Now that Quintiles and IMS Health have agreed to merge and LabCorp acquired Covance, some people believe we’ll see additional large, transformational transactions among contract research organizations (CRO). Some sector participants and observers believe that until revenue growth at the larger CROs slows, we will not see meaningful consolidation. Maybe we’re approaching that point. Others believe that smaller, nimbler companies in the CRO sector will continue to be the primary acquisition targets for the larger CROs. These ‘add-on’ acquisition targets have been the primary acquisition strategy of the group. Competition has been strong for the most sought after targets over the last few years. Below is a summary of the arguments for large, transformational transactions and for more of the same, smaller, ‘add-on’ deal activity.

The case for large, transformational transactions
The industry needs fewer but larger CROs to best serve the growing needs of its global biopharma customers. Some CROs are attempting to be one-stop shops for their biopharma customers. This includes covering geographies, scientific expertise in a range of therapeutic areas, experience from Phase I through post-marketing and outcomes studies, developing and/or using leading technologies and improving the efficiency of studies.

Strategic partnerships at some CROs are creating customer concentration. A transformative transaction could mitigate that concentration and may create an opportunity to take on incremental revenue from the sponsor.

In addition, operational integration of two large CROs is less of a concern today compared to a few years ago.

Also, some larger CROs have indicated they prefer larger transactions as smaller transactions can take similar amounts of internal and external resources making them less attractive.

The case for continued ‘add-on’ acquisitions
CRO revenue expansion has been driven by a number of factors including the growth of biopharma research and development (R&D) spending, the growth of the portion of R&D spend that biopharma sponsors outsource and the increasing complexity of clinical trials. Some sector observers and participants believe that these and other factors will continue driving CRO revenue growth in the coming years. Therefore, they don’t see the impetus for larger CROs to combine.

Other concerns include customer reaction and the potential loss of revenue. Customers may reevaluate their vender diversification upon a transformational transaction in the CRO space.

The challenges of integrating two large CROs would be difficult, expensive and time consuming. While redundant overhead would be quickly rationalized, legacy technology systems and infrastructure would need to be kept in place as trials some years from concluding were completed.

Until the revenue growth among the largest CROs slows, the M&A activity will continue to focus on adding unique services and technologies offered by small and mid-sized companies.

The high cost and long time to market for pharmaceutical products continues to attract novel technologies and services that improve efficiencies and/or reduce cost. Led by experienced entrepreneurs and fueled by private investor appetite, smaller companies are developing innovative solutions to address the clinical research sectors most pressing problems. There is a long history of these companies growing quickly and being acquired by one of the larger CROs. For example, Aptiv Solutions, CoreLab Partners, MediMedia Pharma Solutions, Novella Clinical, Radiant Research, Synexus and Theorem Clinical Research all were acquired by larger CROs.

Private investment—venture capital and private equity funds—interest in pharma services remains strong. Small and mid-markets funds are targeting companies focusing on niche technologies and services. In many situations these funds and their management team partners have successfully grown and then sold to a larger CRO or a larger private equity fund. There are a number of high-quality, fast-growing companies that are prime acquisition candidates for larger CROs.

Larger private equity funds have been appropriately focused on larger targets in the sector. For example, Thomas H. Lee Partner’s 2010 acquisition of inVentiv Health, KKR’s 2013 acquisition of PRA Health Sciences, Carlyle’s and Hellman & Friedman’s 2011 acquisition of PPD, Cinven’s 2014 acquisition of Medpace and Genstar Capitals’s former investment in eResearch Technologies. Earlier this year inVentiv Health filed with the SEC to potentially sell shares to the public.

Time will tell how the M&A activity in the CRO sector will unfold in the coming months and years. But it’s clear given the private equity investments and interest in the sector that transaction activity of a variety of sizes should remain active.