Mark Shapiro is the Vice President of Clinical Development at Clinipace.
Both Outsourcing Pharma and Centerwatch Monthly recently asked me whether the role of private equity (PE) in the CRO industry is changing. They were specifically interested in determining if PE investors have decided to shift investment away from CROs and if so, why.
It’s clear the industry has changed dramatically over the past two years. When analyzing the market structure, we estimate the Hirschman-Herfindahl Index, a measure of market concentration, has increased about 4% over the last two years. This can easily be seen in the following chart, which shows estimates of the annualized revenue (consolidated to include acquisitions, non-GAAP) based on public information available from the largest CROs. During this time, total clinical CRO industry revenue grew from approximately $13B to $16B, while the revenue of these firms went from about $11B to $14.5B.
PE money has been busy at work financing consolidations within the CRO industry, but as I noted in my previous post, approximately half of full-service CROs already had PE investors., After several years of PE activity in the CRO industry, it is safe to say that CROs with strong financials probably have already received PE money (if they wanted external investors), and put that money to work through geographic expansion, consolidation, and technology investments.
CROs still continue to offer investors low-risk, stable growth and the ability to generate cash—exactly the type of investment that appeals to pension funds or other long-term institutional investors who want exposure to the biopharma sector. However, as a bear market turns into a booming equities market, investors’ appetite for risk increases. Further, there are many small, private pharmaceutical and biotech companies looking for investment, but fewer potential PE deals to be made in the CRO space.
It should also be noted that PE funds tend to make investments over a 2- to 5-year period, work with their investments and look for exits after about 3-7 years. This translates into a roughly 5- to 10-year cycle, which could mean we see a trend over the next 5 or so years of IPOs by PE-backed CROs, so long as public equities markets are favorable. One of the many benefits PE groups bring is the ability to help management teams improve operations and financial structure, while also assisting with the costly and time-consuming process of preparing for a public offering.
Given how Quintiles led the industry down the PE path with their LBO in 2003, their IPO is probably a harbinger of things to come. Although PRA initially filed for an IPO, then went to PE for equity investment, we saw them re-file their IPO paperwork with the SEC. INC Research followed the same path a few weeks later, and both CROs recently closed their IPOs in November. If the public markets continue their upward movement, IPOs certainly become attractive for the larger CROs and provide liquidity for their PE investors. So, expect to see PPD, inVentiv, and others join Quintiles, Covance, ICON and Parexel as publicly traded CROs in the near future.