Pharma Cost Cuts Could Be a Tonic for Quintiles

HELEN THOMAS

Dec. 20, 2013 12:44 p.m. ET

The pharmaceutical industry is getting into virtual reality. Investors wanting to play the game should consider U.S.-listed Quintiles Transnational Holdings. Q +0.58% Drug makers have in recent years turned to contract-research organizations to carry out large clinical trials needed to win approval for new medicines, an outsourcing trend known as “virtualization.” The global market for outsourced development is about $26 billion, estimates Jefferies.And, while contract researchers can no longer rely on double-digit-percentage growth in pharmaceutical company research-and-development spending to boost revenue, the shift toward more outsourcing should help the industry. The portion of total spending outsourced has risen more quickly in recent years, says Jefferies, and could hit 55% by the end of the decade, from 44% in 2012.

Quintiles, as the largest contract research company globally, looks well-positioned to benefit. The company, which had revenue of $3.7 billion last year, operates in 100 countries and employs 28,000 people, more than twice its biggest rival. That should help Quintiles win business as pharmaceutical companies seek to cut costs.

Moreover, drug makers are starting to use such businesses for a wider range of services, a trend that could benefit the largest companies.

Instead of merely handing over a study’s execution to their preferred research firm, and potentially paying extra charges when trials hit problems, some pharmaceutical companies are involving the organizations upfront. Germany’s Merck MRK.XE +0.55%KGaA in May agreed to an exclusive development partnership with Quintiles, giving it a greater hand in trial design and decision making.

Such moves reflect the expense of keeping a sufficiently global development team in-house to run large, complicated trials. Two years ago, Merck spent two-thirds of its research dollars on employees, labs and other in-house infrastructure; that is now down to one-third. The hope is also that drugs get approved more quickly, in more jurisdictions.

Meanwhile, another group may be pushing pharmaceutical companies into the arms of contract researchers: governments. Persuading payers of a new drug’s efficacy is an additional hurdle that, in the age of austerity, comes with its own demands. As different governments demand evermore granular information, a researcher’s broad experience and data can help anticipate their requests.

Yet shares in Quintiles have risen barely 7% since its private-equity owners floated the company in May. That they retain a large stake may weigh on the shares.

But some pharmaceutical companies remain wedded to keeping what they see as core expertise, such as a trial design, in-house. Winning new contracts can be lumpy; worries about growth weighed on Quintiles before a weak third-quarter from rival Parexel International PRXL +3.94% prompted concerns about the health of the contract-research market generally.

Quintiles’s third-quarter figures, however, looked reassuring. Its business pipeline—defined as the ratio of business booked to that billed in the quarter—was surprisingly strong at 1.44 times, boding well for growth next year. The company said it had struck an exclusive relationship with another “important” but unidentified pharmaceutical company.

True, competition for longer-term strategic contracts may lead to price pressure; contract-research companies may need additional resources, weighing on margins. But Quintiles, at about 19 times forward earnings, is trading at a discount to smaller rivals at a time when global scale and experience look like a virtual necessity.