CEO SUMMARY: Over the past two decades, investor-owned anatomic pathology companies captured significant market share from community hospital-based pathology groups while delivering profits to their owners. Despite the recent downturn in the economy, Wall Street believes histology laboratories remain an attractive investment for investors. Financial analyst Kemp Dolliver explains the reasons why professional investors remain ready to invest in anatomic pathology firms.
DURING THE PAST TWO DECADES, most private pathology groups failed to fully benefit from the emerging market opportunities in anatomic pathology (AP) services. That made it possible for private investors to jump in and launch new businesses that competed with community pathologists for specimens.
During these same two decades, a parade of companies entered the AP market. Urocor, Inc. (1992); Dianon Systems, Inc. (1994), AmeriPath, Inc. (1995), Pathology Partners, Inc. (1998—now Caris, Inc.); US Labs, Inc. (2000); and CBL Path, Inc. (2003) are examples of investor-funded anatomic pathology companies which were formed to compete for AP specimens.
All continue in business today, despite experiencing changes in ownership. Unlike the clinical laboratory start-ups of the 1970s and 1980s, only one of the above-named companies was started by pathologists or had a pathologist as a Chairman or CEO during its formative period.
Despite today’s tough economy, Wall Street remains bullish on anatomic pathology as a lucrative business opportunity. To help pathologists understand why professional investors continue to see dol- lar signs in anatomic pathology, THE DARK REPORT interviewed a Wall Street insider.
Kemp Dolliver is a financial analyst based in Boston, Massachusetts. In recent years, he has closely tracked the market for AP and clinical laboratory testing services. “A change in Medicare reimbursement for surgical biopsy services has positioned pathology laboratories as an attractive investment,” observed Dolliver.
Medicare And 88305 Price
“This did not happen overnight,” he continued. “For example, in 2001 Medicare paid $88.38 as global reimbursement for Billing Code 88305,” he explained. “This was split 50-50 between the lab which performed the technical component (TC) and the pathologist who diagnosed the case (professional component, or PC). That meant about $44 was earned by each provider.
“Today, in 2009, Medicare’s global reimbursement is $103.87 for the biopsy,” said Dolliver. “But the split is now $66.72—or 64% of that $103.87 payment—for histology services (TC), while just $37.15—or 36%— is paid for professional interpretations (PC).
“Investors recognize how the higher amount paid for technical services creates an incentive for pathologists to have a stake in providing both technical and profes- sional services in order to bill globally for their services,” Dolliver said. “That makes histology laboratories quite attractive to professional investors who could provide the capital for a laboratory. So, even as Medicare tightened up payments for professional services, related changes in TC reimbursement opened up a highly attractive business opportunity for pathologists.”
“To take advantage of the favorable economics of histology laboratory services, investors formed or acquired laboratory companies that either employ or partner with pathologists to compete for the biopsy referrals of office-based physicians,” said Dolliver. “These investor-owned AP companies then become direct competitors to community hospital-based pathology groups which traditionally had a lock on biopsy referrals in their local community.
“Moreover, these investor-owned AP companies aggressively use sales reps, superior service, and, in some cases, lower prices to win new clients,” added Dolliver. THE DARK REPORT notes that, in client-bill states, some investor-owned AP competitors will deeply discount their prices as a way to win new business from office-based physicians.
Dolliver offered another insight about why professional investors like anatomic pathology more than clinical laboratory testing. The anatomic pathology profession remains highly fragmented. Thus, it is ripe for the same consolidation that has occurred in other medical specialties. “Rightly or wrongly, investors view clinical pathology testing as more of a commodity business,” he stated. “For example, a urinalysis involves little professional judgment because automated analyzers perform the test and report out a number that is easy for the referring physician to understand.
“On the other hand, investors see a different value proposition in the diagnosis of biopsies,” he observed. “Investors consider pathologists to be highly-trained professionals who provide essential information in life-or-death situations. The point is that a pathologist’s professional interpretation is less prone to commoditization, relative to highly automated testing of blood and urine samples.
“Of course, investors know they need pathologists to be part of these businesses,” commented Dolliver. “Investors believe they bring several things to the table that have value to pathologists. First, as the lab increases specimen volume and revenue, pathologists can increase their incomes.
“Second, as the company expands its business regionally or nationally, pathologists get more income from the professional services they provide on the ever-increasing number of cases. Third, having investors run the operational and business development functions of the histology business offers pathologists relief from time-consuming administrative functions they dislike, including payroll, billing, collections, and sales and marketing.”
Two Growth Drivers
Dolliver further noted that Wall Street recognizes two growth drivers that give anatomic pathology a bright future. One, demographic trends guarantee that the incidence of cancer and other diseases will increase and that will drive increased case volume for pathologists. Two, anatomic pathology is expected to play a key role in the practical application of genomics information and nanotechnologies for disease prevention, personalized medicine, and diagnostics.
“This is why turmoil in financial markets during the past year has not dampened investor enthusiasm for histology and AP services,” stated Dolliver. “This sector continues to attract new investment and continues to consolidate. Those laboratories and pathology groups willing to take an entrepreneurial approach to expanding currently have no problem finding interest and backing from venture capitalists.”
“I expect this trend will continue,” concluded Dolliver, “as long as: 1) these companies offer pathologists an appealing work environment with competitive com- pensation; 2) the current reimbursement system remains in place; and, 3) the public markets and/or the industry’s leaders (Quest Diagnostics and LabCorp) will value these businesses at attractive multiples of earnings.
Professional Investors Actively Funding Companies involved in Anatomic Pathology
SUSTAINED INTEREST BY PROFESSIONAL INVESTORS in anatomic pathology companies (AP) is demonstrated by the number of transactions that were funded in recent years.
Referencing a report issued by Cowen & Company, financial analyst Kemp Dolliver offered a list of 10 independent pathology laboratory companies that either: 1) received funding from venture capitalists to expand and/or consolidate; or, 2) announced plans to expand in the trade press. The list of acquisitions and expansions includes:
- Nashville-based American Pathology Partners received $75 million from New Enterprise Associates, a global venture capital firm. Some of these funds were used to acquire the histology labs owned by Denver-based UniPath, the largest pathology practice in the Rocky Mountain region.
- Florida-based Aurora Diagnostics LLC received $150 million since 2006 from two venture capital firms, Boston-based Summit Partners and New York-based GSO Capital Partners, to acquire 13 pathology practices.
- Water Street Capital, a Chicago-based private-equity fund, acquired New Jersey- based Lakewood Pathology in 2006 for $50 million, and last year renamed it PLUS Diagnostics. Some of the money went to expansion of lab facilities, to hire sales people, and to upgrade reporting systems.
- Laboratory Corporation of America, a publicly-traded company based in Burlington, North Carolina, acquired IDX Pathology, of Boise, Idaho, and PathNet Esoteric Laboratory Institute, of Van Nuys, California.
- Bostwick Laboratories of Richmond, Virginia, filed a prospectus as the first step of an initial public offering (IPO) last year. It then delayed its IPO due to conditions in the stock market.
- CBLPath, a laboratory company headquartered in Ocala, Florida, and backed by the New York investment firm Galen Partners, has retained an investment bank to evaluate strategic options to merge or sell.
- Southern California-based Clarient, part of publicly-traded Safeguard Scientifics, announced a $50 million investment from Connecticut-based Oak Investment Partners to expand laboratory biopsy services to meet the growing demand of outpatient oncology practices nationally.
Additionally, three laboratory firms announced plans to expand: Southern California-based Pathology Inc.; Augusta, Georgia-based ClariPath (a subsidiary of urology equipment supplier Healthtronics); and North Texas-based Caris Diagnostics, a national diagnostics laboratory services provider backed by the private investment firm Caris Limited.