FTC Opposes LabCorp’s Acquisition of Westcliff

At issue is how the acquisition might reduce competition and lead to higher prices in So. Calif.

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CEO SUMMARY: On November 30, FTC commissioners filed an administrative complaint opposing Laboratory Corporation of America’s acquisition of Westcliff Medical Laboratories, Inc., on the grounds that it “violates antitrust laws and would lead to higher prices and lower quality in the Southern California market…” This is the first serious FTC challenge of a clinical lab acquisition since Quest Diagnostics Incorporated announced it would purchase Unilab Corporation in 2002. LabCorp is responding to the FTC’s action.

IN THE PAST 15 YEARS, it has been a rare event for the Federal Trade Commission (FTC) to oppose the acquisition of one clinical laboratory company by another laboratory company.

But that is exactly what occurred on November 30. That’s the day when the FTC issued an administrative complaint against the acquisition of Westcliff Medical Laboratories, Inc., by Laboratory Corporation of America.

“Violates Antitrust Laws”

In public documents, the FTC described the administrative complaint as “charging that LabCorp’s acquisition of Westcliff, which was completed June 16, 2010, violates antitrust laws and would lead to higher prices and lower quality in the Southern California market for the sale of clinical laboratory testing services to physician groups.”

The FTC has established May 2, 2011 as the date for an administrative law judge to commence a trial on this matter. The FTC said it will also take steps to obtain an injunction in federal court “to prevent LabCorp from integrating the Westcliff assets while the case is being tried in the administrative court.”

For its part, LabCorp has gone to the federal bankruptcy court in Santa Ana which oversees Westcliff’s Chapter 11 bankruptcy action. LabCorp filed documents with the bankruptcy court to “seek declaratory and injunctive relief to prevent the Federal Trade Commission from collaterally attacking the Court’s June 9, 2010, Sale Order.”

Thus, it appears that the FTC and LabCorp may be heading for the proverbial Mexican standoff concerning this matter. At issue is whether LabCorp’s acquisition and integration of Westcliff Medical Laboratories into its Southern California operations will lessen competition in the region and thus have anti-competitive consequences for that lab testing marketplace.

Westcliff Medical Laboratories is based in Santa Ana, California. It primarly serves physician clients in Southern California. LabCorp had acquired Westcliff after the financially-struggling lab company filed Chapter 11 bankruptcy last May. (See TDR, June 1, 2010.) LabCorp’s acquisition of Westcliff was completed on June 16, 2010.

At that time, the FTC moved swiftly and directed that LabCorp not integrate Westcliff into its company, but operate it as an independent business until the FTC made a final decision about the anti-competitive issues relating to this acquisition. Nine days later, on June 25, LabCorp agreed to hold the Westcliff assets separate and apart while the FTC investigated the transaction.

Details of the FTC Complaint

In its November 30, 2010, complaint, the FTC wrote: “LabCorp and Westcliff are two of only three vendors of clinical laboratory testing services for the vast majority of physician groups in Southern California, with the other being Quest Diagnostics Incorporated. By eliminating one of only three significant alternatives for most physician groups, the acquisition will result in higher prices and inferior service for physician groups… .”

For this complaint, the FTC defined Southern California as the counties south of and including San Luis Obispo, Kern, and San Bernardino. The FTC stated that the Westcliff acquisition “would leave LabCorp and Quest in control of approximately 89% of the market.”

Effect on Competition

The FTC explained that, if it was determined that LabCorp violated the Clayton Act or the FTC Act, then the federal agency could mandate a variety of remedies. It could: order divestiture; prohibit LabCorp from doing business with Westcliff; require prior notice of any anticipated mergers, consolidations, or combinations of the two businesses; require the filing of periodic compliance reports; or, order any other appropriate relief.

The FTC staff, in researching the facts about the California laboratory testing marketplace and the events leading up to Westcliff’s Chapter 11 bankruptcy, recognized how Westcliff’s competitive marketing efforts had changed under new owners and new executive teams following its acquisition by BioLabs, Inc., in 2006.

Repeatedly in the complaint, the FTC characterized Westcliff, under its new owners and managers, as willing to aggressively pursue capitated contracts with managed care companies and IPAs (independent practice associations). Westcliff was described as a “price-cutting maverick competitor.”

It seems that the FTC considered the rapid growth of Westcliff from 2007 on— when it vigorously used discounted pricing and other differentiators to pursue capitated lab testing contracts—as evidence that Westcliff was a robust competitor during that period.

Westcliff’s Sales Success

In fact, in the complaint, the FTC indicates that Westcliff was winning more managed care contracts than LabCorp during this time period. The FTC noted that: “LabCorp admits that Westcliff has been able to secure over [redacted number] physician group contracts in Southern California in just over three years and that in the same time frame, LabCorp has won [redacted number]. Westcliff’s impressive success rate demonstrates that it has a much greater chance of winning upcoming business than would be implied by its current market share.”

The FTC also wrote that “The Acquisition eliminates a price-cutting maverick. As an upstart competitor seeking to expand its share of physician group business, Westcliff had the incentive to win business by aggressively pricing managed care contracts and did so…

“Westcliff also extended capitated contracts to physician groups that LabCorp and Quest would only service on significantly higher fee-for-service terms. In contrast, both LabCorp and Quest were seeking to increase prices and reduce services to physician groups in Southern California over the same time period.”

The FTC noted that, in Southern California, Quest Diagnostics is the leading vendor and LabCorp is second. It also wrote that, prior to its acquisition by LabCorp, Westcliff was the third-largest provider of lab services in the region and Southern California was its primary market area. The FTC says that the acquisition has an anti-competitive effect because it eliminates “an aggressive competitor” and “a price-cutting maverick.”

Public Documents Inform

The various public documents surfacing on this matter will reflect the different legal arguments that the FTC and LabCorp will put forth in support of their positions. These documents help laboratory executives and pathologists understand the regulatory implications of the FTC’s decision to oppose LabCorp’s acquisition of Westcliff.

One has to go back to 2002 to find a similar action by the FTC involving mergers and acquisitions of clinical laboratory companies. On April 2, 2002, Quest Diagnostics announced an agreement to acquire Unilab Corporation of Van Nuys, California. At this time, Unilab had revenue of $390 million and Quest agreed to pay a purchase price of about $1.1 billion. (See TDR, April 22, 2002.)

FTC Challenged Acquisition

The FTC decided to challenge this acquisition. It took many months for the FTC and Quest Diagnostics to agree on a resolution. Almost one year later, on February 21, 2003, a settlement agreement was announced.

Quest Diagnostics was allowed to acquire Unilab. However, to meet the FTC’s concerns about maintaining competition in Northern California, Quest was required to divest to LabCorp the following: 46 patient service centers (PSCs); five rapid response laboratories; all of Quest’s Northern California contracts with physicians; one Unilab contract with Northern California physicians; plus “all related assets necessary for the provision of clinical lab testing services to such groups, including customer lists and information.” (See TDR, March 3, 2003.)

THE DARK REPORT believes that this current FTC challenge to LabCorp’s acquisition of Westcliff is the first time since 2003 that the FTC has decided to challenge a laboratory acquisition that it views as potentially violating laws relating to anti-competitive business practices. Moreover, the fact that the acquisition involves the California lab testing marketplace may be relevant.

In California, IPAs play a major role in contracting for laboratory testing services. IPAs often prefer capitated prices for lab testing. Many of the same executives who led Unilab prior to its sale to Quest Diagnostics were also working at Westcliff during the years prior to its Chapter 11 bankruptcy.

Déjà Vu on Capitated Prices

At Unilab, this executive team became known for its willingness to offer very low capitated prices as a way to access the IPA physicians’ fee-for-service pull-through business. A similar pricing strategy was instituted at Westcliff between 2007 and 2010.

Thus, it may be that the FTC received complaints from IPAs who—having experienced the higher prices that followed Quest Diagnostics’ acquisition of Unilab since 2003—were wary of similar price increases they expected might follow after LabCorp acquired Westcliff Medical Laboratories.

Regardless of how this case is resolved, the bigger issue is whether the FTC has finally recognized how years of acquisition activity by the nation’s largest lab companies changed the competitive balance in different regions across the country, particularly in the market segment of office-based physician lab test referrals.

FTC’s Complaint in the Westcliff/LabCorp Matter Argues that Westcliff Had Other Business Options

IN ITS ADMINISTRATIVE COMPLAINT issued November 30, 2010, against Laboratory Corporation of America, the Federal Trade Commission (FTC) addressed the issue of Westcliff Medical Laboratories, Inc.’s financial condition at the time of the Chapter 11 bankruptcy filing.

To address the issue of “failing firm” (referring to Westcliff’s Chapter 11 bankruptcy), the FTC laid out its arguments, as follows:

FAILING FIRM

  1. LabCorp’s acquisition of Westcliff is not immunized by the “failing firm” doctrine. That affirmative defense places the burden firmly on defendants to demonstrate that:

(1) the allegedly failing firm faced the imminent prospect of business failure at the time of the acquisition;

(2) that the firm could not have been successfully restructured under Chapter

11; and

(3) that the firm seeking to acquire the failing firm is the only available purchaser. LabCorp cannot meet these strict criteria.

  1. At the time of the Acquisition, Westcliff was generating profits from its operations and had [redacted number] in annualized revenue. Its financial difficulties stemmed primarily from approximately [redacted number] in debt generated by a 2006 private equity deal.

Despite that debt, Westcliff was an attractive business. It was the third- largest independent clinical laboratory in Southern California, and its revenues had increased [redacted number] percent over the preceding two calendar years. As a result, Westcliff had significant enterprise value, and other firms were willing to acquire Westcliff throughout the time that the LabCorp deal was being negotiated.

In these circumstances, LabCorp was not, as it would have to be, “the only available purchaser,” and Westcliff cannot be said to have made, as required, “unsuccessful good-faith efforts to elicit reasonable offers that would keep its tangible and intangible assets in the relevant market and pose a less severe danger to competition than does the proposed merger.” Merger Guidelines §11.

  1. The fact that Westcliff was in Chapter 11 bankruptcy at the time the Acquisition closed does not affect the failing firm analysis. The bankruptcy was not an indicator that Westcliff was failing; rather, it was a specific condition imposed by LabCorp as part of the acquisition.

Further, the fact that an auction was conducted after LabCorp was installed as the “stalking horse bidder” and that no bids were received shows nothing more than that there were no bidders willing to pay the stalking horse price of $60 million or more for Westcliff. Even at that late date, there were a number of firms willing to purchase Westcliff for a consideration above liquidation value.

  1. Under these circumstances, it is unreasonable to conclude that Westcliff would have been liquidated. Westcliff had “minimal” liquidation value, and virtually all of its value was as a going concern. The secured creditors realized that they would not receive any return on their investments if Westcliff had been liquidated, and therefore believed that even if LabCorp did not purchase the company, Westcliff would have been sold to an alternative purchaser, albeit at a lower price.

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