CRO industry poised for recovery--followed by a shakeout

Three top Wall Street analysts spent an hour at the Partnerships in Clinical Trials conference in Orlando diagnosing the financial health of the CRO industry. And they generally agreed that their patient had survived the body blow of a major recession and appears to be recovering nicely.

Over the past year, said John Kreger, an analyst with William Blair & Co., CRO stocks surged as optimism about the economic recovery-along with the prospects for new drug research-began to spread. Interestingly, he added, CROs focused on preclinical work saw their shares jump 42 percent compared to a 33 percent increase for CROs dedicated to the clinical arena - even though the clinical work has traditionally outperformed preclinical. Kreger thinks the unusual balance was triggered by investors' belief that a recovery will initially tilt in favor of earlier-stage work as more new programs are launched.

"I'm pretty impressed with how everybody did," said Eric Coldwell, an analyst with Robert W. Baird. Coldwell tracked a plunge in revenue from 2008 to 2009 for the CRO industry's top players, but believes this year will end with a five percent jump followed by a 10 percent surge in 2011. Just as importantly, though, the top CRO companies did a good job managing their finances through the course of a rough year, ending 2009 with an operating profit approaching $1 billion.

"There is a lot of capital for acquisitions to occur now," said Coldwell, who expects to see some of that money used to complete buyouts and snare new technologies. There are still plenty of opportunities for "niche vendors and esoteric solutions," said the analyst, "but a shakeout is coming."

David Windley from Jefferies & Co. emerged as the most bullish of the analysts. While pharma companies are likely to keep their R&D budgets relatively flat for the near term, he said, ambitious biotech companies will drive a three percent overall increase in research spending. That growth rate may be slower than what's been seen in the past, but it's a big improvement after the shock waves felt over the past two years.

It helped that biopharma companies came out of the long wrangle over health reform in good shape, with new benefits covering the cost of drugs and a 12-year haven on data exclusivity for biotechs. That helps set the stage for a rebound in CRO bookings in the second half of this year, said Kreger.

The battle over reform may be over for now, Kreger also noted, but the war over the crisis concerning rising healthcare costs is just beginning. And that will set the stage for a new round of debate among lawmakers after a temporary lull. - John Carroll (twitter | email)

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