Was WuXi PharmaTech’s Q1 Hurt by the AppTec Acquisition?

Wednesday, WuXi PharmaTech (NYSE: WX), the Shanghai-based CRO, reported first quarter financial results that were sharply ahead of the year-earlier figures and also slightly better than analysts’ forecasts – but the stock price nevertheless fell by $1 or 5% in the session following WuXi’s announcement.

Some observers laid the blame for the drop on disappointing news from the newly acquired US-based AppTec subsidiary. At the time of the AppTec acquisition, WuXi projected full-year revenues from the subsidiary would fall in the $85 million to $90 million range. But Wednesday, WuXi reported that AppTec contributed $11 million in revenues during the two months of the quarter that AppTec belonged to WuXi.

At the midpoint of WuXi’s original projection for AppTec – $90 million per year – the new subsidiary should be running at a $7.5 million per month revenue rate. The $5.5 million per month of actual revenues represents a $2 million or 27% deficit. That’s a significant shortfall, though WuXi could reasonably be expected to say that, in two months, it has not had time to fully take advantage of its newly acquired American presence and figure out how best to allocate its operational resources.

Also, WuXi admitted its manufacturing revenues in Q1 did not keep pace with the growth of its laboratory division. Overall, manufacturing was up 53% while laboratory services climbed 77%. The company said utilization rates were low in the manufacturing division, and promised that they would improve. Presumably, WuXi has more than an inkling of the orders signed for manufacturing services, even though it did not release specific details. AppTec also has a manufacturing operation, one that was underused during the first quarter, causing gross margin rates to slip into single digits. AppTec is more than manufacturing, but that division seemed to be especially short during February and March.

From the start, the AppTec acquisition raised eyebrows. It seemed to dilute the purity of WuXi’s story – the company built a fast-growing business by delivering Western pharma services at Asian prices. By acquiring an established US-based operation, what would happen to margins?

A shortfall in initial revenues only increases the concerns. But it’s too early to pass judgment. For one thing, manufacturing revenues for the clinical trial business is dependent upon exogenous events – clients may elect to defer delivery until they are ready to begin clinical trials. And secondly, WuXi probably has a fairly good ear for what its clients want, the competitive pressures it feels when it seeks to sign new clients for its clinical services. AppTec must fill a need; otherwise, it was $151 million poorly spent.

Upon reflection, investors must also have decided that the WuXi report was not as disappointing as it first seemed. Wednesday, the stock was lower by $1, closing at $20.76. Thursdday, WuXi gained more than half of that back, rising 61 cents to $21.37.

Disclosure: none.