“[CROs] are the experts…in the regulatory landscape, the therapeutic area, and the database of patients and investigators” – Clinical Development at PRXL Customer
We’re long shares of Parexel International (PRXL), a leading clinical research organization (“CRO”) with a multi-decade track record of double-digit growth. Founder & CEO Josef von Rickenbach launched the business in 1982 and took it public in 1995. Over the past decade, von Rickenbach grew Parexel’s revenue from $545m to $2bn, EPS expanded from $0.36 to $2.70, and Parexel solidified its position as a top three CRO, all while maintaining an unlevered balance sheet and generating consistent free cash flow. Short-term market gyrations, triggered by a guidance reduction of NTM EPS growth from 20% to 17%, then aggravated by a broad-based healthcare selloff, have left Parexel with the undemanding valuation of 1.9x NTM EV/Revenue (peers are 2.3x – 3.5x) and 13x EBITDA.
Amongst the large public CROs, Parexel trades for an anomalously low EV/Revenue multiple, suggesting that operating margins have room to expand. We’re inclined to support that view for a few reasons: i) a recent hiring spree, in anticipation of a growth uptick and move towards later-stage trials; ii) management recently introduced a $50-60m cost reduction plan, to be realized by FY17; and iii) PRXL operates with a 35% tax rate, but believes it can decline to 20-30% over time. Quotes paraphrased from our calls with customers indicate there’s room to reduce overall costs: “[PRXL] staffs with one Senior Director, one Director, but only one contract Analyst on the ground”; “[PRXL has a] ‘clubby,’ ‘Ivy League’ feel”; “Pfizer is very top-heavy, and Parexel is very top-heavy, so they go together.” We also heard that a shift towards junior employees wouldn’t impact service levels. Parexel has gone a step further by outsourcing staff abroad: its headcount in India grew from 500 in FY14 to about 1,000 today, with a March 2015 acquisition targeting the pharmacovigilance market (detection and collection of adverse events) staffed largely out of India. Parexel’s organic growth, cost reductions, and tax opportunities could lead to 100-120bps of margin expansion per year over the next few years.