CEO SUMMARY: Two fascinating aspects about the AmeriPath story are: 1) the strategy to boost share values; and 2) the strategy to develop profitable pathology revenues. With managed healthcare transforming pathology at an astounding rate, will AmeriPath succeed in both strategies?
DURING THE LAST YEAR, intense curiosity swirled about AmeriPath, Inc. Pathologists heard plenty of rumors but learned few details about the Florida-based company.
Such curiosity was warranted. Physician incomes are dropping for well-known reasons. Reimbursement levels are in decline. Capitated agreements push risk onto pathologists. Hospital acquisitions trigger pathology practice consolidations. Cost-cutting efforts by individual hospitals further reduce pathology revenues.
As pathologists watched their revenue sources come under the cost-cutting axe, they also saw the phenomenal success of those physician management companies which went public. Such companies as Phycor, MedPartners, Physician Reliance Network and others have grown at phenomenal rates.
These companies enriched the primary care and specialist physicians who sold their practices in exchange for stock and other consideration. They also made tens of millions of dollars for investors. As a result, one of the hottest industry segments on Wall Street is the physician management company. Some 22 companies now crowd the category.
Share prices in this segment trade at an average multiple of 23.5 times EBITDA. (EBITDA stands for “earnings before interest, taxes, depreciation and amortization” and is widely used to measure cash flow.) The EBITDA multiple of 23.5 is one secret behind the AmeriPath strategy to boost share value.
Share Price Strategy
Were AmeriPath share prices to achieve the same EBITDA multiple as the average physician management company, then profits would be substantial. The arithmetic reveals how this occurs.
According to company documents, Ameripath spent approximately $110 million in stock, notes and cash to acquire the 12 pathology practices. Based on four-year contingency payments, as much as $40 million more could be paid to those 12 practices. This means that it cost AmeriPath approximately $150 million to acquire the existing $82 million in annual company revenues.
Assume that the Initial Public Offering (IPO) sells out at $14.00 per share. Based on figures in the company’s prospectus, it would appear that $14.00 per share would be an EBITDA multiple of around 13.5.
Should AmeriPath successfully sell all 6.2 million shares at $14.00… market capitalization of AmeriPath would be $238 million
Were AmeriPath’s profit margins to remain at the current level, and if Wall Street bid AmeriPath shares to the 23.5 EBITDA multiple, that would create a share price of $24.00.
With 10.8 million of the company’s 17 million shares still in the hands of the venture capitalists and the original pathologist-stockholders, that represents a potential gain of almost $110 million dollars! The actual gain is even larger, because many of the shares issued in pathology practice purchases were at share prices under $10.00.
For those who ask the question about how wise it was to pay as much as $150 million for $82 million in annual revenues, the answer is simple. Should Ameripath successfully sell all 6.2 million shares to the public at $14.00 per share, there would be a total of 17,051,356 shares outstanding. Multiply that by $14.00, and the market capitalization of AmeriPath would be $238 million!
This is money magic, practiced the Wall Street way. By understanding this arithmetic, it is easy to know why the organizers of AmeriPath feel confident that their hard work and entrepreneurial risk will pay off.
Although the arithmetic makes this look easy, there is a sizeable downside. Much hard work lies ahead for AmeriPath. Investors will only bid up the share price of AmeriPath if they are confident that AmeriPath can deliver solid, consistent revenue growth and increased earnings.
This means that AmeriPath must demonstrate to investors that their pathology practices can generate profits equal to, and preferably greater than, existing private pathology practices.
It is this fact which generates controversy among pathologists throughout the country. The most common question they ask each other is, “Will a pathologist on salary in a public company produce more work than a pathologist who is a full partner in private practice?”
That is one of the great unanswered questions in pathology. It is precisely why pathologists will closely watch what AmeriPath does, and how well AmeriPath does it.
The business plan that AmeriPath intends to pursue is that of integrated regional pathology networks. Florida will be the protype network, since AmeriPath already has seven pathology practices in the state employing 62 pathologists.
The foundation for this pathology network is substantial. Besides the six outpatient laboratories, AmeriPath’s Florida region has con- tracts with 29 hospitals and 17 outpatient surgery centers. AmeriPath has ten sales representatives who are actively soliciting new business for the local practices.
In offering regional pathology services, AmeriPath was successful in expanding an existing anatomic pathology services contract with SmithKline Beecham Clinical Laboratories. The original contract was for exclusive pathology services in five Florida counties. The expanded contract now includes 57 of Florida’s 67 counties.
Building on this early success will require skillful management and focused effort. AmeriPath’s business strategy must accomplish two things to create the earnings growth necessary to support higher share prices.
First, AmeriPath’s pathologists must demonstrate sustained productivity, for
this is a major source of operating profit. Second, the sales force has to generate new revenue without discounting prices. Clinical laboratories have already demonstrated the near impossibility of that fact in today’s managed care environment. Should AmeriPath succeed in both areas, it fully deserves the financial success which will result.