Equity Research: Does ICON present a compelling investment opportunity? (Part 4 of 4)
The largest catalyst for ICON throughout 2014 will be quarterly earnings reports. The company is scheduled to report 1Q earnings on April 25th. Given that mgmt just recently issued guidance, it’s unlikely we see a positive revision. However, a beat appears likely, as the Street is expecting sequential margin contraction. Capital deployment is an ongoing point of focus for the company as well. Just recently, the company spent $143.5 million to acquire Aptiv Solutions, which probably takes it out of the acquisition market for the time being, but investors will be looking for updates on potential accretion and synergy targets, if any. Per some Street estimates, the company could add approximately $125 million in revenue and more than $10 million in EBITDA. Additional contracts could be another catalyst for the company, as recent checks have indicated multiple strategic partnerships are still being negotiated. While investors could initially associate large new deals with margin compression, these should generally be nicely accretive.
Our price target of $60 is derived by applying its current multiple relative to consensus (21.4x) on our 2015 estimates of $2.80, as we believe investors will begin focusing far more on 2015 earnings in the next six months or so. Note $2.80 compares to current consensus $2.45. Note that the implied multiple ex-cash would be roughly 20x our 2015 estimates.
Market Realist Take
According to ICON’s annual filing, catalysts that could drive further growth opportunities for global CROs include:
- Innovation driving new drug development activity – New technologies together with improved understanding of disease pathology (driven by scientific advances such as the mapping of the human genome) have greatly increased the number of new drug candidates being investigated in early development and greatly broadened the number of biological mechanisms being targeted by such candidates. As the number of trials that need to be performed increases, drug developers will increasingly rely on CROs to manage these trials in order to continue to focus on drug discovery.
- Pressure to accelerate Time to Markets; Globalization of the marketplace – Reducing product development time maximizes the client’s potential period of patent exclusivity, which in turn maximizes potential economic returns. ICON believes that clients are increasingly using CROs that have the appropriate expertise to improve the speed of product development to assist them in improving economic returns. In addition, applying for regulatory approval in multiple markets and for multiple indications simultaneously, rather than sequentially, reduces product development time and thereby maximizes economic returns. ICON believes that having access to both traditional and emerging clinical research markets gives global CROs a competitive advantage.
- Emergence of the biotechnology sector – The nature of the drugs being developed is changing. Biotechnology is enabling the development of targeted drugs with diagnostic tests to determine whether a drug will be effective given a patient’s genomic profile. An increasing proportion of research and development expenditure is being spent on the development of highly technical drugs to treat very specific therapeutic areas. Much of this discovery expertise is found in smaller biotechnology firms. As the majority of these biotechnology companies do not have a clinical development infrastructure, the services offered by CROs will continue to be in demand from such companies.
- Cost containment pressures – Over the past several years, drug companies have sought more efficient ways of conducting business due to margin pressures stemming from patent expirations, greater acceptance of generic drugs, pricing pressures caused by the impact of managed care, purchasing alliances and regulatory consideration of the economic benefit of new drugs. Consequently, drug companies are centralizing research and development, streamlining their internal structures and outsourcing certain functions to CROs, thereby converting previously fixed costs to variable costs. Larger drug companies in particular are actively entering strategic partnerships with a limited number of CROs in an effort to drive increased efficiencies. The CRO industry and in particular large CROs with global capabilities and considerable scientific knowledge and expertise are often able to perform the needed services with greater focus and at a lower cost than the client could perform internally, although CRO companies themselves are facing increased cost containment pressures as drug companies seek to further reduce their cost base.
- Increasing regulatory demands - ICON believes that regulatory agencies are becoming more demanding with regard to the data required to support new drug approvals and are seeking more evidence that new drugs are safer and more effective than existing products. As a result, the complexity of clinical trials and the size of regulatory submissions are driving the demand for services provided by CROs.
- Increasing requirement to show the economic value of new treatments – The rising costs of healthcare in most developed countries means there is an increasing pressure to show that new medical treatments are more cost effective and deliver better patient outcomes than existing treatments regimes. Sponsors need to increasingly generate outcomes data both as part of the product approval submissions and as part of post-approval research programs. This is creating opportunities for CRO’s who can offer support in developing and interpreting this outcomes data.
ICON peer Quintiles said the potential of the CRO market served by its Product Development segment is primarily a function of two variables: biopharmaceutical R&D spending and the proportion of this spending that is outsourced (outsourcing penetration). Despite continued softness in the economy and concern about global credit markets, Quintiles expects outsourced clinical development to CROs to grow 6%-8% annually from 2013 to 2016. Of this annual growth, it believes that up to 2% will be derived from increased R&D expenditures, with the remainder coming from increased outsourcing penetration. It estimates that overall outsourcing penetration in 2013 was 37%. Another peer Covance is expecting revenue growth of between 6% and 10% for 2014, and pro forma diluted earnings per share in the range of $3.65 to $4.00, on the back of continued expansion of its central lab, Phase IIb-IV and market access services.
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