DSI Sale Shows Value of Lab Outreach Program

LabCorp’s acquisition of DSI Laboratories confirms a number of laboratory industry trends

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CEO SUMMARY: For other hospital laboratory outreach programs, the pending sale of DSI Laboratories, Inc., of Fort Meyers, Florida, to Laboratory Corporation of America provides useful insights about the market value of these programs. Applying general formulas for determining a sales price, DSI Labs’ $40 million in yearly revenue may have fetched between $40 and $89 million for its owner, NCH Health System.

THERE ARE SEVERAL SIGNIFICANT ASPECTS to the pending sale of DSI Laboratories. Inc., of Fort Meyers, Florida, to Laboratory Corporation of America of Burlington, North Carolina.

First, it is the latest example of a health system choosing to sell its laboratory outreach program in order to raise capital that can be reinvested in other areas of the health system’s primary business: acute and critical care.

Second, the sale demonstrates that LabCorp and Quest Diagnostics Incorporated continue to the primary drivers in the ongoing consolidation of laboratory testing services in the United States. They stand ready and willing to bid aggressively for any attractive laboratory business that comes to market.

Third, the sale demonstrates that outreach labs have substantial capital value for the specimen volume and cash flow they produce. A conservative estimate is that LabCorp will pay between $40 million and $80 million for DSI Laboratories.

Fourth, DSI Laboratories provides an example of how a professionally-managed laboratory outreach program can create a service infrastructure that can equal or exceed that of the national laboratories within that same community.

Fifth, LabCorp’s statement that it will continue to operate its new acquisition under the name DSI Laboratories, Inc., confirms that the national laboratories have finally learned an important lesson. Retaining the name of the acquired regional laboratory helps in retaining clients.

Insights For Lab Directors

For laboratory directors and pathologists currently managing a hospital laboratory outreach program, a study of the DSI–LabCorp deal can be useful in several ways. Probably the most useful insight is that a well-run, professionally managed laboratory outreach program can be a surprisingly valuable asset.

Although neither party to the sale has yet revealed the purchase price, an estimate of value can be developed, using two methods. One method is to take annual sales and multiple that by a factor that reflects recent, comparable sales in the marketplace. Under that approach, DSI’s 2006 revenue of $39.3 million could be multiplied by a factor of no less than one, and as much as two, generating an estimated sales price of as little as $40 million and as much as $80 million.

Determining Market Price

Another method is to calculate cash flow—the amount of income that remains after subtracting the direct cost of testing. EBIDTA (Earnings before Interest, Depreciation, Taxes, and Amortization) is often used as a valuation benchmark. In the case of DSI Laboratories, if cash flow is assumed to be 15% of $39.3 million, that would equal $5.9 million per year.

It is known that, when Quest Diagnostics acquired AmeriPath, Inc. last month, it was willing to pay $2 billion, or 15 times cash flow, for AmeriPath. Use that same multiple for DSI, and 15 times $5.9 million would generate a valuation of $88.5 million for DSI’s outreach business.

These are impressive numbers to a hospital CEO, particularly if the hospital is operating in the red. The ability to convert a laboratory outreach program into cash, ranging from $40 to almost $90 million, certainly can get the attention of the hospital CEO. As noted on pages 3-4, in recent years the hospital owners of both Spectrum Laboratory Network in Greensboro, North Carolina, and Health Alliance in Cincinnati, Ohio, decided to sell their laboratory outreach programs for amounts ranging from $44 million to more than $100 million.

Educating CEOs About Value

THE DARK REPORT recommends that laboratory administrators and pathologists managing laboratory outreach programs should discuss these three sales and valuations with their CEO and CFO. It will help them understand that their laboratory outreach program, besides generating cash flow each year, is building value as a capital asset. This makes it easier to obtain investment funds when the outreach program needs additional equipment or infrastructure in order to grow further.

It should also be noted that representatives from the two blood brothers regularly call on hospitals and health systems with laboratory outreach programs specifically to discuss a potential sale. This was true at DSI Laboratories.

“They [LabCorp] were attracted to DSI,” said Carl Westman, Chairman of the Board of Trustees at NCH Health System, the owner of DSI Labs. “They were very aggressive, I think (that) is a good way to describe their desire to talk with us.”

In fact, over the years, LabCorp made regular visits to NCH and DSI Laboratories to express their willingness to buy DSI Labs. As the timing of this deal shows, NCH wasn’t interested—until the health system began losing money this year. Reports are that NCH could lose between $11 million and $20 million this year.

Operating Under Pressure

Peripherally, LabCorp’s exclusive contract with UnitedHealth was a factor. UnitedHealth has a significant concentration of beneficiaries on the west coast of Florida. LabCorp will add DSI’s 20 patient service centers (PSCs) to the 23 it already operates. That will give LabCorp a total of 43 PSCs in the region.

A final observation about the DSI–LabCorp sale is that NCH Health System will continue to own and manage its two hospital laboratories. In fact, about 120 of DSI Labs’ 400 employees will remain with NCH to staff these laboratories.

The unwillingness of NCH to allow a national laboratory to own or manage, under contract, its hospital laboratories is a reminder that hospital administrators like to maintain control of their laboratory. The insistence by hospital CEOs to control their laboratories is a major hurdle that prevents national labs from developing contracts that allow them to manage hospital laboratories.

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