Parexel & Icon downgraded amid strategic deal concerns
Icon slashed its 2011 financial guidance yesterday because of the level of upfront investment needed to support the Pfizer deal. As Pfizer’s other contract research partner Parexel has also been hit with the fallout, with both companies being downgraded by Jefferies & Company.
“Our enthusiasm for strategic deals is waning and Parexel has a lot of them”, said David Windley, equity analyst at Jefferies. Downsides of strategic deals include upfront investments, the time between inking the deal and revenue generation, and, potentially, client concentration.
With a small number of strategic partners accounting for a large chunk of revenue, contract research organisations (CRO) are more vulnerable to shifts in clients’ research and development. Also, smaller clients may believe the CRO is too focused on its partners and choose a mid-tier vendor instead.
“Icon has a lot on its plate right now, and an admitted appetite for additional strategic arrangements is somewhat unsettling given potential for additional investment requirements”, said Eric Coldwell, equity analyst at RW Baird.
Despite these concerns RW Baird maintained its ratings for Parexel and Icon. “We do not believe Icon is a broken story, but we do anticipate additional challenges ahead and we’ve taken a sharp pencil to our forward estimates”, Coldwell said.
A brighter future?
Once hires have been made Peter Gray, CEO of Icon, expects margins to stabilise and Icon to benefit from a substantial amount of Pfizer business. Revenues from the Pfizer deal should arrive sooner than in other strategic relationships as active projects are being transitioned, but this may raise problems.
“Pfizer is more likely to transition projects in most need of help, which translates to lots of cleanup and an extra challenge to the relationship kick-off”, said Windley. Combined with the need to quickly hire and train staff this could mean the transition of work is “messy”.
Equally, it is unclear how the deal’s pricing will affect margins. Gray said the pricing was based on achieving efficiency levels that Icon has hit in the past, but Windley thinks it will be tight.
“We believe price discounting on individual rate cards in strategic deals is at least double digit, with volume rebates adding to that. We do not have quantitative information on Pfizer, only anecdotes that pricing was tight. Still, it has been the industry's most aggressive historically”, said Windley.
Despite all these concerns, shares in Icon and Parexel fared relatively well yesterday, falling 3.8 per cent and 3.5 per cent respectively. Coldwell suggested the “muted market response” may mean issues with the Pfizer deal are “already reflected in the shares”.
