Charles River Nabs WuXi PharmaTech for $1.6 Billion

Charles River (CRL), a leader in outsourcing for the health care industry, has agreed to pay $1.6 billion for China's WuXi PharmaTech (WX). The deal comes to $21.25 per share, which consists of $11.25 in cash and $10 in stock. JP Morgan Chase (JPM) and Bank of America Merrill Lynch (BAC) have provided a $1.25 billion credit facility commitment.

Charles River recently moved into China because of the affordable wages and high-quality talent. But the process of setting up shop there can be time-consuming, so the acquisition of a Chinese pharmaceutical outsourcing company makes good sense.

The Move Towards Outsourcing

To bring a drug to market, a pharma company can spend more than ten years in development and over $1 billion in costs. An industry emerged in the 1990s to help manage this process by providing services like research and development (R&D), clinical trials, data analysis, and animal testing. The upshot is usually lower product development costs.

China is one of the best areas for these pharmaceutical outsourcing services, with industry growth expected to run at 30% per year. And of course, one of the industry leaders is WuXi.

Founded in 2001, the company first built a business by providing discovery chemistry services and then expanding into other categories like safety pharmacology and drug metabolism. WuXi's growth rate has been strong. From 2006 to 2009, revenues have climbed from $69.9 million to $270 million, and the company is expected to hit revenues of $310 million to $320 million in 2010. WuXi employs 2,900 scientists with advanced degrees and operates four large facilities in China.

The Challenges

The past couple of years have been difficult for Charles River with revenues dropping 10.5% in 2009, in part because of consolidation within the industry, lack of funding for biotech operators and uncertainty regarding health care reform.

But adding WuXi should help. The company will expand the capabilities of Charles River and also provide a low-cost platform, which should boost margins. In fact, it will also be easier to conduct animal trials because of China's leniency.

However, cross-border deals can get complicated. Just look at WuXi's acquisition of AppTec Laboratory Services in 2008. The deal was definitely challenging because of the cultural issues.

And yes, such concerns help to explain why shares of Charles River are down 11% in Monday's trading. Simply put, the company is in a tough spot and needs to take on more risks it if wants to remain competitive. No doubt, its rivals will try to find an edge by building platforms in countries like China as well.