More Lab Consolidation: LabCorp Buys Dynacare

LabCorp gains entry into new regional markets and expands into Canada

CEO SUMMARY: Recent weeks brought many rumors about an impending deal between Laboratory Corporation of America and Dynacare. That speculation was ended last week when it was disclosed that LabCorp would pay about $685 million in cash, stock and assumed debt to acquire Dynacare. The acquisition also spells the end to Dynacare’s strategy developing lab testing joint ventures with hospitals.

NEWS THAT Dynacare, Inc. would be acquired by Laboratory Corporation of America, Inc. confirms that 2002 will be a milestone year in the ongoing consolidation of independent commercial laboratory companies.

LabCorp’s purchase of Dynacare follows on the heels of two earlier acquisitions involving the purchase of American Medical Laboratories, Inc. and Unilab Corp. by Quest Diagnostics Incorporated, announced since January 1 of this year.

The acquisition agreement was announced last Thursday. LabCorp will pay approximately $480 million in cash and stock. It will also assume $205 million of Dynacare’s debt. Dynacare reported annual revenues of $402.4 million for 2001 and operates 24 laboratories in the United States and Canada. It has 6,300 employees.

There are three interesting aspects to this transaction. First, it removes another independent laboratory company from the physicians’ office marketplace and concentrates that testing volume into LabCorp.

Second, LabCorp now acquires laboratory operations in Canada. This makes it the first United States-based laboratory firm in many years to have a presence in that country.

Third, the end of Dynacare as an independent laboratory company represents a failure of the business strategy that originally brought Dynacare into the United States back in the mid-1990s. Dynacare had declared its intent to build a laboratory testing business based on developing lab testing alliances and joint ventures with hospitals and health systems.

The sale of Dynacare to LabCorp is due, in part, to its failure to develop a sufficient number of viable lab testing ventures with hospital partners. In fact, as part of the announcement that it would sell to LabCorp, Dynacare also confirmed that it is terminating two of its four existing joint ventures with hospitals in the United States. The JVs with Ellis Hospital in Schenectady, New York and Allegheny General Hospital in Pittsburgh, Pennsylvania will be ended.

Benefits To LabCorp

In acquiring Dynacare, LabCorp is projecting that it will boost cash flow significantly as it integrates Dynacare’s operations into its own. By the end of 30 months, LabCorp predicts it will gain $45 million in cash flow, attributable to operational consolidation, internalizing esoteric testing, and its lower costs for reagents and supplies.

“The numbers provided by LabCorp indicate they believe they can double the current profitability of the Dynacare business they are acquiring,” stated Bill Bonello, Senior Analyst at U.S. Bancorp Piper Jaffray, based in Minneapolis, Minnesota.

Economies of Scale

Bonello’s assessment about LabCorp’s ability to squeeze more profit from Dynacare’s business supports either of two conclusions about the lab marketplace in the United States, mainly: 1) Dynacare was operating in a relatively inefficient manner and had unrealized potential for substantial cost savings; or 2) LabCorp’s economies of scale give them significant cost advantages over regional independent laboratory companies.

The right answer is important. If it is true that the nation’s two billion dollar testing behemoths have intrinsic cost advantages due to their sheer size and purchasing volume, then more trouble lies ahead for the handful of larger independent commercial labs that still remain in business. It means the two blood brothers will continue to dominate the market segment for physicians’ office-based lab specimens.

After all, as of January 1 this year, AML ($300 million), Unilab ($390.2 million), and Dynacare ($402.4 million) were the three largest independent lab companies still competing against Quest Diagnostics and LabCorp. It must be assumed that each of these three sizeable companies decided to sell, at least in part, because they believed selling their company was a better financial option than continuing to compete against the two blood brothers.

Sign Of Market Change

The fact that all three “second tier” public lab companies decided to sell to either of the two blood brothers within a four-month period may be an important signal about the changing marketplace for specimens originating in physicians’ offices. It may mean the clout and market power of Quest Diagnostics and LabCorp now make it extremely difficult for an independent commercial lab company to compete in this segment of lab testing.

This leaves hospital lab testing outreach programs and hospital-owned, for-profit commercial lab ventures as the only viable class of competitors for specimens from physicians’ offices. It will be interesting to see what happens to these lab organizations now that Quest Diagnostics and LabCorp have removed the largest remaining commercial laboratory companies from the marketplace.

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