Outsourcing M&A Year In Review

Reviewing 2008’s mergers, acquisitions and buyouts

By Michael A. Martorelli

This time, it was different. While the extent of consolidation in outsourcing in 2008 was not bad, we suspect it would have been stronger had it not been for deteriorating economic and capital market conditions. Moreover, the uneven financial results of some drug development firms and  outsourcing service providers probably inhibited many contemplated transactions from coming to fruition. In the pages that follow, we comment on patterns of consolidation activity within various outsourcing segments, and on the details of specific transactions. First, we think it’s useful to examine the broader backdrop to all consolidation activity.

The Nature of Overall Consolidation Activity

Consolidation in the outsourcing industry does not occur in a vacuum. Capital market conditions affect strategic and financial buyers differently, but it’s undeniable that those conditions have an effect on the pace of consolidation.

Strategic buyers can use cash and/or stock to make acquisitions. The performance of their stock has a tangible effect on the appetite and behavior of most of them. In most industries, the largest publicly held companies tend to be most active purchasers and the most willing to pay premium valuations.

The availability and cost of debt to finance transactions has a tangible impact on the willingness and ability of financial buyers to pursue their acquisition programs. In the recent past, private equity (PE) firms with access to debt and equity capital were willing and able to bid more aggressively for solid companies. In many cases, they defied the traditional behavior pattern which saw only large strategic buyers go the extra mile on valuation for a target with strong prospects.

Following one of the most robust periods of activity ever recorded, 2008 witnessed a decline in the extent of consolidation across the economy. Our source for the following observations is the December 2008 edition of Monthly Market Observations, published by the Capital IQ division of Standard & Poor’s. It provides figures and perspective on capital market transactions in North American and Europe, and is widely used by investment professionals. That report uses figures compiled for the 12 month periods ending November 30 of the past several years.

• Overall consolidation activity in North America and Europe fell in 2008. The number of transactions declined 11%, after increasing 18% in 2007. The value of those transactions declined 40%, compared to the 12% increase posted in the prior year.
• In 2008, strategic acquisitions accounted for just under 90% of the total, a percentage not very different from results in the prior two years. However, they also accounted for 90% of the value of all transactions in 2008, compared to only 75% in both 2007 and 2006.
• In contrast, PE buyouts that represented 10-11% of the total transactions consummated in each of the past few years accounted for only 10% of the value of all transactions completed in 2008, compared to levels of 25% in 2007 and 2006.
• Activity in Capital IQ’s broadly defined Healthcare sector was also down in 2008. The total number of transactions fell 10%, after increasing 15% in 2007. The value of those transactions fell 26%, following a 20% decline in 2007.
• The number of strategic acquisitions in that Healthcare sector declined 9% in 2008, bettering the 11% decline in overall strategic activity. The value of those transactions actually increased 5%; the value of all strategic transactions declined 30%.

Pressure to close deals before the end of the year frequently makes December an active month. Offsetting that seasonal trend in 2008 was the continuing weakness experienced in the economy and the capital markets since the end of October. We suspect that the final results published by Capital IQ will show that 2008 was the weakest period for overall consolidation activity since 2005.

Factors Influencing the Pace of Consolidation in the Outsourcing Industry

The extent of consolidation activity across the outsourcing landscape did not change that much from 2007, yet the rhythm of that activity seemed sluggish, particularly in the last part of the year. At least some of that sluggishness was related to difficulties experienced by drug development companies.

The business of discovering, developing and marketing new drugs and medical devices has long been a particularly lucrative one. From time to time, however, the pharmaceutical and biotechnology industries’ financial results can show the strain of overseas price controls, robust competition from low-priced generic drugs, and the limited financial contributions of fewer-than-expected new products. Those industries faced such conditions in 2008. Sponsors reacted by delaying some research or development projects, suspending or eliminating others, re-evaluating plans for staff and facilities expansion, and taking other measures to restrain costs to the extent necessary to maintain profit margins.

Throughout the first half of the year, most large outsourcing providers were able to cope with those measures, restricting their own expense levels to the extent necessary to deliver their forecasted results to investors. However, struggling for much of that period to adjust to their customers’ changing needs caused many management teams to focus more intently on delivering their own results than on aggressively pursuing multiple acquisition opportunities. The pace of their acquisition activity slowed again in the late fall. In reporting their third quarter results, many large outsourcing firms saw the need to reduce their financial guidance for the last quarter, reflecting the quickening pace of their clients’ project suspensions and delays.

Even in the first half of the year, many smaller outsourcing providers were unable to adjust their expense levels to accommodate lower-than-expected revenue recognition. Several had been in the midst of meaningful expansion projects to take advantage of the accelerated demand for services that had arisen in the previous few years. Many companies that had transitioned from 2007 into 2008 with the hopes of continuing to post strong financial results that would support a corporate sale were not able to deliver the results needed to excite potential buyers. We suspect there would have been more completed transactions in mid-to-late 2008 had a range of private outsourcing companies been able to report more robust financial results.

Financial buyers did not abandon the pursuit of investments in outsourcing. As detailed later, however, they were involved in a relatively low 21% of the transactions we counted.  We cannot quantify the extent of potential activity that might have been concluded had the private equity firms exploring this industry had access to as much debt financing as they wanted. Moreover, without the ability to sell portions of many prior investments in Initial Public offerings (IPOs), they were forced to husband their available equity capital and use it to continue funding the growth of their existing portfolio companies.

Total Activity Was Good, But Could Have Been Better

In 2008, the companies we track were involved in just as many transactions (about 120) as in 2007 and 2006. The pace of activity was much stronger in the first half, with 70 deals announced or closed in that period. Ascertaining the total value of the completed transactions is difficult; as is typically the case, financial details were provided for only about half of them. The largest transaction was Invitrogen Corporation’s $6.7 billion acquisition of Applied Biosystems. Only two deals had values of more than $200 million: General Electric’s $750 million purchase of Whatman plc, and 3i’s $395 million purchase of the API business of Alpharma.

It is worth reiterating that we take a broad view of the word outsourcing, but still include in our analysis only transactions involving companies that provide services or sell products to the drug development industry. Various databases track the number and nature of such transactions. However, no single data source uses our categorization of outsourced pharmaceutical services to separate transactions involving what we believe are relevant companies from those involving outsourcing firms in home healthcare, diagnostic imaging, health benefit programs, radiology services, managed care services, et al.

Private Equity Firms Were Less Active

We noted above that 21% of the acquisitions we catalogued in 2008 involved a PE buyer. In 2007, 23% of the transactions involved one or more PE groups. In that year, there were 13 cases of PE firms buying complete or effective control of an operating company; in 2008 we noted only four. Each had a unique story.

• In February, 3i agreed to back the $395 million management buyout of Active Pharmaceutical Ingredients from Alpharma Inc. At the time, the seller reported that business unit had trailing 12 months’ revenue and EBITDA (earnings before interest, taxes, depreciation, and amortization) of approximately $188 million and $49 million, respectively. Thus, the buying group valued the business at 8x the latter number.
• In June, the private equity firm ECI Partners and the mezzanine capital firm Indigo Capital supported the £60 million management buyout of Premier Research Group. That UK-based contract research organization thus completed a round trip from private (founded in 2002) to public (listed on the Alternative Investment Market of the London Stock Exchange in December 2004) to private. In announcing this transaction, management expressed its disappointment with the company’s stock price and its limited ability to raise additional capital to support its growth. The transaction was valued at just over 7x Premier’s trailing 12 months EBITDA.
• In July, The Halifax Group and SV Life Sciences aided a management recapitalization of Trio Clinical Research. It became the first participating company in a planned series of strategic acquisitions by a partnership between those two private equity firms and a management team led by Pat Donnelly, an experienced operating executive who had been the chief executive officer of PRA International.
• In September, Gryphon Investors led the simultaneous recapitalization of Synteract Inc. and Vince & Associates Clinical Research. The managements of those firms remained in place and became shareholders in Synteract Corporation, a newly-formed holding company. Celerity Partners, a previous investor in both companies, also remained a shareholder in that corporation.

Two other transactions also deserve special comment.

• In May, Saints Capital completed one of the most unusual transactions we have ever seen. It purchased Safeguard Scientific’s equity interests in a portfolio of five life science companies, including the contract manufacturer Laureate Pharma. Saints has a history of purchasing majority or minority interests in private companies from venture investors. In this transaction, it paid Safeguard $74.5 million, including $6.4 million to be held in escrow for one year, and released it from an aggregate of $31.5 million in debt guarantees for the companies which were sold. Neither party publicly disclosed the cumulative financial results of the six operating companies or the extent of Safeguard/Saints’ ownership interests in those individual firms.
• Also in May, MPM Capital invested $20 million in Sai Advantium Pharma,  a Hyderabad-based CRO offering chemistry, process development, and GMP manufacturing services. It was the first overseas investment in Sai Advantium, and MPM’s first investment in an Indian company.

In addition to making new investments in established companies, PE firms also support the expansion efforts of their existing portfolio holdings. These instances of financial support are not always publicly announced. In 2008, the following PE-backed companies made acquisitions. While some of these firms may have had enough self-generated cash to fund their purchases, it is reasonable to assume that their PE backers approved of and possibly provided financing for at least some of these acquisitions.

Acquisitions Made by Private Equity-Backed Companies
Acquiring Firm	Target
Algorithme Pharma Holdings	Baltimore Clinical Pharma Research
Algorithme Pharma Holdings	Simbec Research
CMC Biologics A/S	Lilly’s ICOS Biologics Manufacturing
Cambridge Major Laboratories	Cambridge Major Labs Europe
Cetero Research	Diabetes & Glandular Disease Clinic
Chiltern International	Drug Development Solutions
Decision Resources	Manhattan Research
Frontage Laboratories	Advanced Biomedical Research
Haupt Pharma	Amareg
Haupt Pharma	Wulfing Pharma
Medidata Solutions	Fast Track Systems
QPS, LLC	Bio-Kinetic Clinical Applications
Quintiles Transnational	Targeted Molecular Diagnostics
Tripos International	Pharsight Corp.
United BioSource	Envision Pharma
Worldwide Clinical Trials	MediQuest

Finally, a range of other companies received funding from one or more PE firms. These included such familiar names as Inclinix, SDI Health, and TargetRx, and two dozen others. The investments these firms announced receiving ranged from less than $1 million to more than $25 million.

Divestitures Remained Important

Following the experience of 2007, we entered 2008 expecting to see another large group of divestitures by companies refining their strategies and reorganizing their portfolio of businesses. There were indeed many such transactions. We have already noted a few of them:

• Alpharma sold its API manufacturing business to private equity firm 3i.
• Bioanalytical Systems sold its Baltimore Phase I unit to Algorithme Pharma.
• Eli Lilly sold the ICOS Biologics Manufacturing business to CMC Biologics.

There were several more:

• Patheon sold its OTC manufacturing business drug to Pharmetics.
• Wyeth sold its Rouses Point plant to Akrimax Pharmaceuticals.
• MDS Inc. sold two of its Nordion unit’s product lines to Best Medical International.
• BASF sold its contract manufacturing business to Dr. Reddy’s Laboratories.
• Dowpharma sold its small molecules business to Dr. Reddy’s Laboratories.
• PAREXEL International sold a bioanalytical lab in France to Synchron Research.

Finally, in one of the most widely-noted transactions of the year, Eli Lilly sold a multi-functional laboratory in Greenfield, IN to Covance — and gave that CRO a long-term contract for work.

Moderate Activity in the CRO Arena

Even in a year not characterized by any mega-mergers, an assortment of CROs were active purchasers of companies to round out their list of capabilities, fill in geographic gaps, or enhance their existing businesses. None of the acquisitions were so large as to require all parties to disclose the complete financial details. The transaction values ranged from less than $1 million (Algorithme’s purchase of Baltimore Clinical Pharma Research) to $198 million (PAREXEL’s purchase of ClinPhone). Several involved PE-buyers, and were included in the preceding table as well. Even in the absence of extensive financial details, it is our impression that most buyers generally paid prices in line with historic averages. They were not forced by competitive bidding to pay exorbitant valuation premiums. These buyers are not noted for purchasing “broken” companies that they intend to fix, so we doubt they would characterize any of the transactions listed in the table as bargain-basement deals.

Acquisitions Made by CROs
Acquiring Firm	Target
Algorithme Pharma Holdings	Baltimore Clinical Pharma Research
Algorithme Pharma Holdings	Simbec Research
Cetero Research	Diabetes & Glandular Disease Clinic
Chiltern International	Drug Development Solutions
i3 Research	Lege Artis
ICON plc	Healthcare Discoveries
ICON plc	Prevalere Life Sciences
Kendle International	Decision Line Clinical Research
PAREXEL International	ClinPhone
PAREXEL International	Phase I site in Ahmedabad, India
PharmaLink FHI	Matrix Contract Research
Piramal Healthcare	Tangent Data
PPD Inc.	InnoPharm
PSI Pharma Support	Thywill
Quintiles Transnational	Targeted Molecular Diagnostics
United BioSource	Envision Pharma
Worldwide Clinical Trials	MediQuest

Strong Activity (Action) in the Non-clinical Arena, and in the Labs Too

Trade publications warned of excess capacity; analysts worried about wavering new business signings; conferences discussed the latest FDA regulations; through it all, companies involved in chemistry, manufacturing, instruments and tools were particularly active consolidators in 2008. In the related area of laboratory services used in the preclinical phases of research, numerous companies also expanded their capabilities.

The largest acquisition in our universe occurred in this segment. It was Invitrogen Corporation’s purchase of Applied Biosystems. The company changed its name to Life Technologies upon the closing of this $6.7 billion transaction. Applera Corporation announced plans to divest Applied Biosystems in January; Invitrogen announced its intention to make the acquisition in June and closed it in November. Life Technologies used cash (for which it secured new bank lines, and stock to fund the purchase. The purchase price represented just under 14x ABI’s trailing 12 months EBITDA. The deal stands as a testament to the fact that even in troubled economic times, well-reasoned acquisitions can obtain financing.

There were several other relatively large transactions in these broad segments in 2008. GE Healthcare paid just over 16x Whatman’s trailing 12 months EBITDA. Comparable financial details were not announced for the remainder. See chart on the next page for details.

Foster Wheeler, Intertek, Lab Corp., MDS Inc., and Pall Corp. also made smaller acquisitions in these areas.

Limited Activity in the “e” Arena

There were only a handful of transactions involving electronic data capture companies.

• Phase Forward paid $40 million to acquire Clarix Inc.
• Bio-imaging Technologies paid $23 million for Phoenix Data Services.
• Jubilant Organosys paid €466,000 to acquire TrialStat Clinical Analytics.
• And Medidata paid an undisclosed sum to acquire Fast Track Systems.

It was also noteworthy that both DATATRAK International and eTrials Worldwide hired investment banking firms to “enhance their shareholder value,” which is usually code for trying to sell the company.

What about the Others?

The reader might be wondering why we did not spotlight his/her favorite acquisition in 2008.  There were, indeed, deals made by some familiar companies as well in some unfamiliar ones.

• Cross Country Healthcare acquired the locum tenens and staffing company Medical Doctor Associates.
• Decision Resources added the physician and consumer opinions businesses of Manhattan Research.
• inVentiv Health acquired Patient Marketing Group.
• WebMD Health acquired Marketing Tech. Solutions.
• The packaging company Perrigo Company acquired both JB Laboratories and Unico Holdings.
• The Irish-based United Drug acquired Sharp Corporation, a contract packager with facilities in Bethlehem and Conshohocken, PA.
• And a 50/50 joint venture between Bilcare and MeadWestvaco purchased International Labs.

Acquisitions Made by Manufacturing, Preclinical, Instrumentation or Laboratory Companies
Acquiring Firm	Target	Transaction Val. ($Mil.)
GE Healthcare	Whatman PLC	750
WuXi PharmaTech	AppTec Laboratory Services	164
Affymetrix Inc.	Panomics Inc.	73
QIAGEN	Corbett Life Sciences	70
Illumina	Avantome	60
Life Tech (fmr. Invitrogen)	CellzDirect	57
Charles River Laboratories	NewLab BioQuality	53
Varian Inc.	Oxford Diffraction	37
ATMI Inc.	Levtech	27

Anticipating 2009

It is worthwhile reiterating the reasons we continue to view the outsourcing industry as one that should sustain a certain level of consolidation activity in almost any economic environment.

• It is highly-fragmented, with hundreds of small and mid-sized companies that can make attractive acquisition candidates for both strategic and financial buyers.
• Industry participants of many sizes and descriptions offer their pharmaceutical, biotechnology, academic, and government clients products and services that help make the drug development process faster, better or cheaper.
• The industry’s largest customer base of commercial drug development organizations is facing unprecedented challenges in transforming laboratory discoveries into commercial drug products; most such companies are increasing their use of outsourcing service providers in order to improve the efficiency and efficacy of those efforts.

Given the weakening economic backdrop and the poor health of the markets for new debt or equity capital, it is difficult to be optimistic about the pace of overall economic growth in the coming months. We are hopeful, however, of experiencing more robust activity in the second half. Similarly, it is hard to envision a record-breaking year for overall consolidation activity. Yet, we suspect that attractive stock market valuations and the ticking clock on many private equity funds’ limited spans of existence will support at least a period of moderate consolidation activity across the economy.

Given the large numbers of willing sellers and potential buyers, we do expect further consolidation in all segments of outsourcing. The fly in the ointment might be the potential for meaningful changes in the research, manufacturing, and marketing budgets of the drug development industry. The new President and the leaders of the Democratic Congress have expressed their intentions to “stick it to the drug companies” (my words, not theirs). Pharmaceutical and biotechnology company executives undoubtedly are evaluating contingency plans if they are forced to restrict their pursuit of growth at the expense of current profitability. Doing so could lead to more outsourcing, which would make smaller, entrepreneurial service providers even more attractive purchase candidates to larger firms interested in increasing their business base.

In closing, we again refer the reader to the closing sentence in last year’s article on consolidation for our best guidance on the trajectory and pace of such activity in the forthcoming months.

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 Tel (610) 260-6232 or Fax (610) 260-6285.