Memphis Path Lab JV Purchased By AEL

Hospital lab-commercial lab joint venture ends with sale to American Esoteric Labs

CEO SUMMARY: Memphis Pathology Labs’ two hospital owners and their JV partner, MDS, surprised many with the sale of the lab venture to American Esoteric Laboratories (AEL). It’s the end of a successful joint venture between several hospitals and a commercial laboratory company. It also positions AEL to use Memphis as a base to market its reference and esoteric tests to hospitals and physicians’ offices.

ANOTHER JOINT VENTURE between hospitals and a commercial laboratory company ended last month when American Esoteric Laboratories, Inc. (AEL) purchased Memphis Pathology Laboratory (MPL).

In purchasing MPL, American Esoteric Laboratories cashed out the three partners in the laboratory joint venture: MDS, Inc., Baptist Memorial Health Care, and Methodist Healthcare. The sale was announced on September 24, 2004, the day when AEL took control of the laboratory.

For its ownership share, MDS was paid US$20.4 million. Neither Baptist nor Methodist disclosed the prices paid for their shares in the laboratory joint venture.

The sale of MPL to American Esoteric Laboratories is significant for several reasons. First, it marks another step in the withdrawal of MDS, Inc. from the laboratory marketplace in the United States. Second, with its purchase of MPL, American Esoteric Labs shrewdly gains a major laboratory asset in one of the nation’s best transportation hubs.

Third, by deciding to sell their shares of a laboratory joint venture that included what outsiders considered to be a profitable and growing outreach program, hospital administrators again demonstrate that they consider such enterprises to be complex and a distraction from their core business, which is managing acute care hospitals.

Fourth, because the buyer is a new laboratory company, the willingness of MPL’s existing owners to sell to this entity shows that a credible laboratory business start-up can gain traction quickly in the marketplace. Also, since the sellers selected AEL to be the buyer, that decision implies that other bidders for Memphis Pathology Laboratories may have been viewed as having certain strategic conflicts in how they would develop MPL’s assets going forward.

AEL Acquires MPL

To understand why the MPL acquisition is a coup for AEL, it is necessary to review this infant lab company’s business strategy. American Esoteric Laboratories launched operations in August, 2003. It has $70 million in venture capital funding and a bank credit facility.

Over the past fourteen months, it acquired three small specialty laboratory companies. It also began construction of a central laboratory in Dallas. It expects this lab facility will become operational in November.

In an exclusive interview with THE DARK REPORT earlier this year, AEL Chairman and CEO Brian Carr laid out a simple business strategy. AEL wants to be a national provider of high-end reference and esoteric testing to hospitals and office-based specialist physicians. (See TDR, April 26, 2004.)

Central Lab In Dallas

It selected Dallas as the location for its central lab facility because of the city’s excellent air service, with direct flights daily from the major population centers of the United States. AEL’s first three acquisitions involved lab companies that specialized in coagulation, virology, and molecular-based assays. Each lab is located in Texas and can be easily folded into the new Dallas facility.

In contrast, MPL is neither a specialty lab company nor located in Texas. Nonetheless, AEL believes its acquisition of Memphis Pathology Laboratories brings it, in a single transaction, several important business advantages.

“Acquiring Memphis Pathology Laboratories jumps our business plan forward by seven or eight steps,” said Brian Carr, Chairman and CEO of AEL. “Over the course of its 40 years of operating experience and business success, it has created several valuable assets.

“To support AEL’s national testing program, MPL provides an interesting capability in both test menu and logistics,” explained Carr. “Let me explain. Within the hospital marketplace, the reference testing needs of larger, urban hospitals are different from smaller hospitals, particularly those in rural areas. The logistics challenges are also different and we believe our labs in Dallas and Memphis are well-suited to serve these differences.

Send-Out Test Mix

“Larger hospitals are generally located in urban areas. They tend to perform many common reference tests internally. The specimens they refer out are thus primarily complex reference and esoteric tests,” he explained.

“Our Dallas laboratory is designed to provide this menu of high-end reference and esoteric tests,” said Carr. “Because there are multiple direct flights daily from the nation’s larger urban centers to Dallas, AEL has the capability to transport these specimens directly into our Dallas lab and provide excellent turnaround times for those hospital laboratory clients.

“In contrast to the rather sophisticated reference/esoteric testing needs of larger hospital labs, the specimens referred for testing by smaller hospitals generally involve more routine types of reference and esoteric tests. This is a consequence of their patient mix. Patients with complex diseases and severe health problems are typically referred by smaller hospitals and rural hospitals to the tertiary care centers in their region.

“Memphis Pathology Laboratories is perfectly positioned to serve this market segment in both logistics and test menu. Memphis has the logistics hub for Federal Express. It also is the third largest logistics hub for UPS. These companies pick up packages from nearly every population center in the United States, whether small or large. This gives AEL the ability to move specimens quickly from small hospitals and rural hospitals into the laboratory at MPL.

“For the most part, these specimens can be tested at MPL in Memphis. That’s because MPL already performs a wide menu of reference and esoteric testing for the hospitals owned by Baptist and Methodist,” added Carr. “Any specimens received in Memphis that require complex reference or esoteric testing will be forwarded to our Dallas laboratory.”

Competitive Advantages

“We believe this system will give us two competitive advantages,” observed Jim Billington, AEL’s President and COO. “One is speedy, reliable transport of specimens into our laboratory, whether from an urban center or a rural town, allowing us to provide a fast turnaround time on test results.

“The second advantage is a full test menu of reference and esoteric assays, without redundancies, across our Dallas and Memphis laboratories,” he commented. “We should be cost-competitive while offering high quality results and in-depth clinical expertise.”

Even as AEL recognized how Memphis Pathology Laboratories could provide it with the capability of providing targeted and more intense services to smaller and rural hospitals, it did not overlook other assets. “MPL brings us a top-flight lab operations and clinical lab services team,” stated Carr. “Every laboratory knows how tough it is to find and recruit talent in today’s laboratory marketplace. The existing skill mix at MPL closely matches the needs of AEL.”

Battle-Tested Lab Systems

“Along with a pool of talented people, another resource that AEL values highly is the existing operations and lab testing systems already in place at MPL,” added Billington. “MPL’s current test menu allows us to move to market even faster because these tests and the lab systems which support them are battletested and are operating daily. In the short term, that allows our Dallas laboratory to concentrate on the business initiatives which most complement the existing resources at MPL. This accelerates our ability to sell aggressively in the field.”

Probably the single most interesting conclusion to be made about the decision of MPL’s owner/partners to sell to American Esoteric Laboratories is that it once again illustrates the unpredictable nature of the lab testing marketplace.

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A Highly-Valued Prize

This was demonstrated earlier this year when LabOne, Inc. outbid the two blood brothers and acquired Health Alliance Laboratories in Cincinnati, Ohio. (See TDR, February 23, 2004.) Now American Esoteric Laboratories has outbid the “usual suspects” and walked away with a highly-valued prize.

Equally surprising is the way AEL believes it can capitalize on the assets of Memphis Pathology Laboratories. MPL’s existing test menu gives it added capability, without having to build it from scratch. The excellent logistics offered by the Memphis hubs of Federal Express and UPS may enable AEL to offer faster turnaround times to a class of reference clients—smaller hospitals—that can sometimes be underserved in this regard.

Bold Business Move?

Was AEL’s acquisition of Memphis Pathology Laboratories a bold business move that quickly establishes this new lab company as a tough competitor? Or will it turn out to be a case of over-reaching, the too-big acquisition done too soon? Carr and Billington paint a detailed picture of how and why the acquisition of Memphis Pathology Laboratory gives them the perfect platform for growth. The challenge will come in execution, and whether competitors are effective in their response to this acquisition.

Bidding For MPL: It was All or Nothing

WHY DID THE PARTNER/OWNERS of the Memphis Pathology Laboratory (MPL) joint venture decide to sell the entire business?

When asked that question, Don Pounds, Senior Vice President and CFO for Baptist Memorial Healthcare had a simple answer. He stated that several potential buyers expressed an interest in acquiring MPL. During negotiations, all potential buyers stated their interest was specifically in acquiring 100% ownership of MPL. They would not tender a bid to purchase a partner’s share in the laboratory joint venture.

None of the principals in this deal have spoken on the record about which laboratory companies entered the bidding for MPL. On the short list, it would be expected that Laboratory Corporation of America, Quest Diagnostics Incorporated, and LabOne, Inc. would be included. As a bidder, American Esoteric Laboratories (AEL) would have probably been considered a dark horse candidate.

Yet its selection as the winning bidder probably rested on several interesting factors. First, it was clear that AEL would continue to maintain MPL’s existing lab facilities in Memphis. Second, AEL intends to fully utilize the management and staff of MPL. That means no lay-offs, always a big plus to sellers.

If these assumptions are correct, it explains why MPL’s selling partners considered more than highest sales price to select the winning bidder for Memphis Pathology Laboratory.

It also is another sign that a new laboratory company can have credibility as a bidder when laboratory assets are shopped for sale.

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