Are CROs Good Strategic Investments in 2024?

Powerhouses Behind Pharma and Biotech Innovations

Volume 2 of Argo’s Healthcare Insights

Contract Research Organizations (CROs) are currently a hot spot in the healthcare M&A market. The sector has seen significant deal activity, reflecting strong interest from strategic buyers and private equity firms. We give you the key insights into the trends and dynamics shaping this sector:

– CROs provide outsourced research services to the pharmaceutical, biotechnology, and medical device industries. These organizations support various aspects of drug development, including clinical trials, regulatory compliance, data management, and more.

– By leveraging their expertise, CROs help sponsors reduce costs and time-to-market for new products, making them an integral part of the drug development process.

– CROs allow sponsors to avoid the high fixed costs associated with maintaining in-house research teams. By outsourcing, companies can allocate resources more effectively and reduce the capital burden of drug development. This flexibility is particularly appealing in an environment where R&D costs are escalating. Average spending per newly approved drug has increased more than 14x from $179m in the 1970s to $2.6bn today.

– Further CROs also possess specialized knowledge and experience across various therapeutic areas and phases of drug development. This expertise can lead to improved efficiency and effectiveness in clinical trials, enhancing the likelihood of successful outcomes for sponsors.

CROs serve a wide range of clients, from large pharmaceutical companies to small biotech firms, as well as academic institutions and government agencies. This diversity mitigates risk and provides multiple revenue streams.

Increasing Demand for CRO Services

The global CRO market was estimated to be worth US $48 to $83 billion in 2023 and is expected to reach up to US$149 billion by 2028.

Growth in the space is driven by rising investments in clinical and non-clinical research activities, as well as increased outsourcing to CROs.

Pharma and biotech companies are increasingly relying on CROs due to the rising costs and complexity of drug development.

Attractive Business Model

CROs provide specialized services across all stages of drug development, from compound selection to post-approval functions.

Once a sponsor company outsources a function to a CRO, it is difficult to bring it back in-house, creating a strong barrier to entry and a recurring stream of revenue.

CROs make money regardless of whether a drug succeeds, making it less risky than investing in a drug development company.

Consolidation Opportunities

M&A activity has slowed down in the CRO marketplace, with organic consolidation growth being prioritized.

There are opportunities for private equity firms to invest in the roll-up of smaller CROs into larger, more efficient organizations.

Technological Advancements

CROs are investing in developing future-looking capabilities, including building out technology offerings to attract and retain clients.

Specialized technology can make the drug discovery process more efficient and boost positive results.

Current M&A Activity & Insights

Recent M&A and Private Equity activity in the CRO space reflects a dynamic landscape influenced by various market trends and investor interests. Below are the key insights for the sector to consider:

– Transaction Volume: In 2023, the CRO sector saw 131 completed deals worth a cumulative $16.8 billion, maintaining activity levels consistent with 2022 despite a general softening in the broader M&A market. Private Equity driven transactions accounted for over 71% of this volume, indicating their strong interest in the sector.

– Private Equity Interest: PE firms are drawn to the CRO sector due to their robust growth prospects and potential for consolidation. They are particularly focused on acquiring specialized CROs that can meet the evolving needs of pharmaceutical companies amid a challenging funding environment for biotech firms.

– Focus on Smaller Transactions: The general trend has shifted towards smaller to mid-sized transactions rather than large-scale deals exceeding $1 billion. This is largely due to the diminishing pool of eligible companies and increased financing costs. Many larger CROs are now recalibrating their portfolios to prioritize core operations while divesting non-essential units. Recent surveys further indicate that M&A activity in the larger CROs segment has raised concerns among sponsors about service delivery and project stability. Nearly half of the surveyed decision-makers expressed apprehension regarding the impact of large CRO consolidations on project timelines and team stability, suggesting a potential preference for smaller, more agile CROs that offer personalized services.

– Sector Fragmentation: The CRO market remains fragmented, with many smaller players offering specialized services. This fragmentation presents opportunities for consolidation, as larger firms seek to enhance their capabilities through strategic acquisitions of niche CROs, particularly in areas like patient recruitment and digital monitoring technologies.

– Valuation Trends: Following a period of declining public market valuations, CRO valuations have begun to rebound, aligning with broader market trends. Investors are becoming more selective, emphasizing cost efficiency and synergies in their acquisition strategies. Currently publicly listed CROs trade at an average 17x forward EV/EBITDA, with multiples peaking earlier in 2024 at 19.6x. It should be noted that CROs changing hands in the private market did so at a significant premium, with an average 31x EV/EBITDA multiple.

Future Outlook

The outlook for M&A activity in the CRO sector remains positive, with expectations for continued deal-making at levels similar to recent years. However, the focus will likely remain on smaller transactions as larger CROs navigate the complexities of integration and service delivery challenges.

As CROs adapt to the evolving regulatory landscape and the increasing complexity of drug development, the emphasis on technological investments and specialized service offerings will become critical. This adaptation may further influence M&A strategies, as firms look to bolster their capabilities through targeted acquisitions.

In summary, the CRO sector presents a compelling arena for investment, driven by ongoing M&A activity, the strong presence of private equity, and a market that is evolving to meet the needs of an increasingly complex pharmaceutical landscape. Investors should keep a close eye on smaller CROs and the potential for consolidation in this fragmented market.

Written by, Martin Iliev, CFO @ GlycanAge

Argo Advisory | Published: September 2024

Sources:

The Long-Term Investment Opportunity in Healthcare R&D | Dominion Funds

Ultimate Guide to Contract Research Organization Market Size | Alimentiv

Top 10 Contract Research Organizations to watch in 2024 | proclimincal

Discovering the Investment Opportunity in Pre-Clinical CROs | Lincoln International LLC

The Business of Clinical Trials Is Booming. Private Equity Has Taken Notice | KFF Health News

CRO M&A and Sector Update | Canaccord Genuity

M&A activity at larger CROs a concern, according to market research | informaconnect

CRO M&A deals reach new record, but what does this mean for clinical trial sponsors? | Clinical Trials Arena

M&A activity and valuations | Canaccord Genuity

CRO deal making dominated by skills and reach focused mergers in 2023 | informaconnect