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Gainesboro Machine Tools Corporation EssayKendle International Inc.We looked at the competitive beautify and, based on what was happening, k naked as a jaybird we were any button to sell Kendle, dumbfound or disappear.It was whitethorn 1997, and Candace Kendle, the chairman and chief executive officer of Kendle International Inc. (Kendle), and her husband Christopher C. Bergen, the hot seat and chief operating officer, were reviewing the strategic options for their Cincinnati, Ohio based c all in aller. Kendle, a commerce they had founded over 15 years previously, conducted clinical psychometric tests for pharmaceutic and ergonomics companies to test the caoutchouc and cleverness of their crude do drugss. The company had grown successfully to $13 one trillion trillion of deals and had attracted significant short letter from major pharmaceutical and bioengineering companies. Kendle was competing, however, with several larger sign up look organizations ( orbit), many of which had an international presence that allowed them to do clinical studies outside the linked States and gave them an advantage when competing for major projects.To compete more effectively, Candace and Chris had embarked on a protrude to grow through acquisition, particularly internationally, and to finance this growth through a overt offering of rightfulness. Toward this end, by the spring of 1997 Kendle had lined up deuce emf European acquisitionsU-Gene, a strike in the Netherlands with 1996 sales of $12.5 million, and gmi, a Germanbased ambit with $7 million in sales. To finance these acquisitions, Kendle had worked out possible debt financing with Nationsbank and was on the job(p) with two investment banks on an Initial Public Offering ( initial public offering) that would repay the bank debt if successful and provide the equity base for future acquisitions. It was now beat to decide whether to go ahead with the full program of two acquisitions, a large debt financing and an equity issue.Kendle HistoryCandace and Chris met in 1979 piece working at The Childrens Hospital of Philadelphia. Candace had veritable her doctorate in pharmacy from the University of Cincinnati, then taught in North Carolina and Pennsylvania. Her scientific specialty was virology. At the Childrens Hospital, Candace was serving as the managing director of pharmacy, working as an investigator on a study of an antiviral drug for the pharmaceutical company Burroughs Well distinguish. Chris, a Wharton MBA, was a senior decision maker at the hospital. research Associate Indra A. Reinbergs prepared this case under the supervision of Professors Dwight B. Crane and Paul W. Marshall as the basis for class discussion preferably than to illustrate either effective or ineffective handling of an administrative situation.Copyright 2000 by the President and Fellows of Harvard College. To order copies or solicit liberty to multiply materials, call 1-800-545-7685, write H arvard Business School Publishing, Boston, MA 02163, or go to http//www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a recuperation system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of Harvard Business School. 1Looking for something new, Candace and Chris began to discuss the idea of going into business together. One day in early 1981 Candace received an unexpected visit from a new physician, replacing the chronic medical monitor for her project with Burroughs Wellcome. This physician was a pioneer in the melt off clinical research business. As he described how his business worked, Candace became more and more intrigued. When he left that day, she immediately called Chris and said, Ive got a business idea The concept was to set up a small research consulting loaded that would take on outsourced research and schooling (RD) work on a contract bas is from large pharmaceutical and biotechnology companies. Based on the positive response she received from potential clients, Candace left her job at the hospital in June 1981 and Chris left his job in declination 1981.Kendle International Inc. was incorporated in Cincinnati, Ohio in 1981, with Candace fetching 55% of the offices, and Chris 45%. Candace had strong ties to the Cincinnati area. Her grandfather, a coal miner, had moved there from Appalachia, and the clan had grown to to the highest degree 140 members, including Candaces two sons from a previous marriage. By January 1982, Candace and Chris were working from Candaces parents home.Kendle started as a small company with a few contracts, and business grew slowly through referrals from professional colleagues. Kendle suffered the usual bumps of a start-up business, particularly in the late 1980s when it suffered a loss for two years and ran up $1 million in bank debt on a $250,000 line of credit. Afraid that its bank wou ld call the loan, the company went through a bankruptcy scare. Fortunately, Kendle succeeded in attracting business from a new client, the pharmaceutical company G.D. Searle Co. (Searle). By the early 1990s, the company was turned around and it generated annual sales of about $2.5 million. Candace and Chris were married in 1991.The pharmaceutical LifecycleThe clinical research play was influenced by government regulations that required drugs to pass through a series of steps before they could be marketed for public use. In the linked States, the Food and Drug Administration (FDA) regulated pharmaceuticals. To receive FDA sycophancy, a drug had to meet safety and efficacy standards for a specific indication (medical diagnosis). A drug for hypertension, for example, would wee to lower blood pressure by a certain statistically significant centre withoutproducing unacceptable side effects. The entire FDA approval process could take from 8 to 15 years and involve several thousand tolerants.1After a pharmaceutical company discovered a new drug and faultless pre-clinical scrutiny on animals in the laboratory, an Investigational New Drug application was filed with the FDA. The drug then passed through three phases of clinical testing on humans. Before beginning each subsequent phase, the drug company had to submit superfluous regulatory information to the FDA. phase angle IPhase I studies were originally concerned with assessing the drugs safety. This initial phase of testing in humans was done in a small issuance of healthy volunteers (20 to 100), such as students, who were usually give for participation.Phase IIOnce Phase I testing had proven the drugs safety, Phase II tested its efficacy in a small number of patients (100 to 300) with the medical diagnosis. It was specifically designed to determine the likely effective dose in patients.Phase IIIIn a Phase III study, the drug was tested on a larger patient population (1,000 to 3,000) at multiple clin ical sites. The purpose was to provide a more thorough understanding of the drugs effectiveness, benefits, and the range of possible adverse reactions. Most Phase II and Phase III studies were blinded studies in which some patients received the experimental drug, while control groups received a placebo or an already approved drug. Once a Phase III study was successfully completed, a pharmaceutical company requested FDA approval for marketing the drug by filing a New Drug Application, which averaged about 100,000 pages.200-033Phase IV Post-marketing testing (of at least 300 patients per trial) was sometimes conducted for high-risk drugs to catch serious side effects (liver toxicity) and monitor them for long-term effectiveness and cost-effectiveness.The pharmaceutical companies traditionally designed and conducted their own clinical trials. They selected the research sites and recruited investigators to conduct the trials of the new drug. Investigators were often medical school prof s at teaching hospitals, tho they could as well be professional investigators who conducted clinical trials at dedicated centers or occasionally regular physicians who ran trials, particularly Phase IV trials, out of their private practices. These investigators then recruited patients, sometimes with the help of the pharmaceutical company, to enrol in the study.After patients were recruited, there was a considerable amount of data collection by the investigators, monitoring of the process and data retrieval by the pharmaceutical company, and analysis of the data to determine whether the statistical criteria for safety and efficacy were met. Finally, there was the mixed process of compiling the data andpreparing the long report for the FDA.The Contract Research BusinessIn the 1970s, large pharmaceutical concerns in the United States began to look for elbow rooms to outsource their clinical testing work as their RD budgets grew. At the beginning, contract research was a small cot tage application and the work was awarded on a piecemeal basis. As Chris recalled, For years, there had been companies conducting animal testing and Phase I, but there was no one managing the entire research and development process. The acronym ambit (contract research organization) did not exist, pharmaceutical companies gave out only small contracts, and did not engender much confidence in for-profit research managers.The growth of the CRO industry was stimulated by pricing pressures on drug companies that led them to try to stir the fixed costs of clinical research into a variable cost through outsourcing. As Chris described,The general problem that drug companies face is balancing a variable workload with a fixed workforce. The problem is that you dont know when the guy in the white lab coat will come running down the hall, beaker in hand, shouting, Eureka, Ive got it, its going to cure disease X. When he does that, you know your workload is going to spike. Your workload is force by the rate of husking, the number of projects killed in vitro and, subsequent to that, how many studies get cancelled due to safety or efficacy problems in human testing. keen CROs like Kendle derived their income solely from the outsourced portion of the RD budget of pharmaceutical clients. In theory, any part of the clinical testing process could be outsourced. magical spell most pre-clinical discovery was conducted in-house by drug companies, the trend in the 1990s was for CROs to receive contracts to manage the entire clinical research piece, especially 3Phases II and III. The whole process was an incredible race against time, as any day for which FDA approval was delayed could cost the pharmaceutical client over $1 million in lost(p) revenues. pharmaceutic contracts ranged in duration from a few months to several years. For multi-year contracts involving clinical trials, a portion of the contract fee was paid at the time the trial was initiated, with the symmetric alness of the contract fee payable in installments over the trial duration, as performance-based milestones (investigator recruitment, patient enrollment, delivery of databases) were completed.Contracts were bid by CROs on a fixed- harm basis, and the research was a labor-intensive business. The contract bids depended on careful estimation of the hourly labor rates and the number of hours each activity would take. The estimation process gnarled statistical algorithms, which similarlyk into account the length of the study, frequency and length of site visits, the number of sites involved, the number of patients involved, and the number of pages per report form. A premium would be added for more complicated therapeutic testing. As the chief financial officer Tim Mooney described the business,The way that Kendle makes money is like any professional service strongWe focus on maximizing labor utilization, especially at the running(a) level. We assume a 65% to 70% utilization rate, s o profit margins are high if we have a higher utilization rate of personnel. We have the same assumed profit margin on all levels of people, but we can charge higher rates for contracts where we have specific therapeutic expertise that is in demand. Margins can also be higher on some large projects when we can share overhead costs across more sites. The business of contract research entailed several types of business risk. With contracts running at an average of $1 million for companies of Kendles size, client dependence was a major risk. Project cancellation by the client and change orders to reduce project costs werealso increasingly frequent in the CRO industry, as healthcare cost pressures intensified. On the other hand, product liability for medical risks was borne by the pharmaceutical company.Competition in the 1990sBy the mid-1990s, contract research had evolved into a full-service industry, recognized by both(prenominal) the pharmaceutical/biotech industries and the finan cial community. In 1995, worldwide spending on RD by pharmaceutical and biotechnology companies was estimated at $35 billion, with $22 billion spent on the type of drug development work that CROs could do. Of the $22 billion, only $4.6 billion was outsourced to CROs in 1995. eon RD spending by pharmaceutical companies was growing at 10% a year, CROs were growing at twice that rate.2 Specialized CROs could manage increasingly complex drug trialsin the previous decade, the number of procedures per trial and average number of patients per trial had doubledfar more efficiently than their pharmaceutical clients.3Kendle participated in this growth in clinical research. Its net revenues grew 425% from $2.5 million in 1992 to $13 million in 1996. From a loss of $495,000 in 1992, its net income rose to $1.1 million by 1996. By 1996, Kendle had conducted clinical trials for 12 of the worlds 20 largest pharmaceutical companies. Kendles three largest clients were G.D. Searle, Procter Gamble, and Amgen, which generated 48%, 19%, and 13% of Kendles 1996 revenues, respectively. (See attests 1 and 2 for Kendles income statements and balance sheets.)2 J.C. Bradford Co., analyst report, January 15, 1998, pp. 5-6. 3 The Economist, Survey of the pharmaceutic Industry, February 21, 1998, p. 4.200-033The contract research industry was very fragmented, with cardinals of CROs worldwide. In the 1990s, in response to the increased outsourcing of pharmaceutical RD, and a demand for global trials, consolidation among the CROs began. A few key players emerged and went public, creating a new industry for Wall Street to watch. Many CRO start-ups were founded by originator drug company executives who decided to form their own operations. After a period of internal growth, some of the start-ups began growing through a financial roll-up strategy. An industry publication listed 18 top players in North America, with aggregate contract research revenues of $1.7 billion. The top quin publi c companies, ranked by 1996 revenues, were Quintiles Transnational Corp. ($537.6 million), Covance Inc. ($494.8 million), Pharmaceutical Product Development Inc ($152.3 million), ClinTrials Research Inc. ($93.5 million), and Parexel International Corp. ($88 million).4 (See Exhibit 3 for recent sales and profit data on CROs.)With its talent pool of scientists at the Research Triangle and U.S. headquarters of the pharmaceutical giants Glaxo and Burroughs Wellcome (later merged as Glaxo Wellcome), the state of North Carolina quickly became the center of the burgeoning CRO industry. Two of the big five companies, Quintiles and Pharmaceutical Product Development, were started there by academic colleagues of Candaces. Quintiles Transnational was considered to be the gold standard of the industry. Quintiles was founded in 1982 by Dennis Gillings, a British biostatistician who had worked at Hoechst and was a professor at the University of North Carolina, where Candace completed her postdoct oral work. After raising $39 million in a 1994 IPO, Quintiles went on an acquisition spree, adding other professional service businesses. For example, the firm provided sales and marketing services to support the launch of new drug products. By the end of 1996, Quintiles was the worlds largest CRO, with 7,000 employees in 56 offices in 20 countries. A typical clinical study managed by Quintiles was conducted at 160 sites in 12 countries, involving 10,000 patients. Quintiles was more diversified than many of its CRO competitors, with about 65% of revenues derived from thecore CRO business and 35% from other services.5 Pharmaceutical Product Development (PPD) was founded in 1989 by Fred Eshelman, a colleague of Candaces from the postdoctoral program in pharmacy. Like the founder of Quintiles, Eshelman had worked in drug research for several pharmaceutical firms, including Glaxo and Beecham. PPDs revenues jumped viosterol% between 1990 and 1994, based on such work as multi-year contra cts for AIDS research for the National Institutes of Health. PPD conducted a successful IPO in March 1996, with its received jumping from $18 per share to $25.50 per share on the beginning off day of trading. PPD bought a U.K. Phase I facility in November 1995, and in September 1996 merged with another leading CRO. Their combined net revenues exceeded $200 million.Kendle at the CrossroadsTo Candace and Chris, it was clear that certain competitive capabilities were necessary for companies of Kendles size to compete successfully with the major CROstherapeutic expertise (in specific medical areas) blanket(a) range of services (pharmaceutical companies wanted to work with fewer CROs, with each offering a wide range of services across multiple phases of the RD process)integrated clinical data management (the ability to efficiently collect, edit and analyze data from thousands of patients with diverse clinical conditions from many geographically dispersed sites)4 Annual insure Leading CROs, RD Directions, September 1997, pp. 28+. 5 William Blair Co. LLC analyst report, Quintiles Transnational Corp., June 20, 1997, p. 3.international, multi-jurisdictional presence (to speed up drug approval, tests were being launched in several countries at once)With the riddance of international presence, Candace and Chris felt comfortable with their ability to meet these criteria. Kendles staff had scientific expertise in multiple therapeutic areas, including cardiovascular, central nervous system, gastrointestinal, immunology, oncology, respiratory, wasted disease and inflammation. The company also had broad capabilities, including management of studies in Phases II through Phase IV. It did not consider the absence of Phase I capabilities to be an issue, since this activity was quite separate. (See Exhibit 4 for a comparison of CRO geographical locations.)To build an integrated clinical data management capability, Chris had directed the development of TrialWare, a proprieta ry software system that allowed global data collection and processing and the integration of clinical data with clients in-house data management systems. TrialWare consisted of several modules including a database management system that greatly reduced study start-up costs and time by standardizing database design and utilizing scanned image technology to facilitate the design of data doorway screens, the point-and-click application of edits from a pre-programmed library, and workflow management (parallel processing). Other modules included a system that coded medical history, medication and adverse event data and a touch-tone ring system that was used for patientrandomization, just-in-time drug supply and collection of real-time enrollment data.Against the back fell of a changing industry, Candace and Chris felt the need to develop additional business skills and focus Kendles strategy. To clarify their management roles, Candace and Chris switched their existing responsibilities. Chris pointed out, Candace became CEO as we realized that her focus was long-range and I took over as of import Operating Officer to focus on the short-range. In addition, the marketing strength of our competitors was propelling them further and further ahead of Kendle. Candace brought her science background and entrepreneurial skills, while I brought my management. The problem was that we were relatively weak in sales and marketing. To broaden their skills, Candace went off in 1991 to the Owner/President Management Program (OPM), an executive tuition program run by Harvard Business School for three weeks a year over three years. Chris followed her to OPM in 1994.After completing the OPM program, Candace assessed the situation, We have to be big enough relative to our competitors to take on large, international projects. When Searle was looking for CROs for international work, all we could do was possibly subcontract it out to small shops. In contrast, Quintiles had six overseas o ffices of its own. Furthermore, when Searle calls and says, I just got off the phone, Quintiles will cut their price by a million dollars, if youre too small, youre not going to be able to respond to that.Candace and Chris realized that Kendle could not grow fast enough internally to keep up with its peers and did not have the change for acquisitions. They entertained the thought of selling Kendle, and were set outed several times about a sale. But by nature, they were a competitive, athletic couple. Chris got up to play squash both morning at 7 AM, and Candace was an avid rower, recently winning a gold medal in a Cincinnati regatta. Perhaps not surprisingly, Candace and Chris decided to grow the firm and take it public rather than sell. As Candace described their motivation, We were not driven to be a public company as such, but earlier to be bigger, and for this, weneeded public financing to succeed in the new competitive landscape. The whole target was not to let the big guys get too far out ahead of us.Preparations for GrowthBy 1994, Kendle had grown to $4.4 million in revenues. Candace, the driving force throughout the IPO process, sought advice from an old college friend, a well-known Cincinnati businessman. He advised her, before you go public, practice being a public company. Candace therefore formulated a plan for Kendle to go public in 1999. Kendle began hiring key managers to build up functional units. Between 1994 and February 1997, new directors of clinical data management, information technology, biostatistics, finance, mergers and acquisitions, regulatory affairs, and human resources were hired. As Chris described, the plan was to institutionalise this infrastructure in place to look and act like a public company communications, IT, finance. The idea was hire at the top and theyll fill in their organization. Many of these new managers had previously worked together at other companies. To prepare for Wall Street scrutiny, Kendle began issuin g internal quarterly financial statements and sharing them with employees in an open-book management style. Candace and Chris tried to make the growing number of employees feel like part of the family in other ways, too. The Kendle photo gallery displayed professional portraits of employees with their favorite hobbies. In 1995 Chris led the development of a corporate mission statement and a document on strategic plans that was shared with all employees.Kendle was organized in a matrix fashion (see Exhibit 5 for organizational chart). Each department was treated as a strategic business unit (SBU) witha director who established standards and carried profit responsibility. At the same time, each research contract was managed by a project manager who assembled a team from across the various SBUs.clinical trials involved five functional SBUs at Kendle1. Regulatory Affairs recruited investigators, helped them with FDA registration forms, and obtained approval from ethics boards. Regulator y Affairs maintained a database of 5,000 investigators.2. Clinical Monitoring sent clinical research associates (CRA) out to the testing sites (every 4 to 6 weeks) to enforce Good Clinical Practice regulations. The CRAs were typically young, single health care professionals who spent a significant amount of their time on the road. The CRA would collect data from investigators, resolve queries generated by Clinical Data Management, and promote patient enrollment.3. Clinical Data Management produced a locked database that could be submitted to the FDA. Data from case report forms were in set into a computer system and cleaned through a manual review of the forms and an automated check of the databases. The challenge was to lock a database quickly while maintaining data quality.4. Biostatistics would unblind the locked database and analyze it to determine if the data confirmed that the test results met the criteria for safety and efficacy. Biostatistics also defined the scope of new s tudies.5. Medical Writing generated the truckload of paper submitted to the FDA for a New Drug Application, including a statistical analysis, a clinical assessment, preclinical and clinical data, a description of the manufacturing process, and the supporting patient documentation.1996 The celecoxib Study, Filing Preparations, and European acquisitions 1996 was a busy year for Candace, Chris, and Kendles new management team. They concurrently began conducting a major drug study, working with underwriters on IPO preparations, and looking for overseas acquisition targets. In 1996 Kendle managed 62 clinical studies at 4,100 sites involving approximately 20,000 patients. Celebrex StudyIn January 1996, Kendle began working on a major drug called Celebrex (celecoxib). Its client Searle was engaged in a neck-and-neck race with Merck, the largest U.S. drug company, to be the first to market a COX-2 inhibitor. A COX-2 inhibitor was a new type of anti-inflammatory drug that promised low inci dence of bleeding ulcers in long-term, high-dosage users such as arthritis patients. The Searle-Merck race was closely followed in the business press. Searle awarded the international portion of the Celebrex contract to another CRO, since Kendle only had facilities for testing in the United States. However, Kendle did win the contract to conduct all the U.S. Phase II and III trials. The Celebrex contract was a huge feather in our cap, recalled the chief financial officer. In order to beat Merck, we worked very hard and kept compressing the timelines.To head the Celebrex project, Kendle hired Bill Sietsema, PhD, as assistant director of clinical research. A therapeutic expert in skeletal diseases and inflammation, Sietsema had worked at Proctor Gamble for 12 years. While Sietsema served as overall program director, Chris acted as the operational project manager, meeting with his Searle counterpart in Chicago on a monthly basis. In early 1997, Kendle also set up a new regional office in Chicago, close to Searle headquarters. For Kendle, the Celebrex project was a chance to show what we could do and to develop a reputation as a leader in the field of skeletal disease and inflammation. Kendle actively helped investigators recruit arthritis patients, running television advertisements, directing engageed volunteers to a call center. Three hundredinvestigators enrolled over 10,000 patients, producing over one million pages of case report forms.Most importantly, through close integration of information systems with Searle, Kendle was able to beat an industry standard. preferably of taking the typical six months to one year, the time span between the last patient in Phase II and the first in Phase III, which began in June 1996, was only 22 days.Preparation for SEC FilingBy the time the Celebrex program rolled around, Candace and Chris felt that they strength have to go public earlier than intended because of the competitive landscape. The new chief financial office r, Tim Mooney, took a leading role in the preparations. Prior to joining Kendle in May 1996, Mooney had worked as CFO at The Future Now, Inc., a computer reseller and Hook-SupeRx, a retail drugstore chain. At Kendle, Mooney replaced the controller with an audit manager from Coopers Lybrand to beef up his staff. Mooney also led the building of many of the other financially related departments at Kendle.To act as the lead underwriters on the IPO, in August 1996 Mooney chose two regional investment banks, Chicago-based William Blair Company, L.L.C., which had handled the 1995 IPO of Kendles competitor Parexel, and Wessels, Arnold Henderson from Minneapolis. William Blair began putting Kendle through the paces of preparing to file a preliminary prospectus with the U.S. Securities and Exchange Commission (SEC). The process of going public generally took from 60 to 180 days. One of the key steps in the process was the conversion of Kendle from a subchapter toilet to a C corporation at the time of the IPO. (Subchapter S corporations were entities with 35 or fewer shareholders that were treated like partnerships for tax purposes. Corporate income tax was passed through tax-free to the owners who then paid personal income taxes due.)U-GeneIn October 1996 Mooney hired Tony Forcellini, a former colleague, as director of mergers and acquisitions (MA). Tony had worked at Arthur Andersen in the tax department, and then as a treasurer at Hook-SupeRx with Mooney. The search for European acquisition targets was mainly conducted by Candace and Tony Forcellini, with back-up support by Tim Mooney and Chris. All the while, Chris and Bill Sietsema were working away on the Celebrex program. Forcellinis first decision was easywhether to pursue an offering memorandum that landed on his desk shortly after he arrived. The company for sale was U-Gene Research B.V. (U-Gene), a CRO based in Utrecht, the Netherlands. U-Gene was represented by Technomark Consulting Services Ltd. (Technom ark), a London-based consulting firm uniquely specializing in the healthcare industry. Technomark had an extensive database on European CROs and was primarily in the business of matching its pharmaceutical company clients trials with appropriate European CROs, but it also had a small investment banking division.U-Gene, a full-service CRO, was an attractive target for Kendle. The menace capitalist owners were actively looking for buyers. With a 38-bed Phase I facility in Utrecht and regional offices in the United Kingdom and Italy, U-Gene could increase both Kendles service offering and geographic presence. Since its founding in 1986, U-Gene had served more than 100 clients, including 19 of the worlds largest pharmaceutical companies. In 1996, U-Gene participated in 115 studies at approximately 500 sites involving approximately 4,700 patients and recorded net revenues of $12.5 million, a 37% increase over the front year, and operating profit of $1.3 million, a 47% increase over the prior year. Because of its U.K. and Italian offices, U-Gene viewed itself as on the way to becoming a pan-European CRO.(See Exhibit 6 for U-Gene financial statements.) With momentum building, in November 1996, Forcellini seized upon U-Gene as Kendles possible inlet into Europe and submitted a bid, offering cash and private stock. Unfortunately, Kendle lost out on this bid to a competitor, cooperative Clinical Research, Inc, as U-Genes owners either wanted a full cash deal or stock from a public company. Collaborative was a competitor slightly larger than Kendle ($25.7 million in revenues) that had gone public in June 1996 and had established a software partnership with IBM. Although it had access to investigators outside the United States, Collaborative also viewed U-Gene as the origination of a European presence. On February 12, 1997 Collaborative announced that it had signed a letter of intent to acquire U-Gene in exchange for 1.75 million newly issued shares.While this put Ke ndle out of the picture, the prospects of a deal were not completely killed. On the same day, February 12, 1997, Collaborative also announced that its first-quarter 1997 earnings would be significantly down the stairs expectations. On the close day, on analyst speculation that a major client contract had been lost, their stock fell by 27.3%, closing at $9.00.6 This put Collaboratives UGene deal in jeopardy.Underwriter ConcernsAbout two weeks after Collaboratives announcement, on February 25, 1997, another CRO, ClinTrials, also suffered a drop in stock price. ClinTrials stock lost more than half its market value,dropping 59%, to $9.50 per share. The fall began when an analyst from Wessels Arnold downgraded the ClinTrials stock to hold from buy, citing a number of key management departures, and continued after ClinTrials announced that its first-quarter earnings would be half its year-earlier profit. The reason for the unexpected earnings decline was the cancellation of five project s totaling $37 million, with the misfortune of even lower earnings due to an unresolved project dispute with a client.7 ClinTrials negative performance began to affect other CRO stocks, including that of Quintiles.8With client assiduity an issue in ClinTrials stock performance, William Blair developed doubts about the timing of Kendles IPO. Although Kendle was close to filing its preliminary prospectus, on the day after ClinTrials stock dropped, William Blair analysts had a meeting with Kendles management and told them that they had decided to withdraw as lead underwriters in the IPO.Candace was resolved to keep going. She said, Theres no way out of the concentration issue. We cant buy our way out of it, because we cant do MA deals until we have a public currency, and every day Searle is bringing us more work, we wont tell them no. She then asked Mooney to find new investment bankers, and he thought, what am I going to do now? Hoping for a lead, Mooney called up a former security analyst from Wessels Arnold who had gone to work at Lehman Bros. Although Kendle was smaller than Lehmans usual clients, Lehman agreed to underwrite Kendles IPO, with the reassurance that we think we can sell through the client concentration issue. After an agreement with New York-based Lehman was reached, Mooney searched for a regional firm because, as he decided, I didnt want two New York-size egos. J.C. Bradford, based in Nashville, Tennessee, had a good reputation in the industry, and struck us as a nice regional bank. They were more retail-oriented than institutional-oriented, so they wouldnt directly be competing with Lehman in types of clientele. Bradford had managed the IPO of the first large CRO to go public (ClinTrials, in 1993) and Lehman had led the IPO of PPD in January 1996.Gmi and U-Gene revisitedAt the same time, Forcellini was moving ahead on the acquisition search. In January 1997 he tasked Technomark with using its CRO database to generate a list of possible Europ ean acquisition targets that met the following criteria ideally a CRO with United Kingdom headquarters $5 million to $7 million in revenues no Searle business certain types of therapeutic expertise strong in phases II through IV and certain dry land locations. The initial list had 50 European CROs, which Kendle narrowed down to 14 prospects. Technomark then contacted these 14 prospects to sound out their willingness to sell, bringing the number down to five candidates three CROs in Germany, two in the United Kingdom, and one in the Netherlands (not U-Gene). To assess the prospects, Kendle used information from Technomark on comparable MA deals.Candace and Tony Forcellini then travelled around Europe for a week visiting the five companies. They decided to further pursue two companies a small, 15-person monitoring organization in the United Kingdom and one in Germany. The U.K. prospect was quickly discarded because of an aggressive asking price and accounting problems. Kendle then mo ved on to the German target, a company named gmi. Its full name was GMI Gesellschaft fur Angewandte Mathematik und Informatik mbH. Founded in 1983, gmi provided a full range of Phase II to IV services. gmi had conducted trials in Austria, the United Kingdom, Switzerland and France, among other countries, and had give birth in health economic studies and7 ClinTrials Predicts Sharply Lower Profit Shares Plunge 59%, The Wall Street Journal, February 26, 1997, p. B3. 8 David Ranii, Investors avoiding Quintiles, The News Observer, Raleigh, NC, February 27, 1997, p. C8.professional knowledge programs. In 1996, gmi participated in 119 studies at multiple sites and recorded net revenues of $7 million, a 32% increase over the prior year, and operating profit of $1.4 million, a 16% increase over the prior year. At March 31, 1997, gmis backlog was approximately $9.6 million. gmi considered itself to be especially good at Phase III trials. (See Exhibit 7 for gmi financial statements.)While C andace and Forcellini were narrowing down European targets, Mooney was hunting for cash. In February 1997 Kendle met at a special lunch with its existing bankers, Star desire (later renamed Firstar), in Cincinnati. Mooney recalled the conversation vividly After Candace and Chris described their plans, Star Banks CEO made a proposal, If you keep Kendle a private company and avoid the hassles of being public, well lend you the money you need for acquisitions. With the financing in hand, Candace and Forcellini visited gmi in Munich. While gmis owners were willing to talk, they did not have much interest in selling. As Mooney described it, gmi was a classic case of having grown to a certain size, had a comfortable level of income, but werent evoke in putting in the professional systems to grow beyond that level. After several conversations in March, it was not clear that Kendle and gmis owners would be able to reach a mutually agreeable price.At this point in early April 1997, the pos sibility of U-Gene as an acquisition candidate heated up. After the U-Gene deal with Collaborative Research began to collapse, Kendle had initiated a carefully structured inquiry about U-Genes interest in renewed discussions. This inquiry led to further discussions and a request in April for Kendle to meet in Frankfurt to try to reach an agreement. With the gmi deal in doubt, Kendle agreed to try to reach closure with U-Gene. After some discussion, both sides agreed on a price of 30 million Dutch guilders, or about US$15.6 million, $14 million of which would be paid in cash, and the be $1.6 million would be in the form of a promissory note payable to the selling shareholders.U-Gene wanted to complete the transaction within the next several weeks, so it would have to be financed at least initially by sweep upings. Even if Kendle went ahead with an IPO, the equity financing would not be completed until the end of the summer.Discussions with gmi continued through this period since Ke ndle was confident about its ability to obtain financing from Star Bank. Ultimately, Kendles team was able to agree upon a price with gmi. The owners were willing to accept a price of 19.5 million Deutsche marks, or about US$12.3 million, with at least $9.5 million in cash. They would accept shares for the remaining $2.8 million, if Kendle successfully completed an IPO. The owners were willing to hold off the deal until the IPO issue was resolved.Closing the Deals and IPO DecisionTo complete both the U-Gene and gmi deals, Kendle would need to borrow about $25 million to $28 million, so financing became critical. Mooney went back to Star Bank to take the bankers up on their promise. He described their reaction Star Bank said they couldnt lend $28 million to a company that only has $1 million in equity. Nobody did that. They might be willing to finance one acquisition, with the help of other banks, but there was no way that they would provide $28 million. Mooney was quite angry, but h ad no choice but to look for other sources of financing. He first tried to get bridge financing from Lehman and Bradford, but they refused, saying that they had gotten killed on such deals in the 1980s. There was also a possibility of financing from First Chicago Bank, but this did not materialize.Finally, in late April 1997, Mooney contacted NationsBank, N.A., which was headquartered in Charlotte, North Carolina and provided banking services to the CRO industry. Nationsbank expressed interest, but only in a large deal. Even $28 million was a small amount to Nationsbank. In 11a few short weeks, Nationsbank ended up structuring a $30 million credit for Kendle, consisting of a $20 million, three-year revolving credit line and $10 million in five-year, subordinated notes. The interest rate on the credit line was tied to a money market base rate plus 0.50% (currently totaling 6.2%), and the subordinated debt carried a 12% rate. So NationsBank stepped up in a pretty big way. They could h ave ended up with Kendle as a private company, with $30 million in debt. Because of the risk, Nationsbank would also take warrants giving the bank the right to purchase 4% of Kendles equity, or up to 10% if the IPO was delayed and Kendle had to borrow the full amount to do both acquisitions.Lehman Brothers was confident about an IPO. The underwriters felt Kendle could raise $39 million to $40 million at a price between $12 and $14 per share, and that Candace and Chris could sell some of their shares as well. Premier Research Worldwide Ltd., a CRO with $15.2 million in 1996 revenues, had raised $46.75 million from its recent IPO in February 1997. Kendle felt they had a much better track record than Premier.Kendle now faced some difficult decisions. It could do the full program, including both acquisitions, taking the $30 million Nationsbank deal, and planning for an IPO in late summer. The successful acquisitions of gmi and U-Gene would establish Kendle as the sixth largest CRO in Eu rope, based on total revenues, and one of only four large CROs able to offer clients the full range of Phase I through Phase IV clinical trials in Europe. The pricing on the two acquisitions of 8 to 10 times EBITDA seemed in line with recent CRO deals (see Exhibit 8). And, once the IPO was completed, Kendle would have both a cash cushion and stock as a currency to help finance future growth and acquisitions. Assuming an IPO of 3 million new shares at a price of $13.00, Kendle would have a cash position of about $14 million and no debt in the capital structure. (See Exhibits 9 and 10 for pro formaincome statements and balance sheets showing the impact of the acquisitions and the IPO.) A related issue was how many of their shares Candace and Chris should sell if an IPO were done. Their current thinking was to sell 600,000 shares. Thus, a total of 3.6 million shares would be for sale at the time of the IPO, including a primary offering of 3 million shares and a secondary offering of 60 0,000 shares. This sale would reduce holdings controlled by Candace and Chris from 3.65 million shares (83.1% of the shares currently outstanding) to 3.05 million shares (43.4% of the new total outstanding).Doing the full IPO and acquisition program, however, was unprecedented among Kendles peers. Nobody does this combination all at oncean IPO, senior- and sub-debt financing, and MA deals, as Mooney described the situation. Furthermore, the stock prices of public CROs had been falling since last February (see Exhibits 11 and 12 for stock market valuation and price information). If Kendle bought into the full program and the market crashed or the IPO was unsuccessful, the company would have almost $30 million of debt on its books with a very modest equity base. Perhaps it would be better to do just the U-Gene acquisition and use Star Bank to finance it. After completing this acquisition, it could then pursue the IPO. This approach was safer, but of course Kendle might miss the IPO wi ndow and miss the opportunity to acquire the second company. Indeed, instead of discouraging Kendle from doing an IPO, the fall in CRO stock prices might be taken as a signal that Kendle should forge ahead before the window closed completely.