Wednesday, December 16, 1998
Quintiles Seeks Envoy, Dominance
The best companies often have a way of redefining their markets so as to solidify and expand their own competitive advantages. They want to make others play their game or risk becoming increasingly marginalized. Quintiles Transnational (Nasdaq: QTRN), the big daddy among contract research organizations (CROs) that provide outsourcing services to the pharmaceutical industry, appears to have redefined its market. The company announced this morning that it has agreed to acquire Envoy (Nasdaq: ENVY), a leading provider of electronic data interchange (EDI) services to the healthcare market.
The market didn't like the news, dropping shares of Quintiles by $10 5/16 to $45 7/8 even as Envoy soared $8 to $50 1/4. The stock swap calls for each of Envoy's 24.4 million shares, plus 3.5 million outstanding options, to be converted into 1.166 shares of Quintiles in a tax-free pooling of interests. The deal has a collar, meaning it could be terminated if Quintiles' price trades outside a range of $40 to $71.50. Based on Quintiles' closing price yesterday of $56, the agreement valued Envoy at $65 a share, or a 55% premium, making it a $1.7 billion deal before today's sell-off.
Despite the market reaction, the merger solidifies Quintiles' dominance as the ultimate one-stop shop CRO even as it positions the company as one of the chief value-added, data-driven marketing partners for drug developers. With analysts projecting Envoy to do $230 million in sales in FY99, the combined companies should break the $2 billion mark next year. "We see great potential for margin and revenue growth from Envoy in the medium and especially the long term," said Quintiles Chair/CEO Dennis Gillings in today's press release. "[W]e remain comfortable that we can meet consensus analysts' estimates for 1999, excluding transaction costs and other expenses." With those estimates at $1.37 per share, the stock now carries a forward P/E of 34, in line with its projected growth rate.
The CRO market has exploded as pharmaceutical companies and biotechs have re-evaluated their core competencies and outsourced an increasing amount of the time-consuming and expensive work of bringing drugs from lab to market. The top CROs, including Covance (NYSE: CVD), Parexel International (Nasdaq: PRXL), and Pharmaceutical Product Development (Nasdaq: PPDI), now conduct preclinical research, study design, clinical trial management, data collection, biostatistical analysis, and preparation of regulatory submissions for their clients. They get drugs to market more quickly and at a lower cost. Speed is particularly important since drugmakers want to cash in before patents expire.
Yet the CRO market has evolved, with leading players offering more services, including not just marketing and consulting but sales as well. Indeed, contract research firms have moved even further toward analyzing the effectiveness of drug treatments so that pharmaceutical companies can get more bang from their marketing bucks. Companies are spending more money on post-marketing Phase IV trials to collect long-term safety data that can boost marketing efforts as well as test new uses for the drug or new dosing formulas. The goal is simply to collect the kind of data that can expand a drug's market penetration, thus leveraging the tremendous up-front cost of getting it to market in the first place.
Size and scope appear to be meaningful competitive advantages in this marketplace. The CRO space has been consolidating partly because pharmaceutical companies are really looking for partners. They've handed more of their business to the companies that can do the most for them. Indicative of this trend is the tentative agreement, announced Monday, under which Quintiles will pay $93 million in cash to acquire Hoechst Marion Roussel's Drug Innovation and Approval organization, including its 540 personnel. In return, Hoechst will guarantee Quintiles $436 million in business over five years for ongoing research efforts plus first crack at another $144 million worth of business. Quintiles also gains status as Hoechst's preferred CRO partner for new projects.
Quintiles' size gives it a decided advantage. It's annual sales exceed that of its two top competitors while its base of 14,000 worldwide employees in 30 countries is more than its top three competitors combined. Aside from doing business with basically all the 50 leading international drug companies, it has a diversified revenue base. Last year, 52% of revenue came from the core clinical and data management business, 36% from sales and marketing services, and the rest from disease management, healthcare consulting, strategic marketing and other services.
Quintiles led the CRO industry into contract sales services in late 1996 through its acquisition of Innovex Holding, and it has continued to expand its offerings through acquisitions. The Envoy deal means it's now moving aggressively to get fully wired into the more data-driven component of this end of the business. Just yesterday, Quintiles announced a definitive agreement to acquire Pharmaceutical Marketing Services (Nasdaq: PMRX). Its main Scott-Levin unit, with $20.4 million in sales year-to-date, provides market research audits measuring the effectiveness of pharmaceutical promotion efforts in the U.S. Quintiles aims to develop an electronic information network that links patients, providers, and payers in a way that will allow it to enhance the commercial success of its clients' drugs by providing in-depth and timely market data. Both Envoy and Scott-Levin will continue to be run by their current management teams and will operate as subsidiaries of Quintiles.
Envoy is attractive to Quintiles for a number of reasons. For one thing, it's the leader in EDI commercial claims, with a client base that includes 200,000 physicians, 34,000 pharmacies, 38,000 dentists, 4,400 hospitals and half of all payors, including the top 20. According to a research report issued today by Needham & Co. analyst Bernard Lirola, HMOs currently receive only 18% of their claims electronically while just 38% of physicians' claims are sent electronically. The wired world, though, is catching up to the claims process, with real-time EDI growing at 65% a year. Quintiles says analysts expect the healthcare EDI market to grow from $1 billion a year to $3.1 billion by 2002. Lirola expects Envoy's repeat transaction business will smooth out some of the lumpiness in Quintiles' contract business.
The potential synergies of the deal offer the real kick. As Lirola notes, Envoy will allow Quintiles to create a real-time link between the physician who writes the prescription and the pharmacy that fills it. In theory, that marketing data can be made available in real-time both to Quintiles' contract sales force and to its pharmaceutical clients. That's at least one application that will allow Quintiles to leverage its current relationships with drug makers. Joining medical claims data with clinical trial data in real-time also could speed up the analysis of Phase IV trials and provide highly useful data to healthcare payors.
Lirola thinks this merger pressures IMS Health (NYSE: RX), which gained $1 3/16 to $69 15/16 today, while enhancing the value of National Data (NYSE: NDC), which has its own real-time healthcare connectivity network and gained $2 3/8 to $38 15/16. Part of the market's poor reaction to the Envoy merger, though, may be that it's slightly dilutive to earnings and that it represents a significant move by Quintiles outside of its core business. Investors are wondering if Quintiles can get around some of the privacy issues involved in the medical records biz to make real use of this data. Some investors may also hear echoes of the other recent merger of clinical and administrative companies in the healthcare field: HBO's (Nasdaq: HBOC) combination with Access Health and pending merger with McKesson (NYSE: MCK). But the economics of the Envoy deal, at least for Quintiles, appear to be quite attractive given that Envoy's rising operating margins should top 25% for the year, well above Quintiles year-to-date 10.4% margins. There's also the promise of more profitable synergies down the road. If that happens, Quintiles will indeed be the envy of the CRO space.
|Recent Fool on the Hill Headlines|
|Fool on the Hill Archives »|