CEO SUMMARY: Unilab’s desire to purchase $60 million Bio-Cypher must be viewed against the impending acquisition by Quest Diagnostics of SmithKline Beecham Clinical Laboratories (SBCL). Whenever Quest takes control of SBCL’s lab operations, it automatically becomes a significant competitor to Unilab in the Golden State. For Unilab, acquiring Bio-Cypher represents both an offensive and defensive strategy.
IT’S TAKEN A LONG TIME TO HAPPEN, but Bio-Cypher Laboratories (BCL) of Sacramento, California is finally on the sales block.
On April 6, Unilab Corporation announced a definitive agreement “to acquire substantially all of the assets (including the customer list) of Physicians Clinical Laboratory (doing business as Bio-Cypher Laboratories).”
BCL is estimated to have annual revenues approaching $60 million. Unilab is to pay about $36 million for BCL. Terms include $8 million in cash, 1 million shares of Unilab common stock, and a $25 million convertible note, with annual principal payments of $10 million. Unilab will also assume $4 million of BCL debt.
Unilab Is Optimistic
“Unilab is very optimistic about this acquisition,” said Richard Michaelson, a Unilab Director and its former CFO. “Bio-Cypher’s existing client base dovetails neatly into our statewide laboratory network. We believe that we can successfully integrate it’s assets into our operation and generate meaningful increases to our operating profits and earnings.”
Several potential buyers kicked Bio-Cypher’s tires. Among them were Laboratory Corporation of America, Quest Diagnostics Incorporated, and SmithKline Beecham Clinical Laboratories (SBCL).
But no potential buyer could get as much benefit from BCL as Unilab. It already operates a major laboratory in Sacramento, across town from BCL’s core lab. Its laboratory net- work throughout the state is well-positioned to service BCL’s existing client base.
“Both the structure of the purchase and price to be paid for Bio-Cypher were appropriate to Unilab,” stated Michaelson. “Probably no other lab in California can generate as much value from BCL’s assets as Unilab.”
Michaelson’s comments reflect a truth about the California marketplace. As the marketplace eliminates excess laboratory capacity, those remaining labs with low costs and high utilization of capacity will become stronger.
Unilab’s acquisition of BCL represents both an offensive and defensive business strategy. It demonstrates how complex the California marketplace has become.
Leverage Lab Infrastructure
As an offensive strategy, buying BCL allows Unilab to leverage its existing laboratory infrastructure. BCL’s specimen volume will soak up Unilab’s excess capacity, particularly in its Sacramento and San Jose core labs. It also improves the productivity of Unilab’s network of couriers and draw sites.
As a defensive strategy, Unilab’s purchase of BCL blocks Quest Diagnostics. Quest Diagnostics is expected to complete its acquisition of SBCL this summer. SBCL’s California business makes Quest a significant player in that state. BCL’s $60 million client base would help Quest for many of the same reasons that it helps Unilab.
That is why Unilab’s purchase of BCL is really part of a complex business strategy. It benefits Unilab in a variety of ways. However, Unilab faces several hurdles before it can declare this impending acquistion to be a success.
Bio-Cypher is a struggling company. Its problems are widely-known. Unilab’s management team faces significant challenges in the upcoming integration. During the last year, there has been a steady exodus of capable lab managers from Bio-Cypher.
Insufficient Cash Flow
Its cash flow was insufficient to sustain regular operations. Billing and collections, in particular, have proved troublesome, further starving the company of much-needed cash.
But Unilab sees a strong, underlying foundation to BCL, one it believes has value. “For several years, Bio- Cypher had a rough time,” noted Michaelson. “However, its client base has been relatively stable in the most recent period.”
Michaelson is referring to the core of long-time, very loyal clients that continued to support BCL through its most difficult times. Unilab believes existing clients of BCL will stay with Unilab after the acquisition because of the additional services and financial stability offered by Unilab.
Unilab’s recent purchase of Meris Laboratories in San Jose was similar. Meris had severe financial problems for several years. When Unilab purchased Meris last fall, it had great success retaining the client base of Meris. (See TDR, November 8, 1998.) Unilab has confidence that BCL’s remaining core clientele will similarly opt to stay with its new owner.
Clients and regular readers of THE DARK REPORT know that California has been the most intensely-competitive battleground for laboratory service in the United States. The fall of Bio-Cypher has been long predicted. The unanswered question was which of the major lab players would end up purchasing Bio-Cypher.
Bio-Cypher’s removal from the marketplace eliminates the last obvious and sizable quantity of laboratory capacity from California. It will help efforts by remaining labs to improve contract pricing and reimbursement for laboratory testing in the state.
However, expect competition to be fierce for lab business in California. Michaelson explains why. “The numbers we see indicate that some $4 billion dollars of lab testing is done in California each year.”
“Physicians’ offices generate almost $2 billion in testing, and about half of that is performed by commercial labs,” explained Michaelson. “There are still a lot of labs competing for this $1 billion of testing.”
Michaelson’s comments demonstrate that Unilab still recognizes that California remains an intensely competitive marketplace for laboratory testing. It knows that survival and prosperity depend on effective implementation of its business plan.
Disappear From The Market
The truth of this statement is reflected in the collapse of both Meris Labs and BCL during the last seven months. As these two labs disappear from the marketplace, almost $90 million per year of laboratory capacity and infrastructure disappears with them. That improves the competitive position of the remaining laboratories in California. But it also demonstrates that financial pressure on clinical laboratories continues to be intense.
For that reason, laboratory executives and pathologists will find the next market phase in California to be revealing. In this phase, Unilab, Quest Diagnostics, LabCorp and several other key competitors will be fighting under different ground rules.
California’s next competitive cycle will be less about rock-bottom capitated rates and more about “value-added” laboratory services. Predicting winners and losers at this point is impossible.