Charles River Tries to Sail Away With China's WuXi

by Tony D'Altorio

Charles River Tries to Sail Away With China's WuXi

by Tony Daltorio, Investment U Research

Monday, May 10, 2010

If you're a healthcare stocks junkie, you may have caught the news...

U.S. clinical research company Charles River Laboratories International (NYSE: CRL) announced a deal to buy its Chinese rival, WuXi PharmaTech ADR (NYSE: WX).

The $1.6 billion cash-and-stock deal includes each WuXi ADR receiving $11.25 in cash and $10 of Charles' common stock.

For all intents and purposes, it seems like a good match.

Charles River is one of the world's largest research groups to develop drugs for large pharmaceutical companies to test in humans. And WuXi is one of the biggest Chinese clinical research organizations. It also makes molecules to synthesize drugs, among other things.

According to Dealogic, this proposed deal ranks in the top three foreign takeovers of a Chinese company. And it is the largest outside buyout for China's pharmaceuticals industry.

But it probably won't be the last.

The Logic Behind the Pharmaceuticals Industry Deal

An oft-quoted saying in the pharmaceuticals industry is that it takes a decade to go "from molecule to market." In reality, it often takes as long as 16 years. And it costs plenty of money over that time for the 10,000 or so compounds that fail for every one successful drug.

That kind of time and money factor in directly to why Charles River wants to buy up companies such as WuXi. It anticipates a sharp rise in demand for outsourced early-stage research, as big pharma cut cost and downsize their in-house drug research.

And believe me: They are trying to save on costs.

Charles River believes that as they do, they will outsource 80% of their pre-clinical work, as compared to the 40% that they do now. And the company plans to profit off of that through WuXi.

If it successfully sees the deal through, Charles River will have a wide array of services to offer. That includes synthesizing compounds at the discovery stage through pre-clinical and early-clinical testing, and even the manufacturing of commercially successful drugs.

James Foster, the CEO of Charles River, claims that the combined company will even be able to cut drug development times by up to six months compared to pharma in-house development. In addition, it could save its customers 20% - 30% of their usual costs.

That kind of business can bring in some good business, to say the least. But Charles River also likes WuXi simply because of its location and therefore its reach. When pharmaceutical companies look at China, they see large populations and patients in need of treatments for diseases like malaria.

They also see an opportunity to run trials in a market with rising demand for medicine.

Charles River Sinks... For Now

Charles River and other research providers like it have seen their growth rate slow over the last year. The slowdown occurred in part due to uncertainty over healthcare reform. But the financial crisis also contributed with a lack of funding for biotechnology companies.

So Charles River needed something to ignite growth again. And WuXi, with its talented crop of scientists, compliments the company's previous forays into China. Yet, for some reason, investors reacted badly to the news, causing its stock to fall 14%.

Perhaps they don't know about pharma's rapid growth in China or WuXi's high quality research. Or maybe they haven't paid attention to estimates that it charges a fifth of what its U.S. competitors ask, yet produces similar quality work.

Credit Suisse analyst Du Jinson does seem to get it however. He points to the larger trend of contract researchers following large pharmaceutical firms into faster-growth, lower-cost locations with scientific expertise like China and India.

WuXi's medicinal development capabilities make for a good, strategic fit for Charles River, which wants to expand into more upstream services in the drug research pathway.

The combined company expects sales of about $1.5 billion. While WuXi can only contribute a fifth of that at first, it's likely to drive future growth since its revenues have increased 10-fold since 2004.

The deal acknowledges China's growing competitive advantage in the pharmaceutical business. And with drug companies trying to get more bang for their research and development buck, look for this trend to continue.

Other companies such as Covance (NYSE: CVD) and Pharmaceutical Product Development (NASDAQ: PPDI) may also expand into China or other markets like India over the next few years.

Good investing,

Tony Daltorio

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