Pharma services drives hot healthcare M&A market through summer

Healthcare dealmaking has seen no summer slowdown.

With healthcare-services transactions accounting for what PitchBook says is almost two-thirds of the more than 300 PE-backed deals through Aug. 8, the amorphous segment called pharma services has been a standout.

The demand for such services continues to be fueled by drug makers, which are eager to deploy the huge sums of capital they’ve raised to develop innovative therapies. At the same time, these companies are facing significant regulatory and cost pressures, fueling digitization across the drug-development process.

‘Conviction in the space’

“Where else in healthcare services can you find investment opportunities with a top-line-growth rate in the high-single digits to low-double digits with no reimbursement risk?” said Michael Gerardi, global joint head of healthcare-services investment banking at Jefferies. “The percent of outsourcing [by the life sciences industry] is only increasing. It’s very easy for [private equity] to get comfortable with that fundamental, macro theme.”

“At this point, there’s a lot of folks that have tried to win a number of these [assets] and haven’t but are continuing at it because they have even more conviction in the space,” added Kara Murphy, a Bain & Co partner who co-leads the firm’s healthcare PE team.

The first several months of the year have produced an abundance of sponsor-driven transactions in the sector, even as strategics have stepped up their efforts to consolidate. At the same time, investors are all over specialty and tech-enabled assets that corporate buyers arguably overlooked.

The pharma-services universe includes contract research organizations, which run and manage clinical trials and studies, and contract development and manufacturing organizations, which produce and make the drugs. Both offer their services to life-sciences companies via contract.

An array of tech-oriented businesses also center on the drug-development process. The eClinical space, for example, includes technologies and tech-enabled services that help clinical-trial processes run more efficiently.

Among notable megadeals this summer, Pamplona Capital in June took CRO Parexel private in a $4.5 billion transaction, the same month Carlyle and GTCR shelled out $922 million for CDMO Albany Molecular. In May, INC Research merged with inVentiv Health in a $4.6 billion deal. The deal left InVentiv backers Thomas H. Lee and Advent with a slight minority stake in the CRO giant.

In tech, EQT in July announced an $850 million deal for Arsenal Capital’s Certara, which uses software to simulate drug trials and helps pharma companies obtain approval for their treatments. Genstar in March scooped up eClinical company Bracket Global from Parthenon Capital Partners, paying what sources said panned out to about $525 million, or 15x EBITDA.

Strategic Competition

Problem is the buyer universe for pharma services spans well beyond the PE community. In fact, the M&A flurry has arguably created an even more aggressive pool of strategic acquirers.

“In my 20 years of covering this sector, at no point in time has strategic interest been more robust for both CROs and contract manufacturers,” said Gerardi, who leads Jefferies global efforts in pharmaceutical services.

A couple recent CDMO megadeals, including Lonza’s acquisition of Capsugel and Thermo Fisher’s play for Patheon, have woken up other strategics, Gerardi said. “Now all of a sudden you’ve got two big consolidators moving into the CDMO space, one of which is a life-sciences company. The question is: Are other life-science-tools companies like Danaher and GE going to move into the space?”

KKR completed its $5.5 billion sale of Capsugel in July, while Thermo Fisher’s $7.2 billion deal for Patheon was announced in May. Recent strategic wins for CROs include LabCorp’s $1.2 billion purchase of the U.K.’s Chiltern in July.

While corporate buyers often pay a higher price or leverage strategic synergies to prevail over sponsors, there’s also the risk of negative synergies.

If customers overlap between two strategics in a deal, a biopharma client may say, “we don’t want this many eggs in one basket,” Gerardi said. “The combined entity may end up losing revenues from certain customers.”

Pamplona’s acquisition of Parexel is an example of a firm winning over a strategic because of negative synergies, Gerardi added: “Potential dis-synergies in a strategic transaction was a direct reason in my view why they were able to outbid two strategics buyers.”

Where PE Can Win

As tremendous capital chases a finite number of deals, sponsors increasingly recognize the need for speed. A lot of folks that weren’t victors in deals like inVentiv, for instance, are now thinking: “Who else could I action?” Bain’s Murphy said.

“You need to quickly decide where you want to hunt — and then race,” Murphy said. “If you can come to the first round [of a process] with a binding bid, you’re more likely to lock something up.”

With a strategic in the mix, PE’s advantage is the ability to be nimble.

“They compete by developing conviction early on,” Gerardi said. “More often than not, if you see a PE firm winning a process, it’s highly likely that it was preempted.”

In other words, sponsors take a little bit of a leap of faith, Murphy said. Unless you think about what the company can become — versus “do I like it today?” — it’s tough to win a deal in this segment, she said.

EQT’s recent deal for Certara, the biosimulation drug-development company, shows how spending resources and time well before an asset is actionable can be effective. It also illustrates how firms are discovering opportunities in under-penetrated, specialty segments.

The Stockholm global PE firm doubled down in its efforts to find a pharma-services deal after pursuing bids for CRF Health and ERT (eResearch Technologies) in 2014 and 2015, respectively, Eric Liu, a partner at EQT Partners, said.

It was U.K. sponsor Nordic Capital that ultimately bought ERT from Genstar in March 2016, a deal that sources said fetched roughly $1.8 billion including debt. Vitruvian Partners purchased its majority stake in CRF in January 2015 from fellow sponsor Verdane Capital.

EQT took what Liu described as a “tour of middle-market firms,” identifying those that focus on the healthcare sector and have reputations for building good platforms. Through this process, EQT became familiar with Certara, but Arsenal at the time was only about 2 1/2 years into its investment and not ready to exit, Liu said.

When Arsenal ultimately tapped Jefferies in the spring, the company was previewed to EQT and a few others, Liu added: “We were prepared to engage immediately and took the first meeting date offered.”

“Certara was relatively unknown and operated in a niche segment within pharma services,” Liu said. “It’s not a company that a lot of people had heard about or had tracked over time. Jefferies knew that we were highly motivated and had done a lot of due diligence ahead of the process. For a company that is hard to understand, that gave us an even greater advantage.”

While Certara is unique, the eClinical space — in which Vitruvian’s CRF Health, Genstar’s Bracket Global, Nordic’s ERT and Cinven’s BioClinica play — is one area that PE appetite is expected to persist.

EClinical “is a sector where strategics aren’t quite up the learning curve. … It’s clearly an area where PE has effectively competed and they will continue to do so,” Gerardi said.

EClinical providers offer things like eCOA, or electronic clinical outcome assessments, through which patients, clinicians and caregivers use electronic devices like smartphones to track and report patient outcomes.

Early Development-CROs

Investors that don’t have the financial wherewithal to back players the likes of Parexel — or rather would prefer not to pay the mid-teen multiples that the eClinical providers trade for — are placing their bets elsewhere.

Sponsors are also effectively competing for CROs concentrated on preclinical and Phase 1 drug development, as the early-development specialty market remains largely underappreciated by strategics, Gerardi said.

While large CROs have proven highly acquisitive, most have strayed from early development services. Industry giants the likes of Quintiles do encompass Phase 1-related offerings but focus primarily on supporting life-science companies during important late-phase clinical trials.

For some middle-market investors, it’s viewed as an opportunity for consolidation. Clinical services focused on early-stage drug development largely serve biotech companies, which don’t necessarily have the same resources as big multinationals, one PE source explained. There’s significant value in streamlining these early-stage services so clients don’t need to contract out to multiple vendors, this person said.

One provider of Phase 1 clinical-development services up for sale is MTS Health InvestorsCelerion, which Buyouts reported in July retained Lazard to advise on a process.

In recent activity, Audax Private Equity in June surfaced as the winning suitor for Altasciences. The deal marked an exit for Toronto sponsor Kilmer Capital. The U.K.’s Quotient Clinical, meanwhile, was scooped up in December 2015 by Dennis Gillings’s GHO Capital Partners.

Market dynamics fuel deals, prices

The M&A pharma-services breakout is the culmination of a number of factors, including the fact that it’s one healthcare pocket that doesn’t depend on direct reimbursement from the government. Rather, venture capitalists have injected huge sums into biotechs that they need to put to work.

In other words, much of the regulatory uncertainty facing healthcare sectors that rely on Medicaid reimbursement, like long-term care and nursing homes, isn’t a factor.

And the so-called pharma spigot shows no indication of closing, Murphy noted. “Despite a lot of headlines and scrutiny around pharma pricing, at the end of the day, it’s recession-resistant. Dollar growth into the industry [is] only going up.”

Investing in pharma services is also a way for healthcare-focused PE firms to invest in the pharmaceutical sector without taking on science risk or single-product risk, EQT’s Liu said.

“Providers of services to the life-science industry tend to have business models that PE firms are familiar with, such as software companies, logistics businesses, or professional services firms. So PE firms are familiar with how to evaluate these companies and drive value,” Liu said.

And PE has a lot of money to put to work. About 28 healthcare-focused funds in the U.S. have closed through Aug. 1, accounting for about $8.7 billion in total capital, data provided by Preqin shows.

While the sector is poised to remain both expensive and competitive for the foreseeable future, it’s unlikely to deter folks like EQT.

“When the markets are very high, where they are today, it increases the importance of asset selection,” Liu said. “We try to buy companies that are going to be okay in bad times and do great in good times.”

“Most people recognize that PE returns are correlated with where we are in the cycle,” Liu added. “However, it is very difficult to time the market. It’s also hard finding good deals.

“When good companies become available, someone will always stretch on valuation to own it. For the good companies that they already own and like, PE firms will sometimes hold them even longer.”

Action Item: EQT’s portfolio:

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