U.S. clinical research company Charles River Laboratories International agreed to buy Chinese rival WuXi PharmaTech for $1.6 billion to expand its presence in China and deepen its expertise in drug-discovery services.
Charles River is focused on pre-clinical and early-stage research, while Shanghai-based WuXi -- one of the biggest Chinese clinical research organizations (CRO) -- is active in drug chemistry, such as making molecules to synthesize a drug.
Charles River will offer $21.25 per WuXi American Depositary Share in cash and stock, representing a premium of 28 percent to WuXi's Friday closing price.
Each WuXi ADS will get $11.25 in cash and $10 of Charles River common stock, the companies said in a joint statement.
However, WuXi shares were trading up only 19 percent at $19.70 in morning trade Monday on the New York Stock Exchange, indicating investor skepticism about the deal.
Charles River shares fell 14 percent to $34.09 on the New York Stock Exchange on concerns of the U.S.-based company's ability to execute and integrate such a big deal.
Robert W. Baird analyst Eric Coldwell said the deal value was a bit aggressive, adding that given the disparate geographies, cultures and services, he sees more than a modest risk in integration.
We expect some, if not majority of WuXi shareholders, will sell their positions on WuXi post merger given the likely slower growth of the combined entity versus WuXi standalone, said Susquehanna Financial Group analyst Ding Ding in a note.
Analysts broadly agree that the deal made sense thematically due to WuXi's exposure in the fast-growing Chinese market and limited overlap between the service offerings of the two firms. Even though short-term risks remain, the deal can prove to be beneficial in the long term.
We are increasingly convinced China is becoming a very important market for pharma and therefore view the combination as a long-term positive for Charles River, given we believe WuXi is the leading player and brand name in China, William Blair and Co analyst John Kreger said.
Large, concentrated populations, access to patients where certain diseases -- like malaria -- are widespread and an opportunity to run trials in markets with a rising demand for medicines are what make markets like China attractive destinations for the outsourced drug research industry.
Outsourcing is going global and China is increasingly important, though Chinese firms still face headwinds, which Charles River's global brand and image could mitigate, Baird's Coldwell said.
Research service providers to drugmakers have seen their growth rate slow over the past one year, pushing them to look for newer strategies like increased specialization in specific areas and tap faster growth areas like the emerging markets.
Monday's deal is a proof of a growing trend within the CRO industry that is seeing bigger U.S. players specialize more to offer high-end services to their clients, with pre-clinical and early-stage focused Charles River and Covance Inc investing heavily in drug discovery services.
Thus Shanghai-based WuXi is a strategic fit for Charles River that is trying to expand into more upstream services in the drug research pathway.
(The deal would) give Charles River medicinal development capabilities, which is currently outside of Charles River's core competency, Deutsche Bank analyst Ross Muken said.
DEAL TO BOOST MARGINS
Charles River expects the deal to improve its margins, it said on a conference call with analysts.
For 2009, WuXi had an adjusted gross margin of 42.3 percent, while Charles River had a gross margin of 35.7 percent.
Charles River has received a financing commitment for a $1.25 billion credit facility from JP Morgan Chase and Bank of America-Merrill Lynch.
The combined company will be led by Charles River Chief Executive James Foster, while WuXi PharmaTech's Ge Li will become corporate executive vice president. Li will also be the president of global discovery and China services, a new segment.
Q1 PROFIT FALLS
Separately, Charles River reported a lower first-quarter profit, impacted by weak sales volume and higher costs related to the company's enterprise resource planning initiative.
On a non-GAAP basis, net income was $29.3 million, or 45 cents a share, compared with $38.2 million for the same period in 2009, a fall of 23.2 percent.
Quarterly net sales fell 1.4 percent to $297.3 million.
Analysts on average expected first-quarter earnings of 47 cents a share, excluding special items, on sales of $296.8 million, according to Thomson Reuters I/B/E/S.
Charles River was one of the worst affected among its peers and had a tough run in 2009 as drug developers tended to halt early-stage research to conserve cash rather than stopping the development of late-stage drugs that could reach the market faster.
However, the company is finally seeing early signs of demand stabilizing and Baird's Coldwell said he expects to see modest improvement in bookings and significant decreases in cancellations through 2010.
On the call, the company said it sees 2010 sales of $1.51 billion to $1.56 billion for the combined company and expects a 2 percent to 3 percent rise in second-quarter sales from the first quarter.
(Additional reporting by Sakthi Prasad; Editing by Muralikumar Anantharaman, Sharon Lindores, Unnikrishnan Nair, Gopakumar Warrier)