It should have been a good year for eResearch Technology (NASDAQ:ERES). With the withdrawal of Vioxx because of elevated coronary risk, and similar concerns about Pfizer's (NYSE:PFE) Celebrex, you would think that investors would look favorably upon eResearch's business of collecting cardiac data for clinical trials.
Alas, that was not to be; sluggish sequential growth weighed heavily on the stock in the back half of 2004. With positive guidance from last night's fourth-quarter and full-year earnings report, though, investors may be about to rekindle some love for this service provider.
eResearch reported about $27 million in sales for the fourth quarter, down sequentially by about $1 million but up 29% over last year. Earnings were up similarly, and the company raised its guidance for 2005 above the median Wall Street estimates. The company also managed to generate about $42 million in free cash flow for the year -- nearly double that of a year ago.
eResearch's main business is the collection and interpretation of cardiac safety data for clinical trials. The FDA now requires more rigorous cardiac studies for all drugs that enter the bloodstream, and many companies take it upon themselves to engage in so-called "thorough phase 1 studies" to better evaluate cardiac measurements such as the QT interval. (The QT interval normally varies with heart rate -- becoming shorter at faster rates.)
During 2004, though, the FDA began to consider new rules for cardiac testing and many researchers delayed trials pending the new guidelines. Although the new guidelines permitting limited semi-automatic testing (eResearch specializes in manual testing) could lead to some price competition, it is likely that manual testing will remain the gold standard.
There are also concerns about growing competition, as companies such as Covance (NYSE:CVD), Viasys (NYSE:VAS), and Quintiles increase their efforts in the cardiac monitoring space. While these are valid concerns, the market could be worth in excess of $800 million and is likely to continue to grow as pharmaceutical companies look to put ever more drugs into trials.
Merck's (NYSE:MRK) experience with Vioxx may prove to be a costly lesson for the entire industry. As articles in the New England Journal of Medicine have noted, Merck spent upwards of $100 million annually on direct-to-consumer advertising.
For a tiny fraction of that amount, Merck could have performed a more thorough cardiac study of Vioxx, possibly recognizing the problem sooner. Since it now seems inevitable that Merck will be paying hundreds of millions of dollars in settlements for Vioxx litigation, that trade-off is significant, and other pharmaceutical companies will likely take note.
Trading at an EV-to-FCF of less than 17 and boasting a return on equity in the 30s, eResearch looks like an interesting stock, if growth is truly back on track. While the company may have surpassed its hyper-growth phase, I believe there is a case to be made that it will continue to grow as it expands service offerings and as pharmaceutical companies look to invest more in early-stage safety studies in the hopes of avoiding future debacles like Vioxx.
Fool contributor Stephen Simpson, CFA, has no ownership interest in any stocks mentioned.
