LabCorp Buys Esoterix For $150 Million in Cash

“Low” sales price surprises observers, another competitor removed from market

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CEO SUMMARY: Laboratory Corporation of America continues to display an appetite to grow by acquisition. However, its purchase of Esoterix, Inc. creates unique management problems for LabCorp, because Esoterix is itself a product of a lab acquisition strategy. Over the past ten years, Esoterix acquired national specialty labs in coagulation, endocrinology, flow cytometry, and allergy testing.

“CASH IS KING.” That is one reason why Laboratory Corporation of America will soon be the owner of Esoterix, Inc.

In a deal announced by both companies on March 30, 2005, LabCorp will pay approximately $150 million in cash to acquire Esoterix, based in Austin, Texas. Observers considered this to be a relatively low price, given Esoterix’s annual revenues, estimated to be around $130 million.

The deal was cash and the price was relatively low because LabCorp drove a tough bargain with a seller who needed to consummate a sale to meet a looming deadline. An added factor in the mix was the significant decline in flow cytometry reimbursement which took effect on January 1, 2005. Flow cytometry cases represent a significant portion of Esoterix’s case mix.

Cash was the driver in this deal because the seller, Behrman Capital LLCof New York City, had a pressing need to liquidate its shares in Esoterix. Back in 1994, Behrman Capital’s first investment fund provided the original capital to launch Esoterix. This fund had a ten-year life. In order to close out the fund and return the money to the fund’s investors, Behrman Capital needed to sell its shares in Esoterix.

Buyer Interest In Esoterix

Sources tell THE DARK REPORT that LabCorp showed interest in acquiring Esoterix on more than one occasion in 2004. But for several reasons, no deal resulted. Two things changed between the fall of 2004 and the present.

First, as noted earlier, the lower reimbursement by Medicare for flow cytometry testing took effect on January 1, 2005. This reduced both net revenue and net earnings at Esoterix and caused the company’s valuation to decline in proportion to the effects of lower flow cytometry reimbursement.

Second, Behrman Capital’s deadline for closing its investments in its first fund and returning money to those investors was approaching. The closer that deadline loomed, the more motivated Behrman Capital was to strike a deal for Esoterix.

Both companies expect the sale will close second quarter, 2005. The immediate effect of the acquisition will be to remove another competitor from the national marketplace for reference and esoteric testing. The Esoterix deal follows on the heels of LabCorp’s earlier purchase of US LABS, Inc., announced last December and closed in March, 2005. (See TDR, January 3, 2005.)

Management Challenges

LabCorp takes on some interesting management problems with its acquisition of Esoterix. Over the years, Esoterix had acquired a number of national specialty testing lab companies. (See TDR, September 16, 2002.)

Included in this mix were labs that performed testing in flow cytometry, endocrinology, allergy, coagulation, and a clinical trials division. For LabCorp, integrating these businesses into its existing network of laboratories will prove uniquely challenging.

Following LabCorp’s purchase of Dynacare, DIANON Systemsand US Labs, it continued to operate these business units under their original name. Integration and consolidation of these businesses into LabCorp’s national testing infrastructure has been low-key and ongoing.

Integration Issues

Based on this pattern, it is likely that LabCorp will continue to use the Esoterix name after the acquisition. At this time, LabCorp has released no details about how it will integrate and consolidate the Esoterix testing re- sources into its existing system.

Because Esoterix serves a unique blend of customers, including hospitals, office-based specialist physicians, and clinical trials vendors, the acquisition of Esoterix by LabCorp is not likely to disrupt the competitive status quo in the lab services marketplace.

Ventured-Funded Lab Usually Come to Market

LABORATORY COMPANIES FUNDED with money from venture capital and private equity firms will eventually need to cash out those investors.

Typically, venture capitalists want to harvest their profits about five years after their investment. Private equity funds often have longer horizons, but also need to eventually sell their equity, realize the profits, and pay off their own investors.

These types of investors typically have two options to liquidate ownership shares in their portfolio companies. First, the portfolio company can use an IPO (initial public offering) to sell shares to the public. Second is to sell the portfolio company to someone else. This is the option Behrman Capital is using to liquidate its ownership in Esoterix so it can close out its first investment fund.

In today’s market, whenever a venture-backed laboratory company is offered for sale, the most likely buyers are LabCorp and Quest Diagnostics Incorporated. Moreover, they are likely to be high bidders over other interested parties. That’s because, compared to other classes of buyers, the client list, trained lab staff, and service infrastructure of the selling laboratory often have higher value to either or both of the two blood brothers.

By understanding the business model of the venture capital-funded laboratory company, one can anticipate which laboratory companies will eventually come to market and be offered for sale. Obvious examples that fit this description are AmeriPath, Inc. (Palm Beach Gardens, Florida–acquired by Welsh Carson Anderson & Stowe in 2003) and Pathology Partners, Inc. (Dallas, Texas–funded by several venture capital companies in 1998). Also funded by professional investors are CBL Path, Inc. (Ocala, Florida) and Clinical Pathology Laboratories, Inc. (Austin, Texas).

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