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In this quarterly preview, we discuss some common investor
perceptions and identify where we differ from the consensus view.
Key Points
We address these key questions in our MythBusting or Booming:
• Is outsourcing penetration 25%...or much higher? The most
common reference is to a market penetration rate of 25%-30%. We
were previously guilty of an overly cursory analysis of the
addressable market. In our 1Q update we calculated penetration of
40% into a more precisely defined addressable market. Again here,
we update our assumptions, offering that the penetration rate is at
least 40% and likely higher.
• Is penetration accelerating? While harder to verify, we think
penetration is accelerating driven by capacity transfer deals that
move the needle in larger ticks. Combining the industry's headcount
reductions, closures of facilities, and feedback from consultants
advising these companies, one should conclude that outsourcing
penetration is increasing at a faster rate.
• Is the pricing environment stabilizing? Relatively, we believe
price pressure is greater in early development than in late-stage in
the near-term because of softer demand and more available
capacity. In the longer term, we expect sponsors to turn to price
discounts to create cost savings. CROs will have to drive more
automation and flexibility into the development model to maintain
margin in the long-term, in our opinion.
• Is demand improving? This is a mixed bag. In late-stage,
sponsors are starting to make go-forward decisions more easily,
and RFP flow has improved off of 4Q/1Q lows. However, biotech
demand remains weak (despite an uptick in funding) as does
preclinical demand and demand in developed markets (i.e. the
U.S.) relative to emerging markets.
• Are CROs coming out of cyclical trough? We think that the
current improvement in demand is an improvement off a cyclical
low, but only in the context of a broader secular downturn that will
be driven by lower levels of sponsor R&D spending growth over the
next 5 years. Bottom line, we think CROs are not going back to the
mid-teens growth seen immediately prior to 3Q08.
Thoughts on Stocks. We generally believe that the consensus view
is slightly too optimistic for the potential turbulence to be seen in
2H08. Still, a slight improvement in RFPs and a timely decline in the
USD will prevent misses in 2Q for most. ICLR and CVD are the most
confident about their position and outlook. With PRXL's recent
pullback, we view risk/reward very favorably, particularly on FY10
guidance. WX is up 88% this quarter on a 1Q "EPS beat, but revenue
shortfall" plus follow-through. We are cautious about the dilution risk
from WX's business line expansion.
July 14, 2009
Healthcare
Pharmaceutical Services
United States of America
Healthcare
Neither CRO Autobahn nor Bridge to Nowhere?
Investment Summary
We think 2Q09 will reflect a modest sequential improvement from a
mixed, sloppy 1Q09. We think putting money to work in these stocks
should take into account that activity is stronger in late-stage than in
early stage, and stronger internationally (which will also get FX
boosts relative to the last update) than domestically.
David Windley, CFA, CPA
(615) 963-8313, dwindley@Jefferies.com
Timothy C. Evans
(615) 963-8394, TEvans@Jefferies.com
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