Charles River Laboratories (NYSE: CRL) is headed to China. Investors would rather have seen it stay home.
The clinical research organization yesterday said it's purchasing China-based WuXi PharmaTech (NYSE: WX) for $1.6 billion. Each American depositary share of WuXi will be exchanged for $11.25 in cash and $10 of stock in Charles River Labs at a to-be-determined ratio that's capped at both ends. With Charles River falling 15% yesterday -- below the low-end cap -- the value of the stock portion of the exchange was worth only about $9 per share at yesterday's close.
Investors are rightfully a little worried that the $2.2 billion Charles River Labs might have a little bit of trouble integrating such a large acquisition. Generic-drug maker Mylan (Nasdaq: MYL) got dinged the same way when it swallowed Merck KGaA's generic-drug business. Investors are likely to keep a show-me attitude until they're convinced that Charles River Labs can make the cross-Pacific integration work.
That's not to say the move won't be a good one in the long run. Outsourcing is all about margins. Do it more cheaply than a drug developer can and you've got the business. Eli Lilly (NYSE: LLY) outsourced its research business to Covance (NYSE: CVD) a few years ago and even sold it the building to continue operations.
And what better place to keep costs down than China? Last year, PPD (Nasdaq: PPDI) made a smaller purchase of BioDuro to expand its presence in China. Covance originally set up a partnership with WuXi a few years ago, but decided it was better off expanding in China on its own.
In addition to lowering margins, the most recent deal makes sense because the companies are focused on different aspects of pharmaceutical outsourcing. Charles River Labs is focused on preclinical and running clinical trials, while WuXi specializes in drug synthesis. There's potential to cross-sell the services to each company's current customers.
Charles River Labs could be a good value play at these beaten-down prices. The acquisition induces further risk, but with it comes the potential for greater rewards.
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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.
