Publicly owned Quintiles makes a perfect restructuring opportunity

Analysis

The hotly anticipated second flotation of Quintiles has been hailed as a triumph, and no doubt investment bankers cannot wait to pitch ideas regarding the use of new paper to back drug development – a business in which the private Quintiles has taken its first tentative steps.

However, a look beneath the company’s bonnet reveals more pressing issues, namely a mountain of debt and a business that is struggling with falling profitability. There is no doubt that the IPO is a fantastic result for the selling private investors, but as a source of fees bankers should look to restructuring first and business development later.

Demand for Quintiles has been hot, resulting in today’s New York IPO being priced at the top of its $36-40 range; the stock was up 10% to $43.87 in early trade. What is more, the total number of shares sold was increased by 20% to 23.7 million, excluding the underwriters’ overallotment.

However, alarm bells should sound when it becomes clear that this surge in demand was not met by the company offering additional new stock to raise more much-needed cash for itself. On the contrary: Quintiles had initially planned to issue 13.8 million shares, but yesterday this was cut to 13.1 million.

Rather, it is exiting investors who put more of their existing stock into the float – something that did not benefit the company’s coffers at all – and precisely the same applies to the $142m overallotment, which will also be met by the sale of existing Quintiles stock.

Make no mistake: Quintiles’ private investors, led by its founder Dennis Gillings, have played a blinder – and not just once. Quintiles was founded in 1982, and having been floated once was taken private in a 2003 transaction led by Mr Gillings, before a $3.8bn deal five years later saw the entry of private equity funds.

The current IPO values Quintiles at $5.2bn, and will see the selling shareholders walk away with $564m, if the overallotment is exercised in full, while retaining a 64% interest worth over $3bn on paper. In addition they will share a one-off $25m payment for forgoing management fees that amounted to some $5m a year in 2008-12.

Growing pains

Quintiles now stands as the world’s biggest contract research organisation, though it is actually a lot more, offering pharma a range of services including contract sales, and more recently doing deals to take on some of the risk of drug development.

But such growth has not come at zero expense, and a generous dividend policy – private investors took out $568m last year alone – plus acquisitions contributed to Quintiles’ burgeoning debt. Indeed, the main function of the IPO is to start remedying this problem; the company intends to put almost 70% of its $525m share of the IPO proceeds to paying down the debt mountain.

Yet even after this Quintiles will retain a net debt position of some $1.8bn – a hefty 4.7x last year’s operating profit. Servicing the debt accounted for 40% of the group’s 2012 operating cash flow.

Meanwhile, in 2012 the overall business suffered a 27% fall in net profits to $177m, in spite of group revenues climbing 12% to $4.9bn. This is almost certainly a sign of the company taking on increasing amounts of unprofitable work to flaunt its topline performance and dress itself up for flotation.

It will therefore come as a disappointment that at a time when Quintiles desperately needs to cut costs and start paying down debt it was apparently unable to seize the opportunity of surging demand to offer more new stock into the IPO. Its main cause for celebration will be that the stock priced at $40.

Certainly, in time Quintiles will be in a position to pursue innovative deals involving drug development risk-sharing and more. The group says it has less than $40m of such high-risk investments on its books at present, in addition to $49m committed to NovaQuest, a private equity fund.

But the first task will be to turn Quintiles into a leaner and meaner organisation and exploit its considerable leading position in the service industry.

To contact the writer of this story email Jacob Plieth in London at jacobp@epvantage.com or follow @JacobEPVantage on Twitter

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