National Reference Labs Undergoing Changes

Each of four reference/esoteric lab firms is developing new business strategies

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CEO SUMMARY: Maybe it’s a coincidence. More likely it is a response to changes in the reference/esoteric marketplace. Specialty, Esoterix, ARUP, and Mayo have each recently reassessed their core strategies and are shifting their business emphasis. Because three of these four companies are profitable, it is not an industry segment under duress. Rather, this shift in direction is to better pursue opportunities in the market.

FOUR OF THE NATION’S LARGEST reference/esoteric laboratory companies are each undergoing a corporate reassessment expected to change, in some specific way, their corporate structure and particular business strategies.

The companies are Specialty Laboratories, Inc. (Valencia, California), Esoterix, Inc. (Austin, Texas), ARUP Laboratories, Inc. (Salt Lake City, Utah), and Mayo Medical Laboratories (Rochester, Minnesota). These are the largest of the nation’s major laboratory companies that operate with a primary focus on providing reference and esoteric testing to hospital laboratories and other specialist physicians.

It may be a coincidence that each company is actively evaluating new business strategies. Alternatively, this may be a sign of intensified competitive pressures in the reference/esoteric testing marketplace. To respond effectively, the four lab companies are having to change some aspect of their business and/or market focus.

The most visible changes are happening at Specialty Laboratories, Inc. This story provides details on how and why Specialty Laboratories is putting added emphasis into its growth strategy.

Esoterix Looks For a Buyer

Esoterix is next on the list of four reference lab companies developing new business strategies. On February 18, 2005, a Wall Street news source disclosed that Esoterix was for sale and that J.P. Morgan Chase & Co. had been engaged to assist in locating buyers for Esoterix. On February 22, this same source reported that Quest Diagnostics Incorporated had looked at the Esoterix package and was not interested.

The sales price for Esoterix was reported to be around $240 million. According to TheDeal.com, this price was calculated using a factor of eight times Esoterix’ EBITDA (earnings before interest, taxes, depreciation and amortization).

Motive for the sale of Esoterix is simple. In 1994, at the time Esoterix was founded, it was Behrman Capital LP which provided the investment capital from its first venture fund. Five or six years later, Behrman Capital provided additional funding from another of its venture funds.

Need To Close The Fund

Venture funds are closed after a set period of time, often ten years. It is likely that Behrman Capital needs to cash out its investment from the first venture fund (dating back to 1994) so it can return original capital and prof- its to the investors. To accomplish this, Behrman Capital must convert its equity ownership in Esoterix into cash.

Esoterix is a financially-strong laboratory company. During the past four years, it has posted impressive and consistent growth rates for both revenues and net profits. Its primary business lines are: 1) reference and esoteric testing it provides to hospital laboratories and specialist physicians; and, 2) a thriving division in clinical trials testing.

Given Esoterix’s financial strength, if no buyer is found, it is likely to seek capital through other sources, such as an IPO (Initial Public Offering). If so, it would be the first laboratory company to go this route since Specialty Laboratories went public in 2000. In fact, in recent years, Esoterix has hired two different Chief Financial Officers specifically because they had IPO experience and could guide the company through this process.

Three Possible Outcomes

Esoterix faces three possible outcomes. One, if purchased by an existing laboratory company, then its operations would be integrated into that laboratory’s infrastructure, even if Esoterix was allowed to conduct business under its own name.

Two, if it was purchased by a non-lab company or a new group of investors, it would probably operate with little or no change to its existing operation. Three, were Esoterix to complete an IPO, it is likely to continue operating as it is today.

Across the country, in Salt Lake City, ARUP Laboratories has been finalizing refinements to its business arrangements with the University of Utah, with which it has multiple connections. The information which follows comes from a variety of sources. There may be some inaccuracies, but overall it is believed to be a fair representation of recent events.

Most lab directors and pathologists know that ARUP Laboratories is one of the lab industry’s most impressive success stories. Since its founding in the early 1980s, it has consistently posted double-digit growth in revenues and specimens year after year.

A Large Employer In Utah

As well, ARUP is becoming one of Utah’s largest employers. It has almost 1,800 employees and occupies four sizeable buildings. It seems this large size caught the attention of the University of Utah’s former president in recent years. This launched discussions between that president’s office and the executive officers of ARUP Laboratories.

The president’s office was interested to determine if ARUP Labs’ growth made it timely to revisit the business agreements that exist between the laboratory company and the university. One of the issues believed to be part of this conversation was how ARUP pathologists split duties between teaching and clinical practice in the medical school and medical center, and their duties for ARUP Laboratories.

Multiple sources tell THE DARK REPORT that, in general, the tenor of these talks was amicable, and, at least in the initial stages of this process, the president’s office was exploring ways to recast the business relationship between ARUP Laboratories and the University of Utah. The goal was to appropriately recognize ARUP Lab’s current size and impact on the working routines of the ARUP pathology group and the University itself.

During the past year, a new president arrived at the University of Utah. At that time, these discussions took a turn considered to be more favorable to maintaining the business relationship closer to the status quo. In recent months, the two parties have come to basic agreement.

For laboratory clients of ARUP Labs, this process has been nearly invisible. Going forward, it is expected that ARUP Laboratories and the University of Utah will continue to collaborate in mutually beneficial ways. The clients of ARUP Laboratories should only see positive changes.

Developments At Mayo

At Mayo Medical Laboratories (MML), the fourth reference/esoteric laboratory to adopt new business strategies, the pressure to change was a consequence of 9/11. With foreign visitors encountering new restrictions on entry into the United States, the flow of overseas patients coming for treatment at Mayo Clinic declined by a significant number.

One consequence of this unexpected development was a decline in revenue. In the years since 9/11, Mayo Clinic’s senior administration began reassessing all aspects of the organization. During the years 2003 and 2004, attention was focused on Mayo Medical Laboratories. Its strategic role within the Mayo organization was studied and assessed.

During this period, multiple sources offered information about what was occurring. However, when queried by THE DARK REPORT, senior leaders at Mayo Medical Laboratories declined to comment on any aspect of this process. So the outline of developments which follows is believed to be close, although specific details may not be fully accurate.

During the assessment period involving Mayo Medical Labs, several strategic questions were asked. Was a commercial reference laboratory business appropriate to the mission of Mayo Clinic? Was MML using capital and resources to best advantage of Mayo Clinic? What was the best strategic plan going forward?

This assessment process is believed to have included investment bankers. Their role was to provide a market value for MML and evaluate a variety of business options that could maximize that market value for Mayo Clinic.

In 2005, it is obvious that Mayo Medical Laboratories continues as it always has—but with one noteworthy difference. Over the past year, MML is seen to be more aggressive in offering discounted pricing than it ever was in prior years. It is clearly willing to compete more assertively for new client accounts.

THE DARK REPORT considers this to be a visible sign that MML has changed some of its business strategies. It is an outcome of the strategic assessment of MML’s core business and how it can best serve the mission of Mayo Clinic.

Positive Changes

It is noteworthy that Esoterix, ARUP Labs, and Mayo Medical Labs—each a profitable company—are simultaneously developing new business strategies. It is evidence of how competitive pressures are forcing change, even on successful companies. The beneficiaries of this change will be hospital labs and private labs. They should see improved services and competitive pricing for their send-out business.

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