When someone wants to move in on your (lab) territory

Dec. 1, 2009

Even during this
current recession when most companies are trimming payrolls and employee
hours, laboratories remain high on the list of takeover targets for both
investors and regional mega-labs like LabCorp, Quest, and Sonic that are
looking to expand their geographical footprints.

According to Anthony Konkoly, an attorney with
McDonald Hopkins LLC in Cleveland, OH, merger and acquisition activity
in the laboratory sector remains strong because healthcare in general
tends to be less cyclical than other industries.

And the future for labs continues to look bright,
says Robert Michel, editor-in-chief of Spicewood, TX-based The Dark
. Michel explains that the number of baby boomers nearing
retirement and new laboratory technologies coming on line will
eventually lead to higher volumes and values of tests.

The importance of clinical labs and their
potential for generating income has not been overlooked by healthcare
entrepreneurs, says Konkoly. “We see people opening new labs who are
seeing opportunities. It does not take much capital to get going. It is
not that capital intensive.” Plus, he adds, “A small lab can give more
customized services to its clients.”

The ability to generate sustained streams of
revenue — which makes the lab more attractive to buyers — also is at the
core of many hospital lab-outreach programs that serve doctors’ offices.
“There are a growing number of hospitals and health systems that are
beginning outreach programs or growing those they already have,” says
Michel. “Itis a very dynamic sector. It brings in more tests to the
hospital lab and that volume generates cash flow and an operating

Konkoly agrees, but says many non-profit
hospitals “find they are not as good in managing that kind of business.”
As a result, outreach programs may be attractive to a potential buyer.
“A buyer can look at this as an additional asset,” Konkoly says.
“Hospitals have even sold just the outreach business while retaining the
lab for inpatient use.”

The economic impact

Konkoly says there is still substantial interest
being generated by buyers and sellers, and private equity firms remain
in the mix of investors. The financial landscape, however, has changed
dramatically. “It is harder to get deals done now than before. Buyers
have to put in more equity to get the deal done. While bank financing is
out there, lenders are more stringent.” Only a year or two ago it was a
seller’s market, he says. Now buyers want more out of the deal.

But Konkoly is quick to point out that there are
two categories of buyers: strategic buyers who want to combine their
business with the purchased lab, and financial buyers who view labs as
an investment which they plan to hold for three to seven years, then
sell for a profit. “We are seeing a tremendous amount of interest on the
part of financial buyers,” he says.

Michel says that while interest is up, the
economy is taking its toll. “There continues to be strong demand for
clinical labs and pathology groups with sustained growth,” he says.
“Although buyers remain interested, the premium they will pay is lower
because of access to capital and the dismal economy in general.

“Given the economic malaise, the price they will
pay has been lowered,” he continues. “The number of buyers has not
diminished. They are just not as aggressive in what they can offer. And
this motivates some lab owners to defer selling until the economy is

Reasons for selling

Hospitals looking to raise capital often see their labs as an asset
they can sell or put into a partnership.

As with any business, the reasons for selling a
lab are varied. “In many cases the seller needs the money and must sell
even though he will get less money now,” says Michel. Konkoly says it is
also not unusual for labs to be owned by individuals who are nearing
retirement and who want to cash out 100% of their equity.

Then there is the hospital connection. Hospitals
looking to raise capital often see their labs as an asset they can sell
or put into a partnership, Konkoly says.

A case in point

PA Labs Inc., located in Muncie, IN, was jointly
owned by Ball Memorial Hospital and East Central Indiana Pathologists
PC, a pathology group owned by 10 pathologists. In 2007, PA Labs was
sold to LabCorp. “The circumstances locally were such that it was the
right time,” says George Branam, MD, president of East Central Indiana
Pathologists and medical director for PA Labs.

Having 50% of the lab’s ownership controlled by
the health system that was its largest customer put this lab in a
compromising position, Branam admits. But economic conditions,
competition, and the fact that some of the pathologists were planning to
retire also figured into the decision to sell. “In retrospect, I think
we sold at the right time,” Branam says.

Yet, he remains somewhat nostalgic about the lab
he ran as president and CEO. “This lab was a labor of love for us,” he
says. “We built it from $1 million to $40 million in revenue.” But
Branam also admits that he is a realist. “If your heart is in it too
far, you might be disappointed. If you are selling for money, go for

Working with financial advisors and attorneys,
Branam and his associates studied the market and interviewed prospective
buyers. They also looked at their own internal strengths and weaknesses.
LabCorp saw PA Labs as a platform for growth given the lab’s
geographical service area and its reputation for service to its clients.
LabCorp also was impressed with the lab’s management practices.

“We were innovative in IT and had a Web-based
ordering and reporting system,” Branam says. “We also had a huge courier
system and marketing group.” And since both companies did their due
diligence in seeking a partner, the deal was a win-win for both.

Preparation is paramount

At the 2008 Executive War College conference on
lab and pathology management that was sponsored by The Dark Report,
Michel says, “Most medical professionals have never been formally
trained in business management techniques.” Today, he adds to that:
“Many think the lab business is unique. But it is not.”

In fact, buying and selling a lab is no different
than buying and selling any other type of business.

Putting a price tag on a lab, or determining its
valuation, is a process done on a deal-to-deal basis. But a number of
factors are common to all deals. Unless the lab is being liquidated or
is a publicly traded company, buyers take an income approach that
evaluates future cash flow. In determining the lab’s potential
profitability, buyers and their representatives pay close attention to
EBITDA — earnings before interest, taxes, depreciation, and
amortization. And as with other businesses, the more cash flow the lab
generates, the higher its valuation will be. Potential cash flow is
especially important if a private equity firm is acquiring the lab,
because it needs high returns for its investors.

Aside from these basic bottom-line
considerations, potential buyers also look for quality of revenue;
stability of the business; past and potential growth; specific testing
offered; specimen volume; the lab’s reputation in the marketplace; a
solid payor mix; and a strong management team that can assist the new

At the 2008 War College, Konkoly notes that
sellers also need to put in place a strong “deal team” made up of a tax
advisor, attorney, accountants, an investment banker, and members of
upper management to help structure the deal and to provide all necessary
information when a prospective buyer does his due diligence. The seller
also should have strong financial reporting systems and controls, as
well as being regulatory compliant in coding and billing practices.

“A billing audit is a major part of due
diligence,” Konkoly says.

Group sellers need to be aware of all contracts
including non-compete provisions, employment agreements with physicians
who are not owners, contracts with payors, and all contracts with

For those considering selling off part of a lab
or the entire lab while retaining a 50% interest, Konkoly says the
seller needs to ask. “How is this going to be managed and who is going
to be in control? You have to realize you are going to lose some control
but will participate in future growth.”

To ensure a successful deal, sellers must be
prepared and know everything about their own labs. “If you are thinking
about selling, you had better have your house in order,” advises Branam.
“They (LabCorp) were surprised as to the knowledge we had of our own
company.” He also says you should do your own due diligence on the
acquiring company and “meet with the administrative staff that is going
to work with your people.” But all this takes time.

“If I owned a lab and was thinking about selling
it in five years, I would be talking to my advisors now,” says Konkoly.

Richard R. Rogoski is a freelance journalist
based in Durham, NC. Contact him at
[email protected]