For Quest and LabCorp, The Story is “Molecular”

Both lab companies racing to lock up most promising molecular technologies

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CEO SUMMARY: Wall Street likes the potential of molecular diagnostics to infuse new revenues and operating profits into the laboratory industry. That is one reason Quest Diagnostics Incorporated and Laboratory Corporation of America are assertively seeking exclusive access to new molecular technologies. The latest such deal is Quest Diagnostics’ $42.8 million agreement with Ciphergen Biosystems.

WAS IT COINCIDENCE that, on the same day that Quest Diagnostics Incorporated announced a molecular technology agreement with Ciphergen Biosystems, Inc., Laboratory Corporation of America issued a press release about its newest molecular diagnostics initiative?

The date was Friday, July 22, 2005. The day opened with a press release by Quest Diagnostics Incorporated that it had formed a “strategic alliance to develop and commercialize novel proteomic diagnostic tests based on Ciphergen’s proprietary SELDI ProteinChip® technology.”

By day’s end on July 22, LabCorp had issued a press release titled “LabCorp® to Begin Validation and Evaluation of Roche Diagnostics’ AmpliChip™ CYP450 Test.” This AmpliChip test is the first microarray- based molecular assay to receive FDA approval for clinical use.

One notable difference in the two agreements is that Quest Diagnostics is making a major investment to access the Ciphergen proteomics technology. The three-year deal calls for Quest Diagnostics to pay $15 million to commercialize its choice of assays from Ciphergen’s development pipeline.

Quest Diagnostics also purchased about 6.2 million shares of Ciphergen stock, worth approximately $12.8 mil- lion, along with a five-year warrant that allows it to purchase another 2.2 million shares of Ciphergen stock for $3.50 per share.

Quest Diagnostics also agreed to loan Ciphergen up to $10 million “to fund certain development opportunities.” This loan can be forgiven if Ciphergen achieves “certain milestones.” Collectively, not counting the warrants, Quest Diagnostics is committing $42.8 million to access Ciphergen’s proteomic technology.

Validation of AmpliChip

In the case of LabCorp and the Roche Amplichip, LabCorp’s main statement was that it “announced today that it will begin validation testing of Roche Diagnostics’ AmpliChip CYP- 450 test.” It further stated that it would assist Roche Diagnostics in evaluating its research leukemia microarray. This assay is intended to identify leukemia subclasses.

The fact that both lab companies released press releases on the same date indicates the importance of molecular diagnostics to their individual business strategies. The two blood brothers regularly tell the “molecular story” to Wall Street. Both lab companies believe that molecular assays will yield higher revenues and profit margins.

Molecular Technologies

Acquisitions and strategic alliances in molecular diagnostics testing remain one major growth strategy for each company. Both Quest Diagnostics Inc. and LabCorp America want to be first to lock up selected molecular testing technologies through exclusive agreements with strategic partners.

The molecular strategy was given prominent play in the second quarter earnings announcements by both companies. LabCorp had released its second quarter financial report on Thursday, July 21, the day before Quest Diagnostics publicized its deal with Ciphergen. Quest Diagnostics reported its second quarter earnings on Monday, July 25, 2005.

Both companies posted modest gains during the second quarter of 2005. Revenues at Quest Diagnostics Inc. climbed 6.2% to $1.4 billion. This was due to a gain of 5.3% in clinical testing volume and a 1.2% increase in revenue per requisition over second quarter 2004. Net income increased to $149 million, from $127 million for the prior-year period, a 10.6% increase.

At LabCorp, revenues totaled $853.3 million. This was an 8.8% gain over the same period in 2004. Specimen volumes grew by 1.1% and higher prices accounted for 7.7%. Net earnings were $106 million, compared to $98.3 million for second quarter 2004, an increase of 7.8%

Discussions With Investors

As these earnings statements show, both lab companies are experiencing about similar growth. However, there is an interesting difference in the business focus for Quest Diagnostics and LabCorp, as reflected in their public discussions with the investment community.

Based on these comments and company actions, it might be simply stated that Quest Diagnostics is emphasizing an “internal” strategy to drive up specimen volume, revenues and earnings. In contrast, LabCorp is more willing to pursue an “external” strategy to accomplish the same objectives. Certainly this comparison is relative, because each company is willing to bid or pursue any significant market opportunity that would generate more specimens and more revenue.

LabCorp’s actions during the past 24 months reinforce its commitment to the external strategy—grow by acquiring another company’s client-physicians. It was the winning bidder for the two biggest lab acquisition prizes of 2004-05, which were US Labs, Inc. and Esoterix, Inc. Moreover, it continued to acquire small independent labs as well.

It should be noted that Quest Diagnostics was given the opportunity to place a bid for these acquisitions. The consistent outcome of LabCorp as the winning bidder suggests the relative importance of the external strategy to Laboratory Corporation of America versus Quest Diagnostics.

For its part, the language Quest Diagnostics uses with the investment community consistently emphasizes efficiencies and increased volumes— selling more to existing customers and winning new customers—and improving “customer satisfaction.” Its executive team has stated that any acquisition or alliance prospect must be “patient grounded,” reflecting a “patient first” perspective.

Six Sigma Quality Program

This is consistent with the major investment Quest Diagnostics has made in implementing Six Sigma quality systems throughout its network of regional laboratories. In public statements, the company has declared its intention to achieve a “new quality standard for the healthcare industry.”

It must be emphasized that this corporate emphasis on internal versus external is relative. Certainly LabCorp has made plenty of statements to Wall Street about its efforts to improve operational efficiencies, boost quality and productivity, and increase customer satisfaction. And, every time LabCorp tenders a bid for a laboratory acquisition, Quest Diagnostics is considered a qualified and interested buyer for that same laboratory company.

Probably the most accurate conclusion is that Quest Diagnostics Incorporated and Laboratory Corporation of America are competing vigorously in every dimension of the laboratory marketplace. Any differences in style, strategy, or corporate philosophy stem mainly from the need by each company to publicly differentiate itself from its competitor.

After all, there are only a limited number of lab acquisition possibilities, or new diagnostic technology deals at any point in time. Short of capturing more market share from hospital laboratory outreach programs and the handful of remaining independent labs, acquisitions and exclusive access to new diagnostic assays are the most feasible way for either of the two blood brothers to generate increases in specimen volume and revenues.

One Molecular Deal That Never Panned Out

REMEMBER THE $75 MILLION DEAL between EXACT Sciences Corporation and Laboratory Corporation of America? It’s a deal that shows the risks of paying for unproven molecular diagnostic technology.

Announced in June 2002, LabCorp began offering EXACT’s PreGen-Plus™ for the early detection of colorectal cancer in the average-risk population in the summer of 2003. However, not enough physicians ordered the test.

Failure of the clinical market to accept this test was recognized by LabCorp in its second quarter earnings report. The company wrote off $3.1 million of its investment in the EXACT Sciences agreement.

This molecular technology agreement between a development company and a national laboratory is a reminder that every new lab test technology faces daunting hurdles to gain clinical acceptance and earn favorable coverage and reimbursement decisions from Medicare and major health insurers.

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