Since consolidation is a permanent state of affairs in the outsourcing industry, we again offer our analysis of such activity in the year just passed. Since forecasting is usually more interesting than reviewing, we also offer some thoughts about likely developments we think will occur in 2005.

The year just ended was a fairly busy period, in contrast to 2003, which saw limited consolidation activity among outsourcing providers. In 2004, there were more than three dozen transactions among the companies we track. In contrast to the two previous years, the leading participants in several segments made some large acquisitions. Moreover, they paid handsomely for them. At least, that’s the view of an investment banker, and probably most corporate executives as well. Investors are likely to make a judgment about the price of any particular acquisition based more on the impact it has on the acquiring company’s earnings than on the valuation implied in the transaction. These large transactions skewed the total value and average value of all deals consummated in 2004. By any measurement, it was a very good year. In the pages that follow we pay particular attention to several acquisitions we consider strategically important, if not transformational, deals.

Preclinical Meets Clinical—Again
The most obvious place to start when examining the record of consolidation in 2004 has to be at the intersection of the preclinical and clinical service businesses. Two specific transactions should make veteran observers of outsourcing recall the mid-nineties period of consolidation that led to the formation of the so-called “full service” CRO. In September, preclinical specialist Charles River Laboratories extended its presence in that arena and entered the clinical services business with the acquisition of Inveresk Research Group. CRL paid more than 5x trailing twelve months (TTM) revenue and more than 23x TTM earnings before interest, taxes, depreciation, and amortization (EBITDA) for that company. In November, the bioanalytical and Phase I specialist SFBC International announced the extension of its business to Phase II-IV clinical services with the planned acquisition of PharmaNet. The price of that acquisition was more than 2x TTM revenue and more than 11x TTM EBITDA. Despite these high prices, both transactions are expected to be accretive to earnings. They each deserve more discussion:

At a mid-December investor meeting (unfortunately held after the deadline for this article), the management of Charles River Laboratories described in some detail its aspirations for revenue and earnings growth in 2005 and beyond. The new CRL should be able to generate greater revenue growth with Inveresk’s Phase I-IV component than without it. The company will have a broader revenue footprint than before, and should be better able to withstand any temporary disruptions in the growth trajectory of specific business units. The Research Models and Services segment will still comprise about 45% of the revenue of the combined company. It is this business in which CRL has really excelled during the past several years. Its operating margin is running at about 32%, considerably higher than that of either CRL’s Development and Safety Testing segment or of Inveresk. Management has identified at least $10 million in administrative cost savings from this merger. Still, it seems unlikely that it will be possible for CRL to increase its overall operating margin from the recent 27% level. Investors appear to have reacted favorably to this combination. The stock is essentially flat with its level immediately prior to the announcement. However, that puts it within a few dollars of its all-time high. The valuation of the combined company exceeds those of almost all other broad-based CROs.

The combination of SFBC International and PharmaNet was scheduled to be completed before year-end 2004, but it had not closed as of this writing. Assuming its consummation, management has guided investors to expect full-year 2005 revenue and earnings growth in the neighborhood of 20%. In adding $118 million of annual clinical service revenue to its own $155 million base of bioanalytical and Phase I business, SFBC will become a member of the industry’s Top Ten. Because PharmaNet is privately held, we can not glean from its financial history how synergistic this combination will be. It should afford SFBC more opportunities for global expansion and larger contract size, and might lead to more cross-selling of ser-vices. PharmaNet recorded an EBITDA margin of about 18% in the first nine months of 2004; SFBC posted an operating margin of about 17% for the same period. When the transaction is closed, and upon the announcement of SFBC’s fourth quarter 2004 results, we would expect to learn more about the combined company’s margin targets for 2005 and beyond. Investors have responded more favorably to this combination than they did to the Charles River transaction. SFBC’s stock has risen by more than 30% since the announcement of its planned acquisition of PharmaNet. Like that of CRL, this stock is selling at its all-time high and at a valuation that is meaningfully higher than those of most other full service CROs.

Other Clinical Service Providers Continue Expanding
We suspect there are several companies and many more executives and employees who acknowledge the “big story” nature of the combinations profiled above, but who believe there were several other meaningful acquisitions made by participants in the clinical service business. We agree, and offer comments on some other interesting ones below.

Before it acquired PharmaNet, SFBC International expanded its presence in the bioanalytical business with the July acquisition of Taylor Technology. Adding this $12 million Princeton-based company to its existing SFBC Anapharm unit gave the company another Northeast location, a new customer base of brand-name pharmaceutical companies, and specialized capabilities involving hormone biomarkers. In addition, this accretive transaction enabled management to raise its revenue and EPS targets for 2004.

In last year’s article, we wondered what role companies such as UnitedHealth Group would play in this consolidating industry. Part of the answer came in July, when that company’s Ingenix unit strengthened its presence in the clinical research arena with the acquisition of Statprobe, a CRO with annual revenue of about $32 million. The total Ingenix unit still represents a very small percentage of its parent organization.

A new financial buyer was quite busy in 2004. United Biosource Corp. raised more than $150 million in private equity in December 2003 with the expressed purpose of acquiring companies with proven records of providing value-added services to the pharmaceutical and life science industries.

In 2004, United acquired three companies. MEDTAP provides health economics and outcomes research services. DataPhase IV specializes in post-marketing surveillance, pharmacovigilance, and risk management services. And B&B Clinical Innovations is a specialty CRO focused on late-stage drug development, including post-marketing studies, product life-cycle management, and patient registries.

PAREXEL International completed a few small transactions in 2004 as it continued to seek the optimal mix of services to support management’s goals for revenue growth and profitability. In April it expanded its Phase I business with acquisition of the remainder of 3ClinicalResearch AG that it did not own. This 90-employee company operates two Phase I/IIa units in Germany and has annual revenue of approximately $12 million. It also increased its partial ownership of FARMOVS, a clinical pharmacology unit in South Africa.

Omnicare, Inc. acquired Clinimetrics Research Associates, a provider of comprehensive CRO services with a particular emphasis on biotechnology and early stage drug companies. Its annualized revenue run rate is $40 million, so it will increase Omnicare’s CRO business by about one-third. Just as importantly, with a client base that’s 70% biotechnology companies, it will expand Omnicare’s business in that arena. Clinimetrics employs more than 300 people at its five domestic and three international locations. Its current backlog is approximately $85 million.

Following a busy year for acquisitions in 2003, ICON plc was quiet in 2004. In July, it did acquire a 70% interest in Beacon Biosciences, a CRO specializing in the medical imaging field.

Rounding out the most meaningful activity among the publicly-held companies, Quintiles Transnational sold its specialty dermatology products company Bioglan Pharmaceutials to Bradley Pharmaceuticals for approximately $183 million in cash. (While the equity of Quintiles is privately owned, the company has publicly-held debt, files 10-Qs with the SEC, and hosts a quarterly earnings conference call.)

As usual, the industry’s private companies concluded a large number of joint ventures, partnering relationships, and re-seller agreements. There were at least as many acquisitions as in the prior year. Several involved relatively well-known companies.

Cerep SA trades publicly only on the Nouveau Marche in Paris. In January, it expanded into the clinical services business with the acquisition of the Swiss company Hesperion. In November, it agreed to acquire the French biotechnology company Molecular Engines Laboratories (MEL).

In January, CRC Development roughly doubled its size to $20 million by acquiring Premier Research from parent company SCP Communications. This was the third acquisition made by CRC since its founding in 2002.

Swiss-based SGS Life Sciences took another step in building a global CRO focused on early development with the April acquisition of Netherlands-based Medisearch International.

In the closely related clinical service technology area, software provider etrials expanded its service offerings with the May acquisitions of an interactive voice response system and a clinical trial management system. Elsewhere, ClinPhone acquired the clinical trial management system company TrialTrac. Finally, electronic diary specialist invivodata acquired Clinitrac, a traditional service-oriented CRO with a technology mindset.

A Busy Year for Manufacturing And Related Services
Our broad view of this segment of outsourcing includes companies providing both large scale and pilot manufacturing services, chemistry services, and scale-up and synthesis work. We want to highlight several transactions that occurred among these companies in 2004. As was the case with the preclinical/clinical combinations discussed earlier, the large if not transformational ones involving a publicly-held buyer occurred at relatively high valuations.

Last January, Fisher Scientific paid about 3.2x TTM revenue and 14x TTM EBITDA for Apogent Technologies. In February, Invitrogen Corporation paid 3.8x TTM revenue and 15x TTM EBITDA for BioReliance Corporation. In November, Patheon agreed to pay 2.0-2.4x TTM revenue and 7.2-8.6x TTM EBITDA for MOVA Pharmaceutical Corporation.

The acquisition of MOVA Pharma-ceutical by Patheon Inc. was scheduled to close by year-end 2004. The announced purchase price could be adjusted upward, depending on MOVA’s final 2004 results. MOVA is a Puerto Rico-based prescription pharmaceutical contract manufacturer with three plants on that island. Its current year revenue is in the neighborhood of $175 million. Based on confirmed orders for the current period, management believes its annual revenue run rate to be closer to $240 million. This revenue base is much more concentrated than the current $450 million revenue base of Patheon. MOVA tends to produce large commercial quantities for a limited number of clients. Patheon has a larger and more diverse client base, and provides various development services in addition to contract manufacturing of commercial products. During the past five years, Patheon has used internal growth and acquisition to transform itself from a small manufacturer of OTC products to a larger manufacturer of both prescription and OTC drugs and a provider of related drug formulation and development services.

Safeguard Scientific Inc. entered the biopharmaceutical manufacturing in-dustry with the October acquisition of Laureate Pharma. Safeguard is probably not a familiar name to most readers of this magazine. The company has a long history of activity as a strategic investor in growth companies in the Time-to-Volume stage of corporate development. Such firms are generating revenue from a commercially viable product or service, but are facing challenges in scaling their businesses to take advantage of a broader market opportunity. By providing expansion capital as well as operating and managerial expertise, Safeguard intends to drive the successful growth of such a company to become a market leader. The Laureate acquisition is its first in the life sciences arena since management made the decision to focus on that area (along with information technology) in 2003. Laureate is a Princeton-based company that provides process development, cell line optimization, process validation, bioreactor production and other specialty services to biopharmaceutical companies. It employs about 760 people in its two New Jersey facilities. Revenue in 2003 approximated $8 million.

Because it was announced more than a year ago, some readers may have forgotten that Invitrogen Corporation completed its acquisition of BioReliance Corporation in February. That acquisition extended Invitrogen’s presence in the cell culture business and gave it a meaningful presence in the broader biomanufacturing area. The company has apparently exceeded the revenue and earnings estimates it made at the beginning of the year. However, organic growth appears to have been a bit ragged, and operating expenses appear to have been higher than anticipated. The stock made its 52-week high not long after the closing of the BioReliance acquisition. The performance of both the company and the stock in 2004 should be seen as a reminder that many items other than a company’s acquisition record can influence the direction of its financials and its market valuation.

In 2004 there were many acquisitions made by manufacturers of instruments, consumables, tools and disposables. One transaction dwarfing all others in size and scope was the acquisition of Apogent Technologies by Fisher International. That acquisition expanded Fisher’s business as a distributor of a broad array of laboratory products across the scientific community and around the world. Moreover, it increased the percentage of higher-margin, self-manufactured products from 30% to 40%. After increasing its revenue base, profit margin, and cash flow with this acquisition, Fisher used another $410 million in cash and debt to also acquire the revenue bases of Oxoid Group Holdings and Dharmacon Inc., two other providers of high-margin specialty products. Investors appeared to regard these activities favorably. The stock made a large move immediately following the consummation of these deals. It has been a rather steady performer since then, indicating once again that it takes more than a good acquisition strategy to drive a business and a stock valuation forward.

Most other acquisition activity in this arena involved the purchase of a relatively small company by a much larger one. The following are just some of the transactions that appeared to receive reasonably good reviews, but that did not appear meaningful enough in the big picture to change the nature of the business or the valuation of the acquiring firm.

Bio-Rad Laboratories Inc. acquired Hemotronix Inc., a manufacturer of hematology controls, reagents and related products for the clinical diagnostics industry.

Harvard Bioscience acquired KC Scientific, a manufacturer of fluidics equipment used by the research laboratory market.

Molecular Devices acquired Axon Instruments, maker of electronic instrumentation equipment and software for drug discovery and academic research in the field of biology.

Qiagen N.V. acquired the key assets of Molecular Staging, which has developed a range of proprietary products and services based on its Multiple Displacement Amplification (MDA) technology.

Sigma Aldrich acquired Ultrafine Ltd., a UK-based supplier of contract chemistry services for all phases of drug development.

Thermo Electron Corporation acquired InnaPhase Corporation, a premier supplier of laboratory information management systems (LIMS) to the pharmaceutical and biotechnology markets.

Waters Corporation acquired NuGenesis Technologies, a provider of enterprise wide scientific data management systems for several industries.

Unusual Activity in the Sales and Marketing Arena
We don’t normally comment on activities involving the outsourcing of sales and marketing activities, since that category of functional specialties does not seem to fit in the prime area of interest to the readers of Contract Pharma. However, there was some meaningful activity in this segment of outsourcing in 2004, and we think it would be incomplete to write about consolidation without commenting on a couple of transactions. Two of the four leading companies in this oligopolistic industry moved to bolster the size and importance of their service businesses while reducing their emphasis on direct product ownership.

Ventiv Health Inc. was particularly active, acquiring three companies during the second half of the year. In so doing, it added annual revenue of approximately $85 million to its existing annual run rate of about $300 million. The most significant acquisition was the October purchase of Smith Hanley Corporation, a leading provider of outsourced clinical staffing and recruiting services to the U.S. pharmaceutical industry. Ventiv expects to use its skills and experience in managing teams to help win larger contracts for the Smith Hanley Consulting and MedFocus units. In turn, those units can use their involvement in products earlier in the drug lifecycle to introduce the sales and marketing services of Ventiv. The combined organization should have enough scale to pursue larger outsourcing contracts in certain functional areas. This ability should be even more enhanced by the presence of HHI Clinical & Statistical Research Services, a company acquired by Ventiv in November. Investors responded favorably to the acquisitions and the revenue/earnings progress made by Ventiv in 2004. The stock greatly exceeded the performance of the Nasdaq index and PDI Inc., the other independent, publicly-held contract sales and marketing organization.

The aforementioned PDI Inc. also expanded its revenue base last year with the August acquisition of the healthcare communications company Pharmakon L.L.C. That firm’s specialty is the creation, design and implementation of interactive peer persuasion programs. With this acquisition, PDI broadened its position in the medical education field, especially in the interactive arena.

Dendrite International continued to expand its service offerings and its geographic scope, making three acquisitions last year. In January it acquired the Osaka, Japan-based Uto Brain Co. That firm provides specialized market research to the drug industry, and should be complimentary with Dendrite’s leading position in the Japanese sales force effectiveness business. In April, Dendrite acquired the Polish firm Medical Data Management. This company provides physician databases, market research, and sales force support services to drug companies in Poland and surrounding countries. Finally, in July, Dendrite acquired the German firm Schwarzeck-Verlag GmbH, a provider of commercialization services to drug firms in Germany. Combined, these three deals should only add about $20 million to Dendrite’s annual revenue base of more than $400 million. Importantly, they each expanded the company’s footprint beyond its traditional sales force effectiveness software business, which now only accounts for about 70% of total revenue. As is the case with other companies on which we have commented, we suspect the mediocre performance of Dendrite’s stock during the past year has had more to do with investor expectations and revenue and earnings growth than with the details of this acquisition program.

What’s in Store for 2005?
At this writing, the managements of both aaiPharma and NDCHealth Corp. have publicly discussed their consideration of strategic alternatives in order to improve shareholder value. That language is usually code for putting up part or all of the company for sale. We can’t predict the timing of any transaction, but suspect both will conclude some deal before too long.

We would be surprised to witness any particularly large acquisitions involving companies in the clinical service business this year. It seems the major participants in the business are satisfied with their strategic positions. We are still closely watching diversified companies as UnitedHealth Group, Omnicare Inc., and Omnicom Group Inc. for signs that they will meaningfully increase their participation in that business. Alternatively, they could also decide to withdraw from clinical research in favor of other strategic alternatives. Elsewhere, there is a new publicly-held player in the game of seeking growth by acquisition. PRA International now has a cash base and a tradable equity to use to augment its internal growth. Finally, we would not be surprised to see any type of transaction involving the group of smaller CROs that includes Kendle International, Covalent Group, and Life Sciences Research.

In the broad area of manufacturing and related services, we expect to see many more product purchases or licensings, joint venture arrangements, and tuck-in acquisitions. It’s often hard to discern broad trends against a backdrop of numerous individual transactions. Nevertheless, we think a few themes will continue to dominate:

• Biologicals manufacturing is an intriguing growth business
• Global service providers need to expand their presence in low-cost countries
• Mature, slowly-growing companies need to keep adding to their technological capabilities
• Private equity investors use good economic times to seek liquidity events
• Fragmentation may not be a permanent state of affairs
• The roll-up strategy sometimes has its day

One Final Thought
We haven’t discussed consolidation in the drug and biotechnology industries. In the past, the business fortunes of the outsourcing community have suffered substantially in the face of meaningful business combinations involving their large customers. When that happens, a strategy seeking expansion by acquisition takes a backseat to one seeking revenue and profit stability. Historically, drug consolidations have occurred against a backdrop of weak revenue and profit growth, and/or serious regulatory difficulties. We think it would be naïve to ignore the influence that another tough year for the drug industry could have on our expectations for continuing consolidation in the pharmaceutical outsourcing business.