CEO SUMMARY: Many current owners of independent laboratories now wish they had sold during the glory days of commercial laboratory acquisitions. Recent sales transactions demonstrate that current market valuation for clinical laboratories is based on actual cash flow. Even at these new valuations, there are few buyers.
OWNERS OF INDEPENDENT LABORATORIES who want to sell their business face two big obstacles. First, there are few or no buyers. Second, prices to be paid are considerably reduced from the peak pricing levels seen during 1993-94.
From a consistent high valuation during 1993-94 of 1.0 to 1.25 times annual net revenues, commercial laboratory prices have spiraled downward. Current valuations are primarily based on a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). The few market transactions which took place indicate laboratory values currently range about 0.5 times annual revenue.
In the last issue of THE DARK REPORT, it was noted that Bio-Reference Laboratories, Inc. (BRLI) was paying not over $7 million to acquire MediLabs, Inc. of Valley Cottage, New York. MediLabs is a $14.7 million operation, so BRLI was getting MediLabs for under 0.5 times net revenues.
Since 1994, only a limited number of independent laboratories have successfully sold themselves. In April, Laboratory Corporation of America made the news when it announced an agreement to purchase Medlab, Inc. of Wilmington, Delaware.
Medlab is a $20 million laboratory currently in Chapter 11 bankruptcy proceedings. It filed for bankruptcy protection in September 1997 and has been unable to develop a satisfactory reorganization plan.
“Remember that, as recently as 1994, a clinical laboratory could be sold for 1.0 to 1.25 times annual earnings. Today, most clinical laboratories will be offered a purchase price closer to 0.5 to 0.7 times annual revenue.”
Director, Haverford Healthcare Advisors
Terms of this purchase were not announced and the only reference made about details was that LabCorp would “acquire certain of the assets of Medlab.” That probably means that LabCorp will purchase the client list plus specific tangible assets that LabCorp finds useful.
In May 1997, Quest Diagnostics Incorporated acquired Diagnostic Medical Laboratories (DML) of Branford, Connecticut. At $30 million in annual revenue, DML was the largest independent laboratory then remaining in Connecticut. As in the Medlabs transaction, Quest did not reveal specifics about the purchase price and terms.
However, DML was located close to Quest’s regional laboratory in nearby Wallingford. The unusual combination of attractive purchase price, natural opportunities for local consolidation and the acquisition of a major competitor motivated Quest to complete this acquisition. It should be noted that Quest Diagnostics has stated publicly that it will not do acquisitions as a normal course of business.
Probably the only other major laboratory transaction which occurred within the last three years is the sale to private investors of American Medical Laboratories in Chantilly, Virginia. AML does about $60-70 million per year in revenue. It was known to be financially strapped, and the price paid to AML’s owners reflected a low multiple of annual revenue.
The limited number of clinical laboratory sales indicates several things. First, there are only a few potential buyers. Financial problems of the clinical laboratory industry are well-known and discourage outside investors.
Second, in almost every instance, the successful buyer is someone in a unique position to benefit from the laboratory assets being offered for sale. This usually means the buyer already operates in the same geography as the lab to be sold.
Third, EBIDTA is now the stronger measure for determining value, not annual revenues. This means that laboratory owners should concentrate on improving operating income and net earnings if they want to receive a higher sales price.
Because a sizeable number of independent laboratories still operate in the United States, the issue of purchase price and terms will continue to be closely watched. Every consummated laboratory sale becomes an important indicator of actual market values.
Formula For Intangibles Reflects Today’s Values
When Corning Clinical Laboratories was spun off into Quest Diagnostics on December 31, 1996, it was necessary to recast the balance sheet to reflect current market values.
“Intangibles” was the accounting entry used to reflect the excess of purchase price over assets when Corning (previously known as MetPath) acquired clinical laboratories. Corning had paid multiples of 1.0 to 1.25 times annual net revenues to buy these laboratories.
Given the precipitous decline in the financial health of the industry by early 1997, Quest chose to write down its $1.030 billion of intangibles by $455 million. Per company filings, “management’s estimate of fair value is currently based on multiples of revenue primarily ranging from 0.5 to 0.7 times revenue and on multiples of EBITDA primarily ranging from five to six times EBITDA.”
Quest’s valuation formulas closely reflect prices paid in the limited number of actual laboratory sales transactions which occurred in 1997-98.