Contract research organizations (CROs) provide research and development services to the pharmaceutical, biotechnology, and medical device industries. In this article, we will assess the valuation of CRO businesses while providing insight into topics such as:
- Developments in the contract research organization industry
- Value and price expectations of business owners in the contract research organization market
- How to value a company overall
- What determines the price of a contract research organization company
- An analysis of factors influencing prices
- Valuation multiples in the contract research organization market
- Trends within contract research organization operations, such as outsourcing and technology adoption
Ever stronger demand for R&D services from pharmaceutical, biotechnology, and medical device firms has fueled significant growth of the CRO industry in recent years. Outsourcing has become an increasingly popular strategy among sponsors to reduce costs and boost efficiency. As a result, this has led to more outsourcing of R&D activities to contract research organizations.
Another significant trend in the CRO industry is the adoption of new technologies. Innovations have enabled contract research organizations to offer more efficient and cost-effective services. For instance, using artificial intelligence and machine learning has enhanced the speed and precision of data analysis, while cloud computing simplifies data storage and sharing securely. The need for digitalization of clinical operations has led to the emergence of several digital CROs from Spain to Germany, and to Eastern Europe.
Likewise, significant consolidation has taken place in the upper echelon of the industry, with the emergence of global and regional CRO powerhouses, like IQVIA, PPD, Icon, Covance, Eurofins, GBA Group, and Optimapharm in Europe.
Private equity (PE) has been a driving factor for such CRO consolidation in Europe. Another factor has been the need to compete with larger firms by offering CRO services across global locations. This has driven many acquisitions of smaller firms in Europe by US firms, or acquisitions like that of Italy’s Cromsource by China’s ClinChoice. Another example is the buyout of Easthorn in the Czech Republic by the Australian Novotech CRO earlier this year.
For European CROs under 2 million euros in revenue, growth is becoming harder to reach organically. This is because they need more financial resources for business development in the USA, securing scarce talent with higher salaries, or for expensive technology. Therefore, many are looking for a sale to a larger organization as the only option to reach the next level.
European CROs are also under strong pressure to adopt the full-service model of their American counterparts. This means going beyond just offering traditional services like trial management to adding biostatistics, data management, medical writing, and even PV or RWE. Further, expansion into oncology trials has become almost a must, given a large number of studies for this indication. EU regulatory changes are also boosting revenue from medical device and IVD studies, which in the past have been small or non-existent. Lastly, the COVID-19 pandemic has boosted the need for DCT studies across the globe.
Value and price expectations of CRO business owners
Like business owners across all industries, CRO business owners want to understand how much their company is worth. Unfortunately, determining this value can be challenging due to the many variables that can influence it. Entrepreneurs may thus want to seek professional assistance from accounting firms or business brokers to calculate a fair value for their enterprise.
CRO industry consolidation and the increasing participation of PE funds have driven CRO company prices up in the last few years. Thus, many small CRO owners think they can get extremely high EBITDA multiples, for example in excess of 20 times more, for their companies. However, they don’t know how CRO buyers value acquisition targets and come up with a price offer, which is a rather technical exercise of corporate finance.
This creates a far-too-frequent scenario where CRO owners demand an inflated, or crazy price like between 5 – 6 million euros for a small CRO with only 1.5 million euros in revenue and 300,000 euros in EBITDA while a non-EU CRO buyer is only willing to offer 1.5 to 1.7 million euros.
Another common misconception is thinking that value and price are the same. Not only do the price and or value attached by company owners tend to differ quite a lot from the one offered by buyers, but such values also differ depending on the buyer.
In general, financial buyers like PE funds, family offices, and some holding corporations would tend to offer lower prices for a CRO than a pharma consultancy or another larger CRO. One of the reasons for this is that they will need to invest more funds in other acquisitions, staff, offices, or software licenses for instance to build the value of the acquired CRO.
However, that price offer can go up significantly if the buyer must have a presence in Europe or needs access to expertise in biosimilar studies, or wants to add 30 more staff in Germany, for instance.
How to value a company in general?
Valuing a company requires both technical and subjective elements. The technical evaluation includes analyzing financial statements and other quantitative data, while the subjective component involves assessing the company’s competitive position including clients, services, and locations, as well as market trends, and other qualitative elements. At the end of this process is an estimate of its fair market value.
For instance, common adjustments to the EBITDA margin of a CRO include not only the salaries and bonuses to shareholders but pass-through study costs, non-recurring expenses or sales of masks and COVID-19 antigen tests in 2020-21, to name a few we have observed in our practice. Likewise, high taxation on company sale proceeds can artificially inflate asking prices in countries like Austria, Germany, or Italy, for instance.
What determines the price of a CRO company when you sell?
As said earlier, numerous factors can impact a CRO company’s sale price, such as its size, profitability, customer base, taxation, and growth potential. Furthermore, the potential buyers’ interest and ability to realize synergies also play an important role in setting prices.
Here is a breakdown of elements and how they could influence the acquisition price:
- Size: Larger CRO companies of more than 10 million euros tend to command higher prices due to perceived smaller risks, more resources, and greater market share. European CROs under 5 million euros in revenue tend to have unstable financials. They might have some good years of high revenue and profits fueled by large contracts followed by 2-3 bad years when revenue drops by 40% or more, where there are little or no profits and retained earnings have to be tapped to keep operations going. A consistent revenue and profit growth trajectory is preferred by most CRO buyers.
- Profitability: A CRO’s profitability is essential when assessing its acquisition value. Companies with strong financial performance usually command a higher price than those with weaker results. Similarly, complex situations like the common practice of non-consolidation of financial statements of individual CROs with offices across Eastern Europe and Russia by several de facto CRO groups make it hard for a buyer to estimate the true profitability and price of such acquisition targets. EBITDA margins of more than 20-25% are considered as a minimum for acquisition discussions by many CRO buyers.
- Customer base and concentration: A company with a diverse and stable customer base is more attractive to buyers than one heavily dependent on a few customers. The revenue of many small European CROs depends too heavily on one multi-year, multimillion euro contract from one big Pharma or a single-product American biotech, or on local arms of studies for 2-3 other larger CROs. This is a red flag to buyers, as that business could easily evaporate once there is a new owner or upon contract expiration. Thus, the price will be adjusted significantly downwards to address this risk, but more frequently a deal structure involving a 70% upfront payment plus 30% in contingent or earn-out payments based on future revenue and profits will be used.
- Synergies: Due to the substantial operational expenses faced by global contract research organizations, mergers and acquisitions often lead to cost savings. One can divide these cost savings into three primary categories: operating expenses, labor costs, and facilities. However, most of such cost savings tend to accrue from cost amortization over a larger revenue base than from traditional cost-cutting of staff. This is because labor is not only the largest cost component for CROs but also the key to revenue generation. Further, most synergies post-acquisition will be derived from complementary service offerings, expansion to new locations, and upselling to the existing client base of the combined entity.
- Growth potential: CROs are increasingly diversifying their service offerings beyond traditional R&D. For instance, some contract research organizations now provide digital health and technology solutions like real-world data analytics and telemedicine solutions. Others have chosen to build a niche specialization like ophthalmology or rare CNS disorders. While another might consider adding RA, PV, and data management to their service portfolios. All these areas provide additional growth prospects and are highly valued by buyers.
Valuation multiples in the CRO market
According to Pitchbook data, business sale median valuations of publicly traded contract research organizations range from 12-20 times the EBITDA in earnings and 2.88 – 4.77 times the revenue multiples.
At CFIE, we have recently seen multiples for European CROs ranging from 4 to 10 times the EBITDA or more, if the target is a high-quality CRO. Due to the scarcity of larger independent CROs, multiples have sometimes increased to around 15. Revenue size, a competitive environment, growth rates, margins, management team strength, and buyer motivations all influence valuations within this range.
Likewise, if the CRO buyer is a stock market-listed company, one can expect multiple arbitrages, meaning the likely offer for a CRO target will be a multiple below the P/E multiple at which the buyer’s shares are trading. Another variation of this would be an offer not exceeding the P/E multiple such as in large CROs like IQVIA or Icon PLC that are trading in the stock market. In a way, such P/E multiples are the price ceiling for a CRO anywhere in the world.
The only exceptions to warrant higher multiple would-be targets offering unique advantages to the buyer, like access to trial locations in Eastern Europe, expertise in MEDDEV studies, or an established relationship with key European pharma companies like Novo Nordisk, AstraZeneca, Novartis, or Sanofi.
It is also essential to remember that while past transactions can serve as a useful benchmark when valuing contract research organizations, they may not always accurately reflect current market conditions. Data suggests using multiples from past transactions as the sole valuation measure could lead to an extremely wide range of valuations, making them less reliable.
In conclusion, while the multiples above provide a useful starting point for valuing contract research organizations, it is essential to consider other elements that affect a company’s value. By taking an integrated approach and considering all relevant variables, buyers and sellers can arrive at more precise and informed valuations of a CRO.
Developments in the CRO industry: Outsourcing and technology
The contract research organizations sector has seen tremendous growth recently, with outsourcing and technology playing an increasingly important role. Here are some of the main developments in these areas:
Outsourcing: In recent years, the CRO industry has seen a marked shift towards outsourcing by sponsors. More pharmaceutical and biotech companies are turning towards contract research organizations rather than conducting clinical trials in-house due to cost reduction, improved efficiency, and access to specialized expertise. Outsourcing also allows these firms to focus on their core competencies, such as drug discovery or marketing, while leaving clinical trial management up to CROs.
Technology: Technology has had a major impact on the CRO industry. Developments in data analytics, artificial intelligence, and other technologies are revolutionizing how contract research organizations conduct clinical trials and manage data. For instance, many now utilize electronic data capture (EDC) systems for collecting, managing, and analyzing trial information. EDC systems improve speed, accuracy, and completeness of collection while offering real-time insights into trial progress. Other DCT technologies such as wearables and mobile health apps collect patient information more efficiently and conveniently than ever before.
In addition to these developments, the CRO industry faces other trends and challenges. For instance, there is growing pressure to reduce drug development timelines and costs while guaranteeing the safety and efficacy of new drugs. Furthermore, contract research organizations are being asked more and more for real-world evidence (RWE), patient-centric services, or DCT in addition to traditional clinical trial management. To meet these challenges and capitalize on emerging opportunities, CROs must continue investing in technology, talent, and process improvements.
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