“Where’s The Beef?” AP’s AWOL at AmeriPath

All the fuss over AmeriPath’s sales price overshadows anatomic pathology services

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REMEMBER THAT FAMOUS TELEVISION commercial from Wendy’s burger restaurants? The elderly lady scrutinizes a big hamburger bun that’s obviously short on meat and asks the seminal question “Where’s the beef?”

In 1984, it was a catch line that captured the American imagination and was repeated everywhere. More than 19 years have passed and people continue to recall it with ease. This was an advertising success of the highest order. That’s because “where’s the beef?” cuts to the essential consumer desire: am I getting my money’s worth from this company?

In studying the unfolding events at AmeriPath, Inc. and its pending sale to Welsh, Carson, Anderson, & Stowe, there’s a critical element—“the beef,”—missing. In all the documents discussing the sale released by all parties and interested observers, I find little mention of how the delivery of anatomic pathology services will be improved to the benefit of physicians and patients—and thereby to the benefit of employees and shareholders.

Imagine! A sophisticated private investment firm is about to pay almost $840 million to purchase a company that offers anatomic pathology (AP) services to its customers—and nowhere is there recognition and discussion about how the sale may affect or benefit this company’s core service.

Focus On Finances

There is certainly plenty of discussion about the valuation of the business, how the proceeds will be distributed to shareholders, and the organizational strategy for the company post-sale. But forgive me for saying this—it seems that “AP is AWOL at AmeriPath.” Like Wendy’s actress Clara Peller and her “Where’s the beef?”, I think it is appropriate to ask “Where’s the AP?”

Not only do the acquisition documents and discussions seem to over- look how anatomic pathology services will be affected, improved, expanded, or supplemented, but another key asset of this company seems invisible.

Just as there is little ink devoted to anatomic pathology services, it is difficult to find any mention of the 400 anatomic pathologists and dermatopathologists employed at AmeriPath. How will they fare from this acquisition? Does the post-merger plan include elements that incentivize them and align them with strategic objectives such as higher quality medicine, improved cash flow, and expanded clinical services?

AmeriPath is the big dog in the anatomic pathology community. It employs 400 pathologists, operates 40 independent hospitals, provides AP services to 200 hospitals, and generated revenues of $478.8 million in 2002. Because of its large size, what happens at AmeriPath has impact on the entire anatomic pathology profession.

Large Case Volume

Because of these facts, AmeriPath has become a trend-setter in its own fashion. With such a large volume of cases, its decisions on test menus, informatics systems, and pricing cause ripples that rock pathology practices in many regions.

So what happens at AmeriPath does matter to the pathology profession. Will its new owners, soon to assume positions on its Board of Directors, bring a newly-intensified focus to core anatomic pathology services? Given the history of the company, that is unlikely.

Remember that AmeriPath was originally designed to be a physician practice management (PPM) company. To build revenues, it would acquire independent pathology group practices. From that revenue base, its value-added contribution is, in theory, to bring sophisticated management, professional sales and marketing, and other business resources to the individual group practices it acquires. The PPM model declares that the business parent brings management expertise to the practice, allowing the physician to concentrate on medicine. Both benefit from this division of labor.

As a PPM, however, AmeriPath launched with a unique difference. Unlike the other PPMs of the day, AmeriPath set out to employ its physicians, not share equity with them.

Away From PPM Concept

Since the well-publicized collapse of the PPM industry in 1998-99, AmeriPath has worked steadily to reposition itself away from the PPM business concept. The company’s press releases now describe it as “a leading national provider of cancer diagnostics, genomics, and related information services.”

But it cannot shake its roots. As a PPM, most of AmeriPath’s value- added comes from accounting constructs, not because it provides a superior menu of anatomic pathology tests and services to its customers that are better than local pathology groups in regions where it competes.

Most pathologists do not under- stand the accounting principles which AmeriPath uses to create value. The formula is basic and simple. Accounting rules allow AmeriPath to buy a pathology group practice at, say, six times the group’s annual net cash flow. It can then write off the goodwill (excess of purchase price over assets) by as much as 40 years.

Within the acquired group, pathologist-partners now become AmeriPath employees. They are paid a salary which is lower than their former share of the annual distributed profits. This arrangement allows AmeriPath to show an accounting “profit” annually from the acquired group’s revenues. The combined costs of the goodwill it depreciates and the group’s salaries and expenses are less than the pre-acquisition partner profit shares and expenses.

If AmeriPath, in its PPM role, does nothing else at this group practice, the accounting constructs allow it to book a profit. It is important to understand this accounting concept. It is the reason why AmeriPath pays a high-end market price for a pathology group and still shows a year-end profit on operations. Essentially, nothing has changed in the pathology group’s annual net revenues, but the pathologists have a big pile of money from the sale and AmeriPath has net cash flow it can declare to its investors.

I believe it is important for pathologists to grasp this essential point: AmeriPath was not founded to bring a better business model to the healthcare community, it was founded to take advantage of accounting constructs which allow it to buy pathology group assets and create “profit flow” that benefits the company immediately.

It’s the difference between the business model Michael Dell created with Dell Computers, now a $34 billion dollar enterprise, or Fred Smith with Federal Express. These individuals created value by bringing consumers a new, different, and/or better service than existed before.

The laboratory world saw a new, added-value business model when Albert E. Nichols, M.D. created the Nichols Institute back in 1973.

The laboratory world saw a new, added-value business model when Albert E. Nichols, M.D. created the Nichols Institute back in 1973. Its unique value-added proposition to customers was to bring cutting edge diagnostic technology to clinicians, backed by academic experts who supported the tests they had developed.

By 1990, Nichols Institute was a $280 million public company. The value of this new business model was validated as a host of other esoteric reference laboratories copied Dr. Nichols’ business model and entered the marketplace.

In contrast to the business models of Dell, Federal Express, and Nichols, AmeriPath organized to take advantage of accounting principles. These principles allow it to buy an asset—a pathology group practice—at a premium market price, and immediately book a profit without further redeployment of that pathology group’s business resources.

Reason To Sell

I would suggest that one important reason AmeriPath’s directors feel the need to sell at this time is that, after six years in the business, they have not quite delivered the value-added to their individual group practices which meet customer needs in a way that gives AmeriPath unquestioned competitive advantage over other pathology service providers. Because it was unable to generate higher levels of additional value from the resources (assets) of the groups it acquired, AmeriPath’s profit margins have disappointed its investors.

This conclusion is supported by a look at AmeriPath’s most recent balance sheet, dated December 31, 2002. On assets of $708 million, it is operating with free cash of less than $1 million. Having minimal amounts of cash constrains management’s strategic options and is probably one reason why a sale is being conducted at this time.

This brings me full circle and back to my opening point. “Where’s the AP?” For any company to enjoy robust success in the anatomic pathology field, it must provide compelling added-value to referring physicians and patients. AmeriPath has yet to find that winning formula that allows it to evolve away from its PPM roots to become a unique added-value source of pathology services.

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