Taking a drug through the regulatory pathway can be difficult, time consuming, and expensive. That's why more and more leading biotech and pharma companies choose to outsource that work to contract research organizations, or CROs, instead.

In this episode of The Motley Fool's Industry Focus: Healthcare, host Shannon Jones and Fool.com contributor Brian Feroldi discuss the benefits of investing in a CRO and why Iqvia Holdings (NYSE:IQV), PRA Health Sciences (NASDAQ:PRAH), Syneos Health (NASDAQ:SYNH), and ICON PLC (NASDAQ:ICLR) are top choices to consider.

A full transcript follows the video.

This video was recorded on Jan. 23, 2019.

Shannon Jones: Let's talk about another safer way to invest in biotech and biopharma. That way is interesting because in an effort to curb costs and expedite R&D, many biotechs are now starting to outsource many of their clinical functions. This goes to a class of providers better known as the contract research organizations, or CROs, as they're called. Brian, what makes CROs so attractive as investment opportunities right now?

Brian Feroldi: As I'm sure many biotech investors know, getting a drug through the regulatory approval process and conducting those clinical trials not only takes a long time but it's extremely expensive. That means they're going to be spending heavily on clinical trials. The advantage of buying a CRO is that they're the ones that are directly benefiting from that spending. They're also directly benefiting from that long lead time.

CROs partner with biotech companies, pharma companies, and they handle all facets of the clinical trial process. They can literally design the trial, get in contact with clinics to actually perform the trial, they can run the tests, they can analyze the data, they can help with the regulatory submission. If a company wants to outsource that work, or even just partner to get consulting advice, CROs are a natural go-to partner for them.

The great thing for investors is that the CRO makes money on the drug basically no matter what the outcome is. If a drug fails to live up to its expectations, the CRO still gets paid for conducting a trial. Another nice benefit is, when a drug enters phase 1, by the time it gets through phase 3, that process can take many years. If you partner with a CRO on phase 1 and you have to take it through all the way to phase 3, well, those trials have to be conducted over a course of years. You typically sign contract agreements with the CRO that last multiple years and multiple phases. If a CRO wins a compound early in its life cycle, they get a lot of revenue visibility as the drug develops. That's very attractive.

Jones: Yeah. Interestingly enough, right now, only about 40% of clinical development is currently outsourced. Some analysts are saying this could rise above 50% over the next few years. A couple of reasons why, a couple of drivers, one is just the cost of running these expensive, massive trials. Those are going to continue to grow, especially as many biopharma companies are continuing to expand and run trials on a global basis. You've also got very complex regulations. In some cases, the FDA is starting to back off in some ways and make it less complex, but in other ways, in other areas, like gene therapies, those are going to be the more complex routes that many of these biopharmas will have to tackle. They'll need a partner like a CRO to help get them through.

In addition, another huge driver is insurance reimbursement. We've seen and will continue to see, especially as we get through the next election cycle, continued pressure on drug pricing. You're seeing payers push back, you're seeing politicians get more involved in the mix. Maybe, maybe not, we'll actually see something happen when it comes to drug pricing. Either way, all of this amounts to continued downward pressure on margins for many of these large biopharma companies.

Biotechs, especially the smaller ones, need the expertise, they need the cost efficiencies, and really, they need the global reach that many of the CROs offer. Brian, are there any names in particular that stand out to you in the CRO space?

Feroldi: There's a handful of them that are publicly traded. My personal favorite is the largest one in the sector, which is called Iqvia Holdings. This is a company with 55,000 employees. It literally services 8,000 different customers. They handle soup to nuts, from basically discovery all the way through commercialization. If a biotech needs help with anything, they can get that basically from Iqvia. So, not only do they have resources, a huge army of researchers and regulatory experts in multiple countries that they can use, but Iqvia actually owns a database that has 530 million patient records in it, and they can use that to analyze prescribing habits, that can help sales reps with doctor targeting after a drug gets approval to make the commercialization process as easy as possible.

To give some scale, this company currently has a backlog of future projects worth $60.4 billion. These guys are absolutely enormous.

Jones: I love their focus and their push on the data end. You can see that playing out in so many different ways. You have access to clinical trial data once a drug is on the market. They also have a database that's looking at prescribing trends. I really think it equips the salesforce with better data to go after markets to drive top line for this company. Also, they're expanding globally. I know they've recently been expanding into the Asia Pacific markets. Really interesting there.

There are some other companies in this space, as well. Any others come to mind?

Feroldi: There's a couple of smaller ones. Iqvia is definitely the big dog in the area, but there are a handful of other CROs that take more niche focuses. Because they're smaller, they tend to be growing quicker. A couple for investors to put on their radar, one's called PRA Health Sciences. Their ticker symbol is PRAH. Then there's Syneos Health, which is the sponsor of the show. Their ticker is SYNH. Then there's another one called ICON PLC. Their ticker is ICLR. All these companies have their own niches within the industry. Since they're smaller, if you want to ride the wave, perhaps they could be more interesting to look at because they could post faster growth on a percentage basis.

Jones: Yeah. That's a great point on the smaller companies. What we've seen over the past few years in the CRO space is a lot of M&A action. I think that's set to continue. If you think about it strategically, it makes a lot of sense. Obviously, together, not only can they combine and leverage a much wider network of clinical trial sites, they can also now expand their clinical trial participant pools and start to utilize the big data and the AI tools that many of them are going after. So it wouldn't surprise me to see more M&A heading in the next few years in this space, as well.

Brian Feroldi has no position in any of the stocks mentioned. Shannon Jones has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.