CEO SUMMARY: It’s a surprise to most lab industry observers. AmeriPath, a company built around 400 anatomic pathologists working mostly in community hospitals, is acquiring a national reference/esoteric testing company. However, this deal may be better understood by looking at the motives of Welsh, Carson, Anderson & Stowe, the private equity firm which owns AmeriPath.
WHAT AN UNLIKELY COMBINATION! AmeriPath, Inc. is buying Specialty Laboratories, Inc. At first glance, there doesn’t seem to be a compelling economic or business argument to marry an anatomic pathology services company with a national reference/esoteric lab company.
The sale was announced late last Friday, September 30. AmeriPath will pay $13.25 per share for all 23.8 million outstanding shares of Specialty Labs, for an estimated total of $314.7 million.
Founder James Peter, M.D., Ph.D., along with his family and a trust, will receive approximately $66 million in cash from the sale. They will also invest $119 million for a 20% equity position in AmeriPath after the acquisition closes. Peter has controlled about 60% of Specialty Lab’s stock since its IPO in December 2000.
Subject to regulatory clearance of the acquisition, AmeriPath expects the sale to close in early 2006, making Specialty Laboratories a private company. AmeriPath has stated that the lab facility operated by Specialty Laboratories in Valencia, California will remain open and is likely to receive additional specimens after the acquisition.
As most clients and regular readers of THE DARK REPORT know, in recent years, both Specialty Laboratories and AmeriPath have struggled with different business problems. In the case of Specialty Laboratories, it stabilized its core business following the loss of its Medicare license in April 2002. But the move into the Valencia laboratory facility last December increased the company’s overhead. It has not generated enough new sales to offset its higher operating costs and generate adequate profits.
The primary business challenge at AmeriPath is how to spark—and then sustain—strong growth in specimens, revenues, and operating profits in its hospital-based anatomic pathology group practices. In recent years, a succession of insiders have told THE DARK REPORT that the costs of running these pathology groups, particularly pathologist salaries, have risen much faster than either revenues or profits.
On the other hand, AmeriPath has two profitable and rapid-growing business lines. One involves dermatopathology services and the other is AmeriPath’s reference and esoteric testing services, anchored by its Center for Advanced Diagnostics in Orlando, Florida.
THE DARK REPORT is also aware that, as AmeriPath has shopped itself to potential buyers, these buyers were very interested in the dermatopathology and esoteric testing businesses, but expressed little interest in buying the hospital-based pathology business.
Herein lies the key to understanding AmeriPath’s pending acquisition of Specialty Laboratories. In recent months, AmeriPath has actively reorganized itself into three business units: dermatopathology, reference/esoteric testing, and hospital-based anatomic pathology services.
AmeriPath’s owner, Welsh, Carson, Anderson & Stowe, needs an exit strategy. The reorganization of Ameri-Path into three distinct business lines—two of which are highly attractive to buyers like Quest Diagnostics Incorporated and Laboratory Corporation of America, provides a hint as to AmeriPath’s strategic thinking.
To Improve Profit Margins
Now comes the decision to spend one-third of a billion dollars to acquire Specialty Laboratories. (But remember, Peter is investing $119 million of that number into the post-merger AmeriPath.) The business logic may be that AmeriPath’s volume of reference and esoteric testing, when switched to Specialty’s Valencia laboratory, can improve the profit margins on Specialty’s core business.
Further, having reference laboratory capability on both coasts will allow the Specialty and AmeriPath sales teams to increase the rate of new sales, thus feeding more specimens into the Valencia facility.
Fast forward a couple of years. Now AmeriPath has a profitable national business in reference and esoteric testing. The test mix is highly attractive to Quest Diagnostics and LabCorp because it is a blend of hospital referred specimens (tested mostly in Valencia) and high-end esoteric anatomic pathology specimens (tested mostly in the Orlando laboratory).
Welsh Carson’s Motives
Seen from the perspective of Welsh Carson, this is a viable exit strategy. If they consider their original investment in AmeriPath to be a lemon, then acquiring Specialty Laboratories is a way to make lemonade. This would be equally true of the Specialty shareholders. Alone, Specialty faced several more years of struggle to raise specimen volumes high enough to offset its overhead.
This scenario still misses one point. What happens to the anatomic pathology group practices that were acquired by AmeriPath? Informed sources tell THE DARK REPORT that one potential solution is to sell these groups back to the pathologists, at an attractive price. These sources say the steady rumors about discontented employee-pathologists have plenty of substance. So this strategy would be win-win for AmeriPath and for the pathologists.
Is this a reasonable business scenario? The dots seem to connect in a consistent way. However, it requires effective execution from the management of AmeriPath and Specialty Labs. At a minimum, THE DARK REPORT believes this acquisition is the result of intractable weaknesses within both companies. That will make the next few years at AmeriPath interesting to watch.