Outsourcing M&A Year In Review

Reviewing 2010’s mergers, acquisitions and buyouts

By Michael A. Martorelli

Fairmount Partners

Strategic is the key word to use when reviewing the number and nature of consolidating acquisitions in the pharmaceutical outsourcing industry in 2010. In our periodic Outsourcing Industry Monitor reports, we wrote about five multi-billion dollar transactions that were completed and one more that was proposed but cancelled. We described seven other $100+ milliontransactions that fit anyone’s definition of strategic. And we noted the announcement and/or closing of more than 50 other deals that may not have been quite as large, but that were undoubtedly considered strategic by their parties. Private equity (PE) firms were involved directly and explicitly in about 20% of all transactions and indirectly or not-so-explicitly in another 10%.

In last year’s summary of consolidation activity, we suggested 2010 would be a good year for Initial Public Offerings (IPOs). While we did not list any particulars, we acknowledged that a least a handful of PE-backed firms would be good candidates for either an IPO or a sale to a strategic buyer. Only one outsourcing firm went public last year; several relatively large PE-backed firms were sold to strategic buyers.

Tracking Specifics Rather Than Generalities

In continuing to monitor the broad outsourcing industry, we counted approximately 130 relevant transactions during the past 12 months, compared to 108 and 120 in the two prior years. In our own reports and this wrap-up, however, we focus largely on the M&A transactions or financings that strike us as particularly meaningful for the future of the industry. Consolidation is a permanent part of the landscape in this highly fragmented industry, which is still composed of dozens of publicly owned firms and hundreds of private companies around the world. We note again, as we did last year, that tracing only the number of completed deals during any time period does not allow one to appreciate the extent and intensity of the conversations about potential transactions that were not completed for one reason or another. Moreover, complicated discussions involving strategic transactions such as the transfer of a laboratory or manufacturing facility from a sponsor to an outsourcing provider can easily be spread out over more than 12 months.

The overall health of the broad outsourcing industry was not unusually strong or weak throughout late 2009 and 2010. Few companies exceeded their revenue and earnings targets. Many more fell short of meeting their managements’ financial expectations, due largely to the sluggish nature of R&D spending on the part of their customers in the drug and biotechnology industries. This performance, or lack of performance, certainly had an impact on the extent of consolidation activity.

Moving in a New Direction

We are always intrigued by acquisitions that bring a new player into the outsourcing industry, and by those that result in a company having a much larger presence in providing such services or products than heretofore. Last year, there were a handful of such transactions.

Merck KGaA Expanded Into Instrumentation

In February, the drug company Merck KGaA agreed to acquire the instrument manufacturer Millipore Corp. This particular diversified drug and chemical manufacturing company indicated its interest in moving in the opposite strategic direction from its peers, most of whom have been shedding their non-drug operations. Merck’s management saw the attraction of adding Millipore’s $926 million Bioprocess Division and $730 million Bioscience Division to Merck’s own $1.6 billion Performance and Life Science Chemicals Division. That unit was second in size to the $7.4 billion Merck Serono Division, contributing 16% of corporate revenue. But it contributed a disproportionately low 7% of corporate operating profits. Adding the Millipore business promised to improve both its competitive position and its profitability.

Merck was so intent on making this transaction that it was willing to top the rather generous takeover offer for Millipore that Thermo Fisher Scientific had made in early January. Merck’s financial advisor suggested the ultimate price — 4.3x trailing 12 months’ revenue and 17.4x trailing 12 months’ EBITDA — was fair. But Merck’s shareholders took the stock down almost 11% on news of the purchase agreement. Five months later, the stock was back to its February level, suggesting that investors had come to appreciate the potential contribution of the Millipore business.

Of course, stock prices move on news items other than those involving acquisitions. It’s worth noting that Merck’s share price fell 10% the day in late September that the Committee for Medicinal Products for Human Use (CHMP) of the European Medicines Agency (EMA) issued a negative opinion regarding the marketing application for Cladribine, an important new drug intended to treat relapsing-remitting multiple sclerosis.

Medco Health Services Extended Its Scope

In September, Medco Health Solutions paid $730 million in cash for United BioSource Corp. Medco is a pharmacy benefit management company; it also provides many types of data analytics and conducts research on various aspects of pharmaceutical knowledge. Adding UBC’s capabilities in post-approval studies and evidence-based medicine provides it with additional services for all players in the broad health care services industry. In the emerging new world of health care in the U.S. that incorporates the various aspects of ObamaCare, we suspect more non-traditional players will be entering the world of clinical trials.

ERT Entered New Territory

In June, eResearch Technology supplemented its leading position in the cardiac safety core lab market with the acquisition of the CareFusion’s Research Services unit. The acquisition expanded the company’s addressable market by more than $1.3 billion. ERT’s management has moved aggressively during the past year or two to re-assess the company’s mix of services. Apparently, they have found the respiratory care business to be similar enough to the cardiac safety market to turn some attention towards that arena.

McKesson Moved Into Patient Care

McKesson Corporation is the largest pharmaceutical distributor in North America. It also provides information technology and support systems to hospitals, pharmacies, and physicians. As 2010 ended, it was planning to complete the acquisition of US Oncology, a leading integrated oncology care company. That firm is affiliated with more than 1,300 community-based oncologists who work in all phases of cancer treatment and research. Strictly speaking, this acquisition did not involve a provider of pharmaceutical outsourcing services, yet we believe it was representative of the larger theme noted above; i.e. in the emerging new world of health care in this country, many different types of providers will be combining their service offerings in un-traditional ways.

Keeping to One’s Knitting

Acquisitions involving parties from different industry segments always seem to grab larger headlines than those concerning two parties in the same segment. Yet, we should not ignore some strategic acquisitions made by firms extending and expanding their existing lines of business.

LabCorp Added More Specialty Capabilities

In separate transactions, Laboratory Corporation of America increased its involvement in specialty segments of the lab testing business by acquiring Genzyme Genetics and Enthalpy Analytical. The company had been generating about 35% of its revenue from genomic and esoteric testing before buying these additional specialty labs. They will become additional business units that are experts in using sophisticated, high throughput LS-MS-MS equipment to analyze samples and detect small traces of specific elements. This leading clinical diagnostic lab appears intent on using that knowledge to take advantage of changing technology that promises to make those instruments more usable in a greater variety of diagnostic testing applications.

Oracle Moved Deeper Into the eClinical World

In August, Oracle Corporation completed the acquisition of Phase Forward. Its shareholders did not seem at all upset with the price, which approximated 19x trailing 12 months’ EBITDA. The company has paid premium prices for many acquisitions during the past several years. In mid-2008, Oracle formed the Health Sciences Business Unit as a vehicle for enhancing its ability to serve the needs of the biopharmaceutical research industry. Acquiring Phase Forward added about $213 million to that unit’s estimated 2008 revenue of about $220 million. As is usually the case with a $25+ million revenue company, management has not provided much transparency about the ongoing results of the Phase Forward business, or even the Health Sciences Business Unit.

One Life Science Software Company Acquired Another

In July, Accelrys, Inc. (ACCL) acquired Symyx Technologies, Inc. (SMMX), creating the leading scientific informatics software company. Both firms had gone public at the height of Wall Street’s fascination with the potential for sophisticated modeling and simulation tools in chemistry, biology, and materials science. Both had achieved some success. But their managements believed it would make sense to combine them. At the time, SMMX had a larger revenue base, but a smaller market capitalization. The SMMX board rebuffed a competitive offer from Certara (owner of Pharsight and Tripos). Investors appeared pleased with this transaction; since it closed, ACCL’s stock has advanced by more than 20%.

Thermo Fisher Remained Active

Thermo Fisher Scientific (TMO) agreed to acquire five companies in 2010; each expanded its existing business operations in an important product category. The company signed its largest deal in December, agreeing to pay $1.2 billion in cash for Dionex Corporation. Thus, it will add that firm’s line of ion and liquid chromatography products to TMO’s own gas chromatography business. With this deal, TMO will expand its footprint in China and other Asian markets, and its presence in markets such as environmental analysis and water testing. TMO was able to offer the Dionex shareholders a 32% premium to the stock’s recent selling price and still cause the acquisition to be accretive in the first 12 months after closing.

Other Firms Added Relatively Large PiecesTo Their Operations

In our Outsourcing Industry Monitor reports, we described the activities of many more companies that made vertical acquisitions last year. Buyers making the most meaningful deals included the following:

•Albany Molecular Research acquired Excelsyn Ltd. and Hylauron Inc.

•Asterand plc acquired BioSeek Inc.

•BioClinica, Inc. acquired TranSenda International

•Cambrex Corp. acquired IEP GmbH and a 51% stake in Zenara Pharma

•Cyprotex plc acquired Apredica LLC and Cellumen, Inc.

•Encorium Group acquired Progenitor International Research

•Medpace, Inc. acquired Medical Consulting, Pharma Brains AG, and Symbios Clinical

•Novella Clinical Inc. acquired Prologue Research International

•Recipharm AB acquired Cobra Manufacturing Plc

•Ricerca Biosciences acquired MDS Inc.’s Discovery and Preclinical operations

•Taconic Farms acquired Caliper Life Sciences’ Xenogen Biosciences subsidiary

Private Equity FirmsCan Also Think Strategically

Over the years, we have chronicled the transactions that resulted in private equity firms taking ownership of publicly held outsourcing firms such as PRA International, PharmaNet, Premier Research, and Pharsight. In 2010, this trend continued; four particularly large transactions caught our eye.

•In February, the combination of TPG Capital and the CPP Investment Board completed one of the largest going-private transactions in recent memory by taking control of IMS Health at a cost of $5.9 billion. That price represented a 50% premium over the stock’s recent trading range. However it was more than 20% below its level of two years earlier. In late 2007, management had begun warning investors that consolidation and other changes in the pharmaceutical industry were having a serious impact on the company’s ability to generate its traditional levels of revenue growth and profitability. We found it very interesting that eight of the 17 PE firms contacted by the firm’s investment bankers expressed sufficient interest in IMS to sign confidentiality agreements, but none of the seven potential strategic buyers so identified had enough interest to take that step.

•In April, Thomas H. Lee Partners agreed to purchase inVentiv Health for $1.1 billion. InVentiv was another company with a proud tradition, albeit a shorter one than that of IMS, that had seen its ability to generate revenue and earnings growth sharply curtailed by changes in the pharmaceutical industry. Back in 2003, inVentiv had been the contract sales organization most successful in re-tooling its business to accommodate a different set of changes that engulfed the sales organizations of its client base. The proxy statement describing this transaction noted that the company’s board of directors had begun soliciting takeover bids as far back as March 2008. The economic and industry turmoil that occurred in the second half of that year caused them to suspend that effort. In the fall of 2009, the Board quietly re-activated its program to evaluate potential offers. As many as 10 parties received information from the company’s financial advisor. In late March, the company announced it had received an indication of interest from a financial buyer; five weeks later, it signed the agreement with T.H. Lee.

•In September, SV Life Sciences, The Halifax Group, and the Comvest Group combined the operations of four CROs they owned or controlled: Trio Clinical Research, Fulcrum Pharma, Averion International and ClinResearch/ ADDPLAN. The architects of the new firm are industry veterans Pat Donnelly (chairman and chief executive officer) and Matt Bond (chief financial officer.) It employs more than 800 people on three continents, and is believed to be one of the 15 largest clinical CROs. As a privately owned firm, the new company has not released any financial data, nor has it described its capitalization structure, including the ownership percentages held by the PE firms and managers who have supplied one of its component parts with capital.

•In December, Warburg Pincus agreed to acquire ReSearch Pharmaceutical Services (RPS). Back in June, that firm had filed to go public in the U.S. In September 2009, RPS had received approval from shareholders to delist its shares from the Alternative Investment Market (AIM) of the London Stock Exchange. At the time, management noted this U.S.-based company had not realized the benefits of having a public listing in the UK. The board of directors accepted Warburg’s price of $6.10 in cash per share. Current RPS shareholders will be asked to approve that offer in February.

Seeing the Signals in Two Spin-offs

We have written previously about firms divesting business units no longer considered compatible with other operations and/or considered critical to a company’s future. And we are rarely surprised by the divestiture activities taken by the outsourcing firms we monitor. Last year, two prominent CROs discarded business units that senior managements had long been describing as important components of their organizations.

•In June, PPD Inc. completed the tax-free spin-off to shareholders of Furiex Pharmaceuticals, Inc., a company holding the assets of PPD’s compound partnering business. Since 1998, PPD had differentiated itself from most other large CROs by employing a risk-sharing R&D model to help drug and biotechnology companies develop products. For most of the past decade, PPD’s management had been telling investors that this activity had a favorable risk/reward profile, and that the company could anticipate generating a higher return on equity with the program than it could without it. Investors were surprised in October 2009, when management announced plans to spin-off those activities to shareholders. At the time of the spin-off, Furiex owned royalty and milestone rights to a variety of compounds licensed from several different drug companies.

•Back in November 2009, in its preliminary offering memorandum filed with the SEC and covering the proposed sale of $525 million in senior notes, Quintiles Transnational acknowledged its intention to spin off its PharmaBio Development unit to shareholders. PharmaBio held certain of the assets used by NovaQuest Group subsidiary. PharmaBio and NovaQuest were the parts of Quintiles that enabled the company to obtain ownership interests in certain compounds, both during their development and upon their commercialization. The company completed the bond offering, but as a private company, it did not make any other statements about PharmaBio or NovaQuest. Fast-forward to November, 2010. In an SEC filing, Quintiles confirmed that NovaQuest had become an independent, standalone organization. Quintiles is a minority investor in this company, which recently raised $177 million of a planned $500 million investment fund to pursue other drug development opportunities.

A Special Category: Sale of a Facility

In the November/December Contract Pharma, editor Gil Roth wrote of the increasing number of asset transfer deals between pharma companies and service providers. We have written about some headline-making sales of laboratory or manufacturing facilities, but must admit to not trackingthose transactions as closely as we do the sale of companies.But a few asset-transfer deals from 2010 deserve some attention here.

•In March, Bristol-Myers Squibb sold its manufacturing plant in Latina, Italy to Corden Pharma Latina S.p.A, an affiliate of International Chemicals Investors Group. The plant occupied 360,000 sq. ft. and employed 815 people.

•In July, GlaxoSmithKline sold its Medicines Research Centre in Verona, Italy to Aptuit, Inc. That research site employed 500 scientists and support staff.

•In October, Abbott Laboratories sold its manufacturing facility in Parets, Spain to Recipharm AB.The transaction was part of Abbott’s reorganization of the business it acquired with the February 2010 purchase of Solvay.

•Also in October, Sanofi-Aventis (SAN) signed two important partnership agreements with Covance Inc. (CVD), including one involving CVD’s acquisition of laboratories providing a variety of CMC services in France and England. CVD agreed to pay SAN $25 million for the labs, which occupy a total of 575,000 sq. ft. and employ about 300 people. SAN contracted for $350 million worth of services from those facilities over the next five years. SAN began soliciting bids for these Porchevile (France) and Alnwick (England) sites more than a year ago. While discussing various types of partnering relationships, CVD emerged as the most appropriate buyer.

•In November, GlaxoSmithKline agreed to sell its penicillin manufacturing plant in Bristol, TN to Dr. Reddy’s Laboratories. The transaction is scheduled to close in the first half of 2011, and will include the sale of marketing rights to Augmentin and Amoxil in the U.S.

•In December, the Belgian-based UCB Pharma sold three manufacturing facilities in Germany and Italy to the UK-based contract manufacturer Aesica. When completed, these acquisitions will allow that firm to double its manufacturing capacity.

•Finally, in a reversal of the trend noted above, in August, Merck repurchased the manufacturing facility in Riverside, Pennsylvania that it had sold to the Cherokee Pharma unit of PRWT Services in 2008. The plant employs 454 workers.

One Cancelled Transaction andOne Pending One

We close with a brief recap of one headline-making transaction that did not occur last year and the acknowledgement of a rumored transaction involving that same company. Of course, we’re talking about Charles River Laboratories (CRL).

In April, CRL agreed to acquire WuXI PharmaTech (WX) for cash and stock worth $1.6 billion. Investors appreciated the logic of combining the two companies’ assortment of businesses. However, they did not believe it was worth paying WX shareholders approximately 17x that firm’s trailing 12 months’ EBITDA. During the next few months, a few large CRL shareholders expressed their believe that CRL management was over-estimating the financial benefits of the acquisition and under-estimating the challenges involved in integrating WX’s operations. In late July, CRL management withdrew its offer, and paid WX the $30 million breakup fee included in the original merger agreement.

In December, two different shareholder groups publicly criticized management’s operation of CRL during the past few years, and suggested the board of directors consider selling the company, either as a single entity or as two separate businesses (Research Models and Pre Clinical Services.) CRL management responded to those suggestions by announcing they would pursue the sale of the Phase I clinic in Tacoma, WA and the preclinical facility in China. [For more on CRL’s travails, see this issue’s Preclinical Outsourcing column.—ed.]

Anticipating 2011

We know from our own work that outsourcing companies of all sizes and in all sectors are actively engaged in M&A discussions. It’s impossible to predict the number and nature of deals that will occur in 2011, but we believe there will be more than last year. Perhaps the most interesting type of transactions to anticipate this year will be those involving the entrance of new participants to outsourcing and the exit of some long-time players in the business. The former could be connected to changes in the overall healthcare system related to the coming of ObamaCare in the U.S.; the latter to the realization by some diversified companies that outsourcing is a non-core activity.

We also expect additional asset transfer deals, although we suspect the world’s drug companies will continue to offer many more facilities than the world’s outsourcing firms are interested in buying.

Michael A. Martorelli is a Director at the investment banking firm Fairmount Partners. He also writes the Financial Analysis column for Contract Pharma. For additional commentary on the topics covered in this article, or to be added to the distributionlist for his Outsourcing Industry Monitor reports, contact him atTel: (610) 260-6232; Fax (610) 260-6285 or michael.martorelli@fairmountpartners.com.