As our planet's population continues to grow and age, finding new and innovative healthcare solutions will be paramount. However, it takes a lot of work and money in order to get a new drug to market. From beginning research to running clinical trials, creating new therapies is a daunting task. This intensive process is one of the major reasons why healthcare costs have eclipsed the rate of inflation over the last 20 years. In order to save on expenses, a variety of biotech and drug manufacturers have started outsourcing various steps in the process to a group of independent lab firms. These contract research organizations (CROs) are finally beginning to attract investor attention and could be a great way to play healthcare's growth.
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Big Money in Outsourcing
With more than $106.9 billion worth of annual branded drugs sales coming off patent, from now until 2020, Big Pharma needs to reinvent its pipeline. This is driving an average projected 3.6% to 8% growth in R&D budgets among drug makers and biotechs. However, at the same time, prices for creating these therapies has surged exponentially. New high tech sequencing, further regulation from the FDA and "difficult to crack" diseases have all pushed development costs higher and higher. In order to combat these expenditures, many drug makers have started to outsource steps along the way. (For related reading, see How To Do Qualitative Analysis On Biotech Companies.)
And there's big money for those firms that run all of these clinical trials. According to data from IMS Health, outsourcing drug trials and basic lab work is currently a $60 billion market opportunity. More than 27% of the largest drug makers expect to outsource trials in 2012, while almost half of the smallest biotech companies expect to do likewise. With expanding R&D budgets and rising costs, the CROs are in a sweet spot to profit.
Analysts at Morningstar (Nasdaq:MORN) expect growth in the CRO industry to continue accelerating throughout 2012. The industry has started to adopt a strategic partnership model that will ultimately benefit the sector long-term. This has allowed major drug makers to pair up with leading CROs as long-term partners in research and development. In addition, private-equity buyers have shown a certain enthusiasm for CROs of late and started to gobble them up at premiums. Private equity firms, the Carlyle Group and Hellman & Friedman, recently agreed to pay $3.9 billion in cash to buy Pharmaceutical Product Development.
Running Your Own Trials
For investors, the contract research firms could be a great way to play healthcare's long term picture. While some broad-based biotech ETFs, like the Market Vectors Biotech ETF (ARCA:BBH), do contain some exposure to CROs such as Charles River Laboratories (NYSE:CRL), that exposure is limited. The best way to play is through individual holdings.
Partnering with pharma giant Pfizer (NYSE:PFE), ICON plc (Nasdaq:ICLR) is a great example in the sector. The company has the global scale needed to succeed in the ever-increasing complex regulatory environment and the firm expects to grow revenues 9% annually. In addition, the firm has a healthy cash balance and due to where it is domiciled (Ireland), the company's shares are trading at a discount. Similarly, CRO PAREXEL (Nasdaq:PRXL) has also partnered with Pfizer.
Chinese CRO WuXi PharmaTech (NYSE:WX) has seen its revenues rise as the firm has started expanding its manufacturing operations throughout the R&D process. The CRO is responsible for manufacturing hepatitis C therapy Incivek for Vertex (Nasdaq:VRTX) and Johnson & Johnson (NYSE:JNJ), and will continue to benefit from China's low wages and drug developers' need to cut costs. (For related reading, see A Primer On The Biotech Sector.)
As drug makers need to beef up their pipelines in world of rising costs, the contract research sector will continue to see its stars shine. The previously mentioned firms are great ways to play the need for outsourcing and cost cutting.
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