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Kendle International Inc.

Case Analysis

MGMT 619 – MW 7:20pm

November 8, 2010

Team Polycom:
Anirvan Das
Girish Navalgundkar
Jakub Cech
Kyle Kaido
Prashanth Kalika
Vivek Durairaj
Kendle’s Corporate Strategy

Kendle is a Contract Research Organization (CRO) that performs clinical research for

pharmaceutical companies looking to outsource their R&D. Its corporate strategy is focused on

growing revenue to keep up with its larger competitors in the CRO industry including Quintiles

and PPD. Kendle sees its best opportunity for revenue growth through the acquisition of a CRO

firm in Europe. Kendle currently only operates in the US, relying on subcontractors to perform

work in international markets. U-Gene and gmi are currently under evaluation as potential

acquisitions to fulfill Kendle’s corporate strategy. Since Kendle’s entire revenue comes from

CRO activity for pharmaceutical companies it has a single business corporate strategy. Acquiring

U-Gene and/or gmi will not change this single business corporate strategy.

Benefits Kendle Creates for a Competitor

Kendle’s strong U.S. presence, broad range of scientific capability, and ability to manage

studies for phases II through IV all provide potential benefits to a competitor through acquisition.

The company is operationally focused, with a high utilization of talented resources that ensures

healthy profit margins. Kendle specializes in a range of therapeutic areas with recent emphasis

on skeletal disease and inflammation drugs. Kendle’s strong relationship with large

pharmaceutical companies, including Searle, offers an additional benefit through acquisition.

Potential Sales Price vs. Economic Value

Firms in the CRO industry are typically valued at 8-10 times EBITDA which equates to a

sales price of $15M for Kendle. We used relative and DCF valuation methods and found the

average economic value for Kendle to be $25.3M. Since Kendle’s estimated sales price is less

than its current economic value, Kendle is undervalued in the market.

Strategic Benefits from Acquisition

Exhibit 1a provides more information on the methods of value creation resulting from

Kendle’s acquisition of gmi and/or U-Gene. Exhibits 1b and 1c outline expected synergies and

economies of scope achieved through these acquisitions.

Synergies: Synergies resulting from acquisition are reciprocal, benefiting all three firms through

value and cost drivers. Kendle will become the sixth largest player in Europe after acquiring U-

Gene and gmi, meeting its goals of becoming a full service CRO with international presence.

gmi provides a full range of Phase II to IV services, higher margins, and specific expertise in

health economic studies. U-Gene complements Kendle by adding phase I facilities and resources.

U-Gene and gmi will both benefit from Kendle’s ability to decrease time span between phase

trials utilizing “Trial Ware” software and close customer collaboration. U-gene and gmi also gain

access to Kendle’s US market opportunities and productive labor force.

Resources: All three companies have abundant “soft resources”, which include highly talented

engineers, scientists and research capabilities. The extent of redundant resources is low since

different geographic offices will continue to utilize existing resources and best practices after an


Market Conditions: The pharmaceutical industry is growing 10% annually while demand for

CRO services is growing 20% annually. Pharmaceutical firms are looking for a single CRO to

fulfill all their needs including data collection, research, and management of various phase trials.

These conditions result in a low degree of market uncertainty.

Industry Attractiveness Test: Barriers to entry are favorable due to restrictive government

policies (especially in the US), dependency on highly talented scientists and incumbency

advantages. Although the pharmaceutical industry is highly concentrated with a high influence

on pricing, buyer power is favorable since they require a high level of credibility and technical

skill from CRO firms. Rivalry is high in the CRO industry due to fragmentation and

differentiation of services. Low exit barriers exist due to a dependency on soft resources

compared to more expensive fixed capital resources. Overall, this industry creates a very

attractive acquisition environment.

Cost of Entry Test: We don’t have enough information to determine transaction costs,

integration costs and premium required to entry this industry. We base the cost on entry on the

economic value created by the combined business compared to the individual firms. Based on

our financial analysis, NPV (Kendle, U-Gene, gmi) > NPV(K) + NPV (U) + NPV (gmi).

Therefore these acquisitions pass the cost of entry test.

Better-Off Test: Kendle, U-Gene and gmi are all better off after this acquisition primarily due

to an increase of full service capability (phase I to IV) and end-to-end program management. All

three firms increase their international presence and economies of scope.

Financial Analysis

We conducted a three stage DCF valuation for Kendle since it is in a high growth phase

and a two stage model for gmi and U-Gene as they are in a stable growth phase. We generated

pro forma income statements for a five year period with a constant growth model after the fifth

year to determine the NPV of free cash flows. See Exhibit 2 for a list of assumptions used in our

financial analysis. Our valuation analysis in Exhibit 3 further assumes all equity and funding of

acquisitions is through an IPO only. We estimated full synergy valuation of the combined

company based on different acquisition options: only gmi, only U-Gene, acquiring both. This

analysis shows that both gmi and U-Gene offer significant synergetic benefits to Kendle. The

overall valuation of this combined business far exceeds the values of the companies before

acquisition. Therefore, all three companies are assumed to be better off after the acquisition.

Acquiring both companies also offers a far better economic valuation than acquiring only one

company due to inter-company synergic benefits. It is evident that gmi offers more synergetic

value than U-Gene when acquired separately.

Recommendation: Since acquiring both gmi and U-Gene together offers the highest synergistic

value, we analyzed the following three options: 1) IPO first, then complete acquisitions 2)

acquire before IPO and 3) acquire gmi first, IPO, then acquire U-Gene. Our analysis (refer

Exhibit 4) results in a recommendation of option 3. Kendle should have a more successful IPO

after acquiring gmi because of increased cash flow, resulting in a higher valuation after

acquisition. Since gmi is willing to accept equity of about $2.8M, Kendle requires less funding

through debt. Kendle can also learn from this first acquisition and leverage this experience for

acquisition of U-Gene, potentially decreasing integration costs. This option allows Kendle to

build a considerable cash cushion, enabling future growth (see Exhibit 5).

Scenario Analysis: After choosing option 3, we performed a financial analysis for three

scenarios: no synergy, moderate synergy (base scenario) and full synergy. Moderate synergy is

considered the most likely event, which determines an estimated valuation of the combined

company of $98.8M and synergetic value creation of $41.8M (see Exhibit 6).

Sensitivity Analysis: We used two variables, Weighted Average Cost of Capital (WACC) and

Working Capital/Revenue ratio (WC/Rev), to perform a sensitivity analysis on our base scenario.

This analysis displays possible outcomes of the acquisition values under these variable

conditions (see Exhibit 7). This sensitivity analysis can be used by each firm to determine its

“most likely” NPV. Since WACC is affected by equity value, Kendle can also use this sensitivity

analysis to determine how many shares to issue in an IPO.

Exhibit 1a: Methods of Value Creation

Method of Value Supports Single Explanation

Creation Business

Operational Economics of Yes Leverage Resources and Talent

Capability Transfer Yes Applying capability (e.g.
Knowledge Transfer, Research
capabilities...) to a new business
Leveraging Core Yes Research facilities and full
Competence service offerings to the
Financial Economies of No None of the companies have
Scope significant internal capital to
Anticompetitive Yes Market Power : Combined
Economies of Scope company after both acquisitions
will be sixth largest in Europe
Diversification Economies Yes New economic market in Europe
of Scope can help diversify risk.
Restructuring - Not enough data.

Exhibit 1b: Synergies

Kendle + gmi Kendle + U-Gene Kendle + gmi+ U-

Increased geographical Increased geographical International presence
presence presence
Full range II to IV services Phase I facility --> Full service CRO
- good in Phase III trials increases Kendle's service
Experience in health Full service CRO Emerging leader in
economic studies and skeletal disease,
training programs inflammation drugs and
various therapeutic areas.
Higher margins Emerging leader in Maximize utilization of
cost/rev=79% compared skeletal disease and labor - utilization rate - 65-
to 86% that of Kendle inflammation 70%
Decreased time span Increased SG&A with Decreased time span
between Phase II and access to US markets between Phase II and
Phase II trial 22 days - Phase II trial 22 days -
better than industry better than industry
standard of 6 months to 1 standard of 6 months to 1

yr yr
Maximize utilization of Maximize utilization of Experience in health
labor - utilization rate - 65- labor - utilization rate - 65- economic studies and
70% 70% professional training
Expertise in multiple Expertise in multiple Proprietary software - trial
therapeutic areas therapeutic areas ware for global data

Exhibit 1c: Operational Economies of Scope

Value Chain Activity Shared Activities

Input/Data Collection Activities Common: Data collection software, Research facilities
for various trials, Regulatory Loop-holes
Research Activities Common: Knowledge Transfer, Data Validations, Best
Sales and Marketing Common: Promotional activities, cross-selling, pricing
systems, marketing depts., distribution channels, sales
forces , order processing.

Exhibit 2: Financial Assumptions

Cost of Cost of Debt (Nations Bank)

Unlevered 1.25 Credit Line 6.20%
Beta =1.25 7.1%(30yr Subordinated
Rf 12%
MRP Treasury rate)
7.5%(Ibbotson’s) debt
Wt Avg 8.13%
Ke worksheet)
= Rf+beta*MRP Kd = Wt avg*(1-tax)
Ke 16.48% Kd 4.9%

Kendl U-
e gmi Gene
WC/Re 12.49
v 2%* % 2.50%
costs/Re 86.00 79.00
v % % 90%
Dep/PP 17.22 No No
E % info info
PPE/Re 14.16
v % 2.73% 8.50%
* - Based on assumption. This is used
as a variable in sensitivity analysis
All the values are calculated as
historical averages.
Stand alone assumptions
Revenue Growth
Year Kendle gmi & U-Gene
Based on Q1
1997 revenue. Based on Q1 revenue

Average from
historical Average from historical
1998-99 performance performance
Industry growth Average from historical
2000-01 performance
<GDP due to market
Terminal < US GDP uncertainty.
cost/rev - Historic average for each company.

Full synergy assumptions for all acquisition through

only IPO
First year growth rate is assumed to be individual company growth rate to adjust for the
integration costs in the first year.
Cost of Equity is used as the discount rate.
Acquire only gmi We assume the margins of
2000- the combined company will
1998-99 2001 Perpetual be as that of gmi and the
growth rate would mirror of
growth rate 62% 20% 5% Kendle. The terminal growth
is better than stand alone due
to market diversification.
costs/Rev 0.79 0.79 0.79
Acquire only U-Gene 1998-1999 growth rates to
2000- mirror that of kendle.
1998-99 2001 Perpetual The 2 year growth in 2000-01
is assumed to be better than
growth rate 62% 25% 5% industry growth due to the
offering of full range of
costs/Rev 0.86 0.86 0.86 services and decrease in lost
opportunities to perform
international trials.
The terminal growth is better
than stand alone due to
market diversification. Based
on the synergies, we assume
the margins of the combined
company will be as that of
Kendle as it is operationally
Acquire both gmi and U-Gene at 1998-199 growth rates to
the same time mirror that of kendle.
2000- The 2 year growth in 2000-01
1998-99 2001 Perpetual is assumed to be better than
growth rate 62% 30% 5% industry growth due to the
offering of full range of
services and decrease in lost
costs/Rev 0.79 0.79 0.79 opportunities to perform
international trials.
The terminal growth is better
than stand alone due to
market diversification.

Assumptions for option 3: Acquire gmi through debt and U-Gene through IPO

A debt of 9.5 Million is assumed as the gmi is willing to get the rest in share when Kendle
goes IPO. We assumed a current share price estimate of $13 and later did a sensitivity
analysis to see the valuation with a better share price due to increased cash flow from gmi.
WACC was calculated as shown below.

Share Ke Kd
price SE Debt WACC
11 $33,000 $9,500 16.48% 4.9% 13.9%
16.48% 4.9% =>used discount
13 $39,000 $9,500 14.2% rate
15 $45,000 $9,500 16.48% 4.9% 14.5%

Scenario Assumptions
Analysis Revenue Growth Costs/R
199 200 200 Termin ev
1998 9 0 1 al
Scenario 1- 47% 47 24 24% 4% 86% Same assumptions as Stand alone.
No synergy % % The numbers shown in the table are
the weighted average growth rate
for the three companies based on
their revenue.
Scenario 2 – 55% 55 27 27% 5% 83% Assumptions same as that for the
Median % % No equity, full synergy except the
Synergy(Base terminal growth is better to market
) diversification and availability of the
cash cushion for future growth.
Scenario 3 - 62% 62 30 30% 6% 79% Median values between No synergy
Full synergy % % and Full synergy. This is most
expected scenario accounting for
integration costs, transportation
costs and possible loss of human
resources due to acquisition.

Exhibit 3: Valuation Analysis

Kendle Sales A Gmi Sales DA Gene Sales A
Baselin $12,95 Baselin $1,50 Baseli $12,5
e 9 $1,505 e $6,996 5 ne 08 $1,617
Multipl Multipl Multipl
e 2.35 16.53 e 2.35 16.53 e 2.35 16.53

$30,45 $24,87 $16,44 $24,8 $29,3 $26,7

EVA 4 0 EVA 1 70 EVA 94 21
$20,37 $15,0 $9,44
DCF DCF 57 7
Net Net Net
Avg $25,23 Avg $18,7 Avg $21,8
EVA 2 EVA 89 EVA 54
*Sales and EBITDA are considered most important in this valuation method so other
multiples not included.

Exhibit 4: Option Comparison Detail

Option 1: IPO before Option 2: Acquisitions before Option 3: Acquire 1

Acquisitions IPO Company before
Acquisition and another
after IPO

Cost of capital = cost of Cost of capital = cost of debt Cost of capital = weighted avg
equity Cost structure = Debt for 30 Mil of cost of equity and cost of
Cost structure=100% equity debt
Due to the interest expense the Cost structure = Debt +
Going IPO before acquisition net income might be negative in Equity.
might result in a lower initial years.
valuation. An unsuccessful Acquire the company that
IPO might not only affect the With high debt and almost no offers the maximum synergy
acquisitions of the equity IPO might not be first with debt.
two companies but also any successful as expected. This will improve the free cash
future acquisitions. flow.
If the synergies with the acquired
This is not a productive way companies are not achieved in a With better cash flows and
of using the capital with short period, IPO might have to diversification in different
highest be delayed to get a better markets, it will get a better
cost of capital. valuation and there is also a risk valuation. This will increase
of losing the IPO window. the chances of a successful
With two acquisitions at the IPO compared to other
same time, Integration costs This would hamper any future options.
might be higher. growth and any future
acquisitions. This option will also result in a
No cash cushion for future lower cost of capital compared
growth. With two acquisitions at the to option1.
same time, Integration costs
might be higher. With some time difference
between the two acquisitions,
A small cash cushion for growth. Kendle would be able to
handle integration problems
better than the two other

Highest cash cushion for

Exhibit 5: Cash cushion for Option 3

Cash Cushion Calculation

$ $ $
Cash from IPO 33,000 39,000 45,000
Cash offer to U- $ $ $
Gene 14,000 14,000 14,000
$ $ $
Equity to gmi 2,800 2,800 2,800
$ $ $
Equity to U-Gene 1,600 1,600 1,600
$ $ $
Cash Cushion 14,600 20,600 26,600
Exhibit 6: Scenario Analysis for Option 3

Scenario Scenario 1 - No Scenario 2 - Scenario 3 -Full

Summary Synergy Base Synergy
1998-99 rev growth 62% 55% 62%
2000-01 rev growth 20% 27% 30%
Terminal growth 4% 5% 6%
ue 86% 83% 79%
Result Cells:

NPV of
Kendle $26,178.51 $38,304.77 $67,298.43

Scenario Scenario 1 - No Scenario 2 - Scenario 3 - Full

Summary Synergy Base Synergy
1998-99 rev growth 32% 55% 62%
2000-01 rev growth 32% 27% 30%
Terminal growth 4% 5% 6%
ue 79% 83% 79%
Result Cells:
NPV of gmi $19,041.69 $19,472.12 $32,997.34

Scenario Scenario 1 - No Scenario 2 - Scenario 3 - Full

Summary Synergy Base Synergy
1998-99 rev growth 21% 55% 62%
2000-01 rev growth 21% 27% 30%
Terminal growth 4% 5% 6%
ue 90% 83% 79%
Result Cells: 411.0727044
NPV of U-
gene $11,778.83 $41,107.27 $65,644.58

Total NPV $56,999.03 $98,884.17 $165,940.34

value $41,885.13 $108,941.31
* Assumes no time lag between events: First acquisition, IPO, second acquisition.

Exhibit 7: Sensitivity Analysis

$ 38,305 1% 2% 3% 4%
13.50% $ 43,844 $ 42,021 $ 40,198 $ 38,375
13.75% $ 42,400 $ 40,631 $ 38,862 $ 37,093
14.00% $ 41,038 $ 39,320 $ 37,602 $ 35,884
14.25% $ 39,751 $ 38,081 $ 36,412 $ 34,742
14.50% $ 38,533 $ 36,909 $ 35,285 $ 33,662
14.75% $ 37,379 $ 35,799 $ 34,218 $ 32,638
15% $ 36,284 $ 34,745 $ 33,206 $ 31,667

$ 19,325 1% 2% 3% 4%
13.50% $ 23,104 $ 21,817 $ 20,531 $ 19,244
13.75% $ 22,358 $ 21,108 $ 19,857 $ 18,607
14.00% $ 21,655 $ 20,438 $ 19,222 $ 18,005
14.25% $ 20,990 $ 19,806 $ 18,622 $ 17,437
14.50% $ 20,361 $ 19,208 $ 18,054 $ 16,900
14.75% $ 19,765 $ 18,640 $ 17,516 $ 16,391
15% $ 19,200 $ 18,102 $ 17,005 $ 15,908

$ 19,472 2% 5% 10% 15%
13.50% $ 33,071 $ 30,113 $ 25,184 $ 20,255
13.75% $ 32,026 $ 29,151 $ 24,361 $ 19,570
14.00% $ 31,040 $ 28,244 $ 23,584 $ 18,923
14.25% $ 30,109 $ 27,387 $ 22,850 $ 18,313
14.50% $ 29,227 $ 26,575 $ 22,155 $ 17,735
14.75% $ 28,392 $ 25,806 $ 21,497 $ 17,188
15% $ 27,599 $ 25,076 $ 20,873 $ 16,669