David Windley, CFA, CPA, equity analyst, Jefferies LLC, noted that the reaction in the stocks was typical of the public markets – and they have since rebounded.
“We know that mergers of fairly large companies do have a tendency to cause some disruption to the normal flow of business in short to intermediate term,” he told us.
In the immediate term, the CROs serving Bristol-Myers Squibb (BMS) and Celgene are likely to experience a quiet period with no new awards between now and when the deal is officially closed. However, longer term, they could potentially see more outsourcing penetration as the combined company will boast an early-stage pipeline of 50 high potential assets.
“Bristol [BMS] has been fairly disciplined or fairly consistent about outsourcing approximately half of their studies,” added Windley, “and so we’d have to wait and watch for what they say, what actions they might take, as to whether they would migrate that number higher over time.”
Windley noted that the added nuance today is that many companies have achieved a more mature level of outsourcing, and so they may or may not see more upside to working with third parties. “They may or may not have a desire to increase their outsourcing long term,” he said. In the short term, regardless of strategic decisions, deal-related issues tend to slow new outsourcing awards.
After the merger is completed, Ross Muken, Evercore ISI, senior managing director and partner, equity research, said the question becomes, who gets the new work?
“I think BMS partnerships would survive,” he told us, “The question would be are those two partners enough to handle [the work].” Muken’s guess is no, as BMS is now double the R&D budget.
According to BMS, near-term launch opportunities represent more than $15bn in revenue potential. Additionally, the combined company will have six expected near-term product launches.
Among those partnerships to watch, is with the Ireland-based CRO Icon, which has an established long-term relationship with BMS, one that could potentially see growth following the merger. Icon declined to comment on the length of its contract.
Notably, on its Navigating Healthcare in 2019 webinar, Evercore ISI named Icon as among its small-mid cap picks for 2019. BMS has been working with the Ireland-based CRO since 2010, and the relationship has been renewed twice. Conversely, BMS’ second partner has turned over twice.
As per Celgene’s partners, among which has included Evotec, Muken expects BMS will look to keep at least one if not more of the company’s vendors.
“Projects that are already awarded and those that will be awarded for the next three months or so will continue but flow to the same vendors that those companies have used,” he added. “After the merger, all the awarded business will continue to be executed as it was.”
CRO M&A activity: Mania managed
As per mergers and acquisitions (M&A) among CROs, Windley expects this year’s activity to be more akin to 2018, as opposed to the merger mania of 2017. “It’s unlikely that we’ll see that magnitude of deals [previously seen],” he said. Which over the long term is more normal.
Moving forward, Windley said the space will be more inclined to make smaller, tuck-in acquisitions, with private equity potentially funding some transactions as the effort to grow the mid-sized CRO space continues.
“There’s still a lot of private equity appetite and affinity toward this space,” said Windley, noting the $2bn spread between Medpace and Icon.
Speaking to this mid-sized space, Muken added, “I think if you’re a marginally differentiated mid-sized CRO and you have a growth slowdown and you have a decent amount of leverage on you, you’re going to have to think long and hard about your place in the world and where you end up in terms of partnered with someone or as part of another entity, or merged with a similar entity with an outlook like your own.”
The overall demand environment: Healthy normalization
Addressing the overall demand environment, Muken said it has been a reasonably strong period for bookings and backlog growth, given the dynamic evolution in oncology, rare diseases, as well as gene and cell therapy, among others. “So we think the pipelines remain healthy and will continue to evolve,” he added.
However, after a record-breaking 2018 in terms of biotech funding, it is unlikely that this same pace will continue – though some of this is “just a healthy normalization,” Muken said.
Windley added, “Biotech funding in 2019 is probably going to be flat or maybe down a little bit versus 2018,” though it is doubtful it will have the same negative effect seen in late 2015.
Still, it could complicate hiring plans at CROs, but it is unlikely it will have any significant impact on the core business. “They [CROs] are going to continue to be pretty strong,” said Windley.
The key question is does the recent volatility in the market create a protracted biotech funding drought? Windley asked. “2019 is going to be a year of much higher volatility than we’ve seen for most of last year and pretty much all of 2017,” he said.
Regardless of this volatility, Windley said he is receiving positive feedback on the overall demand environment, “I think there’s an appetite to spend money,” he said. “The science is pretty good … The willingness to fund programs is good.”
Also leveling out this year, Windley noted that big pharma’s shift seen a few years ago to more FSP work is just about over. “I think there was a period of rebalancing among large pharma companies between how much they wanted to do full service, versus how much they wanted to do FSP,” he explained. “There was a period where FSP grew faster because companies were rebalancing. I think that is now done.”
Moving forward, without the headwind on full-service growth, the industry will see a “more natural” advance of full-service work, which is generally higher margin.