Did you know that pharma services are one of the most active areas of healthcare investing? 

On this episode of The Capital Corner, McGuireWoods' Geoff Cockrell sits down with Daniel Brinkenhoff, Managing Director at Centre Partners, to discuss the segmenting of the pharma services sector and some of the headwinds and tailwinds that investors are seeing.

To kick things off, Dan explains how the pharma services sector has seen an uptick in outsourcing due to rapidly evolving science and technology. These advancements have opened the door for players like biotech and biologics by bringing down the cost of targeted therapeutics, but have driven up the costs of bringing new drugs to market by increasing the complexity of production. The market is further segmented by the complexity of the science itself, requiring more specialized skill sets that are difficult for one company to employ. 

Despite the new challenges with more complex science and technology, innovation is driving a strong growth outlook for the sector. Dan anticipates that the new therapeutics coming to market will continue to result in high single to low double-digit growth. 

This sector is also sheltered from the broader economy, with massive capital going into developing new drugs, whatever market conditions may be. Dan also shares insights into the niche subspecialties that he finds particularly compelling, including clinical trial site management, patient recruitment, and anything consulting-oriented. 

“The knock on some of these segments is that sometimes they’re project-based work, but there are some interesting consulting firms that really help the smaller-end biotech firms navigate the FDA approval process, their regulatory submissions, paperwork with the FDA, market mapping, and some interesting specialty firms out there that we think are quite attractive as well,” he says. 

Featured Guest

Name: Daniel Brinkenhoff

What he does: Daniel is the Managing Director at Centre Partners. Before joining the firm in 2008, he gained experience at ClearLight Partners, LLC and UBS Investment Banking. 

Organization: Centre Partners

Connect: LinkedIn

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This podcast was recorded and is being made available by McGuireWoods for informational purposes only. By accessing this podcast, you acknowledge that McGuireWoods makes no warranty, guarantee, or representation as to the accuracy or sufficiency of the information featured in the podcast. The views, information, or opinions expressed during this podcast series are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This podcast should not be used as a substitute for competent legal advice from a licensed professional attorney in your state and should not be construed as an offer to make or consider any investment or course of action.

This is The Capital Corner, a McGuireWoods podcast, exploring investment strategies, capital structures and topics relevant in today’s middle market private equity. Join McGuireWoods partner, Geoff Cockrell, as he and specialists share practical insights to inform your deal work.

Hello, and thank you for joining another episode of The Corner Series. I’m your host, Geoff Cockrell, partner at McGuireWoods. Here in The Corner Series, we try to bring together some of the thought leaders and deal makers of private equity investing in healthcare. It’s certainly an active space with a lot of interesting dynamics. I’m joined today by my good friend, Dan Brinkenhoff, at Centre Partners. We’ve worked on several deals together.

Today, we’re going to be talking a bit about one of the most active areas of healthcare investing, and that’s in pharma services. It’s a pretty expansive area, and we’re going to talk through some segmenting of that market and maybe some headwinds and tailwinds that investors are seeing. But Dan, if we could start off, maybe give a quick intro of yourself and Centre Partners, and then we’ll jump into some questions.

Just quickly about Centre and how we look to invest. We’re typically targeting being the first institutional capital in, so typically working with founders who are looking for a capital provider that could help them grow their business. We can do that by tapping into our network of operating partners, who have experience in these sub-sectors that we focus on. And really can be helpful in terms of being board members or being more actively involved with the companies.

We do majority control buyouts in the vast majority of our investments, and are typically looking at companies, with call it five to 20, 25 million of EBITDA. That’s really us at a high level, but happy to delve in further.

Pharma services is a very large sector. Maybe a good place to start, Dan, would be thinking about the evolution of outsourcing in pharma services.

Why has it come to pass that so many of the services surrounding creating and bringing a drug to market, for example, has been outsourced into this sector?

Yeah, great question. I think there's a lot of different impacts on the increasing move towards outsourcing within the pharma services sector. I think that the two biggest ones are just the science that's changed. The real evolution in the technology, cell therapy, gene therapy, DNA analysis, and CRISPR technologies. Being able to drive down the cost for much more targeted therapeutics, has really opened the world for biotech and biologics to have increased penetration in the market.

But with that, it's also driven up the costs of bringing drugs to market and the complexity of the science around that. The importance to really be nimble and pivot quickly for the large pharma company has been an important change in the industry. It's really you don't have the days of the large, blockbuster type drugs anymore. There's a lot more targeted therapeutics out there that really still have great clinical value, but how those get to market really is a little bit different.

Yeah. The complexity of the science around bringing a drug to market is also driven folks towards specialized skillsets, that are difficult for one company to have every imaginable skillset that's going to be necessary. That further segments the market.

But maybe turning a little bit towards market segmentation, as I talk to investors, I hear different ways of how they think about segmenting the pharma services market. I think your approach is a pretty clean one. Can you maybe walk us through how you would segment the pharma services market?

Yeah. I think it's probably the more traditional way to think about the market and it's really looking at the lifecycle of getting a drug to market. That really starts at the very beginning, with the discovery phase and preclinical. Then going through human, clinical trials, phases two, three and into four. Then getting through approval after that on the back end, you have the commercialization, you have production and then ultimately monitoring, marketing and everything that goes after drug has been approved.

Within each one of those buckets, each one of those phases along the approval process, there are a number of service providers that could be helpful to the pharma companies, in terms of what they're outsourcing, what they're looking to bring in specialists for. Really keying in on some of those subspecialties within each one of those phases, is really how we think about segmenting the market. Look, there are some services that can span multiple areas of that.

You could find consulting companies or data analytics companies that work both in the pre-approval stage but also in the commercialization stage. But overall, I think it's the spectrum of bringing a drug to market is how we typically see it.

The other way that I sometimes hear folks think about segmenting this market is through functionality. Some businesses might fit under a category of clinical operations like site management or CROs, or e-clinicals or the manufacturing component of that. Is that a useful construct as well, or do you overlay some of those distinctions?

Yeah, absolutely. There's no one right or wrong approach and that certainly makes sense as well. For example, CDMOs, you can have CDMOs that are focused on APIs that are pre-approval, so really in the phase two through four stage. Or post-approval and scaling up manufacturing of a drug and some of those skillsets can be applied on both sides.

It's not an either or approach. You can almost think about it as a matrix. What are the timeline of bringing a drug to market, but also the service offerings that are needed in each one of those phases? There's definitely overlap there.

The entire sector is definitely getting a lot of interest from investors. What do you think are some of the drivers of growth in that sector?

Yeah, absolutely. First, as I started out just talking about the science and the fact that there has been so much innovation in the industry over the past really 15 years. The expectation that that is going to continue with the introduction of cell and gene therapy, and the ability to really have targeted therapeutics for some of the most challenging diseases that have been out there.

Alzheimer comes to mind as one and Eli Lilly's announcement a week or two ago with one of their drugs having some promising signs of treatment. But really spend on that is projected to continue to grow depending upon where you look anywhere from mid to high single digits to even low double digits. Very nice growth outlook driven by a lot of the therapeutics that are expected to be coming to market.

Another driver, as I talked to folks, is that the sector is not exactly correlated to the ebbs and flows of the broader economy.

There's a massive amount of capital that is pointing at developing new drugs and is going to continue to be pointed in that direction for the next 10 years at least. That seems to add some staying power to this regardless of market conditions, do you think?

Yeah, absolutely. That's clearly the truth. It's typically an acyclical type of market that doesn't have the typical business cycles that you see. I would caveat and we're not going to the risks quite yet, but I do think in a higher interest rate environment and Silicon Valley Bank and their blow up being a large funder of some of the earlier stage biotechs, that would likely ripple through the industry somewhat.

Some of the earlier stage companies that might not be able to get the financing in this environment, might not make it to the next stage in the next three to five years. But overall, I think that's maybe a near term blip, if anything. The longer term tailwinds are certainly there and not driven by the general macroeconomic.

As you look at investment theses, I think it's always important to think of who are the backend buyers, as these businesses get to scale?

From your view, who are the backend buyers of these businesses after they do get quite a bit larger and what do they want?

There's really two ways that you could think about it. One, who's going to be the payer? That really could be government programs, CMS and Medicare, but also the commercial payer. Clearly collecting data, real-world evidence and being able to show clear value to those payers or what they're going to be getting in return for their investment in these therapeutics. Some of which could be extremely expensive, but that's only one side of it.

The other side is obviously marketing to the patients themselves. Making sure the doctors and the KOLs are getting the message out around the efficacy of these therapeutics and why people should be asking their doctors about it. You can't really have one without the other. You need to have the coverage and payer support there, but you also need to have the uptake from the patient side as well.

In a market that is consolidating, what's your assessment of what the market looks like on that spectrum? Meaning is this in early stages of consolidation?

Is it a little bit more advanced? Is it big on the one end and barbell distribution? What does the market look like for consolidation from your perspective?

I'd say overall, still a very fragmented market. Even in some of the spaces that are, I would say, some of the most consolidated in the outsourced pharma services market, really looking at the big CROs that are out there. You have IQVIA, you have ICON, some of the big players there. I think the estimates that I've seen are top 10 CROs are roughly 60% of the market, so fairly consolidated, but that leaves 40% of the market.

Depending upon where you look, the CRO market alone is this 50 billion plus and growing. Where we're looking to play, you'd say, "Okay. CROs are one of the more consolidated sub-segments within pharma, but it's still a very large market with some specialization. Smaller companies that have created niches for themselves out there, plenty of room for companies of our size range to play."

I do think it's still very fragmented. Opportunities for consolidation through add-on acquisitions has been a tried and true strategy in playbook within private equity.

The niche market is always fascinating to me. I hear about these companies and my immediate reaction is, "Goodness, I wouldn't even have thought of that." What are some of the niche areas in pharma services that you've seen? I think those are some interesting spaces.

Yeah, absolutely. Maybe I'll start with one that that's nearest and dearest to my heart, which is the clinical trial site management organization. These are really, think about it, patient recruitment offices and vehicles working with the CROs and pharma sponsors, that are really doing what I call the last mile of work. You're recruiting the patients, you're getting them to come into the clinics, you are delivering the drug to them.

Well, first you're screening to make sure they meet either the inclusion or exclusion criteria of whatever specific drug is being tested. Once enrolled, you're making sure that they follow through on the drug, essentially whatever's been approved by the IRB. Getting through that process, collecting the data, that's been a highly fragmented market.

We've seen through some of our physician practice management investments, that it's an ancillary service that a lot of times providers have looked at as a revenue opportunity outside of their delivery of care practice. But over time, some companies have sprung up that have been focused and dedicated solely on clinical trials and patient recruitment for the phase two and phase three phase.

Then even more over time, there have been some of these larger multi-site management organizations that have cropped up. That has become a bit of a hot area in private equity recently, probably about a dozen or so platforms in the space. But that market is still really dominated by the small players, the clinicians that are providing this service on the side and ancillary to what they do day-to-day.

Some of the estimates are that only 5% of the market for these site management organizations are done by these multi-site operators. We have an investment in one, IMA Clinical Research, which is up to about 17 sites currently really across the country. What we like about this subspecialty, is the value proposition that it plays within the drug approval process.

It allows us to be a partner for the pharma companies or the CRO sponsors, being able to have a single contract e-clinical, so all e-source documentation. Better QA on the data that we are collecting and quicker patient recruitment so that ultimately the pharma companies can bring drugs to market even more quickly. Really, time is money for these pharma companies.

The quicker that they could bring a successful drug to market and start generating revenue from it, or conversely pulling the plug on a drug that looks like the data aren't there to support their FDA approval, that's all very valuable. That's one of the nichey sub-segments that has gotten a lot of attention recently. But another area that we like is really just anything that's consulting oriented.

I think, the knock on some of these segments is that sometimes they're project-based work, but there are some interesting consulting firms that really help the smaller end biotech firms navigate the FDA approval process, their regulatory submissions, paperwork with the FDA, market mapping, and some interesting specialty firms out there that we think are quite attractive as well.

No sector is all tailwinds, and if it feels like it's all tailwinds, it immediately creates a headwind in pricing.

But from a headwind perspective, maybe beyond pricing or starting with pricing, what are some of the headwinds that this sector can experience?

Yeah. Well, you can start with pricing. Look, historically just given the tailwinds in the sector, the opportunity for consolidation and just above GDP, well above GDP growth rates in the sector, these businesses have commanded premium valuations in the market. Teens, multiples oftentimes as a starting point. But even aside from that, and I think there might be some compression just given interest rate environment. But it will still command higher valuations that I think the broader market, certainly the broader healthcare market.

But specific to the sector itself, there's a number of, I think, headwinds that are impacting a lot of businesses in the sector. One is just competition for skilled labor. If you think about these businesses and these segments, really highly educated workforce out there, and there has been a lot of competition for labor out there. Ability to pass on those cost increases and not have your margins get compressed, is certainly top of mind for really any business nowadays. But that flows through to this sector as well.

One of the other potential headwinds that I mentioned is and I think this applies more to the really the earlier stage biotech market where companies might be in cash burn mode for some period of time, and the equity markets are more difficult to tap right now. Some of the private markets are more difficult to tap just given where interest rates have gone. I mentioned the SVB blow up and just, I guess, general concerns around how that flows through.

I think that's more near term in nature, but there could be some companies that just don't make it out of the preclinical and discovery phase because the funding really isn't there. Then I think one of the bigger questions, and it's been really top of mind recently really since last year, is thinking about, well, I guess going to your question, who's the consumer? Who's the customer for these companies? Ultimately, you need a payer that's going to be there and a lot of that starts with CMS.

I think the industry got, I wouldn't say dealt a blow, but definitely a lot of questions after Medicare denied coverage for Biogen's Alzheimer's drug in April of last year. There's a lot of... You could probably do a whole podcast on that alone. But really the high level is that, I guess, CMS didn't feel like there was enough efficacy or return on investment for what was a high price therapeutic. I think that really impacts the way the pharma companies are thinking about how they allocate their capital dollars.

If the funding isn't going to be there for what could potentially be a blockbuster drug, or are they going to pull the plug on certain drugs earlier? I think the flip side or the glass half full on that, is maybe it means that it creates opportunities for some of the companies we would look to invest in because there is more need for collection of real world evidence. There is lobbying and marketing that go into these decisions.

For drugs like this, they are maybe more likely to spend more upfront to make sure that they have a strong case not when they go for FDA approval, but after the fact when they're trying to make sure there is coverage for these drugs as well.

I feel like every discussion of a sector has to have at least one AI question and whether or not the sector is susceptible to disruption on the basis of AI development. How would you answer that with respect to pharma services?

Great question. TBD like in a lot of sectors, but I do think there are certainly aspects of pharma services that can be disrupted here. There is a lot of data and analytics that go into this sector and being able to target the right therapeutics to the right genes and right cells. That could make its way into clinical trials. I don't see clinical trials ever going fully virtual.

You're always going to have to have testing first in animals and then in humans. But we do see in the preclinical discovery phase, there has been a shift towards simulating models so that you might not need to do the animal studies. I do think there is opportunity there for AI to potentially make certain business models less relevant, other business models more relevant. But we'll just have to see how that plays out over the next five plus years.

I think we will call that an end. This has been super enlightening. It's always great to talk with you, Dan. You have a ton of knowledge and tremendous insights, and thanks again for joining.

Yeah, my pleasure. Thanks, Geoff.

Thank you for joining us on this installment of The Capital Corner. To learn more about today's discussion, please email host Geoff Cockrell at GCockrell@McGuireWoods.com. We look forward to hearing from you. This series was recorded and is being made available by McGuireWoods. For informational purposes only.

By accessing this series, you acknowledge that McGuireWoods makes no warranty, guarantee or representation as to the accuracy or sufficiency of the information featured in this installment. The views, information or opinions expressed are solely those of the individuals involved and do not necessarily reflect those of McGuireWoods. This series should not be used as a substitute for competent legal advice from a licensed professional attorney in your state, and should not be construed as an offer to make or consider any investment or course of action.