Dynacare Buys LabSouth as Gateway into Alabama

Canadian lab company pursues growth by implementing “Southern strategy”

CEO SUMMARY: With the acquisition of ARL/LabSouth, based in Birmingham and Montgomery, Dynacare immediately becomes a major player in the Alabama marketplace. Several interesting aspects to the sale demonstrate that it is becoming increasingly difficult for independent commercial laboratories to access the capital needed to continually upgrade capabilities and fund expansion efforts.

ONCE AGAIN Dynacare Inc. is on the move. The Canadian-based laboratory company announced the acquisition of ARL/LabSouth, Inc., headquartered in Birmingham, Alabama.

The transaction is expected to close during the first quarter 2000. ARL/LabSouth is a major player in the Alabama marketplace. It operates laboratories in Birmingham and Montgomery. Annual net revenues are approximately $40 million.

Major Competitor

“Acquiring ARL/LabSouth immediately makes us a major competitor in Alabama,” said Osama Sherif, Executive Vice President at Dynacare. “It is a high quality lab company with a strong reputation in the markets it serves. ARL/LabSouth provides us a good foundation for further growth and expansion in Alabama and neighboring states.”

This is consistent with Dynacare’s emerging “Southern strategy.” During the last two years, it has done lab acquisitions in Louisiana, Arkansas, and Mississippi. (See TDR, November 29, 1997.) According to Sherif, the eastward march will continue. “We expect to have lab operations in Georgia before too much longer. There are also negotiations under way which would bring us into the Carolinas,” he noted.

Dynacare is pursuing a strategy that THE DARK REPORT defines as “go where they ain’t.” Neither of the two blood brothers operates a regional lab in Louisiana, Arkansas, and Mississippi. There is a Laboratory Corporation of America regional lab in Birmingham. Dynacare’s string of regional laboratory hubs across these four states makes it a dominant provider without having to go head-to-head with the nationals in any city except Birmingham.

“Our plan is to use the ARL/LabSouth facilities in Alabama as core labs,” explained Sherif. “They are ideally situated to support Dynacare’s operations across the South. Also, our laboratories in Baton Rouge, Louisiana and Meridian, Mississippi currently operate in facilities that are somewhat dated. Acquiring ARL/LabSouth gives us new options on how to upgrade those locations.”

ARL/LabSouth was a private company created from two independent labs. In 1995, LabSouth (formed in 1990 in Birmingham) was merged with Alabama Reference Labs (formed in 1974 in Montgomery). Its three owners are Robert B. Adams, M.D.; Ronald Elliott; and Alton Sturtevant, Ph.D. They decided to sell after carefully considering upcoming changes to the Alabama healthcare marketplace.

Dynacare’s Osama Sherif Comments On Future Plans, Industry Changes

“The future for Dynacare will probably revolve around two themes,” stated Osama Sherif, Executive Vice President at Dynacare, Inc., based in Toronto, Canada.

“First, we will continue to do small, fold-in laboratory acquisitions,” he said. “These will be labs typically doing about $5 million to $10 million per year in net revenues. These acquisitions will be done selectively, to support our market coverage and expansion plans.

“Second, Dynacare continues to believe that joint ventures with hospitals make good economic sense. Certainly these do not happen quickly, but we are patient and willing to invest the time necessary to help hospital administrators evaluate our proposals and develop a winning partnership plan.

“During the next few months, we expect to announce additional lab acquisitions and more hospital partnerships,” added Sherif. “We are hopeful that hospital partnerships in West and Middle Tennessee will happen shortly. This will complement our existing partnership in Knoxville with the University Health System.”

Another milestone for Dynacare is the passing of Y2K. “Now that the New Year has come and gone, we can redirect our efforts away from Y2K projects and toward E-commerce activities,” Sherif noted. “We believe there is lots of opportunity to use the Web to enhance laboratory services and generate worthwhile revenue from these services. This will be a priority for us throughout 2000.”

When asked about changes to managed care contracting for laboratory services, Sherif had an interesting response. “For us, managed care contracting has never been an impediment. In our experience, where we have strong operations in a region, the managed care players will carve us out of their national contracts. We expect this to be equally true in Northern Alabama, following our acquisition of ARL/LabSouth.”

Solid Operation

“We’ve done pretty well during the past four years,” observed Elliott. “Despite declines in reimbursement and all the other problems familiar to lab managers, ARL/LabSouth maintained a solid operation.

“But every analysis we did indicated that it would require a significant amount of capital to push us up to the next level,” he continued. “The effort and cost of raising that capital is becoming prohibitive when measured against the steady erosion in laboratory reimbursement.

“Further, Blue Cross of Alabama announced an arbitrary and sizable reduction in laboratory pricing, effective January 1,” added Elliott. “They insure about one third of the population in our service areas. Add to that the increasingly onerous Medicare requirements for getting reimbursed, and we decided it was a smart time to change.

“We had three goals in selling ARL/LabSouth,” Elliott noted. “First, we wanted job stability for the hard-working, experienced people who’ve contributed to the success of our laboratory.

“Second, it was important to affiliate with a company which has the capital and resources to invest in ARL/LabSouth’s continuing growth,” offered Elliott. “We wanted a new owner that would commit to building this laboratory organization.

“Third, Dr. Adams is preparing to retire,” he said. “After closing, both Dr. Sturtevant and I will continue on with Dynacare here in Alabama. Dr. Adams will also continue after the sale to Dynacare.”

Need Access To Capital

During 1999, a number of independent laboratories were sold. Along with the sale of ARL/LabSouth, these transactions confirm that independent laboratories now need access to additional capital. Without it, their ability to maintain market share and adequate profits becomes increasingly difficult.

Most independent lab owners who sold their company during 1999 still ran profitable operations. This was a consequence of the lab’s history of high service levels relative to competing labs, strong customer loyalty, and conservative financial management through the last half of the 1990s.

Given the existing profitability of their labs, what motivated these owners to sell was their assessment of the future. For their independent laboratories to remain competitive during the next several years, it would require a substantial investment of capital and resources. Unfortunately, the expected return on this capital was projected to be meager.

That is why existing independent commercial laboratory owners are making rational decisions to sell their companies. Buyers are invariably better-financed, more aggressive, and willing to make the sizable investments required to push that laboratory organization to a higher level of revenue and profits.

Two Reasons For Selling

Since only a handful of independent labs remain in the $25 million+ category, there won’t be many lab acquisitions during 2000 and 2001. Any sales of independent laboratories which do occur will generally be for one of two reasons.

First, existing owners of some independent laboratories are ready to retire. By selling, they can extract their equity while providing their loyal employees with continued employment. The hospital owner of Louisiana Reference Laboratory in Baton Rouge sold to Dynacare for these reasons. It wanted to extract its equity to invest in other projects, while insuring ongoing employment for the laboratory employees.

Second, existing owners are unwilling, or unable, to invest the significant capital required to upgrade information systems, acquire new testing technology, and fund expanded sales and marketing. Selling to stronger hands permits these owners to continue working with the lab, even while the buyer invests more capital to support further growth.

Continue As Managers

This is certainly the primary reasons why the original owners of both American Medical Laboratories in Chantilly, Virginia and Associated Pathologists Laboratories in Las Vegas, Nevada sold their laboratories, but after the sale continued as investors and active managers.

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