Contract Organizations are the Sell of the Season

Despite the market downturn, private equity investors are lining up for pharmaceutical services.
Apr 02, 2009
Volume 33, Issue 4

Jim Miller
In the business and financial environment we are currently enduring, one wouldn't expect investors to be anxious to buy companies with somewhat uncertain prospects. Yet, that is what is happening in the pharmaceutical services industry. Private equity investors are lining up to own all or a piece of a contract research or contract manufacturing organization (CRO or CMO), and the depressed stock market is creating opportunities for them to get in at very attractive valuations.

The hot interest in pharmaceutical services is slightly different from what we saw two years ago. For one, acquisition prices are a lot lower today. Consider 2007, when the Blackstone Group acquired what is now Catalent (Somerset, NJ) for $3 billion, financing the deal with $2 billion in debt. The price was 1.6 times Catalent's revenues for that year and 10 times the company's pretax cash flow. Premier Research Group (Crowthorne, England) was taken private by ECI Partners (London) last year for a similar multiple. By contrast, today's prices are likely to be less than one times revenue with less than half of the purchase price borrowed.

The lower valuations reflect the restricted availability of debt (when debt was cheap, companies could afford to bid up) and the less certain outlook for the biopharmaceutical and pharmaceutical industries overall. Still, private investors appear confident that the pharmaceutical services business is a long-term winner.

At the same time, major biopharmaceutical and pharmaceutical companies seem to be committed to outsourcing an ever-larger share of their drug development and manufacturing activity. In addition, they are increasingly depending on early-stage companies to do their discovery and early development work, and then in-licensing or acquiring the most promising candidates. This means early-stage companies will continue to get funding to feed their dependence on contract services.

PharmNet deal

One recent big deal is the ongoing acquisition of PharmaNet Development Group (Princeton, NJ) by JLL Partners, a private equity firm that is also a major investor in CMO Patheon (Research Triangle Park, NC). The total value of the deal will be nearly $250 million, comprised of $100 million for the outstanding PharmaNet stock (valued at $5.00 per share in the transaction) and $144 million to retire PharmaNet's outstanding convertible debt.

PharmaNet provides Phase I–IV clinical research services as well bioanalytical laboratory services. The original PharmaNet Development Group was founded in 1996 by a team that included the founders of what is now Covance (Princeton, NJ), and was acquired by publicly-traded SFBC International in late 2004 for $245 million. SFBC International changed its name in 2005 to PharmaNet following a scandal surrounding operations at its Phase-I operations in Florida. It had revenues of nearly $360 million (net of passthroughs) in 2008, putting it among the top 10 clinical CROs by revenue.

PharmaNet's stock price dropped from more than $40 per share in March 2008 to under $1.00 by December 2008. The cataclysmic price drop reflected the overall decline in CRO stock prices (Covance dropped from more than $90 a share to under $35 per share during the same period) and a sharp reduction in revenues and backlog during the second half of 2008. A complicating factor was the company's inability to get holders of the senior convertible debt to agree to redeem those notes for debt with new terms.

In a sense, PharmaNet is a victim of the changed financial environment, which starved many of its customers of capital while cutting off its ability to refinance debt. At the same time, however, the company is a victim of its own problems. The convertible debt was originally issued in 2004 to allow SFBC to acquire PharmaNet, and the subsequent legal problems surrounding the Florida Phase-I sites probably distracted management's attention from creating a more sustainable business model the way competitors such as Covance and PPD have been able to. The sale to JLL will give PharmaNet's management team, which is well respected in the industry, the opportunity to improve the company's operations and possibly expand its capabilities through selected acquisitions.

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