UPDATE 2-Lilly farms out some lab services to Covance

(Adds CEO comment)

NEW YORK, Aug 6 (Reuters) - Eli Lilly and Co (LLY.N) said on Wednesday it reached a 10-year, $1.6 billion lab services deal with testing company Covance Inc (CVD.N) in the latest move by major pharmaceutical companies to cut costs.

The drug development services contract calls for Lilly to transfer responsibility for some toxicology, in vivo pharmacology, quality control laboratory and imaging services to Covance.

In addition, Lilly agreed to a committed level of clinical pharmacology, central laboratory, toxicology studies, and mid-to-late stage clinical trial services.

Covance will pay $50 million to acquire a 450-acre early drug development complex in Greenfield, Indiana, from Eli Lilly, giving Covance 600,000 additional square feet of laboratory space, the companies said.

"For the short- to medium-term, there's not going to be massive change on the site," said Covance Chief Executive Officer Joe Herring during an interview with Reuters.

But he added that over time, Covance plans to expand the site to two or three times its current size.

The Covance-Lilly deal comes after a similar move in late 2007 by Amgen Inc (AMGN.O), which farmed out its clinical field staff to the privately held contract research organization (CRO) Quintiles Transnational Corp.

As large drug makers seek to cut costs in the face of patent expirations for top-selling medicines, they are increasingly farming out clinical testing to CROs like Covance. CROs have seen their shares rise this year against an overall downward trend in healthcare stocks, and analysts expect larger, more diversified research companies to benefit the most from drug makers' troubles.

"Our initial take is extremely positive," said Baird analyst Eric Coldwell in a research note. "This transaction accelerates a trend of major pharmas reducing internal capacity and outsourcing CROs, in order to save time and money in drug development, improve overall infrastructure efficiency and remain competitive in a challenging pharmaceutical environment."

Covance, which has more than 1,000 employees in Indiana, will assume ownership of the site around Oct. 1 and offer employment to its 260 employees.

Shares of Covance were up $5.19, or about 5.7 percent, to $97.01 in late New York Stock Exchange trading, while Lilly shares were up 39 cents, or 0.8 percent, to $48.18. (Reporting by Deepa Seetharaman, editing by Gerald E. McCormick)