Animal Testing in Harvard’s Backyard Offering 60% Gain

Selling lab rats may be the next best thing for buyout firms looking for a deal.

Charles River Laboratories International Inc. (CRL), which rose this week on speculation it may put itself up for sale, has a free cash flow yield of 10 percent of its price, according to data compiled by Bloomberg. That’s the highest among publicly traded companies in the U.S. that raise animals for experiments or conduct clinical tests for drugmakers, the data show.

While the Obama administration is trying to get rats, monkeys and other animals out of the drug-approval process, William Blair & Co. says Charles River may entice private equity firms with its unit that sells half of all the animals used in experiments around the world. Buyout funds could take the lab animal unit, which boosted sales in five of the past six years, and a company such as Sigma-Aldrich Corp., which makes chemical indicators in animal trials, could buy its testing division, said Sterne Agee & Leach Inc.’s Greg Bolan. Charles River can get $50 a share in a breakup, or a 60 percent premium, he said.

Selling lab animals “throws off a ton of cash,” which buyout firms would want, Sterne Agee’s Bolan, a Nashville, Tennessee-based analyst, said in a telephone interview. “If you’re a strategic company, and you want to be in pre-clinical in North America, then clearly Charles River would be the business to own. It’s dramatically undervalued.”

Amy Cianciaruso, a spokeswoman at Wilmington, Massachusetts-based Charles River, declined to comment on whether it is considering a sale.

Mice and Men

Founded more than 60 years ago in Boston in a second-floor loft overlooking the namesake river that flows past Harvard University and the Massachusetts Institute of Technology, Charles River sells rats and mice used in medical studies.

It also conducts pre-clinical trials on the animals and counts drug makers such as Pfizer Inc. and Roche Holding AG as customers, according to data compiled by Bloomberg.

Shares of Charles River gained 11 percent this week as DealReporter, citing investment bankers that it didn’t identify, said the company may be exploring a sale.

Before the speculation emerged, Charles River had declined 24 percent in the previous year as sales at its animal-testing unit fell for three straight quarters after contractors built too many labs and drugmakers cut back on early-stage trials, said Tim Evans, an analyst at Wells Fargo & Co. in New York.

“The stock has been depressed because the pre-clinical toxicology business has been under significant pressure,” John Kreger, an analyst at William Blair in Chicago, said in a telephone interview. “It’s sort of a depressed asset.”

Breakup Value

With Charles River generating $3.11 a share in cash from its operations after deducting capital expenses in the past year, the company now has a free cash flow yield of about 10 percent, based on its price of $31.01 yesterday, data compiled by Bloomberg show. That’s more than the average of about 6 percent for three comparable companies cited by Citigroup Inc.

Covance Inc. (CVD) of Princeton, New Jersey, which breeds dogs, rabbits and Rhesus monkeys for experiments and also conducts pre-clinical tests on them for pharmaceutical companies, has a free cash yield of 6.4 percent, the data show.

By valuing its animal breeding and pre-clinical testing businesses separately, Charles River may be worth $50 a share to $60 a share, according to Sterne Agee’s Bolan, who used a sum- of-the-parts model based on estimates for free cash flow growth.

The lab animal unit, which also helps raise and breed live specimens owned by other companies, could alone be worth $40 a share, or about $2 billion, he said. That’s greater than Charles River’s current market value of $1.5 billion.

Animal Testing

“The fair value of the business under a scenario in which they’d get broken up and sold is definitely higher than where it’s trading,” Wells Fargo’s Evans said in a telephone interview. “You essentially allow the value” of the so-called research models and services business to be unlocked, he said.

In a breakup, a buyout firm seeking the cash flows of the animal breeding unit could team up with a company such as Sigma- Aldrich, which would add Charles River’s testing division to the equipment it already sells for those trials, Sterne Agee said.

Sigma-Aldrich (SIAL) said in a statement this week that it would pay $350 million for BioReliance Holdings Inc., its first major move into animal-testing services, according to Dan Arias, an analyst at UBS AG in New York.

Kim Reno, a spokeswoman for St. Louis-based Sigma-Aldrich, didn’t immediately return telephone or e-mail messages seeking comment on whether it is interested in buying Charles River.

LBO Model

A buyout firm could also buy the entire company in a deal worth $60 a share to gain a business with the biggest portion of the research animal market and then sell off the testing unit, according to William Blair. Charles River controls about 50 percent of the $1.4 billion market for so-called animal research models worldwide, according to an estimate from Citigroup.

Still, leveraged buyout firms could be wary of paying up for Charles River because it has $659 million in net debt, more relative to its market value than any of its closest rivals, said Garen Sarafian a New York-based analyst at Citigroup.

“They’re going to look at that debt load, because they usually lever up,” he said in a telephone interview. “In this case, the debt would certainly be taken into consideration.”

The National Institutes of Health and the Defense Advanced Research Projects Agency also pledged as much as a combined $140 million over five years to encourage scientists to find ways of testing drug toxicity using human cells instead of animals.

For Sterne Agee’s Bolan, demand for Charles River’s lab animals will be strong enough to generate the money for interest payments on any additional debt from an LBO, at a time when borrowing costs are close to all-time lows.

“At the end of the day, you probably could get that leverage down very quickly” because of its cash flow, he said. “You have an opportunity to go after an asset that would instantly have 50 to 60 percent of the market, in probably one of the most stable businesses that one could ever think of.”

To contact the reporter on this story: Charles Mead in New York at cmead11@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.

Bloomberg reserves the right to edit or remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.