Event
     In recent months, we have attended industry conferences (Society of
Toxicology and Partnerships with CROs) and spoken to numerous
CRO management teams (both public and private) and industry
contacts. Based on those discussions, we remain bullish on both the
short and long-term trends for outsourced drug development.
Key Points
• Sustained Growth Always Attracts the Naysayers. With the
CRO group in its 6th year of strong growth, the end of '07 highs in
these stocks prompted an increase in "when is the cycle going to
end" questions. While we are not clairvoyant with our projections,
we do add a little experience to the numerous data points we gather
from the industry. In the case of 1Q08 earnings, we believe that
trends for the group are solid. We are particularly optimistic about
quarters to be announced by ICON plc (ICLR, Buy, $82PT), Kendle
(KNDL, Buy, $51PT), and PAREXEL (PRXL, Buy, $32PT). To be
clear, our checks at Partnerships with CROs turned up some
encouraging data points on RFP flows and bookings for most of the
Clinical CROs. At the previous conference (SOT), we gathered
similar positive feedback on accelerating Preclinical demand. Our
sense is that the above companies fared well during 1Q08.
• So What About Cancellations in 1Q08? While several large drug
programs have been canceled in the last several months, the only
real difference this quarter is that we have more information than
usual on some of the CROs involved. We note that at least one of
these Phase III trials (TAK-475) was spread across multiple CRO
backlogs, and news of elevated transaminase levels (heightened
liver toxicity) was well telegraphed to the market (and the CRO
managers conducting the trials, where applicable) in October 2007.
For a seasoned CRO management team, a cancellation with a
heads up like this would likely be anticipated. Backlog growth for
most CROs has outpaced revenue growth for some time now.
• CRO Group Attractive at These Valuations. The CRO group
currently trades at 18.5x our forward CY09 EPS estimates. This
multiple has bounced recently, but it remains down ~ 8% over the
past several months as a result of: 1) starting off '08 at stretched
valuations, 2) evidence that Pharma is reducing R&D spending
(NOT to be confused with outsourcing), and 3) inconclusive
evidence that cancellations ran high in 1Q08. Based on the tone of
discussions with investors, the sentiment seems conspicuously
cautious...surely contributing to this pullback. The CRO group
represents a defensive investment vehicle, allowing investors to
avoid the noise associated with cyclical sectors in a weak global
economy. We recommend owning CROs at these levels.