CEO SUMMARY: Professional investors with access to hundreds of millions of dollars of investment capital are closely scrutinizing the clinical laboratory industry. They are encouraged by the recent financial performance of public laboratory companies. For independent laboratory owners, this may be a golden opportunity to sell or restructure their business on favorable terms.
RECENT FINANCIAL GAINS by the nation’s highest profile laboratory companies have caught the attention of the professional investment community.
Indications are that these investors intend to act upon their heightened interest by making significant investments across the spectrum of laboratory and diagnostic companies. If this occurs, then the face of the clinical lab industry in the United States may change significantly during the coming 24 to 36 months.
This coming investment boom is fueled by the soaring stock prices of several laboratory and diagnostics companies. Since January, stock prices of several laboratory and diagnostics companies literally skyrocketed upwards. For example, shares of Quest Diagnostics Incorporated now trade at $105, up from $30 in early January.
Laboratory Corporation of America, looking to boost its share price, which was $3.50 per share as recently as January, completed a 1-for-10 reverse stock split and saw its share price jump to $103.
It is a similar story at DIANON Systems, Inc. and IMPATH, Inc., where strong revenue growth in anatomic pathology services boosted revenues and earnings. DIANON’s share price doubled in the last seven months and is currently trading at about $31 per share. Since January, IMPATH’s shares increased 200%, climbing from $26 to $62 in recent trading.
Probably the most spectacular run-up in a lab industry stock has been Cytyc Corporation, manufacturer of the ThinPrep® liquid preparation Pap smear technology. Just 12 months ago, in July 1999, its shares were trading at $12. By January, the price was up to $36 and the stock split. Recently its shares sold for about $65.
Good News For Lab Owners
All this may be good news for the owners of the remaining independent commercial laboratories in the United States. It means there will be more buyers, with strong financial backing, looking to acquire viable commercial laboratory operations.
But it isn’t just the soaring stock prices of the public lab companies which caught the attention of Wall Street investors. During recent years, two high-profile private equity companies made significant investments in clinical laboratory companies. These investments took place at times when the lab industry’s finances were depressed and prospects were poor.
First into the lab industry market- place was Golder, Thoma, Cressy & Rauner Partners (GTCR), based in Chicago, Illinois. This private equity investment firm made two big commitments. First, it provided financing and assistance to allow Harvey Shapiro and his executive team to take Dynacare, Inc., the Canadian lab company, private in 1995.
Purchase Of AML
GTCR’s next foray into the lab industry was to help Timothy Brodnik, Jack Bergstrom, and Jerry Glick finance the acquisition of American Medical Laboratories, Inc., located in Chantilly, Virginia. This transaction was completed in May 1997. During 1999, GTCR again provided capital and expertise when Las Vegas-based Associated Pathologists Laboratories (APL) joined up with AML to form an expanded laboratory company. (See TDR, May 12, 1997 and September 20, 1999.)
The other major lab investment was made by Kelso, Inc. of New York City. In 1999, it purchased Unilab, Inc. of Tarzana, California and took the company private. Kelso paid approximately $420 million to acquire Unilab and its annual revenues of $300 million.
As of this date, indications are that both GTCR and Kelso are pleased with the performance of their investments in laboratory companies. When Wall Street combines this fact with the soaring stock prices of Quest Diagnostics, LabCorp, DIANON, IMPATH, Cytyc, and others, it motivates professional investors to consider additional investment opportunities within the lab, pathology, and diagnostic industries.
Sizeable Investment Dollars
THE DARK REPORT is aware of several investment groups that are willing to commit sizeable investment dollars into a laboratory company or diagnostics vendor. In aggregate, these investment groups can tap up to several billion dollars of capital to fund any lab-based investments that catch their eye.
That is why the commercial laboratory segment of the lab industry may see significant change in the next 24 months. There are several ways that new investors may impact the market.
First, THE DARK REPORT predicts that Wall Street investors will tend to build their strategic business plan around the concept that the most profitable laboratories are high volume labs with the lowest cost-per-test.
Thus, these investors will tend to look for “roll-up” opportunities. They want to consolidate several lab organizations to harvest economies of scale. The expectation is that large size and huge testing volumes should generate improved profit margins. This is the business strategy that fueled fast growth (as well as subsequent financial difficulties) at Allied Clinical Laboratories, Damon Clinical Laboratories, MetPath, National Health Laboratories, Nichols Institute, and others during the 1990s.
Because this new crop of professional investors are “outsiders,” they seldom appreciate the subtle differences that quality of service contribute to lab profits. Yet it is quality of service that allows most surviving independent commercial labs to do a stable, if not thriving, business with local physicians. They compete successfully despite the fact that these independent labs have a higher cost-per-test than the two blood brothers and often are excluded from national managed care contracts.
How New Investors Can Create Change in the Lab Testing Market
PROFESSIONAL INVESTORS CAN CAUSE significant change to the clinical laboratory marketplace. The recent example of American Medical Laboratories, Inc. provides a good example.
In May 1997, three individuals purchased American Medical Laboratories (AML), located in Chantilly, Virginia. The private equity investment firm of Golder, Thoma, Cressy & Rauner (GTCR) provided advice and acquisition capital.
At the time of the purchase, AML was a classic example of the independent commercial laboratory which had an excellent reputation among physicians and hospital lab clients. Over several decades, the existing owners had steadily built the laboratory into a regional power. But for many reasons, these existing owners were content to maintain only modest growth.
That was not the case with AML’s new owners. They had a different vision for AML. They wanted to convert AML into a national reference laboratory. They also wanted to put AML on a fast-growth track. In doing this, they placed AML in full competition with the existing national reference labs, such as ARUP Laboratories, Mayo Medical Laboratories, and Specialty Laboratories, as well as the two blood brothers.
It’s been three years since the AML acquisition. Its new owners, working in tandem with the previous owners who remained part of the executive team, have instilled a more aggressive management philosophy into the laboratory. It didn’t take long before AML was able to double its size and annual revenues.
More significantly, AML has roiled the national market for reference and esoteric testing services. As a serious competitor, it has increased the level of competition among reference laboratories for major clients.
Hospital lab clients welcome this increased competition, because it means lower prices and more “extras.” But the important lesson is this: new laboratory owners, capitalized by private equity investors, entered the lab marketplace and forced a change in the way this segment of the lab industry competes for new business.
Multiple Buyers Possible
Second, all independent laboratories with some size and regional clout will probably find themselves approached by multiple buyers during the next 24 months. If someone wants to invest in the clinical lab business, there are only a limited number of acquisition targets. Thus, it may be a sellers market.
Third, labs operated by these new owners will have a different characteristic from those labs which continue under existing ownership. They will be run under the accepted management philosophies advocated by W. Edwards Deming and ISO-9000 guidelines.
Internally, these labs will be managed with the goal of continuous improvement to regularly lower costs while simultaneously improving quality. Externally, they will maintain a professional sales and marketing program that generates steady growth in specimens and revenues.
What will constrain professional investors is the limited number of independent commercial laboratories that are appropriate prospects for acquisition and subsequent expansion. In many metropolitan areas, only hospital-based lab outreach programs exist to compete against the blood brothers. Sizeable independent lab operations no longer exist in such markets.
It is easy to speculate on the most likely targets for such acquisition activity because the list is pretty short. A representative list of regional independents that might be large enough to be attractive acquisition targets includes companies such as PathLabs, Inc. in Portsmouth, New Hampshire; Medical Arts Laboratories, Inc. in Oklahoma City, Oklahoma; Boyce and Bynum Laboratories in Columbia, Missouri; and Sunrise Medical Laboratories in Hauppauge, New York.
These examples represent likely acquisition candidates for several reasons. One, they are independently owned and operated by individuals, not hospital systems. This means that new owners can move quickly to institute changes and expand into new geography. This was the case when Dynacare, Inc. purchased Laboratory of Pathology (LOP) in Seattle, Washington in 1995. Once Dynacare closed on the sale, it immediately expanded the areas serviced by LOP.
Two, the specimen volume and operational infrastructure of independent clinical labs like these is usually large enough to support expanded sales and marketing without requiring an expensive expansion of lab capacity.
The new owners of both LOP in Seattle and AML in Chantilly were able to double the specimen volume moving through their lab systems without any significant new construction or expansion of lab capacity.
Top Service In The Region
Third, these laboratories have a lengthy history of providing top service to their regional market. But for many reasons, existing owners have chosen not to pursue obvious growth opportunities. This gives the new owners an easy starting point to boost revenues. Again, LOP and AML demonstrate this principle. New owners doubled the annual revenues of these labs in under 36 months!
THE DARK REPORT expects that new investment groups will join the existing lab buyers, such as Dynacare and Laboratory Corporation of America, in approaching independent lab owners. During the next 12 to 18 months, some very interesting lab deals will result from all of this buying activity.
In recent years, only a handful of significant lab sales were completed. But that could change if new buyers are willing to pay healthy prices for existing independent commercial laboratory companies.