The Quintiles IPO was completed on May 14th. This is a positive development for the pharmaceutical services industry for several reasons. In 2001 some 30 pharmaceutical service companies were publicly traded and followed by more than 30 analysts, mostly focused on CROs. Today there are five large public CROs and a scant handful of smaller public firms.

The 20 analysts that cover the five largest also follow markets such as healthcare IT, life sciences, technologies, and medical devices. Heavier workloads are a sign of the times. However, the unintended consequence is that the depth of analysis and the frequency of reporting has declined, leaving a paucity of useful information. Not only is there a dearth of reliable data, but the gap has been filled with much misleading, inaccurate, and inflated information. The presence of another large public company will improve the standards of research and analysis.

Consider some of the misguided information that has paraded as fact:

• In a relatively flat pharmaceutical R&D spending environment (most estimates are between 0% and 2% annual growth over the next 5 years), several research firms publish reports claiming that the CRO industry will grow at compound annual rates between 10 and 14%
• One research house reported in 2012 that the preclinical outsourced market would grow at 11.2% per year over a 5 year period! The preclinical market has bounced along the bottom since early 2009 and has shown no sign of a meaningful resurgence

How are inaccurate numbers developed and why are they being sold and used? I spend a lot of time sifting through facts and data to provide useful information for my clients and developed a hypothesis based on experience.

• First, there are not enough public companies whose disclosure requirements serve as a useful reference points for industry pundits. Private companies cannot be held accountable for their statements. Each year, analysts attend the Society of Toxicology and meet with the CEOs of the private firms. These executives, while well-meaning, put on a brave face and talk about how well they are faring. Several leaders were predicting better days by 2010. It’s now 2013. Meanwhile, most of the Clinical CROs are now private and the same conversations are taking place at the DIA or Partnerships Meetings. How can the optimistic claims of private company leaders be validated? It takes digging, cross-referencing and more effort than the already overstretched analysts can afford. Hard data has been replaced by nonvalidated anecdote and subjective surveys
• Enter the market research firms. In the past several years, many of these firms have enjoyed notable growth by filling the void left by fewer analysts and fewer public companies. Some of this growth is fueled by firms helping facilitate the sale of public and private companies. To support the inflated sense of value of many owners, a market report with a bold growth rate and a colorful bar chart with an impressive footnote has become a requirement in a confidential memorandum. Savvy buyers understand this and discount the now standard practice of inflated estimates. Few sellers seem to recognize that it impairs their credibility and only inspires smart buyers to dig deeper.
• A third piece of the hypothesis is that better growth rates sell. Better growth rates sell research reports and in some cases, help sell companies. Who wants a report that says the market is flat? Who wants to buy a company competing in a flat market?
• The large research houses that sell reports on a menu of industries often rely on junior analysts who have neither the experience nor the contacts to perform the necessary networking to get valuable data. They depend on public sources and public company data. Research reports become a triumph of form over substance

Finally, the few large public companies are gaining market share at the expense of small and medium companies. If researchers point to Parexel, Icon or Covance growth in clinical services and project their growth rates on the rest of the market, they have done a disservice. Big public company numbers are easy to find and easy to like, but as one company executive said, “the top five CROs have 50% of the market and the other 800 have the other 50%.¹ Large CROs are gaining share due to increased globalization, more outsourcing to fewer approved vendors and increasing trial complexity. As the below chart of clinical study starts and enrollees demonstrates, trials continue to decline gradually.

The privatization of the CRO industry over the past several years created a number of companies with ambitious forecasts and highly leveraged balance sheets. This combination can be a formula for disappointment. Just one extraneous event such an unexpected compliance issue can create disaster. Witness the recent demise of Cetero Research and its successor, PRACS Institute. Both Chapter 11 (reorganization) and Chapter 7 (liquidation) occurred less than a year apart. The leverage was in place for several years but the catalyst was a compliance issue that began in 2005. Barring any judgment on the compliance issue, the net effect of the demise is that hundreds of good employees were fired without notice or benefit and dozens of sponsors have lost valuable time and data from clinical trials.

Leverage can be a positive force and many private investors have helped their portfolio companies achieve heights they otherwise would not reach. This message is for the firms that buy high, have higher expectations, and heap high debt on their conquests.

The Quintiles IPO should be welcomed by all market participants. With a $4.0 billion company back in the public market, we can expect more market data, increased analyst coverage, and new investors. Most importantly, several private firms such as PPDI, PRA, and INC Research may take heart that the public markets are again viable for CROs. With more public companies, we should expect better research and improved insights into this fascinating, complex market called pharmaceutical services.

¹ While variations of this theme have been said by many, this statement was made during a Covance presentation at a Citibank Investor Conference in February, 2013.

Steve Sullivan

Steve Sullivan is President of CRO Advisors LLC.  After twelve years in leadership positions in pharmaceutical services, Mr. Sullivan founded CRO Advisors LLC as a specialty consulting service to help CROs, partners and investors to find strategic solutions in a changing outsourced drug development industry. As the leader of several Covance late-stage businesses and the CEO of Harlan Laboratories, Mr. Sullivan’s experience spans the global drug development continuum from discovery to pre-clinical, clinical and post-approval services. CRO Advisors services include strategy assessment and development, M & A due diligence and integration, negotiation skills and strategies and interim management and leadership assessment.  For more on negotiating with powerful buyers, please call +1 (609) 841-4521 or contact stephen.sullivan@croadvisors.com. To read or download previous issues of The CRO Advisor, go to https://www.dropbox.com/sh/qv607dqvdiuzri1/FMjCOLRHSO.