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French drug giant Sanofi-Aventis S.A. (SNY) has signed a 10-year agreement to outsource research and development services to Covance Inc. (CVD) in a deal that could be worth up to $2.2 billion.

The deal is the latest sign of increased outsourcing by pharmaceutical companies as they seek to cut the costs of searching for new products in the face of looming generic competition for top-selling drugs in coming years. For Princeton, N.J.-based Covance, the deal marks another long-term partnership with a leading drug maker and allows it to expand its European presence.

Under the leadership of Chief Executive Chris Viehbacher, Sanofi has significantly cut back on internal R&D projects, instead favoring alliances and licensing deals with drug developers to fill the product pipeline. He has said it is difficult for a company as large as Sanofi to make efficient use of internal R&D resources.

The move will save "hundreds" of jobs, Sanofi said, as Covance will maintain employment on the sites for at least five years.

In a conference call, Covance Chief Executive Joseph Herring called the Sanofi deal "the largest and most comprehensive drug-development alliance in industry history." It comes as "the pharma industry needs to challenge traditional thinking in order to improve productivity," he said.

Shares of Covance recently rose 11.1% to $46.88. Sanofi shares closed down 1.2% at EUR48.88 in Paris.

Under the deal, Covance will provide services in the fields of toxicology, chemistry and all stages of clinical study development. Payments over the course of the deal will range from $1.2 billion to $2.2 billion. Covance had revenue of $1.96 billion last year, compared to Sanofi's sales of about $40 billion.

Sanofi is also selling R&D sites in Porcheville, France, and Alnwick in the U.K. to Covance for $25 million. The sale is expected to be close by year-end.

The acquired sites give Covance excess capacity for toxicology testing on a company-wide basis, but they will fill a lacking presence in France and southern Europe for such services. Herring expressed hope that the location of the sites will attract increased business with local drug developers.

The deal is Covance's second major partnership with a large pharmaceutical company. In August 2008, it struck a $1.6 billion deal with Eli Lilly & Co. (LLY) to provide broad drug-development services over 10 years and assume control of Lilly's early-drug-development facility and related workers.

Herring said such deals with contract research organizations, or CROs, like Covance will drive research and development outsourcing from the current level of 30% in the pharmaceutical industry to 50% to 70% in coming years.

The biggest CROs, which include Parexel International Corp. (PRXL), Pharmaceutical Product Development Inc. (PPDI), Ireland-based Icon PLC (ICLR, IJF.DB) and privately held Quintiles Transnational Corp., are also involved in strategic relationships with large drug makers. The top five CROs control about 50% of the global market, according to estimates from Wells Fargo.

Covance's purchase of the two site includes $350 million in guaranteed business over five years, which the company will record as a flat $70 million per year over the period. The sites will be profitable immediately, Herring said.

Covance received about $35 million in services revenue from Sanofi last year, but it expects that to rise to $55 million next year at a minimum, meaning total revenue from Sanofi will be at least $125 million.

A "significant ramp" of services revenue is expected for 2012 and 2013, Covance spokesman Paul Surdez said, as clinical trials begin to become active. He declined to elaborate on the level of revenue growth, but said "it has to multiply".

The company will recognize $1.2 billion from the deal in its third-quarter order backlog. Herring expects Covance to realize the full $2.2 billion value of the deal over its life. The remaining billion will be recognized as the underlying work is actually ordered from Sanofi.

Despite the deal's size, Herring expects Covance to maintain a diverse customer base with no single client exceeding 10% of its total annual revenue.

-By Thomas Gryta and Mimosa Spencer, Dow Jones Newswires; 212-416-2169; thomas.gryta@dowjones.com

(Jennifer Cummings contributed to this story)

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