AmeriPath Stock Offering Pulled By Underwriters

Efforts to become first publicly traded pathology management firm stymied by market conditions

CEO SUMMARY: Ameripath planned to go public in March. However, the stock market’s significant decline and further evaluation of the company’s business plan caused Wall Street underwriters to defer issuing the stock. Pathologists are curious as to whether AmeriPath’s “employee” business model influenced decisions about the public stock offering.

UNDERWRITERS on Wall Street decided to delay AmeriPath’s Initial Public Offering (IPO). Their action represents a significant setback for AmeriPath.

AmeriPath hoped to raise $71.7 million selling 36% of the company’s shares to the public. If successful, AmeriPath would have become the first publicly traded physician practice management company exclusively devoted to pathology.

For that reason, pathologists throughout the United States watch AmeriPath with keen interest. Professionally, pathologists are challenged by declining income and the pressure to consolidate pathology practices. Any business model which can solve either or both of these problems will be rapidly copied.

“For AmeriPath, the decision to delay or cancel the stock offering must be a tremendous blow,” stated one pathologist who closely tracks the company. “From the beginning, AmeriPath’s driving goal was to go public. Without a public market for their stock, it becomes a very different business vehicle for the pathologists who sold their practices to AmeriPath.”

As of December 31, 1996, AmeriPath had acquired 12 pathology practices in five states. At that time, 81 pathologists were employed by the company. Consolidated revenues are $82 million per year. During the “quiet period” since the company’s S-1 filing with the Securities and Exchange Commission, no additional pathology practices were acquired.

Company officials still decline to speak publicly about their situation, so specific reasons why the IPO was delayed or cancelled remain unknown.

When THE DARK REPORT detailed AmeriPath’s plans and the business strategy of the company earlier this year, AmeriPath was preparing to offer their stock by March 31, 1997.

Several events may have changed that timetable, particularly as the stock market declined significantly over the last four weeks. AmeriPath was looking to offer 6.2 million shares at $14.00. Such an offering would generate net proceeds of $71.7 million.

Underwriters apparently believed that the market would not take AmeriPath’s stock at that price. THE DARK REPORT learned that underwriters were only willing to offer 4 million shares at $10. This changed the economics of the stock offering for AmeriPath and its venture capital investor, Summit Partners of Boston. Instead of raising over $70 million, the revised offering would only provide $40 million, most of which was earmarked to pay existing bank debt. The decision was made to pull the IPO.

Another consideration which may have played a part in the underwriters’ decision is AmeriPath’s business structure. Unlike the majority of physician practice management companies, which use a “service fee” arrangement for sharing profits, AmeriPath’s pathologists are employees and compensated by salary.

There is speculation that the underwriting syndicate questioned the productivity of pathologists who are to be paid salaries at a level below their previous earnings as partners in the practices acquired by AmeriPath.

AmeriPath’s potential to shed light on the employee/partner productivity debate comes from a remarkable fact. AmeriPath’s consolidated financials for 1996 show revenue of $82 million. Thus, the company’s 81 pathologists generate an average of $1 million per pathologist per year in revenue. This flies in the face of industry experience.

“Typically, hospital-based pathologists generate $400,000 to $600,000 per year in revenue,” stated a pathology business consultant. “That is well below AmeriPath’s average of $1 million per pathologist. Either they have a management productivity secret we need to learn, or those numbers will not be sustained in coming years by AmeriPath’s pathologists.”

Strategic Plans

Although AmeriPath’s initial public offering will not take place at this time, company officials intend to press forward with AmeriPath’s strategic plan.

During the last six months, company executives continued discussions and presentations with a number of pathology practices around the United States. THE DARK REPORT believes that AmeriPath will attempt to do two things during the next year.

First, AmeriPath will continue to acquire pathology practices. Funds for this effort will come from venture capital sources and credit lines from banks or similar lenders. Summit Partners will play a key role in helping AmeriPath access capital through these sources.

Second, look for AmeriPath to arrange a second attempt at an IPO. This will probably not take place until last quarter of 1997 or first quarter of 1998.

Now that AmeriPath’s IPO has been scratched, the company must demonstrate healthy earnings to convince Wall Street that a second attempt at an IPO is valid. Acquiring additional practices will help increase Ameripath’s 1997 earnings over the same time periods of 1996.

Also, look for AmeriPath to concentrate on acquiring dermatopathology practices. This is a high-yield segment of the pathology marketplace and makes it easier for AmeriPath to show the earnings necessary to meet Wall Street’s expectations.

AmeriPath Moved Ahead

During 1996, AmeriPath moved far ahead of any competing pathology roll-up company. It now has an $82 million revenue base, ample support from a credible venture capital company, and assumably a checkbook that is open and ready to purchase more pathology practices.

Notwithstanding arguments concerning the merits of the employee versus equity business model, AmeriPath now possesses the resources to demonstrate whether their model of pathology consolidation can be successful.

Marketplace Challenges

AmeriPath must deal with the same marketplace challenges as all pathology practices: hospitals seeking to lower pathology costs, reductions to Medicare and Medicaid pathology reimbursement, and managed care plans offering less reimbursement.

Like all pathology practices, AmeriPath must deal with a financially stressful healthcare environment. Because they now have economies of scale unmatched by any other pathology company, the financial performance of AmeriPath will provide many valuable management lessons to the entire pathology industry.

AmeriPath, Inc. Time Line

1994: Pathologists Evangelos Poulos, M.D.: Michael Demaray, M.D.; A.P. Kowalzyk, M.D.; and Summit Partners develop con- cept of pathology-based physicians practice management company. Company is based in Florida.
January 1996: James New is retained as AmeriPath’s president.
February 1996: AmeriPath incorporated as the holding company for American Laboratory Associates, the precursor company. Two pathology practices are part of AmeriPath at this time.
June-November 1996: AmeriPath acquires ten additional pathology practices, bringing the total number to twelve pathology practices and 81 pathologists.
December 1996: AmeriPath files S-1 registration for an Initial Public Stock Offering with the Securities and Exchange Commission.
April 1997: Officials at underwriting syndicate and AmeriPath decide to delay or cancel AmeriPath’s IPO.
Coverage of AmeriPath in THE DARK REPORT: November 4, 1996; January 27, 1997

Great Debate…Equity Model Versus Employment Model

THIS QUESTION of employee model versus equity model is a key distinction between the three pathology practice roll-up companies currently
purchasing pathology practices.

Within the healthcare industry, there is still no consensus about what business models successfully encourage physician productivity and maintain the quality of healthcare services provided by those same physicians.

For example, just 18 months ago Moody’s Investors Services warned hospital bondholders that those hospitals with large physician practice acquisitions were losing significant money on those practices. (See TDR, December 18, 1995.) At that time, Moody’s Senior Analyst Lisa Martin told THE DARK REPORT that “We see a lot of cases where the physician practice component is losing money. There are instances where the losses equal, and even exceed, any income the hospital itself earns.”

Because most hospital-owned physician practices work on an employee model, Moody’s assessment provides evidence that the employee model may not be an effective business structure for physician roll-up companies.

The employee/equity model controversy is relevant to pathologists for an important reason. The price paid for a pathology practice by an employee model company such as AmeriPath can be significantly higher than what is paid by an equity model company.

“It is important to remember that a physician roll-up company which pays the pathologist a salary after acquiring the practice gains a greater portion of the cash flow,” observed one financial analyst. “The pathologist agrees to a 3- 5 year employment contract and probably gets some type of stock kicker as an
incentive. For this reason, physician management companies using the employment model can outbid equity model companies when doing acquisitions.

“However, few of the publicly traded physician practice companies use the employee model,” he continued, “so there is still a question about whether physicians and pathologists will maintain high levels of productivity and quality during the three-year to five-year term of their employment agreement.

“After all,” he concluded, “they have gone from status as an equity partner to one of employee, at a much reduced rate of earnings. Human nature predicts that they would begin to ease off the pace under those circumstances.

“Many pathologists looking at AmeriPath’s business plan have a question that can only be answered by actual demonstration,” he continued. “What happens to pathology revenues when pathologists are employees, not partners?

“The key feature that distinguished AmeriPath from other pathology practice models is the fact that their pathologists are employees and paid on salary. Is the productivity of salaried pathologists equal to that of pathologists who are partners? Is that productivity difference great enough to give AmeriPath a competitive advantage when bidding against traditional pathology practices?

“The employment model is viewed as a threat by many pathologists,” he explained. “That is why AmeriPath generates so much interest among the profession. That is also why every quarterly financial statement AmeriPath releases will be scrutinized by pathologists. AmeriPath provides the first opportunity to evaluate the impact of employment status on pathologist productivity and the profitability of pathology practices.”

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