Spectrum Lab Network Is Sold to Equity Investor

One of three original health system owners continues to hold equity in new company

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CEO SUMMARY: Timing of the sale of Spectrum Laboratory Network to Apax Partners, L.P. was unexpected, but it’s been known for some time that the fast-growing regional laboratory was entertaining purchase offers. Under new ownership and with ready access to ample capital, Spectrum is optimistic that it can sustain its rapid rate of growth while maintaining above-average profit margins.

SPECTRUM LABORATORY NETWORK of Greensboro, North Carolina, was sold last week to Apax Partners, L.P. of New York City. Details of the sale were not disclosed.

The transaction was announced on November 7. One motive for the sale to Apax was to cash out the ownership interest of High Point Regional Health System. This is the second time in 24 months that a hospital owner of the fast-growing regional laboratory company has decided to convert its equity position into cash.

Apax Partners is now the majority owner of Spectrum Holdings, Inc., which holds the company’s assets. As part of the deal, Moses Cone Health System retains “a significant ownership position in the company.” Moses Cone is one of the three original health system owners which founded Spectrum Laboratory Network in 1997. Novant Health System sold its interest in Spectrum at the end of 2003.

There will be few significant changes in the day-to-day operations of Spectrum as a result of this sale. “We will continue to manage the laboratories of 10 acute care hospitals and maintain our existing sales and marketing program,” stated Nate Headley, CEO of Spectrum. “Existing staff will continue as employees of Spectrum. We expect it to be ‘business as usual’ under our new owner.”

Headley attributes Spectrum’s current size (annual sales estimated to be $124 million in fiscal year 2005) and rapid growth as the major reason for the decision by High Point and Moses Cone to sell Spectrum Laboratory Network. “Our health system owners have evolved in their thinking about this laboratory organization in recent years,” said Headley. “Back in 2000, about the time I arrived, the three owners didn’t fully anticipate the potential of this laboratory to become a significant and viable competitor in the outreach marketplace.

Sustained, Rapid Growth

“Spectrum has grown rapidly in recent years,” he continued. “Since 2000, Spectrum has posted an annual revenue growth rate of 27% compounded. EBITDA (earnings before interest, taxes, depreciation, and amortization) has increased 54% per year during the same period. (See TDR, March 7, 2005.)

“The mindset of the health system owners changed as they watched their original investment grow rapidly. “Of course, their primary business is to provide inpatient and outpatient services through hospitals and related facilities,” he noted. “To maintain strategic focus on this mission, each of the original three partners, in their own timing, decided to convert their equity to cash and put this capital to work elsewhere in their health system.

Partners Opt For Cash

“Novant was first to reach this decision. In late 2003, they converted their equity into cash and left the partnership,” recalled Headley. “High Point and Moses Cone made the same decision earlier this year. High Point has immediate plans to use the proceeds from this sale elsewhere in its health system. Moses Cone has rolled a portion of its equity into the new holding company. Going forward, it will continue to be an investor in Spectrum.”

One factor that encouraged Spectrum’s health system owners to sell their laboratory at this time was a plenitude of buyers. During the past two years, a steady stream of interested buyers has approached Spectrum’s owners with strong offers to purchase the laboratory.

“These buyers fell into two categories,” said Headley. “There were a number of strategic buyers, like public lab companies, already active in healthcare and for which Spectrum’s laboratory testing business would complement their existing business activities.

“Private equity firms were the other category of buyer that approached us,” he continued. “These companies are looking for good investments. They want to acquire a laboratory, retain the existing organization and utilize it as a platform for further growth.”

Lots Of Buyer Interest

According to Headley, the parade of potential buyers was ever-growing. “We were contacted by a significant number of private equity companies,” he noted. “Our owners preferred this category of buyer over the strategic buyer for several reasons.

“The primary reason was to maintain continuity in both the management philosophy and operational team that manages the 10 acute care hospital laboratories of our former owners,” said Headley. “The private equity buyer generally wants the company to maintain all its existing operations without significant change, which is what our owners also want.

“Next, our owners wanted the new buyer to be able to provide capital whenever needed to fund additional growth. In fact, after the sale, Spectrum will hold a modest capital reserve and Apax has stated its willingness to fund acquisitions that we believe will be synergistic with Spectrum’s operations,” he observed.

No Acquisition Plans

Headley was quick to add that Spectrum has no specific plans to acquire laboratories. But he did note that the purchase of MedEx Laboratories in late 2003 had been highly successful. “MedEx contributed significantly to our growth and enhanced our operating margins,” he stated. “In fact, we currently add two new clients per day across our five-state service region. If we were to acquire another laboratory, it would need to be one that compliments the momentum we already have in the marketplace.”

Spectrum is glad to have an owner with plenty of capital. “Competition in our region is intense,” observed Headley. “We continue to add market share, and we attribute much of this to the investments we have made in information technologies. Currently we have 725 client sites that are electronically-linked to our laboratory.

Uses of Laboratory IT

“In many ways, these electronic bridges to our physician-clients have allowed us to offer enriched services and do a better job on the basics, from getting the original test requisition right the first time to delivering test results in near-real time, in a manner which allows the physician to access those results via the Internet.

“That is one of our corporate strengths and it made us attractive to many buyers,” he continued. “But we know that competing labs are spending lots of dollars to develop services and new capabilities in informatics. So that keeps us continually looking for new ways to add value and retain Spectrum’s competitive edge.”

Laboratory executives and pathologists will want to track the ongoing progress of Spectrum Laboratory Network under its new owners. Founded in 1998 as a shared laboratory organization by three major health systems in North Carolina, its financial performance and success in the outreach market provide a powerful example to other hospital outreach programs.

From a modest outreach revenue base of $22 million per year in the late 1990s, Spectrum Laboratory Network is on track to post revenues of $137 million in 2006. Spectrum demonstrates that hospital laboratory outreach programs do have unlimited potential for growth and profits.

Apax Partners Is Familiar With Clinical Lab Business

APAX PARTNERS, L.P. IS NO STRANGER to the clinical laboratory business. Its acquisition of Spectrum Laboratory Network is the private equity firm’s third investment in a clinical laboratory company.

In 1998, Apax invested in Irvine, California-based US Labs, Inc. prior to its acquisition last year by Laboratory Corporation of America. Apax also made investments in Prometheus Laboratories, Inc., located in San Diego, California in 1999. Prometheus is a company founded to offer both diagnostic and therapeutic services to gastroenterologists.

Founded in 1969, Apax Partners has taken part in the startup of companies such as Apple Computer and Office Depot. The company manages investment funds totaling approximately $12 billion. Its investment window is three to seven years. Typically the firm invests between $5 million and $100 million in a single company.

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