acquisitions these firms may have considered but did not make in 2013 as it is to evaluate the transactions they did announce and/or close. Outsiders rarely get a window into such companies’ internal deliberations about potential acquisitions. Our position as an industry insider with proprietary information about many companies’ M&A strategies precludes us from describing such considerations. Suffice it to say that planning and executing an acquisition program intended to achieve a strategic objective is more complicated than playing armchair M&A consultant and merely proposing that Company A should buy Company B.

Outsourcing firms described as “small” by any standard have been selling themselves to strategic or financial buyers throughout the two decades we’ve been involved in analyzing the industry. The motivations of the sellers involve both personal and business considerations. It’s easy to rattle off a list of potential buyers for any particular small outsourcing firm. But it’s also easy to grossly underestimate the importance of the interpersonal relations among the management and employees of the buyer and the seller. In our experience, too many observers tend to ignore that factor when evaluating a completed transaction.

Reviewing the Numbers
Recently, many industry newsletters and non-specialist investment banking firms have been describing what they’ve termed another surge of acquisition activity across the outsourcing landscape. It’s true that during the last few months of 2013 buyers announced the purchase of such well-known firms as AAIPharma, Acurian, CRI Lifetree, Novella, and DSM Pharmaceutical Products. And those deals followed the acquisitions of firms with familiar names such as Beardsworth, BioClinica, Harrison Clinical Research, Liquent, and PRA International.

We only counted about 140 transactions in 2013, compared to about 170 in 2012. That number was very close to the totals we tracked in both 2010 and 2011, so we don’t think the reader should panic about the seemingly low volume of transactions announced or closed during the past 12 months. As we’ve noted many times, we don’t attach much importance to the raw number of deals announced or closed in any particular time period, since we continue to see a consistently high level of interest in M&A activity among a range of potential buyers and sellers.

In telling the M&A story for 2013, we think it’s appropriate to highlight two types of transactions: those involving a publicly held company, and those involving a private equity firm. As usual, we describe only a sample of the most intriguing deals in those categories, several of which involved both a publicly owned firm and a private equity buyer or seller.

Publicly Held Firms Were More Active Than Usual
Some divestitures were particularly intriguing:
  • In December 2012, the contract manufacturer Patheon Inc. completed the acquisition of Banner Pharmacaps, a specialist in developing and manufacturing gelatin-based dosage forms. It paid $255 million in cash to the Netherlands-based food company VONN N.V., a hefty premium over Banner’s annualized sales level of about $92 million. The acquisition enhanced Patheon’s position as a provider of proprietary manufacturing services.
It’s difficult to know the importance of that new source of revenue to the people who orchestrated the Patheon deal announced in mid-November. The board of that firm agreed to accept $9.32 per share to merge the company into the Pharmaceutical Products business unit of Royal DSM, a diversified health, nutrition, and materials company. JLL Partners, the majority owner of Patheon, will own 51% of the combined company, while DSM will own 49%. With estimated annual revenue of about $2 billion, the new company (whose name has not yet been announced) will be one of the largest in the contract manufacturing industry.  [See our Newsmakers interview with Patheon’s CEO, Jim Mullen –GYR]
  • Also in December 2012, PAREXEL International acquired Liquent, Inc. from its private equity owner Marlin Equity Partners. The price was approximately $75 million in cash. Liquent provides software solutions for regulatory submissions and product registration management. Adding its estimated $40 million in annual revenue to the Perceptive Informatics unit’s $200 million annual run rate promised to strengthen PAREXEL’s position as the CRO with the largest commitment to electronic research services.
  • In April, PAREXEL expanded another business unit by purchasing HERON Group Ltd., a life sciences consulting firm specializing in evidence-based commercialization services.
  • In January, Charles River Laboratories completed the $27 million purchase of a 75% interest in Vital River, the leading provider of research models and related services in China. In October, it acquired BRASS Pte. Ltd. The company had had a partnership with this Singapore-based provider of microbial detection and identification services since 1997.
  • In February, ICON plc completed the acquisition of the Clinical Trials Services Division of Cross Country Healthcare. Its total payment of $52 million in cash and as much as $3.75 million in earn-outs appeared to represent just under 1.0x that business’s trailing 12 months’ revenue and about 7.0x its trailing 12 months’ earnings before interest, taxes, depreciation, and amortization (EBITDA). Adding the clinical staffing companies ClinForce, Assent Consulting, and AKOS to ICON’s existing DOCS unit gave that CRO a global staffing and resourcing capability that differentiates it from its major full-service competitors.
  • In March, Ajinomoto Co. expanded its presence in the pharmaceuticals and specialty chemicals sectors by agreeing to acquire the contract biopharmaceutical manufacturer Althea Technologies, Inc. The seller was the private equity firm Telegraph Hill Partners. The Japanese manufacturer agreed to a purchase price of $175 million, approximately 3.3x the $53 million in annual revenue the buyer mentioned in the press release announcing the transaction.
  • In April, Frazier Healthcare led a group of three other private equity firms in paying $308 million for the AndersonBrecon contract packaging business of AmerisourceBergen Corporation. The price was approximately 1.3x the revenue generated by that unit in the 12 months ending September 31, 2012, and approximately 19.2x its pre-tax income for the period. Frazier announced its intention to combine AndersonBrecon with another portfolio company, Packaging Coordinators, Inc. (PCI) that it had acquired from Catalent Pharma Solutions in June 2012.
  • That same month, an affiliate of the private equity firm Med Opportunity Partners agreed to purchase Pfanstiehl Laboratories from Ferro Corporation. Thus, Ferro became the latest diversified manufacturer to divest an asset its board did not consider to be a strategic one. The private equity firm paid $16.9 million in cash, and agreed to pay as much as $8.0 million more in earn-out incentives during the next two years. The Pfanstiehl business unit generated sales of $24 million in 2012, and posted an operating margin of 10%.
  • Also in April, the Telerx customer care subsidiary of Merck & Co. expanded its Pharmaceutical and Healthcare business unit by acquiring Sentrx Safety Solutions, a leading provider of outsourced pharmacovigilance services.
  • In May, Quintiles Transnational returned to the public market by selling more than 27 million shares at $40.00 each. In September, it expanded its business in the oncology and medical device areas with the acquisition of Novella Clinical.
  • We have long been tracking the acquisition of outsourcing service providers by companies not historically engaged in that business. The latest example occurred in September, when Columbia Laboratories agreed to acquire Molecular Profiles. Columbia is a drug company that generates virtually all its revenue from sales and royalties on CRINONE8%, a progesterone gel marketed by partners in the U.S. and abroad. Molecular Profiles provides a range of development, formulation and contract manufacturing services to the biopharma industry. The announced price of this acquisition was $25 million, consisting of $16.7 million in cash and 1.05 million shares of Columbia’s stock.
In October, two Asian CROs made modest acquisitions.
  • EPS International acquired Singapore-based Gleneagles CRC Pte. from its co-owners Parkway Holdings Limited and MITSUI & Co.
  • Hangzhou Tigermed’s Hong Kong-based consulting unit acquired a 55% stake in BDM Consulting, a data management and biostatistics company based in Somerset, NJ.
Private Equity Firms Remained Active
Many participants in drug development continue to regard investments by private equity firms in outsourcing firms with suspicion. Rather than bemoaning the entry of such firms to the industry, we believe more operating executives should welcome this source of growth capital.
  • In December 2012, American Capital committed $212 million to the purchase of Cambridge Major Laboratories from Arlington Capital Partners. Then in October, American committed another $391 million to purchase AAIPharma from Water Street Partners and combined its operations with those of Cambridge Major.
  • In January, Arsenal Capital made two additional investments in the IRB arena. It acquired majority ownership of Tract Manager and Research Delaware LLC, provider of the software application IRBNet. In 2012, Arsenal acquired both Copernicus Group Institutional Review Board and Western Institutional Review Board.
  • In March, Arlington Capital purchased Micron Technologies from Colorcon, Inc., a portfolio company of Berwind Corp.
  • Also in March, JLL Partners paid $7.25 per share in cash to acquire the publicly owned shares of BioClinica, Inc. At the same time, it acquired CoreLabPartners from Ampersand Capital Partners and merged that firm into BioClinica.
  • In April, the public shareholders of ShangPharma Corporation approved the sale of that company to a group including chief executive officer Michael Xin Hui and TPG Funds. In recommending the offer, the company’s board believed management would have “greater flexibility to focus on improving the company’s financial performance without the constraints caused by the public equity market’s valuation of the company and emphasis on short-term, period-to-period performance.” Being publicly held is not for everyone.
Also in April the healthcare specialty firm Water Street Partners expanded its involvement in pharmaceutical outsourcing by investing in CCBR-SYNARC.
  • In May, another private equity firm, Audax Group, made its first entry into the clinical research business with the purchase of another IRB, Chesapeake Research Review.
  • That same month, the UK-based Invesco Perpetual committed $50 million to DrugDev.org. In October, that company acquired CFS Clinical from Archbrook Capital Management.
  • Also in May, the Toronto-based Kilmer Capital Partners helped its portfolio company Altasciences Group acquire Vince & Associates Clinical Research.
  • KKR was particularly busy in 2013. In June, it paid $1.3 billion to acquire PRA International from Genstar Capital. A month later, it helped PRA acquire Research Pharmaceutical Services from Warburg Pincus. And in December, it helped PRA complete the purchase of CRI Lifetree from its private equity owners.
  • In August, Parthenon Capital Partners moved into another area of healthcare services by acquiring Brackett and its assortment of e-clinical services from Express Scripts.
  • That same month, Carlyle Group helped its portfolio company PPD acquire the patient recruitment firm Acurian. At the beginning of the year, Carlyle had sold Qualicaps Co. Ltd. to Mitsubishi Chemical Holdings Corporation. It had invested in that pharmaceutical capsule maker through a management buyout from Shionogi & Co. in 2005.
  • In September, the KKR portfolio company Capsugel agreed to acquire dosage form CMO Bend Research.
  • In October, bio-CMO Gallus BioPharmaceuticals expanded its position in biologics contract manufacturing by acquiring Laureate Biopharmaceutical Services. The former is owned by Ridgemont Equity Partners. The latter had been a portfolio company of Saints Capital.
What Type of Activity Do We Expect in 2014?
It’s always easy to answer this question. Simply put, we expect more of the same! The largest firms will continue to seek selective opportunities in specific service categories. The still-expanding mid-tier firms will continue to expand in their attempt to serve more clients. The smaller firms will continue to sell to strategic and financial partners. And private equity firms will continue to be active as both buyers and sellers.

Plus ca change . . .  CP

Michael A. Martorelli is a Director at the investment banking firm Fairmount Partners. For additional commentary on the topics covered in this column contact him at Michael.martorelli@fairmountpartners.com  or at Tel: (610) 260-6232; Fax (610) 260-6285.

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