CEO SUMMARY: Pathology supergroups in California and Tennessee have each announced major recapitalizations. Both groups will use some of the money to cash out retiring partners. The balance of the new capital will be used to expand their businesses. With so many baby boomer pathologists approaching retirement, these two transactions are likely to be studied by many pathology groups and should be considered early examples of a trend that is soon to become more prominent.
PATHOLOGY GROUPS across the United States are taking active steps to deal their partner pathologists. As this happens, it creates an opportunity for professional investors to take an ownership position in these pathology groups.
This seems to be true in several recent venture capital transactions announced in the final months of 2009. One example is the deal between Pathology, Inc. of Torrance, California, and a consortium of investment companies that included ABS Capital Partners, England & Company, and Orix Venture Finance LLC. This agreement was signed in October and the total investment amount was not disclosed.
Recent M&A Activity
A more recent example is the recapitalization undertaken by PathGroup, Inc., of Brentwood, Tennessee. On January 5, 2010, it announced a $100 million funding agreement. Taking a minority investment position in PathGroup were Primus Capital Funds of Cleveland Ohio, and Brentwood Capital Partners LP, of Brentwood, Tennessee.
Included in the recapitalization was a syndicate of lenders that included Bank of with the looming retirements of America and Fifth Third Bank. Subordinated debt was provided by Maranon Capital LP, of Chicago, Illinois.
These transactions have at least two elements in common. First, each pathology group retained significant control of its business. Second, each pathology group will use some of the proceeds to close out the partnership interests of retiring pathologists.
These two transactions continue a pattern that has emerged over the past year. Much of the merger & acquisition (M&A) activity involving pathology groups and pathology labs during this time are motivated by the need of a pathology group to accommodate the retirement plans of partner pathologists.
For that reason, the number of pathology group practices involved in M&A activity and recapitalization deals will increase during the next few years. After all, the oldest of the baby boomer generation of pathologists have now reached the age where they can qualify for Social Security and Medicare benefits. The long-predicted day of reckoning is arriving at many pathology groups across the nation.
What is notable about the Pathology, Inc. and PathGroup transactions is that both pathology groups rejected the option of an outright sale of their pathology group to a buyer. Instead, both groups decided to raise outside capital, using a deal structure which continued their ownership and business control.
This seems to be an emerging theme in merger and acquisition activity involving pathology groups. Last year, UniPath, Inc., of Denver, Colorado, took a similar approach. It sold its histology laboratory business to American Pathology Partners, Inc. (APP), of Brentwood, Tennessee, while keeping 100% ownership of its professional corporation. As part of the transaction, the UniPath pathologists have an agreement with APP to provide pathology professional services. (See TDR, February 2, 2009.)
Looming Wave Of Retirees
Thus, the looming retirement of baby boomer pathologists is poised to drive up the number of pathology group acquisitions and recapitalizations that happen each year. This trend will be a direct response to the need to cash out retiring partners.
Increased M&A activity within the pathology profession will have another consequence. Pathology groups which sell to a buyer or accept investor money will have to adopt a more aggressive business posture in the marketplace.
That means more competition at the regional and national level within the pathology profession. Companies that purchase pathology groups will want them to increase specimen volume and revenue. Expect to see Pathology, Inc. and PathGroup—having accepted investor capital and having added representatives of the investor groups to their board of directors—take steps to intensify growth by the use of expanded sales programs.
Another source of fuel for these fires is keen investor interest in molecular diagnostics specifically and laboratory testing generally. Over the past 15 years, a succession of clinical laboratory and pathology companies have returned handsome profits to professional investors.
Investors view pathology laboratories as perfectly placed to benefit from three developments. One development is the steady introduction of genetic and molecular tests for cancer and other diseases. These allow pathologists to offer physicians more precise information for diagnostic and therapeutic decisions.
The second development is the emergence of companion diagnostics and personalized medicine. Pathologists will be a central player in these developments.
The third development is strong demand for lab testing that is expected as the population ages. This will increase the incidence of cancer and other diseases related to aging.
Collectively, this means that the pathology testing marketplace will become more competitive, more intense, and less friendly than it has been during the past two decades. Further, because baby boomers make up between 25% and 30% of the total pathologists now practic- ing in the United States, this trend will be widespread and will touch almost every community in the nation.
Early Warning Of New Trend
These insights provide an early warning to all pathologists and their practice administrators. The need for pathology groups to finance the buy-outs of their retiring partners is about to become an important trend.
It means that every private pathology group practice should be developing at least two strategies. One strategy is internal and should address the retirement situation within the group. The other is external and should anticipate how intensified competition for biopsies in the local service market can be countered.