Charles River Laboratories (NYSE:CRL) is buyingInveresk Research Group (NASDAQ:IRGI) in what appears to be a bid to control more of the burgeoning market for preclinical drug development services.
The $1.5 billion cash-and-stock deal is the largest transaction in the contract research space for some time, and investors appear to be viewing the acquisition with some skepticism. Charles River shares are down 9.5% on heavy volume. This wariness is not entirely surprising because the history of large-scale consolidation among service providers has been less than glowing.
The last time an acquisition near this scale was proposed was back in 1999, when Covance (NYSE:CVD) offered to buy PAREXEL International (NASDAQ:PRXL). The deal later fell apart when the companies concluded that earnings growth for the combined firm would be below initial expectations.
Indeed, many industry watchers feel that large purchases offer few benefits and present numerous challenges. A contract research company's chief asset often is its people, and integration usually results in personnel reshuffling that can disrupt customer relationships, especially with all-important large pharmaceutical clients. In addition, cost savings usually are not enormous. As a result, instead of merging with competitors, firms have moved into complementary businesses, or explored alternative strategies such as drug ownership. For example, aaiPharma (NASDAQ:AAIIE) and PPD (NASDAQ:PPDI) have pursued variations on the latter theme.
The Charles River/Inveresk acquisition, however, has some merits that may outweigh the downsides. A key component of success in the contract research business is global reach. Pharmaceutical and biotech companies want to conduct studies worldwide to facilitate regulatory approval for their drugs in as many markets as possible. Through the combination, Charles River will gain a critical European presence in toxicology testing and biosafety.
With improved global coverage in these areas, the new company will be poised to capitalize on the very healthy biotech financing environment. In June alone, three new drug firms completed their initial public offerings, and two others filed to go public. These and numerous other outfits that are raising cash lack the infrastructure to develop their own drugs, many of which are early stage candidates. As a leader in the preclinical space, the new Charles River can probably count on capturing a healthy chunk of this business.
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Fool contributor Brian Gorman is a freelance writer living in Chicago, Ill. He does not own shares of any companies mentioned here.
