Laboratory M&A: Most of the Smaller Players Have Been Absorbed, Leading to Fewer, But Bigger Deals

Fewer deals. Bigger pricetags. That in a nutshell sums up the merger and acquisition activity in the laboratory sector during the first half of 2015.

Altogether, there were 10 deals involving labs during the first half of 2015 in the U.S. That compares to 15 during the first half of 2014, according to data from Crosstree Capital Partners, a health care investment bank based in Tampa Bay, Fla. There were 26 deals consummated in all.

Although there were significantly fewer deals completed so far during the first half of this year compared to last year, their enterprise value is far larger: $2.6 billion among the deals where transaction terms were disclosed (six) versus the $1.25 billion among the seven disclosed deals from the year-ago period, according to the data from Crosstree.

The smaller number of deals and the larger enterprise total is a reflection of a specific trend: There has been enough merger activity in the lab space that there are fewer entities who can actually join forces in a way that will enhance their bottom lines.

Another study of the market by Connecticut-based Irving Levin & Associates more or less confirmed Crosstree's data. Altogether, the company confirmed eight pure laboratory deals taking place during the first half of this year, with a total enterprise value of $1.47 billion, according to Lisa E. Phillips, who edits the Levin publication Health Care M&A News. Her data excludes dental laboratories, which Levin also tracks.

But Christopher Jahnle, a managing director with Haverford Healthcare Advisors, charted only four lab deals that took place during the first half of 2015. His company excludes esoteric laboratories and focuses primarily on medical labs and pathology practices.

"My sense is that demand among the big commercial labs is strong, and the valuations are high, but I think the supply of candidates is low," Jahnle said. He added that there's a shortage of candidates, primarily because 20 years of steady consolidation within the laboratory sector has weeded out a lot of potential takeover targets. And although there remain thousands of independent labs, Jahnle said they tend to service portions of the health care business that are less fiscally desirable, such as skilled nursing facilities.

Jeff Ellis, a Crosstree managing director, concurred with Jahnle regarding the lack of candidates. "There are fewer smaller deals due to a dearth of assets out there. There are just fewer smaller independent laboratories," he said.

Nevertheless, the environment to cut a deal has been healthy. "Equity valuations are very strong, and valuations have been on the rise for years now," Ellis said, noting that low interest rates play an interrelated role because they not only help drive valuations but provide an abundance of capital to make purchases.

As a result, the deals have been among somewhat larger players that had tended to acquire smaller labs in the past. The biggest deal during the first half was the much smaller OPKO Health's acquisition of Bio-Reference Laboratories for $1.52 billion in company stock. The deal is expected to lend synergies to OPKO's point-of-care testing business.

"It is a very interesting combination of two companies, somewhat of a surprising announcement, and very exciting news for the lab industry," Jahnle said, noting that such transactions suggest that labs are looking to expand their businesses beyond bread-and-butter testing.

Phillips noted that deals such as LabCorp's acquisition last year of pharmaceutical testing firm Covance falls along such lines as well, suggesting that labs are beginning to think outside of the box for their expansion plans.

"The climate on the diagnostic testing side has been difficult, whereas the clinical research side has been fairly healthy and growing and more profitable," Ellis said.

Another significant deal was Quest Diagnostic's acquisition of the outreach business of MemorialCare Health, a hospital system in Southern California. Although Ellis believes there will be fewer outreach deals moving forward because a significant number of deals have been consummated and they tend to take a very long time to execute, Jahnle thinks they will continue to trickle in as they have over the past half-dozen years.

Meanwhile, there appears to be a consensus that the second half will perk up a little. Jahnle noted that there have been a few deals consummated right after the end of June, and his company has entered into letters of intent with a couple of other labs.

Ellis believes that there will be some pickup of sales of pathology labs and practices, after reimbursement slashes that drove down valuations and ground transactions in that arena to a halt. However, both he and Jahnle noted that Aurora Diagnostics has been one of the few active players acquiring pathology businesses. In July, Aurora acquired Texas-based Brazos Valley Pathology, which provides services to several hospitals in Southeast Texas.

Phillips also noted that there has been an upsurge of overall health care deals in the third quarter, prompted in part by the recent settlement of the King v. Burwell case by the U.S. Supreme Court.

"In fact, July dollar volume has already surpassed $157 billion, which should put the third quarter at a new record," she said. "We'll have to wait and see if the Federal Reserve raises interest rates in September, which could slow down deal volume again."

Takeaway: Mergers and acquisitions in the laboratory sector are growing in value but appear to be slowing down overall.