How private equity wins
The aim of private-equity investors is simple: make a large cash return on the cash invested. This goal is accomplished in
two ways: by taking advantage of the acquired company's cash-generating capability and by making the company worth more when
it is sold than when it was bought.
Most private-equity deals take advantage of the acquired company's ability to support a significant debt burden. By using
the target's debt capacity, the private firm is able to borrow much of the purchase price and limit the amount of cash it
must put up to make the acquisition in the first place. Current interest rates make borrowing especially attractive.
Clinical CROs are an attractive vehicle for leveraged buyouts. Their capital-
investment requirements are usually small in comparison with manufacturing businesses, so they can throw off a lot of cash.
Further, those cashflows are highly predictable because clinical CROs tend to have highly diversified multiyear project backlogs.
A growing CRO is likely to be able to pay out substantial dividends to its owners as well as carry a substantial debt burden.
Enhancing the value of the acquired company may just be a matter of timing, such as by buying the company at a low point in
the market cycle and going public when market multiples are high again. The private-equity firm also can improve the value
of its target through further acquisitions, expansions of offerings, or restructuring to improve profits. Stock analysts who
were following PPD before the acquisition speculated that PPD's laboratory businesses might be in for restructuring.
Risky propositions
Buyouts by private-equity companies are not without risk as such moves are subject to not fully understanding the prospects
of the business or changing market conditions. Both of these things appeared to happen to the buyers of the European CMO Nextpharma,
whose Belgian injectables manufacturing business was recently forced to file for bankruptcy protection, as well as to the
French CMO Osny Pharma, which filed for bankruptcy protection in early 2011 and was absorbed by another CMO, Cenexi.
While PPD's track record of profitability and market position (it is thought to be the second largest for Phase I–IV clinical
research after Quintiles) would seem to guarantee a strong performance over the typical private-equity holding period of
five years, the changing CRO and bio/pharmaceutical research environment could present challenges. As global bio/pharmaceutical
companies reduce their CRO relationships to a few preferred providers, competition for those relationships has become intense.
There reportedly has been aggressive price cutting in the industry to get those deals, thereby leaving "winners" saddled with
lower profit margins but losers shut out altogether.
Investors have been attracted to the CRO industry because the ongoing reinvention of the bio/pharma business model has outsourcing
as a core strategy. The ultimate form of that business model is still being evolved and tested, and there is no guarantee
that it will ultimately look like what it looks like today. Buyers of PPD bought one of the crown jewels of the industry.
The greater risk is probably faced not by them, but the private-equity firms that bought PPD's small and mid-size competitors.
Jim Miller is president of PharmSource Information Services, Inc., and publisher of Bio/Pharmaceutical Outsourcing Report, tel. 703.383.4903, fax 703.383.4905, info@pharmsource.com
http://www.pharmsource.com.
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