Charles River Labs: Caught in the Credit Crisis Crossfire

| About: Charles River (CRL)

The so-called contract research organizations (CROs, for short) have been thought to be in the sweet spot of the current biopharma industry cost-cutting trend.

More and more drug companies have been farming out an increasing amount of their research to firms like Charles River Labs (NYSE:CRL) and Covance. For example, Eli Lilly (NYSE:LLY) and Covance (NYSE:CVD) recently did an exclusive deal worth about a billion-and-a-half bucks over time. And CRL just opened up a new facility in China, and has been expanding its square footage here in the U.S. and hiring a lot of people. But that was before the credit crisis.

To be sure, CRL says it's in good financial shape. The company has $213 million in cash and "a favorable debt to equity ratio". But this morning when CRL reported its earnings, it revealed that its pre-clinical lab business is taking a hit because small, cash-strapped biotechs, in particular, aren't spending as much money on that kind of research for the time being. Pre-clinical means that the work is done in the lab in Petri dishes and on animals, that a drug hasn't been tested yet on people. It's the earliest stage of pharmaceutical research.

That unit at CRL saw sales grow only 4.6 percent in the third quarter because of what the company called, "study slippage and delays as a result of pharmaceutical and biotechnology companies' restructuring and pipeline reprioritization and negative foreign currency translation." The downturn is so severe, though, that CRL had to cut its sales and earnings guidance for this year and that's why the stock in midday trading has lost more than a fifth of its value and hit a new intra-day low of $25.65. CVD shares are also being punished.

Charles River Labs Chairman and CEO Jim Foster says a lot of the work is being pushed out from this year to next. "They (clients) are continuing to outsource," Foster is quoted as saying, "but due to heightened cost controls and year-end budget constraints, are spending in a more measured way." For pharma, Foster says the problem is drug patent expirations. But for baby biotechs he specifically blames "the availability of funding."

Small biotech companies usually don't have a product on the market and little or no cash coming in, so they constantly have to control how much money they spend. And in times like these when credit and borrowing is extremely tight, especially for risky businesses, the biotechs have to earmark their cash for only the most promising and/or most advanced pipeline product(s) in development. That means a lot of stuff that hasn't entered the clinic yet is likely going to fall by the wayside.

And that's how Charles River Labs got caught in the cross-current of the credit crunch.