SINCE LAST FALL’S SUCCESSFUL IPOs (initial public offering) raised $92 million for Specialty Laboratories, Inc. and $50 million for Dynacare, Inc., the financial fortunes of the two lab companies have begun moving in different directions.
Lab administrators and pathologists can better understand the diverging business directions of Specialty Labs and Dynacare by studying each lab’s balance sheet. Moreover, balance sheet issues are part of what hinders American Medical Laboratories, Inc. from moving forward with its announced IPO.
The balance sheet reflects financial strengths and weaknesses for a company. It can directly enhance or inhibit a company’s ability to expand and grow. Professional investors understand the importance of a sound balance sheet. For example, balance sheet differences are one reason why Specialty Labs’ IPO pulled in almost twice the funds as Dynacare’s IPO.
Strong Balance Sheet
Specialty Labs has a particularly strong balance sheet. In contrast, Dynacare’s financial structure limits its business options. Both companies’ pre- and post- IPO balance sheets are reproduced on page 16 and highlight key differences.
The most basic analysis of a balance sheet can focus on several items: cash and cash equivalents, long term debt, and shareholders’ equity. In the case of Specialty Labs and Dynacare, each item will illustrate a fundamental difference.
Increased Cash Holdings
First is cash and cash equivalents. This is the money available to pay bills, service and/or retire debt, and expand business activities. As the two balance sheets show, Specialty Labs’ cash holdings increased by $75 million after its IPO. More than 80% of its IPO monies were retained to fund future growth.
In contrast, at Dynacare, cash in- creased by just $1.8 million. Dynacare used the cash from its IPO differently, as shown by the $61.3 million increase in Dyncare’s total assets, from $288.5 million pre-IPO to $349.8 million post-IPO. This increase reflects the value of the lab acquisitions Dynacare completed during 2000.
The telling difference is long term debt. Specialty Labs used its funds to retire 100% of its long term debt. But it’s a different story at Dynacare. On annual revenues of $352 million for 2000, it carries about $209 million of long term debt (of which $5.9 million matures during the next 12 months and must be retired). Of course, it must also service the interest payments due on this debt. This diverts cash flow that could be used to fund expansion or to pay stock dividends. Investors recognize this fact and have allowed Dynacare’s stock price to fall considerably below its IPO level of $10 per share.
This brings us to a comparison of shareholder equity. At Specialty Labs, total shareholder equity totals $111.7 million and, with liabilities, yields a balance sheet total of $142 million.
Dynacare’s shareholder equity, defined as “capital stock” under Canadian accounting rules, totals (after foreign currency adjustment) $55.2 million post-IPO, compared to $1.6 million pre-IPO. This shows how the $50 million raised during the IPO has been absorbed and helped boost “capital stock” from almost zero.
There is one more key difference in the balance sheets of Specialty Labs and Dynacare. Because Specialty had no lab acquisitions in 2000, there is no goodwill on its balance sheet. That is not the case at Dynacare, which has used lab acquisitions as a major way to boost revenues. It has “licenses and goodwill” of $166.7 million. This is 47.6% of its total assets.
Accounting principles define goodwill as the difference between the purchase price paid for a company and the value of its tangible assets. It is a “paper” accounting entry and is usually amortized over several years.
As a balance sheet item, goodwill affects a company’s ability to borrow money, float debt issues, and attract equity investors. If a company were to be liquidated in a bankruptcy action, goodwill frequently has zero value. Obviously, banks and investors want to know that, if liquidated, a company has enough assets to fully cover liabilities and, hopefully, all the stockholder equity.
Lots of goodwill on a balance sheet, without significant amounts of compensating cash, tends to dissuade investors and banks from providing capital on the most favorable terms.
That is a reason why certain lenders and investors would consider, along with other factors, Dynacare’s relatively large percentage (47%) of goodwill to be a balance sheet weakness. Subtract the $166.6 million in goodwill from its $349.8 million in total assets, and only $183.2 remains to cover its $294.5 million in total liabilities.
Risk Factors To Consider
Shrewd lenders and investors see this as one risk factor they must consider before extending credit or capital to a company like Dynacare. At the least, it raises the cost of borrowing to the company with a weak balance sheet.
This frames the business challenge facing Dynacare. Investors understand the particular strengths and weaknesses of its balance sheet, revenue stream, and strategic business plan. Both investors and lenders are closely scrutinizing the financial performance of Dynacare to see it can deliver the revenue growth and increased profits it promised in its strategic business plan.
Each quarter, Dynacare must hit ambitious targets for revenue and earnings, otherwise investors will cease to support the stock. There is already evidence that some investors question Dynacare’s ability to deliver strong and sustained growth in sales and profits. Since early January, Dyncare’s stock price has fallen steadily. It now trades near $5 per share, less than half of its IPO price of $10 in November 2000.
Softening Stock Prices
Although Specialty Labs has a stronger balance sheet than Dynacare, banks and investors are also keeping a close watch on the ability of Specialty Labs’ executive team to meet its projections on revenue growth and earnings. That may be one reason why Specialty Lab’s stock prices softened considerably in the past 60 days.
As demonstrated in this story, a closer study of the balance sheets of lab companies helps explain some reasons behind the business successes and failures they experience. For example, a less-than-ideal balance sheet, along with other financial factors, at American Medical Laboratories has made it difficult for AML to place an IPO on terms it considers reasonable.
At another time and place, Quest Diagnostics Incorporated, when it was spun off from Corning Corporation, was able to write off $450 million of intangibles and goodwill from its balance sheet. It started business on January 1, 1997 with a balance sheet that allowed Quest Diagnostics much greater freedom of action than the other two national labs. Did it make a difference? Certainly! Today, the world’s largest public clinical lab company is the one which had the strongest balance sheet at the beginning of 1997.
Balance Sheet Analysis
In the pathology world, analyzing the balance sheets of the leading pathology companies like AmeriPath, Inc., DIANON Systems, Inc., and IMPATH, Inc. reveals interesting clues to their financial future. For example, AmeriPath, which has relied heavily on acquisitions to fuel its rapid growth, has as much as 79% of its assets comprised of intangibles (goodwill and the like) and hospital contracts (a capitalized value for its pathology group contracts with hospitals).
Obviously, these observations about the balance sheets of the two newest public lab companies don’t represent a comprehensive analysis. But this simple assessment does highlight the balance sheet differences of Specialty Labs and Dynacare. It helps lab execs and pathologists understand the different financial resources available at each company to support each lab’s business strategies.