Last week PRA Health Sciences filed details of an initial public offering (IPO) with the US Securities and Exchange Commission (SEC), becoming the largest privately owned contract research organisations (CRO) to signal its intention to go public since Quintiles raised more than $1bn (€800m) last year and crossed back to the public sector.
The news came just days after Ingo Bank, the CFO of publically owned Parexel, predicted more CROs would go public and William Blair analyst John Kreger noted an under-attended Quintiles investor day was indicative of waning interest from financiers in clinical research firms.
While a successful IPO for PRA would mean four of the top five CROs – Quintiles, Covance, Parexel, PRA – were publically owned, “the PE [private equity] community remains quite interested in the CRO industry,” according to Michael Martorelli, Director at investment banking firm Fairmount Partners which has been involved in over 100 pharmaceutical services deals, including 10 in the past year.
“I think it is a mistake to correlate either the relatively low or relatively high number of transactions announced in any particular calendar period with any changes in that level of interest,” he told Outsourcing-Pharma.com.
Fairmount’s Managing Director, Neal McCarthy ran the sale of CRO Medpace to the investment group CCMP in 2011, and earlier this year helped lead the $915m sale to UK-based PE firm Cinven. He agreed with Martorelli that the level of interest had not changed between the two deals, adding CROs are still compelling PE investments due to their levels of cash flow.
“The PE investors have a typical investment window of 3-7 years. If things are going well, they can sell any time in the window. If things are not going well, they typically hold on longer, waiting for the market to improve,” he told us.
“Many PE firms invested in 2007 and early 2008, just before the market for CROs tanked. Those investors have had to hold on for a longer period, waiting for the market to come back.” This has led to a “bunching up” of deals, this year and next, helping to explain why it looks like PE is pulling out, he explained.
However, results of a recent poll show our readers are not fully convinced PE still has its eyes on the clinical sector, with 38% of respondents believing interest in CROs is either falling or has been on the decline for a while. Just over a third (35%) said PE was still interested, while 27% said it was too early to tell.
Hockey Stick Growth
One factor that may be discouraging PE is over-inflated expectations on price. Vladimir Walko, Managing Partner at corporate development firm Medical Growth Partners told us “many CROs which were hard hit after 2008 are still recovering and feel that the ‘hockey stick’ growth is ahead.
“Given that their historical P&L over the past few years reflects a down market, sellers are holding off for higher EBITDA and better valuations. This is creating a shortage of deals in general, and few getting done because of price.”
Therefore, an “overly optimistic outlook” and unrealistic price expectations may currently be holding PE back, he continued. “I recently worked on a deal where the seller of a small development company wanted a 30X EBITDA valuation!”
Booming equities market
Mark Shapiro, VP of Clinical Development at privately owned CRO Clinipace Worldwide, told Outsourcing-Pharma.com the factors that made CROs so attractive over the past several years - low-risk, stable growth and the ability to generate cash – are less attractive during a booming equities market.
Furthermore, he said there may have been so much PE investment in the sector already that the opportunities have now dried up.
“CROs with strong financials have probably received PE money—if they wanted external investors—and are putting that money to work through geographic expansion, consolidation and technology investments.”
As for further pull outs, Shapiro echoed Parexel’s Bank, suggesting there could be a number of IPOs from PE-backed CROs in the next five years, so long as public equities markets are favourable.
“Quintiles was way ahead of their time when they led the industry down the PE path with their LBO [leveraged buyout ] in 2003, so I think their IPO is probably a harbinger of things to come.”