Research
FORUM TRANSCRIPT

Pre-clinical CRO – Charles River vs Covance Q4 2021 Update – 12 November 2021

  • Public Equity
  • Healthcare
  • Global
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Specialist

Former Commercial Offcier at Quotient Sciences Ltd

Agenda

  • Key developments and trends in the pre-clinical CRO (contract research organisation) industry
  • Competitive positioning of key players – Covance (NYSE: LH) vs Charles River (NYSE: CRL)
  • Expected pace of consolidation and likely acquisition targets
  • Increasing focus on CGT (cell and gene therapy) RFPs (requests for proposal)
  • Pricing and labour dynamics, margin trends and outlook for Q4 2021 and beyond

Questions

Transcript

1.
What recent developments have been shifting the CRO [contract research organisation] industry since our last Forum Interview [see Pre-clinical CROs – Market Update & 2021 Outlook – 25 March 2021]?

SP: I think the most recent development is twofold. Basically, we’re continuing to see a very significant organic growth, top-line growth, in 2020-21, as a result of COVID. A number of INDs were filed.

I believe I mentioned it last time, the year COVID hit there were more INDs filed that June than the previous five years combined. The result of that is, the pre-clinical market continues to show a significant trend and strength, and the other thing that has come up is the merger and acquisition activity continues to grow. One company that has been on a significant prowl for acquisitions is Inotiv, which is a former BSI. Inotiv has gulped up many players in the space, and most important acquisition they made in the pre-clinical stage is Envigo. Envigo, as you remember, had a partnership with Covance and basically Inotiv went out and acquired them for just under USD 300m.

That was a significant strengthening of Inotiv’s portfolio. Inotiv, they had previously acquired Avanza and with everything else, with BSI, in terms of their bioanalytical expertise, they really are surfacing as one of the major players in the pre-clinical space.

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2.
What is your updated overview for R&D outsourcing on the pre-clinical side? How do you expect this proportion of outsource work to trend? Has there been any significant impact since our March 2021 Interview or do you expect any significant impact over the next couple of years?

SP: Yes, still I remain very bullish. We continue to see a very strong upside to the safety assessment, the preclinical toxicology business. In fact, many companies including Charles River have increased their pricing. The RFP volume continues to grow in double digits. Clients are booking projects well into 2022. That’s driven by two things, that’s driven by lab capacity and availability of animals, so beagle dog and non-human primate.

There was one point where you couldn’t get any animals, large animals out of China, but that’s getting better, but now it’s getting better it’s that there is still a significant backlog of work that needs to be worked through. I think there is a very strong pipeline of safety assessment work, safety tox work that needs to be completed, and companies are more concerned about getting on somebody’s lab schedule or in-life schedule vs worrying about the pricing. There is a very bull case for strengthening of the margins as well, in the Charles River model.

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3.
Our Q1 2021 Interview largely focused on Charles River’s strategy to enter manufacturing. How has this progressed? How is the company integrating the Cognate acquisition or subsequent ones? Have there been any success indicators or red flags?

SP: I think, I was reading their Q3 financial report and it looks like they’re continuing to report very strong results. The EBITDA margins are at record, they’re continuing to provide really good data and deliveries for their in vivo studies, in vitro studies, PK studies. I think there were some costs associated with the integration of the CDMO business, so even though the revenue growth, which is as a result of the impact of COVID-19, has been in line with the company’s expectation and outlook. They are expecting a low double-digit organic growth for the COVID-19 business.

I think the safety tox business continues to show that the drug discovery and safety assessment, that business, also continues to grow. It’s up 14% YoY on an organic basis. The manufacturing business, which is the acquisitions they made, or the cell gene therapy for Cognate and Vigene, it’s up 20% on an organic cost and currency basis, so that also continues to show double-digit growth in the quarter.

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4.
Charles River has been more active in M&A than Covance, entering new verticals and being slightly more innovative. How should Covance respond to its peer’s advances? Where does it stand competitively?

SP: I think that’s a really good question. The thing with Covance is that they are, and Labcorp, they are such a broad company and such a diversified company that they have their hand on so many different things. They are playing in the diagnostic testing business, they’ve been one of the market leaders through COVID-19 testing, antigen antibody testing and all different types of testing, but they also have a significant CRO piece, which is a very diversified model. You’ve got pre-clinical, you’ve got early clinical, you’ve got late phase, you’ve got central laboratories. You’ve got drug discovery, so a very diversified model. For them to come up with a strategy just geared towards pre-clinical, they’re not going to be as focused as a Charles River because of the diversification of their model.

I see a lot happening at Labcorp, but I think because of COVID, the testing-related services have really seen the upsides for them. They continue to be a significant player in the COVID-19 testing market, and they are getting more and more involved in the vaccine trials, and vaccine PK and PD testing. As part of their biologics business, they’re doing a lot of immunogenicity testing, so a lot more clinical involvement at Labcorp vs Charles River.

Charles River, it’s primarily a major pre-clinical player. Not that Covance is not. Covance and Charles River, of course, are the two market leaders in the space, but I see a lot more innovation and thoughtful thinking happening at Charles River in terms of pre-clinical evolution than I see at Labcorp.

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5.
What do you make of the suggestion that Labcorp would benefit from divesting Covance? Would it make sense?

SP: It would be kind of going backwards. They were Labcorp, and then they acquired Covance and brought it under the fold. Of course, PPD became part of Thermo Fisher, where Thermo Fisher is trying to integrate their manufacturing business with the clinical business. Charles River has kind of done that. Charles River has got their manufacturing business, though it’s only for cell gene therapy, but they are playing in the manufacturer CDMO space with Vigene and Cognate.

You can see those parallels happening at both organisations. The size of Covance is so huge that I am not sure that Labcorp, trying to operate Labcorp can provide the innovation to the CRO business or the clinical business as much as they want to. Again, anything is possible. It is possible, the CRO market is really, really hot right now, and I wouldn’t be surprised if they’re able to find a private equity group or another large manufacturer of equipment or laboratory services could pick up Covance, it’s very possible. Again, it would be counterproductive to what Labcorp did a few years back.

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6.
How might Covance under Labcorp fare in the market against a more potentially innovative Charles River? Is it too late to try differentiating itself the way Charles River has done via more complex acquisitions? What path would you suggest for Covance?

SP: I think the innovation that could have been brought on by the integration of Labcorp and Covance, I think there was a small window of opportunity to make that happen, and because given the size, I think the most innovation I’ve seen or most direct positioning that I have seen in that area is that Covance is no longer called Labcorp. Covance is no longer called Covance, it’s going to be referred to as Labcorp. I think that was the biggest statement that I heard from them in terms of bringing innovation to the CRO sector of the business as a result of Labcorp’s acquisition and integration with the IT platforms. I don’t know if I can say that I have seen that.

In fact, the only thing that I have seen, every day I talk to clients who are saying, “We are unhappy with Covance, or Labcorp, because they never, nobody got back to us,” or, “It took them two weeks to even execute a confidentiality agreement.” All I hear is that Covance is a very slowmoving company, and I think Charles River is probably not, from everything I gather. They seem to be very hungry, very driven, because they are really focused on the CRO sector of the business. I see the Labcorp culture slowing down the agility and the responsiveness and the flexibility that one expects from a CRO like a Covance.

Third Bridge (TB): If the company were to potentially improve in this regard, what would you do if you were at the helm of Covance?

SP: I think one of the missing pieces… I may have mentioned cell gene therapy is where a lot of innovation is happening. Biologics is where a lot of innovation is happening. I think trying to really capture that market, I think Charles River, to be honest with you, was ahead of the game by acquisition of a cell gene therapy CDMO like they have done. I don’t see Covance making any moves in the manufacturing space. I see PPD, I see other companies having the partnerships, or organically have that capability.

I think I would definitely try to see if it makes sense to have an integration of the CDMO model in the Covance model, because the CDMO sector is really hot, especially for sterile products, cell gene therapy products. Trying to offer the CDMO, the integrated CRO-CMO model is important, and for one company to be able to offer that, and so the vendors don’t have to go to multiple places, I think that there is definitely value in that. I think I would definitely try to consider that as a strategy.

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7.
Biotech funding has been very strong and you were quite bullish in this potentially trickling down to players such as Charles River. How sustainable is this funding or demand environment? If industry-wide demand were to revert to a longer-term mean growth rate in 2022, would Charles River, for example, be able to meet its expectations for the year?

SP: Yes, I think – so you’re talking about the outlook for Labcorp, I mean for Charles River and then also the outlook on the funding?

TB: Yes, I know you’re quite bullish when looking at funding, but do you have any expectations for that to go back to the longer term mean we’ve seen? To what extent might that impact Charles River meeting its expectations?

SP: I think, like you said, there are three types of money available. There’s public funding, there’s private funding and there is state funding or government funding or federal funding or Department of Defense funding.

Every day I get contacted by companies, somebody is working on a COVID-19 vaccine or antiviral drugs and they just got a USD 13m grant from DoD that they probably would have never, never thought, and on top of that they went public, so they’ve got two of those things happening in their favour. They’re flush with cash, speed is their biggest criteria to select a CRO, so I think if they’re able to, and it’s not uncommon right now, one of the things that I wanted to mention on this call is that there is, in terms of pricing, there’s been a significant increase in pricing of doing business and research, pre-clinical research, clinical research.

In fact, companies are, because they’re so flush with cash and funding, they are more interested to make the timeline and make a public announcement that, “We’ve initiated our pre-clinical study,” or, “We’ve initiated our safety tox,” or, “We’ve initiated our phase 1.” They’re willing to pay up to 30% premium for expedited timing because they’re more interested in the milestone and what that brings for them.

In terms of Covance and Charles River’s outlook, I think they will be able to continue to support, there is a lot more lab capacity coming online, so ever since Iqvia repurchased their stake in the Q2 Solutions venture, they are putting more money into that. They’re opening up a brand new facility in North Carolina, that will be focused on DMPK and bioanalytical and central lab testing. I think there is more capacity that’s coming online to support the laboratories testing part of the business. In terms of the in-life portion where you’re dealing with IND enabling, safety tox studies, safety assessment studies. I do feel that Covance, Charles River will continue to dominate the market.

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8.
What are some of your broader expectations for the conversion between contract research and contract manufacturing on the clinical front, thinking of Thermo Fisher and PPD? Last time you were quite bullish, particularly on pre-clinical research and manufacturing as a combination. Has your assessment changed? Are you slightly more critical or favourable towards the combination?

SP: I still believe that there is still tremendous value, because one of the things that’s happening is that a lot of funding is going to smaller companies, small biotech companies. I’m hearing from companies that I never heard of before, and they are talking to us because they’ve got this promising API, but they also have limited resources.

The CEO’s sitting somewhere in Phoenix, Arizona, the CFO’s sitting somewhere in California, and they’re relying on a lab or a partner that can manage as many things as possible. From science, from delivering of the data, to regulatory compliance, to IRB approvals.

I do believe that the quotient model of integrated CRO-CDMO services where everything is being offered under one umbrella is still extremely valuable in the current environment, one – to expedite things for many companies and also trying to get things to a proof-of-concept stage from a clinical development perspective. This integrated CRO-CDMO model allows you to do that very effectively and very quickly and without spending a lot of API and a lot of R&D dollars.

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9.
What are your expectations for international players such as Wuxi, which has a relative lack of presence in North America? Have any other industry players stood out?

SP: Yes, I think two players that have really, I think Wuxi and Pharmaron, I think these are the two leaders in the market that are making a lot of waves, they’re expanding across the vaccine business, the biologics business, the pre-clinical business. They are playing both in the China market and the US market, and European market, and continue to invest heavily in all aspects of drug development.

That could be CDMO, that could be CRO, that could be clinical. Wuxi is not playing so much in clinical, but Pharmaron definitely is playing in the clinical space and the pre-clinical space, so I think some of the partners, some of the Chinese players are definitely investing.

Again, this is in the public domain, but Frontage also announced a 315,000 square foot facility for safety tox business in China and that facility should be operational early in 2022. They already have a DMPK set up, so there is a lot of interest from the US companies because of the shortages of lab space and availability of animals to even do in vivo pharmacology studies or in vitro pharmacology studies or early-stage drug discovery work in rodents and things like that.

There’s a lot more desire for companies to go back to China for that type of work, so I see significant investment. PPD also announced expansion and setting up of their bioanalytical centre labs in Suzhou. I’m not sure they’re playing much in the pre-clinical stage, but they’re definitely expanding their laboratory footprint in China. I think, I would say the market leaders for pre-clinical research in China are Wuxi, Pharmaron and Frontage.

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10.
Can you elaborate on Covance and Charles River’s M&A strategies and which potential targets come to mind? What would make sense for either company to acquire? How concentrated is the industry?

SP: I think I would say Sinclair comes to mind, Will and MPI and Cytox and Envigo were all acquired already. I think Calvert comes to mind, Toxikon, Battelle, Product Safety Labs, Avogadro comes to mind. ITR Laboratories may have been acquired already, I’m not sure on that, and then, yes, I think those are the major players that are on the acquisition target list, if they haven’t been acquired already

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11.
How strong do you think Charles River’s competitive positioning is vs larger, more established CDMOs [contract development and manufacturing organisations] such as Lonza and Catalent? How are you assessing Charles River’s respective manufacturing assets despite not having the scale?

SP: I think Cobra, Cognate, Vigene, these are smaller CDMOs which focus on a very niche market, which is the cell gene therapy market. Although there are more than 1,000 trials and 1,000 biotechs working in different aspects of cell gene therapy, and FDA has a very strong mandate to significantly increase the number of approved cell gene therapy drugs four, fivefold in the next 10 years, I do feel that the broader biologics market, the broader vaccine market, even small molecule for that matter, will still continue to be very strong.

A company like a Lonza or a Catalent or Siegfried, they’re playing in a much broader market, not just a very niche cell gene therapy market. I think the strategy that Charles River has really focuses on, how do we identify cell gene therapy opportunities with clients based on our ability to manufacture as our leader. As our loss leader, if you can use that expression. Meaning that using, and this is the kind of approach that Quotient use.

Quotient approach to feed their clinical CRO business was to talk to the CMC folks at a biotech company and convince the CMC, CDMO guys to give them a shot and let them drive the decision to select the CRO or the clinical business at quotient. I think Charles River is trying to use a similar strategy, where they’re trying to use the pre-clinical manufacturing piece for the cell gene therapies to drive pre-clinical business in-life safety tox business to their in-life facility for animals. They are using that, but as these compounds, these drugs enter into clinical stage, of course Charles River does not have any clinical capabilities. My question for their CEO would be why are you stopping at the clinical stage of the conduct, at the pre-clinical stage of the conduct? Why aren’t you using the drug product that’s being manufactured from a CDMO perspective, have the partnerships or have even your own facility to be able to manage that? The challenge that you run into with cell gene therapy products is that a lot of these products are curative therapies. These are not products that you can run into healthy volunteers, so you cannot really say, “I’m going to set up a 100-bed clinical facility and try to do these.” No, you’ve got to go where the patients are, and a lot of times there are 5,000 patients or 3,000 patients located all over the world.

From an access to patient, from a clinical perspective, Charles River’s plan makes sense that, “Playing the cell gene therapy manufacturing market, we really don’t need to be having our own clinical facility like Quotient did, but we can find a way to get the drug product.” Like Quotient did. Quotient did a lot of orphan drug disease manufacturing, not for cell gene therapy but for oral solids or high-potency API compound. They would get the drug product to multi-site orphan or paediatric trials, so they had a partnership because they knew that even though they had the clinical business, they couldn’t get into those clinical facilities doing special population trials.

They partnered up with the recruiting network of PPD to get the drug products in those clinicians’ hands. I think Charles River may be thinking along the same lines, that, “We’re going to partner up with all the cell gene therapy market players.”

There are tons of medium-sized CROs, there’s Parexel in terms of the leading CRO, that need that drug product. They may be having a strategy to partner up with these larger or mediumsized or even boutique CROs focused on cell gene therapy. A long-winded answer to your question, but I think there is some good information here.

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12.
How do you estimate where Charles River will fit in, particularly as plenty of CGT [cell and gene therapy] supply is coming online recently? What’s your take on the mid-to-long-term supply and demand balance? Is there any sort of risk of overbuilding on supply for Charles River?

SP: That’s a great question. No, I think for the foreseeable future… so here’s the thing, pre-COVID the vaccine market was estimated at USD 6bn. It’s now expected to be more than USD 100bn in the next 3-5 years. I think COVID-19 is here to stay, I think vaccination is going to become a norm, and there may be lots of innovation that’s happening in the whole vaccine space.

I think in terms of the CDMOs, CDMOs that were historically struggling because they only focused on small molecule oral solid drugs, as Catalent and Lonza got engaged with these 10,000 patient vaccine trials and sterile drug products, a lot of their focus has been tied to these bigger trials and bigger product lines and so forth. That a lot of the smaller CDMOs, believe it or not, who were struggling for business are now thriving. They are getting acquired, so there’s a lot of consolidation happening within the oral solids market in terms of the CDMOs, that they’re getting bought out all the time.

I think in terms of the foreseeable future, because of COVID-19 and of all the revolution and evolution that’s happening in the vaccine space, I do feel that there is not going to be Lonza and Catalent and Novasep and RI Bio. All these CDMOs, I don’t think they’re going to still have the bandwidth or even the desire to work on smaller supply projects and contracts for cell gene therapies, where you manufacture a product to send it to five patients in Africa. I’m not sure if that’s still going to be something that they want.

I think there are still going to be other things for them to do, so I think for that reason, for the foreseeable future I agree with you very much that there is a lot of capacity, everybody’s investing in it, in-house or external-to-external partnership. I think we should be OK in terms of supply and demand.

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13.
How have contract negotiations shifted in recent months, particularly given some of the pandemic disruption? What normalisation is occurring?

SP: : In terms of contract negotiation, that’s another really good question. I think there is, fortunately or unfortunately, CROs and CDMOs have a leg-up. They’re basically calling the shots. The lead time at many labs for whether it be testing or manufacturing, the lead time is pretty long. You’re talking about 4-6 month lead time to get a lab slot, and that’s from signed contracts.

Many companies are signing the contracts in Q4 so that they’re able to start the work in April, May, June time frame. Even last night a company was asking me, “Can I get a small discount?” I said, “There are companies willing to pay 10-15% premium to be able to accommodate the work. There is no way we can offer a discount.” I think in the past people would offer 5-10% discounts to close the deal. That desire has completely gone away. People are willing to pay premium to get into a slot. If no premium, basically they’re looking for a quality lab that has the expertise, the technical know-how, the access to equipment, the compliance history with the appropriate regulatory body, too, that can take on the project and deliver it successfully. I think that’s what it’s coming down to. They don’t want to choose a partner that they’re going to have problems with the regulatory body down the road or not be able to start the trial on time.

Pricing, and that’s what we saw in the Charles River report, they’re going to continue to see strengthening of pricing. Inflation numbers came out this week and they were at about 6.5% higher than they have ever been, and what that means is that employees and talent acquisition has become, retention, acquisition for talent has become a big, big deal in our space, currently.

There is a massive exodus of companies that are trying to balance quality of life with a meaningful life. Many employees are leaving high-pressure CRO-CDMO jobs and joining pharma, biotech companies for better pay, stock plans and 9:00-17:00 jobs. I think CROs and CDMOs have to really soften this, sweeten the pot for them to offer them competitive wages, perks, work-life balance. That’s another thing on the laboratory side that’s happening that wasn’t happening before.

As a result of that, people are getting huge raises to be able to stay, and that’s putting a burden on the EBITDA margins, the net profit margins of the company, and many companies are increasing pricing pretty quickly, and have planned increases for 2022.

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14.
To what extent is the price increase informed by the labour dynamics in the industry? What’s feeding into potential pricing increases?

SP: There are multiple reasons for that. The first reason is, it’s supply and demand. The demand is high, supply is limited, so if you’re competing for the same mass spec to run your samples, before you could run a sample for USD 65 a sample. Now you’ve got to run it at USD 75 a sample, because the reagents that you were acquiring from VWR, or the column that you were getting Waters, the entire cost of business has gone up. For a while there was the COVID factor where everybody was using PPEs and masks and BSL-3 lab and so forth, so that also put a lot of burden on the business. As those requirements became more of the norm and not a special situation, the other things. Everybody is, all players in the market, third-party players, FedEx for example, everybody that you’re using on a clinical trial or some aspect of drug research, everybody is increasing their pricing. As a result, a CRO or CDMO that’s holding a contract with the biotech company is also passing on those initial costs to their client. I think overall there’s, I would say, a 10-15% increase on an average contract to get going and if somebody wants to expedite that then there’s another 15-30% expedited fees that are added on top of that. To my point earlier, because of the availability of the cash, and to partner up with an experienced CRO or CDMO, companies are willing to pay that. It’s rare that somebody would lose a contract based on pricing, as long as you’re not gouging. It’s a fine balance, you don’t want to come off as, “We’ll charge whatever because there’s not enough supply.” As long as you’re reasonable and you can defend why you’re charging this much, most clients are OK with that price increase.

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15.
You previously mentioned how smaller biotech firms are looking for more of a right-sized player, but some of those options are currently quite limited given the market consolidation. What is your updated overview on this, particularly with your earlier pricing commentary?

SP: Yes, I think there are still a number of medium-sized players, so Covance, Labcorp, they dominate 60% of the market, but I think there are still enough players that are playing in the small-to-medium-sized scale in terms of pre-clinical CROs that are able to accommodate. If you go to the West Coast, there are tons of companies that are there, that are supporting the needs of the market. Frontage acquired a company called Quintara, that used to be a very reputable, they still are a very reputable player for pre-clinical drug discovery, DMPK-type support, but now they are part of an organisation like Frontage.

Most of their clients who are California-based or West Coast-based have seen no disruption in the service that they’re seeing. They continue to work in very good harmony with Quintara as their partner. I think as these companies are getting acquired, the acquiring companies are doing their best not to affect the business – for example, Inotiv that acquired recently Envigo. I think companies are going out of their way to make sure they don’t disrupt any of the existing relationship. A lot of the smaller to medium-size companies, where there’s significant amount of innovation is happening and funding is available, they don’t want to go to Covance or Labcorp unless they really have to. They don’t feel they will get the A team or the pricing or the availability of the resources as opposed to Eli Lilly or some of the Aventis-type thing. I think there is still enough option there.#

I think a lot of these companies, historically, that were probably getting a better price at these smaller companies may not be getting that now, because of the supply and demand. I think, as I mentioned to you earlier, pricing has fallen at the bottom of the top 10 list of reasons to choose a CRO.

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16.
When thinking of pricing and bundling, Covance has pre-clinical and clinical, Charles River now has preclinical and manufacturing, whereas PPD is now under Thermo Fisher. How might bundling play out given all these combinations and where supply-demand dynamics stand?

SP: Yes, there are very few CROs that offer everything from soup to nuts. PPD is one of them, Labcorp is one of them, Altasciences is another one, Frontage Labs is another one. There are very few CROs, Pharmaron is another one, that are playing in every aspect of the business. It depends a lot, so if you take it from a very reasonable commercial perspective, so if I go and call on the company XYZ, if they are Pfizer, they’re going to have different people buying all these five or six different services that you need in a drug development trial. If you’re a small- to medium-size biotech company located in San Diego, you’re going to have two or three people outsourcing everything. If you send five salespeople from Covance to these people, they’re going to get frustrated and they’re not going to see the value of individual service offerings.

If you’re a medium-sized CRO and you may have one or two people, one for pre-clinical, one for clinical, and they can cover and talk and the clients are confident that you can handle every aspect of your need, then that’s a compelling story. I think there is still definitely value in that, and the more they can bring to the table, whether it be CRO, CDMO, pre-clinical, clinical, central lab, I think the value proposition gets stronger and stronger.

I think it’s the bigger CROs, the Icon, PRA Health, Labcorp, PPD, who do have all of these services, but I am not sure if they have their commercial strategy sorted out to capture the market.

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17.
What rough percentage of customers prefer to use the same CRO for pre-clinical and clinical work? What are the implications for Covance? Is a CRO offering both pre-clinical and clinical services a competitive advantage in this regard?

SP: It’s a really good question. I think if you’re like a behemoth like Amgen, it also depends on the therapeutics area that you’re focused on. Amgen is a good example of, they have a strategic partnership with Covance to handle all of the pre-clinical work, the clinical work, because Amgen has a lot happening in oncology and Covance is one of the few CROs in the space that can do a lot of early pharmacology studies in patients. They’re able to be able to handle all the different modalities of drugs that Amgen is working on, from biologics to ABCs to ASOs to small molecule.

Not every pre-clinical is able to handle biologics vs small molecule, so as a pre-clinical company you want to be able to handle as many modalities as you can in the current drug development environment, and if you’re able to handle that, and if you’re able to handle that from a clinical perspective and patient recruitment perspective, then your value proposition is very solid. However, those discussions need to happen at a strategic level at a client like Amgen. I remember when I was involved with that, with Amgen a lot of discussions happen at the senior VP R&D.

Where they brought procurement and all different people at the table to figure out how are we going to transition research from pre-clinical to clinical, or from DMPK to GLP tox-type thing. It’s not something that you can just say, “I’m going to get the business from all these buckets without a common strategy.”

You could do that with small- to medium-sized companies, but for larger companies like Eli Lilly and Amgen who are truly looking for that clear advantage, who are truly looking for that continuity model and looking to spend USD 1bn in research with Covance per year, those strategic discussions need to happen for that to happen. I don’t think it’s going to happen at the commercial level, where you can send a couple of different BD people to try to get their business.

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18.
Thermo Fisher has a very clear goal of being an end-to-end provider and there’s a clear intent to enter the pre-clinical sector. How might that play out and how might it impact Charles River and Covance?

SP: Yes, that’s a great question. You know PPD used to own a pre-clinical business? They got out of it, they sold that to a company in Seattle, and then that company sold it to Altasciences, so that pre-clinical business got SMB’d out as part of the Altasciences pre-clinical offering. I’m not sure how keen they will be. They will really have to make a splash and acquire a significant capacity player, and I’m not sure who that would be, who has got enough bandwidth and capacity and the resources.

They’re not going to acquire a Sinclair in St Louis-type thing. They’re going to acquire a major player if they were to build that capability so that they can truly become one-stop shop, but I think it’s going to depend a lot on how the integration goes on the clinical CRO and the CDMO level before they do that, but it’s very possible.

It’s very possible, especially right now the pre-clinical sector is really hot, and more and more companies are expanding. I think where that could happen, now that I’m thinking about it, it could happen in China. It could happen in China where, through PPD, they may have a strong foothold in the Asia Pacific market for preclinical research.

TB: With that said, you mentioned there aren’t necessarily many acquisition targets for Thermo Fisher to potentially acquire, so how difficult would it be for the company to do this in-house?

SP: You can set up a pre-clinical facility, you definitely can. You will need to build up a team, you will need to hire the resources, and again right now talent acquisition is the biggest challenge that the industry is facing. Everybody is trying to find the right resources, everybody is trying to hire the right people. I’m not sure how willing PPD or Thermo Fisher would be to take a hit on their bottom-line EBITDA to try to set up a massive pre-clinical business.

I think in China they could do it, because in the Chinese market they were very successful in setting up a very solid bioanalytical and central lab. Maybe this could be an extension of their China PK footprint that they set up a pre-clinical. I think it could be done in China. I think it would be a lot more harder in the US market, trying to get the talent you need, and the PPD brand is fairly strong in the Chinese market as well.

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19.
How are margins trending? Can you break down any notably high- or low-margin categories?

SP: If you look at the Charles River results, they offered, in their Q3 ’21 results, they talked about a 14% revenue growth, and they talk about offsetting that by 130 basis points for operating margin pressure. Primarily due to the benefits of temporary COVID-19 cost control that they took and then the integration of their lower margin cell therapy business. It was a little bit lower in terms of their final, bottom line margin, but I think the margins still look pretty good. I think a lot of companies have gotten really smart about really doing more with the resources that they have. I think there’s also a lot of use of technology that’s being brought in to accommodate trials, especially the clinical trials.

There is a lot happening with a decentralised space for the clinical CROs, but from the preclinical perspective I think there is a lot of automation that’s being brought in, a lot of new platforms that are being utilised and throughputs are being improved. I think COVID-19 has changed the outlook on how things should be handled and how the market should react to try to do more with less. One way they’re doing that is trying to adopt the right platform and technology that can give them the outcome they need. I think the worst for the margin is over, to be honest with you, because I think COVID-19 had a very strong impact on the margins.

I think as COVID becomes more of the norm and everybody is getting vaccinated, I think that’s not as big of a concern. You don’t need to set up a huge BSL-3 lab to be able to deal with COVID19, because any sample could be potentially COVID-19 positive. Initially I remember when COVID-19 happened, CROs were charging 15-20% premium on pricing because they had to set up and analyse COVID-19 samples in a special environment. In a BSL-2 or BSL-3 lab, and that required a lot of cost to set that up, and pay analysts premium pricing on an hourly basis to be able to take on those samples, but now that has gone away.

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20.
Is there anything important to conclude with? What’s your broader 12-18-month outlook for the industry?

SP: I think there is going to continue to be a lot of strength for specialty labs, bioanalytical labs focused on biologics, biomarkers, cell gene therapies. I think there is a lot of movement of talent focused on these areas. I think that’s point number one. I think the second is that there is a lot of capacity that’s coming online for even existing players, either organic or through acquisition, I think that’s the second thing.

I do feel that the supply-demand issue in the foreseeable future will be there. If you ask PPD, they’ve got a 36- week lead time to take on a new project, unless you’re a strategic partner, or if you have FDA agreements in place. I think that’s something that can change that. More and more companies are looking to have FTE agreements in place, where you have the equivalency of a full-time person dedicated to you. They don’t want to deal with the management of that person so they’re outsourcing five, six, 10 FTEs to work on a project, or the programmes, but in your lab. They’re looking for dedicated lab space. I think FTE model will continue to grow.

I think precision medicine is going to be another very, very strong area of growth for the company. That market is expected to double in the next five years, from USD 50bn to USD 100bn, and a lot of that innovation is coming from companion diagnostic, laboratory diagnostic tests.

I think labs will continue to play a very, very important role, including Charles River and Covance, in that area. I think the last thing is decentralised trials. More and more trials are being done, they’re not being done in a typical, historical research setting. You have to find a way to get to your patient, and companies that have access to patients and can get them kits and collect samples are the companies that will really propel. In terms of pre-clinical it’s going to be all about access to animals and access to not just do your small molecule.

I think one of the biggest challenges a lot of the pre-clinical CROs are facing is that they’re just focused on small molecule oral solids, IV-type drugs. I think administering biologics and ADCs and cell gene therapies and oligonucleotides, I think companies like Charles River and Labcorp lead the market in that front. I’m not sure how familiar Sinclair or Toxikon or Calvert, I don’t think, or Product Safety Lab, how innovative those smaller pre-clinical CROs are being. I think these two players, and I think Inotiv as well, are going to try to claim the market share in some of these fastest-growing and the largest-growing segments of the market.

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