Quest and SBCL Expect Merger Date Of July 2

Lab industry “big bang” will create behemoth national laboratory company

CEO SUMMARY: After months of waiting and planning, executives at Quest Diagnostics Incorporated believe that July 2, 1999 will be the date when their acquisition of SmithKline Beecham Clinical Laboratories becomes official. During the month of July, expect a flurry of activity at Quest Diagnostics as managers of the combined laboratory company work to harvest the potential benefits of this industry mega-merger.

NOT ONLY IS IT THE super-marriage of the century for the clinical laboratory industry, but the wedding ceremony may happen by Friday of this week.

Executives at Quest Diagnostics Incorporated indicate to THE DARK REPORT that, as of press time, they still expect their acquisition of SmithKline Beecham Clinical Laboratories (SBCL) to become effective on July 2.

Upon completion of the acquisition, the “new” Quest Diagnostics will have $3 billion per year in revenues and employ more than 25,000 people. Wall Street and the investment community remain positive about this merger.

During June, Quest Diagnostics successfully completed the financing arrangements necessary to complete the transaction. To acquire SBCL, it will pay SmithKline Beecham, Ltd. $1.025 billion in cash and 12,564,336 shares of stock, worth about $399 million at a price of $25.50 per share.

Shareholders of Quest Diagnostics will gather tomorrow, June 29, at the Intercontinental Hotel in New York City to vote on the merger. It is expected they will approve the acquisition. Baring any unforeseen delays, by Friday, July 2, Quest Diagnostics will be the owner of SmithKline Beecham Clinical Laboratories.

Once Quest Diagnostics takes title to SBCL, it must move swiftly to realize the potential benefits of the acquisition. To this end, an integration team has been assembled under the direction of James Chambers, President for Corporate Services at Quest Diagnostics. This integration team has established working groups at both lab companies to identify issues which need immediate attention once the merger is completed.

Public Silence About Plans

Company officials from both laboratories have maintained a public silence about post-merger plans. This is due to Securities and Exchange Commission regulations which govern forward-looking statements in advance of certain corporate activities, including stock offerings and acquisitions.

However, general statements have been made about the basic strategies Quest Diagnostics intends to pursue after the merger. These statements indicate that company executives intend to avoid the merger mistakes of their predecessors earlier in the decade. Instead of rushing to consolidate testing as fast as possible wherever possible, Quest Diagnostics will follow a careful path.

First, during the initial 24 months following the merger, Quest Diagnostics will concentrate on closing redundant facilities such as patient service centers, stat labs, courier hubs, and a number of the SAMSHA-certified drugs of abuse testing facilities operated by both lab systems.

Study Individual Markets

In the short term, this avoids tinkering with the large regional laboratories which exist side-by-side in cities like Philadelphia, Detroit, and Chicago. It gives Quest Diagnostics the time to study individual markets and understand the best ways to consolidate testing without alienating long-time, loyal clients of either SBCL or Quest.

Further, THE DARK REPORT believes that Quest Diagnostics intends to use the months following the merger to carefully evaluate and select the best management talent from each laboratory company. One of Quest’s goals is to forge a common company culture and that requires time to accomplish.

As noted on these pages in past years, Ken Freeman, the Chairman and CEO of Quest Diagnostics, is well schooled in the principles of quality based management. He appreciates that the success of any laboratory organization rests more on the capabilities of its staff and leaders than on any technical or scientific advantage. This is another reason why Quest will devote the post merger months to evaluating people and building solid management teams from the best of both companies.

Pursue “Best Practices”

The second area of significant savings that Quest Diagnostics intends to pursue is something we will call “best practices.” Quest wants to identify the best management processes within each system, and introduce them throughout the combined laboratory company.

For example. Quest has specifically noted that, between 1996 and 1998, it reduced the number of requisitions with incomplete billing information from 16% to 6%. This helped bad debt expense shrink to 6.1% at the end of 1998.

In contrast, Quest notes that SBCL estimates the percentage of requisitions lacking complete billing data is around 15%. SBCL’s bad debt expense during 1998 was 9%. If Quest can get SBCL’s business down to similar ratios, it will pick up $45 million per year from reduced bad debt expense.

There are similar operational areas where the opportunity exists to transfer the best practices of one lab over to the other. This activity will occur in tandem with the operational restructuring and consolidation of the two laboratory systems.

None of this will come cheap. Quest Diagnostics is borrowing $1.18 billion to fund the purchase, provide capital for restructuring, and maintain necessary working capital. This debt will have to be serviced. Assuming a rate of 9% per year on this debt, Quest will pay $109 million per year in interest, not including any reductions to principal that might be required.

Significant Debt Service

Meanwhile, Quest Diagnostics estimates that, at the end of three years, it can realize savings of $100 million per year between the two laboratory organizations. During this time, it expects to incur acquisition and integration charges of $190 million for 1999. It also estimates that another $200 million in integration charges will accrue in the years following the merger.

In acquiring SBCL, Quest Diagnostics is undertaking an immense task. The size and scale of this laboratory consolidation project has never before been attempted. Although the financial community is generally optimistic that Quest Diagnostics can successfully pull off this acquisition, it will not be an easy task.

The biggest risk to the acquisition is loss of existing client accounts. On one hand, the new management team at Quest must skillfully implement restructuring plans in such a way as to maintain good client service. Any less than that, and clients will switch to competitors.

On the other hand, a swarm of competitors are circling around the existing clients of Quest and SBCL. These range from commercial labs like Laboratory Corp. of America and Unilab, to reference testing labs such as ARUP, Specialty, and American Medical Labs.

Everybody wants a piece of this deal. Management at Quest Diagnostics will be hard-pressed to keep the wolves from their clients even as they turn their
attention on internal restructuring and consolidation.

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