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WuXi's Shortsighted Deal

This is one partnership I didn't see coming.

WuXi PharmaTech (NYSE: WX  ) has been firing on all cylinders lately, persuading big pharma like Merck (NYSE: MRK  ) and AstraZeneca (NYSE: AZN  ) to outsource their research and development with it. The company has even acquired a U.S. presence.

But on Tuesday, the Chinese outsourcing giant announced that it's partnering with one of its biggest rivals, U.S.-based Covance (NYSE: CVD  ) . The duo still needs to work out a few details, but the crux is that the companies will form a joint venture to provide outsourcing for preclinical drug development. WuXi will provide the space in a new building expected to be completed next year, and Covance will donate $30 million to get the venture started.

The benefit to Covance is clear: It gains a presence in China, where scientists' wages are considerably cheaper. Higher margins should help it compete for pharma and biotech business against PAREXEL International (Nasdaq: PRXL  ) , PPD (Nasdaq: PPDI  ) , and others.

For WuXi, I don't really see the long-term benefit. Sure, the joint venture will give it access to drug companies that have been working with Covance for years, but it seems like it was headed down that path on its own anyway. Its top 10 customers made up 77% of its revenue in the first quarter of 2007, but that dropped to 62% in the most recent quarter, even as spending by the largest customers grew by 35%. Clearly, the company is picking up plenty of new business on its own.

As drug developers cut costs and try to do more with less, contract research organizations should be able to prosper. Unfortunately for WuXi, it'll only get to enjoy half of the growth from the joint venture.

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Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. The Fool has a disclosure policy.

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  • Report this Comment On June 25, 2008, at 4:11 PM, irishmanbob wrote:

    Is it possible that such a co-operative venture would give WuXi an advantage when it comes to the Chinese government looking at who should be given preference compared with other companies left to fight for their position in the future of drug development in China?

  • Report this Comment On June 25, 2008, at 4:26 PM, smooth13 wrote:

    I think you are getting confused about the sector. WuXi doesn't really compete against Covance, except in a few minor areas. WuXi provides discovery work and development scale manufacturing. Covance provides clinical research services and preclinical animal research. Both provide analytical lab work, but that is relatively minor for both. Also, Covance doesn't compete against PPD and PAREXEL on preclinical drug development. It's major competitor in this area is Charles River, who announced plans to establish a Chinese operation a while back.

    The point of this deal for WuXi appears to be Covance's expertise. WuXi will provide the facility and the basic staff, but Covance will provide the expertise in running a high quality operation that will attract big clients. This looks to be very positive for WuXi in the short-term and gaining access to new large clients will work out for the best in the long-term.

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