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Morningstar | CROs Poised to Benefit From Biopharma Outsourcing; Syneos Shares Look Most Attractive With $53 FVE

We've transferred coverage of the major late-stage contract research organizations, and our thesis for the industry remains that continued outsourcing from biotechnology and pharmaceutical companies will drive growth for the larger global CROs that help design and conduct clinical trials. We are maintaining our narrow moat and stable trend ratings for Syneos, PRA Health, and Icon, and we've downgraded market leader IQVIA's moat to narrow from wide after reconsidering the company's long-term competitive positioning in both the clinical research and data spaces. Of these four narrow-moat CROs, Syneos looks most attractive in 4-star territory, but we note that it's the only of these CROs with a high uncertainty rating due to its high debt load from the 2017 merger of INC Research and inVentiv Health.

With IQVIA's moat downgrade, we've lowered its fair value estimate to $114 from $118, and we continue to view shares as fairly valued. While we believe that intangible assets and switching costs underpin a narrow economic moat for IQVIA, we no longer have confidence that the firm will earn excess returns for at least 20 years. The company's returns on invested capital were significantly diminished following the 2016 merger of Quintiles and IMS Health, and we do not have high confidence that the firm will maintain its monopolistic hold on aggregated patient data for more than a decade. Contract research organizations and software companies are both increasingly engaging with patient data as it begins to play an increasing role in clinical research and commercialization, and we believe improving technology and interoperability could eventually lower barriers to accessing patient data.

We are maintaining our fair value estimate of $53 per share for Syneos Health, the result of the 2017 merger of INC Research and inVentiv Health. After lackluster growth in quarters following the merger due to some large cancelations, the commercial segment is finally stabilizing, and we like the company's focus on integrated deals that drive revenue for both the clinical and commercial businesses. However, the company took on significant debt for the merger, which could constrain the capital allocation strategy in the near term. We expect Syneos to complete fiscal 2018 with total debt at about 5.6 times adjusted EBITDA, with most of the debt maturities pushed out to 2022 and beyond.

We've raised Icon's fair value estimate to $111 from $106 per share due to a slightly higher growth expectation in the near term. We expect Icon to continue diversifying its revenue base away from client concentration risk from its top client, Pfizer, while maintaining focus on lucrative partnerships with large biopharma clients. Shares remain overvalued, but we like management's disciplined acquisition strategy and solid execution, as evidenced by its higher operating margin and higher adjusted returns on invested capital compared with peers.

We've lowered PRA Health's fair value estimate to $81 from $87 per share after re-examining our long-term cost assumptions and view shares as fairly valued. We still model robust top-line growth and continued margin improvement, but we note that the company has slightly higher exposure to lower-margin staffing solutions than its peers. In 2019, we expect management to roll out its plans for integrating Symphony data with its clinical research solutions.