- Q is the leader in its market. Explaining the world’s largest contract research organization or CRO.
- Where is retail? Over 85% of the shares are held by well-known institutions and funds.
- We explain where the growth is coming from and where it is going.
Quintiles Transnational Holdings, Inc. (NYSE:Q), a Durham, NC based firm with over 30,000 employees, recently hit its year and 52-week high of $57.33 on July 30. On July 31, the company reported that its second quarter diluted adjusted EPS increased 30% to $0.65 per share compared to the second quarter of 2013 and its second quarter GAAP reported diluted EPS increased 113% to $0.64 per share compared to the second quarter of 2013. The report went on to state that net new business grew 21.2% compared to the same period last year to $1.23 billion representing a book-to-bill ratio of 1.19 in the quarter ended June 30. This net new business contributed to an ending backlog of $10.26 billion at June 30. The company also updated its full year 2014 guidance, which includes service revenues estimated to be between $4.20 billion and $4.24 billion, representing growth of 10.3% to 11.3% compared to 2013, and diluted adjusted earnings per share of $2.57 to $2.67, representing growth of 22.4% to 27.1% compared to 2013, with diluted GAAP earnings per share between $2.49 and $2.61. In addition, in June the firm was added to the Fortune 500. This is based upon the firm's gross revenue rankings.
The firm, founded in 1982, went public (actually for the second time), at $40.00 in May 2013. Before we go into our reasons for liking the company despite its heavy debt coverage (over $2B) let's go over a little background of the firm, their business model, and the major shareholders of the firm.
According to the Investor Relations section of the firm's website: "Quintiles helps to improve healthcare worldwide by providing a broad range of professional services, information and partnering solutions to the pharmaceutical services, biotechnology and healthcare industries." This is all well and good but it is still not detailed enough so we looked further.
What does Quintiles actually do?
The company is slightly difficult for most small investors to understand on a basic level what it fully does. The sheer breadth and depth of services the firm provides globally and successfully have made it a favorite of institutional and fund investors. Basically, the firm's services range from various Consulting Services, Portfolio and Strategy Planning, Clinical Trial Execution, Laboratories, Real-World and Late Stage Trials, Technology Solutions, Patient and Provider Engagement, Product Marketing and Sales.
Another division's focus is Therapeutic Areas which include Acute Care and Pain, Cardiovascular, Diabetes, Immunology, Oncology, Rare Diseases and Vaccines among others. Its third division's focus is the Markets and include the Biopharmaceutical R&D, Biopharmaceutical marketing, Medical Device and Diagnostics, and Small Biopharma among others. The firm has offices worldwide including UK, Brazil, China, Russia, Japan, Spain among other offices. The firm is so entranced among leading and developing stage pharmaceutical and biopharmaceutical firms that the firm has helped develop or commercialize 100% of the top 100 products or compounds in 2013.
This is a truly impressive company in terms of the institutional shareholders as well. As mentioned, over 85% shares are held by institutions, which represent 446 institutions. Firms such as Bain Capital Investors hold 19.5M shares or 15.38% of the shares outstanding, TPG Group Holdings Advisors holds over 14M shares, and Alliance Bernstein L.P. holds over 6.59M shares amongst others. Funds such as Vanguard Specialized-Health Care Fund, Wells Fargo Advantage Growth Fd, and Lord Abbett Securities Trust-Fundamental Equity Fund are large mutual fund holders. This brings us down to the question of why there are so many large institutions and so few direct retail investors? Pfizer (PFE), as a comparison of a big healthcare developer and pharmaceutical firm is held by 74% by 1721 Institutions and Funds. One of Quintiles competitors, Covance, Inc. (CVD) also has large institutional ownership, at above 96%. The basic answer is twofold, Bain and TPG became the lead investors in Quintiles in January 2008 after One Equity Partners sold its stake in the company. Britain's 3i Group Plc (III.L) and Singapore's Temasek Holdings are also investors in Quintiles. According to Forbes Magazine, Bain's own report details that many PE firms, aka "sponsors," are simply holding on to their investments for a longer period of time. "Sponsors are holding on to the assets in the space for longer and they will need to jump on the popularity in the sector if they're to achieve the hurdle rate of 15 percent net IRR." The report went on to state that sponsors are simply holding their investments longer each year to achieve their desired return after all fees and costs and no dividends. As such, they are long term investors and it provides a strong reason to purchase shares at this level as well. The second reason is the sheer complexity of the company and the long term nature of the business model. It takes significant amount of time and analysis to understand fully what the company does and how it works (as we discovered as well).
The question comes up of, what exactly is a Contract Research Organization or CRO and why are they so important?
What is a CRO and how does it work?
A CRO is defined as an organization that provides support for the pharmaceutical, biopharmaceutical, biotech, medical device industries in the form of research services outsourced on a contract basis. Many of the firms, such as Quintiles, specifically provide clinical-study and clinical-trial support for drugs and/or medical devices.
The key benefit of firms such as Quintiles is that they can specialize in early, mid to late stage trial services. They can offer their clients the expertise of having a conduit or pipeline to regulatory approval, both regionally and globally, hence the reason for the many global offices of firms such as Quintiles. Some firms only focus on US FDA approval while others such as Quintiles are heavily investing and developing trials and services in rapidly developing markets such as China and India. As such, Quintiles works with regulators worldwide in the approval process.
It is estimated that CROs control roughly 36-38 percent of the market. IBISWorld estimates that the industry is still in its growth phase of its life cycle, as it barely existed a decade ago and were primarily focused on one facet of research or trials as a boutique firm. IBISWorld stated, "During the ten years to 2019, the industry's contribution to the overall economy (IVA) is anticipated to rise at an average annual rate of 10.5%, well above annualized GDP growth of 2.7% during the same ten years. Industries with IVA greater than GDP are considered to be growing." The percentage of market share for the next four-five years that have been stated range from 50% to over 60%. We feel that a 60% market share for overall CRO outsourced business by 2018-2019 from "Big Pharma" is very easily a possibility. Some of our research into the company's business models gives us ammunition to state this.
Quintiles Business Model and why it is a good long term investment
We delved deeper into the company's business model and earnings and forward projections. The $7.15B market cap company (as of August 20) has an operating margin at 13.86% and a profit margin at 7.2%. These are attractive margins in any business of this size. These margins look to continue going forward based upon the service revenues being generated at the firm. The overall revenues total for both product development and services is $3.98B (TTM) with a quarterly revenue growth of 9.70% and a gross profit of $1.34B. The firm is moving forward with significant growth in services as contracts and trials continue worldwide. One area of service growth that investors should note is the further development of what are called electronic health records or EHR. Quintiles recently acquired a firm called Encore Health Resources. The importance is emphasized as major stakeholders including payers and providers along with biopharmaceutical customers seek real-world evidence that can be quickly obtained and disseminated in a short period of time.
The company has new clinical trials constantly beginning and others ending throughout the year and around the globe. They are leaders in patient recruitment efforts for these trials in what are termed Partner Site Networks. We look for this to continue due to outbreaks of not only infectious and lethal diseases such as MERS and Ebola but increased presence of long term diseases such as diabetes and heart disease in developing countries. Extensive work with late stage clinical trials and working with a team called the global regulatory team allows the firm to have a more predictable outcome when companies seek approval on new drugs or treatments from governments and regulators across the globe. The business of trials and development is growing significantly in China and SE Asia, in general. It will continue to do so as the country and region develop their pharmaceutical and hospital treatments further towards Western medicine's best practices.
Another important area is called Model-Based Drug Development. The company uses models and simulations that allow pharmaceutical companies to determine the best strategy and process to take with new or existing medication. In essence the company is a technology company, as well, in spite of the fact it is often overlooked by tech investors. In fact, the company was named to Information Week Top 500 list of Information Technology Innovators for five consecutive years. The product marketing and sales division has supported more than 220 product launches in 20 countries in the past five years. It works as contract sales organization, an outsourcing tool for major pharmaceutical and biotech firms a marketing and contract sales arm of the firm's allowing it to not only save money and resources but preventing mistakes in coming to market and educating patients and prescribers. In this way, the firm mitigates risk for major pharmaceutical firms and positions itself in a risk management role. This is a valuable contract service and a profitable one for Quintiles that will continue further in the future.
Why $2BN in debt is not an issue
Returning to the financial numbers, one of the negatives of the company is the book value at -$4.89 per share. The main reason is the tremendous debt the firm has remaining of $2.07B and cash per share of only $5.00(mrq). The debt remains from the past buyout and is being paid down over time. The interest expense was $24.8 million during the past quarter compared to $31.9 million for the same period last year. The company has benefited by lower interest rates and a decrease in the average debt outstanding. We feel this is a good sign and should continue into 2015. We do not see this debt as a negative for the company as it has provided substantial resources for the company to expand over the past five years and to develop new markets and grow further in the developing markets. With the pipeline rather full and new business forecast both from "Big Pharma" and Biopharmaceutical firms, and developing markets, this is again not a concern at this time and for the conceivable future. As such we are quite comfortable in stating that the debt exposure of the firm will only improve over time.
Massive backlog a positive
One reason we see revenue and positive earnings continuing is the ending backlog of new business at the end of June of $10.26 billion. The company is not clear on how long this backlog will take to be covered. Our estimation is approximately 3-5+ years for a total covering of this backlog with new business constantly on the horizon. One thing to keep in mind is the tremendous time to bring a new product or drug to market. In the US it takes almost 12 years for a drug to come to market. There is a tremendous failure rate for new drugs that some have estimated at 1 in 5000. As such, the growth years for the company are ahead. The developing markets as mentioned, including China and SE Asia business, are growing. With this backlog constantly developing new business, this is truly a growth company that will be a welcome addition to any portfolio or fund.
Earnings and Projection
Earnings for the company are presently at $2.04. Currently 16 analysts give a median target of only $62.00, with a high target of $66.00. As noted, the company is looking for diluted adjusted earnings per share of $2.57 to $2.67 per share, representing growth of 22.4% to 27.1% compared to 2013, with diluted GAAP earnings per share between $2.49 and $2.61 per share. I am looking for slightly above the $2.70 per share diluted adjusted and diluted GAAP earnings per share of $2.64.
My 12 month target based upon these numbers is $68.00 which represents a one year return of 20.8% and a P/E of 25.7. The current 52 week performance is 27.57% and P/E is 27.45, respectively. As such, we expect the share value to improve and grow further in the coming year as the firm's revenue and services continue to grow and expand in its present market and in developing market areas, especially Asia and for the backlog to create new opportunities going forward as well. We also look for the growth of the CRO market to continue not only in the US, but worldwide (especially the developing markets), with Quintiles leading the way.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.