Why Selling CROs Like Parexel May Be Short-Sighted
The market may have gone higher this past fall, but the rising tide did little to help Parexel shareholders. Instead, shares of the company fell sharply as investors focused on short-term results rather than long-term industry growth. That may be creating opportunity for investors willing to look beyond the company's struggles this past summer and embrace Parexel and its competitors Quintiles , Covance , and Icon .
Driving future demand
Facing a steep patent cliff, big pharmaceutical companies have increasingly shifted to outsourcing research and development in order to cut costs. That has helped the the contract research organization, or CRO, market jump to $13.6 billion, up 10.2% from 2011. Signs suggest the industry will continue to grow as drug makers target orphan disease and biologics.
Those orphan drugs and biologics command greater patent protection and higher, margin friendly prices, making them especially attractive to drug companies. However, bringing those drugs through clinical trials to commercialization is increasingly tough. Those trials need to be designed appropriately, and changes need to be implemented quickly. Identifying, enrolling and monitoring patients is also challenging when it comes to the small patient pools associated with uncommon diseases. And making sure trial results hold up in global markets can add snags, too.
Lacking elbow room
Parexel is far from alone in vying for a share of drug R&D budgets. A host of other midsized companies compete against it for business including Quintiles, Covance, and Icon. An even larger group of competitors operate as smaller, niche oriented CROs. That competitive landscape means drug companies have plenty of options, prompting CROs to underbid in order to win scale.
However, a transformation has been occurring that's shifting drug developer's demand toward the largest players and away from the smaller specialty firms. As drug companies increasingly look to faster growing health care markets in Asia and Latin America, those with the biggest global footprint are getting the nod. That's putting pressure on the smaller players, who are finding it more compelling to sell than see their market share continue to fall.
Parexel has taken advantage of that trend to buy HERON in a move that added nearly 5% in quarterly sales to its clinical research services segment, and Liquent, which boosted sales at Parexel's Perceptive Informatics IT group by 18.5% year-over-year during Q3.More broadly, consolidation continues to support revenue growth for Parexel, Quintiles, Covance and Icon.
Bidding on deals hits new highs
Parexel's lackluster top line this summer wasn't just because it lost out on more deals than it hoped. It also came because of program delays at its biggest customers. Revenue from those large customers is notoriously lumpy and summer-inspired delays aren't uncommon, particularly in vacation-heavy European markets. The impact of those delays may have been significant considering that Parexel's top five customers account for 48% of the company's sales.
As a result, if activity at Parexel's big clients is indeed temporary, sales should rebound in future quarters. But it's not just an expected cyclical improvement at big drug makers that could help Parexel return to solid footing.
The equity, credit, and private equity markets have all perked up, and that's providing plenty of low cost funding for emerging biotechnology companies eager to move pre-clinical drugs into trials. As these newly funded firms take the next step in development, Parexel, Quintiles, Covance, and Icon should see orders pick up.
Additional revenue growth may also come at Parexel as bidding activity ramps. Despite Parexel admitting it didn't win out on as many deals as hoped last quarter, it also acknowledged it bid on more business than at any time in its history. It's likely they'll end up winning some of those deals, which could boost its backlog beyond its current $4.6 billion.
Foolishly tempting opportunity
CROs serve an important role in reducing inefficiencies inherent in legacy drug companies R&D practices. Eliminating those inefficiencies can save drugmakers billions in terms of avoided trial changes and time-to-market delays. That suggests the environment for CROs remains positive, regardless of short term hiccups at Parexel. If so, the broader industry, including Quintiles, Covance and Icon should benefit.
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The article Why Selling CROs Like Parexel May Be Short-Sighted originally appeared on Fool.com.Todd Campbell has no position in any stocks mentioned. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd also owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool owns shares of ICON plc (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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