Inside the Lab Industry: Uncertainty Slowed M&A Activity During 2012; Caution Expected to Continue in 2013

The year 2012 was filled with uncertainty about reimbursement, taxes, and a variety of other issues that impacted the laboratory sector. And as a result, lab mergers and acquisitions slowed dramatically compared to 2011. There were 21 deals consummated during 2012, according to data from Haverford Healthcare Advisors in Paoli, Pa. That compares to the 30 that were undertaken during 2011, based on data gathered by Laboratory Industry Report. Haverford identified 34 deals (see chart on page 6). The overall valuation of the 2012 lab deals was about $290 million. That was a fraction of the more than $3 billion valuation of the 2011 transactions. “It was surprising,” said Dennis Weissman, founder and executive editor of G2 Intelligence and president of Dennis Weissman & Associates. “The general sense was there would be a good many deals, particularly since it was likely taxes would go up in 2013, and you would probably want to get a deal through before that happened. But when all was said and done, it was a very mediocre year for mergers and acquisitions.” Weissman noted that uncertainties regarding coding reimbursement issues for both molecular and pathology testing were not settled by the Centers for Medicare and Medicaid Services (CMS) until the latter half of the year, which put many potential dealmakers on the sidelines. “Buyers were dragging their feet,” said Chris Jahnle, a Haverford managing director. He noted that the reasons were numerous. There were doubts about the outcome of the presidential election. “If Romney were elected, he was going to find a way to unwind Obamacare, even though systems were moving toward an ACA [Patient Protection and Affordable Care Act] model anyway,” Jahnle said. Prior to that, there were doubts about the constitutionality of the ACA, which were settled by the U.S. Supreme Court midyear. Like Weissman, Jahnle agreed there was much uncertainty about the coding issues. Moreover, Jahnle noted the accelerating trend of hospitals buying physician practices disrupted traditional lab traffic and created some uncertainties in valuations prior to making offers. Tax Worries Pushed End-of-Year Deals However, the pressure regarding the capital gains tax being raised in 2013 pushed many deals through just under the wire, according to Jahnle. Of the 21 transactions listed by Haverford, nine occurred in the fourth quarter. Eight of them closed in December. Moreover, two big M&A players in 2011—Aurora Diagnostics and Solstas Lab Partners—stayed on the sidelines in 2012. Combined, they had accounted for nine of the 2011 transactions. Aurora, which Weissman observed may have overpaid for some of the $78.1 million it laid out for its 2011 transactions, took significant write-downs during 2012, according to filings with the Securities and Exchange Commission, and posted a $111.4 million loss during the third quarter of 2012. It also put off a planned initial public offering. Jahnle, who is an Aurora shareholder, declined to comment on its operations. Sources have suggested that Solstas—which like Aurora is privately held but is not disclosing its earnings data because it is not planning an IPO—has also had issues digesting some of its deals. The biggest deal of 2012 involved LabCorp’s acquisition of Medtox Scientific Inc. in August for $241 million in cash, an indicator of the relative strength of the drug testing sector. However, that was a far cry from the biggest deal of 2011, when Quest Diagnostics bought Athena Diagnostics for $740 million. Jahnle said the consolidation of the toxicology niche was the biggest M&A trend of 2012. Altogether, five deals in that sector were consummated. Ongoing M&A Climate Mixed Meanwhile, the M&A climate for 2013 remains mixed at best. Jahnle noted that of the 21 deals that took place in 2012, 15 involved anatomic pathology (AP) and other specialty laboratories, and he expects more consolidation to occur in these areas this year. However, the recent 52 percent cut in reimbursement for the technical component of CPT code 88305 is expected to seriously devalue the worth of AP labs in the coming months. Weissman said when the cut was announced by CMS in late fall, it all but froze venture capital looking to make acquisitions in the AP space. “There will be some deals, but they will be very selective. It will be tough for pathology practices to draw private capital, and if they do, it will be at very unfavorable valuations,” Weissman said. Whereas valuations in prior years reached as much as three times annual revenue, Weissman believes it could drop to as low as 1.5 times revenue, or in some cases, attract no multiple at all. Should tailwinds begin to blow, Weissman believes it likely will be in specialty segments, such as molecular, genetic, or other forms of esoteric testing. But he added any movement would be reliant on more clarity emerging regarding the pricing of the more than 100 new molecular billing codes, payment of which will be determined by the gap-filling method. Both Weissman and Jahnle believe that sales of laboratories by hospitals—such as the recent acquisition of the University of Massachusetts Memorial Medical Center’s lab business—are likely to pick up some momentum. Although terms of the Quest-UMass transaction were not disclosed, the size and breadth of the UMass lab and the fact that Quest is investing in a new lab to consolidate operations in the region suggest it was not only one of the biggest deals of 2012, but likely the one with the biggest long-term impact. “Many hospitals are deciding they want to monetize their stake in labs and use that money to acquire physician practices. I haven’t met a hospital yet that has not considered the reallocation of lab space for additional beds,” Jahnle said. “And so I’m anticipating additional hospital lab divestitures.”

Clinical Laboratory Transactions - 2012
Date	Acquirer	Target	Target State	Purchase Price	Target Revenue	Target EBITDA	Price to Revenue
Jan-12	Quest Diagnostics	S.E.D. Labs	NM	NA	$75,000,000	NA
Apr-12	Laboratory Corporation of America	Millenium Laboratory	NC	NA	$25,000,000	NA
Apr-12	Waud Capital	Sterling Reference Laboratories	WA	NA	$10,000,000	NA
Apr-12	Bio- Reference Laboratories Inc.	InCellDx Inc. (a)	CA	$6,000,000	$1,121,000	NA
Jul-12	Life Technologies Corporation	Navigenics Inc.	CA	NA	NA	NA
Jul-12	Genova Diagnostics Inc.	Metametrix Inc.	GA	NA	NA	NA
Aug-12	Laboratory Corporation of America	MEDTOX Scientific Inc.	MN	$241,000,000	$111,600,000	$14,400,000	2.16
Aug-12	Quintiles	Expression Analysis Inc.	NC	NA	NA	NA
Sep-12	AccelPath Inc.	DigiPath Solutions LLC	TX	$2,400,000	$1,100,000	$561,000	2.18
Sep-12	Ampersand Capital Partners	Calloway Laboratories	MA	NA	NA	NA
Oct-12	Laboratory Corporation of America	Genetica DNA Laboratories	OH	NA	NA	NA
Dec-12	Pathology Associates Medical Laboratories	CellNetix Pathology and Laboratories (a)	WA	NA	NA	NA
Dec-12	Quest Diagnostics	UMass Memorial Medical Center clinical outreach lab	MA	NA	NA	NA
Dec-12	Prost-Data Inc. d/b/a OURLab	UMass Memorial Medical Center clinical outreach lab	TN	$40,000,000	NA	NA
Dec-12	Laboratory Corporation of America	Pee Dee Pathology	SC	$40,000,000	NA	NA
Dec-12	Bio-Reference Laboratories Inc.	Florida Clinical Laboratory Inc.	FL	$7,000,000	NA	NA
Dec-12	Bio- Reference Laboratories Inc.	Meridian Clinical Laboratory Corporation	FL	$1,850,000	NA	NA
Dec-12	Sterling Reference Laboratories	Graham-Massey Analytical Labs Inc.	CT	NA	NA	NA
Dec-12	Sterling Reference Laboratories	SECON Laboratories	MA	NA	NA	NA
Dec-12	InCyte Pathology	Eastside Pathology	WA	NA	NA	NA
Source:Haverford Healthcare Advisors, with financial information from press releases, SEC filings and other publicly available sources. EBITDA: Earnings before interest, taxes, depreciation, and amortization (a) Acquisition of a minority interest