CEO SUMMARY: Times are good in the laboratory industry. At least that’s the opinion of a growing number of professional investors. They are searching throughout the country for laboratories to acquire. They are motivated by the consistent financial performance of many lab companies, both public and private. Another message from the Spectrum sale is that hospital laboratory outreach programs have great potential.
NEWS THAT A PRIVATE EQUITY FIRM is about to acquire Spectrum Laboratory Network can be taken as a sign of heightened interest by professional investors in the lab testing marketplace.
Over the past 10 years, a handful of laboratory companies have enjoyed substantial financial success—even as the overall financial environment for laboratory testing was acknowledged to be dismal for most of the lab industry. In many cases, private equity investment firms were the original source of capital for these laboratory companies during both start-up and early growth years.
Similar Lab Acquisitions
From that perspective, the purchase of Spectrum Laboratory Network, in Greensboro, North Carolina, by Apax Partners, L.P. is just the latest of these types of deals. It provides an opportunity to gauge ongoing investor interest in purchasing other laboratory companies.
In the case of Spectrum’s sale to Apax, neither the price paid nor the equity shares owned by Apax and the remaining health system owner were disclosed. However, in the sidebar on the facing page, Chris Jahnle, Managing Director of Haverford Healthcare Advisors in Paoli, Pennsylvania, provides assumptions that indicate Apax may have paid as little as $100 million and as much as $200 million for a majority stake in Spectrum of between 60% and 80%.
What THE DARK REPORT considers significant is the statement by Spectrum CEO Nate Headley that his lab company had been contacted by a “significant number of private equity companies” expressing serious interest in acquiring Spectrum Laboratory Network. (See this article.) Pathologists and laboratory directors should recognize that a huge pool of investment money is continuously scanning the laboratory testing marketplace for attractive lab companies to buy.
However, since most private equity firms are looking for a laboratory company doing a minimum of $50 million in annual sales, this eliminates the majority of hospital-owned clinical laboratory firms. Spectrum is different because its executive team aggressively used sales and marketing techniques to lift its annual revenue well past $100 million. That is why it became an attractive acquisition candidate for these types of professional investors.
Haverford Healthcare Advisors Dissects Sale of Spectrum Lab Network to Apax
HOW MUCH DID APAX PARTNERS, L.P. PAY to acquire Spectrum Laboratory Network? The answer to this question is important for hospitals that operate laboratory outreach programs. That’s because the price paid for Spectrum’s outreach testing business provides a useful benchmark for the capitalized value of other hospital-based laboratory outreach programs.
Since specific details about the Apax/Spectrum acquisition were not made public, THE DARK REPORT turned to Haverford Healthcare Advisors of Paoli, Pennsylvania for insight and comment. Over the past two decades, the principals of Haverford have played a role in a significant number of sales involving laboratories and pathology group practices.
“Based on indicated guidelines for valuing a clinical laboratory, we can develop a reasonable range for the probable price that Apax paid to acquire Spectrum,” stated Chris Jahnle, Managing Director at Haverford. “Assume that Spectrum had annual revenues of $125 million in 2004. Also assume that Spectrum’s cash flow, as measured by EBITDA (earnings before interest, taxes, depreciation and amortization) is in the range of 15% to 20%.
“In recent years, we’ve seen buyers pay a price that is about nine to 10 times EBIT-DTA for large lab companies, those with revenues of more than $100 million,” explained Jahnle. “Given the assumptions listed above for Spectrum, that would indicate a sales price as low as about $170 million and as high as $250 million.
“Further, based upon press releases, we do know that Apax purchased a majority interest and that Moses Cone Health System holds the remaining equity,” he continued. “If Apax acquired between 60% and 80% of Spectrum, that would indicate that it paid between a low of $100 million and a high of $200 million to Spectrum’s owners, using the same assumptions I’ve already mentioned.”
Jahnle uses the market capitalization of lab companies like Quest Diagnostics Incorporated and Laboratory Corporation of America to verify these value assumptions.
“Based on recent share prices for these companies, they are valued at between nine and 12 times EBITDA. One reason for this high multiple is the market’s perception that these companies will continue to grow and be successful,” noted Jahnle.
“The next smaller group of lab companies with significant revenue and similar to Spectrum, have in recent years been sold at prices based on a multiple of nine or 10 times EBITDA,” observed Jahnle. “That generates a sales price that often approaches two times annual revenues.”
“By contrast, the prices paid for smaller lab companies are often based on multiples that range from four to six times EBITDA. This generates a sales price that typically ranges from
.06 to 1.2 times annual revenue,” he added.
“There is another variable which must be considered,” he continued. “Spectrum performs a considerable amount of hospital inpatient testing for 10 hospitals, including those of its owner, Moses Cone. In many cases like this, the hospital pays the laboratory on the basis of its historical cost. The ongoing pricing arrangement for lab services between a hospital system owner and the laboratory obviously affects the profit margins of the lab and can reduce or increase the value of the laboratory to a buyer.
“In such cases, we’ve seen a hospital owner agree to a higher-price, multi-year contract for inpatient lab testing as a way to support a higher sales price for the laboratory,” explained Jahnle. “Terms of the laboratory services agreement between Spectrum and its hospital system clients are not known. But that is a variable which could considerably raise or lower the price ultimately paid by the buyer.”
Going forward, pathologists and laboratory managers should understand that Spectrum Laboratory Network is no longer an example of a collaborative, shared laboratory services organization owned by multiple health systems. Once it is sold to Apax Partners, Spectrum Laboratory Network becomes a stand-alone, for-profit corporation that happens to hold laboratory management contracts with 10 hospitals.
Following the change of ownership, Spectrum can be expected to act more like a profit-minded commercial laboratory company than a hospital-owned laboratory organization which reflects the values and clinical mission of its parent (often not-for-profit) hospital. However, this takes nothing away from Spectrum’s spectacular growth in recent years, which shows the full potential of a well-run, hospital laboratory outreach program to grow profitably and to contribute significant profits to its parent health system or hospital.
Spectrum’s Fate Is Known
It should also be remembered that the ultimate fate of Spectrum Laboratory Network has been determined, once it is owned by Apax Partners. Apax is investing capital that comes from several investment funds it manages. Apax Partners states that its investment window is three to seven years.
That means, as early as 2008, but more likely after 2010, Spectrum Laboratory Network will either be packaged for an initial public stock offering (IPO) or shopped for sale to another buyer. That’s because Apax will need to convert its investment in Spectrum so it has enough cash to pay off and close the investment funds it tapped to buy Spectrum this year.
The lab industry is familiar with the parade of laboratory companies funded in this manner, and then later sold so that the equity investment firm could realize profits and pay off their investors. This was the fate of Unilab, American Medical Laboratories, Dynacare, US LABS, Clinical Pathology Laboratories, PathLabs (in New Hampshire), and Esoterix, to name a few. It is the probable fate of AmeriPath and its new business unit, Specialty Laboratories, since AmeriPath’s primary shareholder is a private equity firm.
For hospital laboratory administrators and pathologists now operating laboratory outreach programs in their community, the main message from the Spectrum sale should not be overlooked. Because its executive team built a profitable outreach business, Spectrum’s health system owners were able to realize tens of millions of dollars from their original investment, in 1998, that created the shared services laboratory organization.
This money is now available to Spectrum’s parent health systems. It will be used to expand and enhance the ability of these institutions to provide necessary medical services in their community. Lab directors and pathologists should find inspiration in Spectrum’s success at building outreach revenues and profits. It shows that hospital laboratory outreach programs can be competitive—if they are professionally managed.