CEO SUMMARY: In a blockbuster deal valued at almost half a billion dollars, Labcorp will manage dozens of hospital labs in 10 states on behalf of Ascension Health, one of the biggest health systems in the country. Labcorp will also spend $400 million to acquire certain assets of Ascension’s outreach laboratory services. Labcorp’s CEO characterized the deal as “one of the most significant of its kind.
LIKE THE CHINESE ADAGE ABOUT STEADY DROPS OF WATER WEARING AWAY THE ROCK, after four decades of persistent effort to convince hospital CEOs that a commercial lab can manage labs better and cheaper than hospital staff, one commercial entity has just won the biggest-ever agreement involving a major hospital system and a public lab company.
The deal is worth almost half a billion dollars and involves Labcorp and Ascension Health, the Catholic health system based in St. Louis, Mo., that operates 142 hospitals in 19 states and the District of Columbia.
Announced on Feb. 10, the deal has two primary elements. First, Ascension will sell its hospital laboratory outreach business at a number of locations to Labcorp. Second, Labcorp will manage the inpatient laboratories of many Ascension hospitals.
The new lab management agreement covers at least 75 of Ascension’s hospital labs in Alabama, Florida, Kansas, Maryland, Michigan, New York, Oklahoma, Tennessee, Texas, and Wisconsin. Financial terms of this part of the agreement were not announced.
As is true in many of the hospital/health system agreements with public lab companies that have happened since the mid-1990s, Ascension will receive a substantial amount of cash. Labcorp will pay approximately $400 million for the outreach lab businesses Ascension is selling.
This cash infusion is likely a most welcome development at Ascension. The chain had operating revenue of $27.2 billion in FY 2021, including $5.7 billion in net income, according to Hospital CFO Report. However, the prior year, in FY 2020, Ascension posted a net income loss of just over $1 billion on operating revenue of $25.3 billion.
Ascension’s sizeable loss in 2020 (the year the pandemic commenced) is notable for an interesting reason. Over the past 25 years, a substantial proportion of hospital/health system lab outreach sales to commercial lab companies have involved hospitals which had been losing money and needed the capital infusion that the sale of their lab outreach program would bring them.
In commenting on this agreement, during a fourth-quarter earnings call on Feb. 10, Adam Schechter, CEO at Labcorp said, “this is a notable opportunity for us and one of the most significant deals of its kind in the sector.”
This agreement should benefit Labcorp in multiple ways. First, Labcorp can use the Ascension lab outreach businesses it is buying in the different regions to expand its existing market share of physicians’ office testing. Second, its management of inpatient laboratories at a number of Ascension hospitals will feed its esoteric testing division at the expense of other reference labs, such as Quest Diagnostics, Mayo Clinical Laboratories, and ARUP Laboratories.
The third potential benefit might be overlooked by anatomic pathologists. In managing inpatient labs, Labcorp is in a position to direct tissue specimens to its own pathologists, particularly the more complex cancer cases that require extensive workups and multiple diagnostic procedures. That would reduce case referrals to the local pathology groups currently serving Ascension hospitals.
Labcorp’s Schechter was optimistic about the positive financial impact the Ascension pact would have on his company’s financial performance. The deal is probably being arranged in such a fashion that Labcorp will get to add the revenue generated by the hospital inpatient laboratories it is managing to its top-line revenue.
To that point, Shecter told investors and analysts during the call that “we expect the first-year annualized revenues to be between $550 million and $600 million from the combined hospital business and lab asset acquisition. “While operating margins are expected to be less than segment margins initially, they are expected to improve each year. The transaction is expected to be accretive to our earnings and cash flow in year one and should return its cost of capital by year two.”
During the Feb. 10 conference call, Labcorp announced that its full year revenue for FY 2021 was $16.1 billion, up from $14 billion in 2020. The company’s free cash flow for 2021 was $2.6 billion. A substantial portion of that free cash flow was generated by COVID-19 testing. For that reason, Labcorp has a big war chest of cash it can use to go out and do more deals with hospitals and health systems.
Collaboration in Other Areas
Schechter mentioned that Labcorp and Ascension Health may explore other areas in which to collaborate. “We believe there will be opportunities for us to work together in many different ways as we go into the future—not just with hospital work, by the way,” he commented. “We’re going to explore clinical trial work together, and oncology opportunities that enhance patient access.”
This is where the company’s Labcorp Drug Development (formerly Covance) gives Labcorp an advantage over its larger competitors. Labcorp is a major player in clinical trials and can help Ascension generate additional revenue by helping enroll its patients in a wide range of clinical trials and research studies.
One factor that may have played a role in Ascension Health’s willingness to sell its hospital lab outreach businesses and engage Labcorp to manage inpatient labs at many of its hospitals is the ongoing financial erosion and lost revenue attributed to the Medicare Part B Clinical Laboratory Fee Schedule (CLFS) cuts that were mandated by the Protecting Access to Medicare Act of 2014 (PAMA).
Under PAMA, lab prices were cut by a maximum of 10% in 2018 and another 10% cut in 2019. The additional price cuts scheduled for implementation in 2020, 2021, and 2022, have been delayed in response to the pandemic. Because most regional laboratories work on thin operating margins, the PAMA fee cuts have caused a significant number of community laboratories to close, to file bankruptcy, or to sell.
PAMA Price Cuts
One example of a health system selling its lab outreach business in response to the Medicare Part B lab price cuts was the decision by Eugene, Oregon-based PeaceHealth to sell PeaceHealth Laboratories to Quest Diagnostics in 2017. At the time, Ran Whitehead, CEO of the lab, told The Dark Report that financial modeling indicated the PAMA price cuts would erode the financial stability of the laboratory business. Thus, the health system administration decided to shed the outreach lab business. (See TDR, “PeaceHealth Outreach Laboratory Sells to Quest Diagnostics,” Feb. 21, 2017.)
Schechter recognized this factor during the Feb. 10 call. “We think that the future is very bright for diagnostics and our ability to grow, but it’s not through pricing, and there will continue to be pricing pressure. It’s more through geographic expansion, hospital deals, and continued growth in the segment itself.”
Another important element to watch is how much turnover happens with the lab staffs at the Ascension hospitals where either or both the lab outreach program is being sold and the hospital laboratory will be managed by Labcorp.
Currently, the “Great Resignation” is a major trend. Across the nation, clinical labs and pathology groups are reporting an acute shortage of staff. This is true at every position, from phlebotomists, couriers, and accessioners to medical technologists (MTs), microbiologists, even CLIA lab directors.
Both hospital and independent labs report that staffing levels are only at 70% to 80% of necessary and authorized levels. To fill that gap, most hospital labs are paying substantial overtime, as well as engaging locum tenens med techs and other technical positions.
Lab Staff Retention
Labcorp thus faces the risk that a significant number of key technical staff at Ascension hospital labs may opt to go across town and work for competing hospitals.
Given the signing bonuses being offered to MTs by many hospitals, staff retention may turn out to be one of Labcorp’s biggest challenges as it assumes operational responsibility at the Ascension laboratory sites.
Labcorp Focuses on Lab Outreach Business
THE OUTREACH LABORATORY MARKET HAS BEEN A PRIME TARGET of Labcorp acquisitions over the past two decades.
For example, in July 2021, Labcorp acquired the outreach laboratory business of Minnesota-based North Memorial Health and began managing the system’s inpatient lab. Further back, Labcorp made these similar deals:
- In 2017, Labcorp bought the lab outreach business of Mount Sinai Health System in New York City. (See TDR, Jan. 30, 2017.)
- In 2013, the owners of Genesis Clinical Laboratory in Berwyn, Ill., sold their lab outreach business to Labcorp. (See TDR, July 29, 2013.)
- In 2020, it acquired the clinical ambulatory laboratory business of Franciscan Missionaries of Our Lady Health System in Baton Rouge, La. (See TDR, Sept. 14, 2020.)