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Blood Brothers: The Two Major Players in the Clinical Lab Business
North Carolina-based Laboratory Corporation of America Holdings (LH) and New Jersey-based Quest Diagnostics (DGX) are the two biggest companies on the clinical laboratory testing landscape. Indeed, both companies offer a wide range of diagnostic testing services from routine blood and prenatal tests to sophisticated cancer and genetics tests. Quest is the biggest independent research and testing lab in the world, holding about a 15% share of the more-than-$50 billion U.S. market. LabCorp is a bit smaller, accounting for a little more than 10% of the domestic market, but is growing at a faster pace than its main rival.
Growth via Acquisition
For years now, these companies have been driving industry consolidation, as a means to bolster revenues as well as their portfolios of testing services. Most recently, Quest bought Celera for about $670 million. The move broadened its assortment of genetic tests and gave it access to proprietary genetic tests used by customers UnitedHealth (UNH) and Aetna (AET). Not long before that, Quest purchased Athena Diagnostics for $740 million, boosting its share in the large market for neurology testing, where its main competitor is LabCorp. All told, Quest has made over 10 mid-sized acquisitions in the past decade in addition to a slew of tuck-in purchases. LabCorp has also been active on the M&A front. It’s most recent notable purchase came back in 2010 when it bought Genzyme Genetics, a leading provider of reproductive and oncology testing services, for about $925 million. (LabCorp is in the process of acquiring Orchid Cellmark (ORCH), an international provider of DNA testing services with a presence in the United Kingdom, for about $85 million.) Much like Quest, LabCorp has made more than 10 major purchases since the turn of the century, on top of a host of smaller deals and partnerships.
At present, diagnostic tests are responsible for over two-thirds of clinical decisions. The costs of these screens are less than 5% of all healthcare expenditures, demonstrating their tremendous value and cost effectiveness. Both LabCorp and Quest are busy building their respective portfolios of services, which currently include genetic, anatomical pathology, and cancer testing, since these offerings carry much higher margins than simple blood work (that is needed to check cholesterol levels, etc.). Moreover, the market for testing is currently growing at a low-single-digit rate, but certain segments, such as molecular diagnostics, are growing much, much faster.
Exclusive Deals with Clients
In this industry, contract renewals can have major implications. Back to 2006, LabCorp and UnitedHealth inked a 10-year exclusive deal, shaking up the clinical laboratory landscape. It sparked something of a price war between the major players in the industry, and triggered a number of managed care contract changes in the years that followed. LabCorp pursued the UnitedHealth contract aggressively in order to increase its scale and gain a toehold in the New York City marketplace. Quest signed an exclusive five-year deal with Aetna in 2007. (The contract has since been extended.) Prior to this deal, Quest and LabCorp were both contracted providers with Aetna, though Quest got much of the business. We think Quest worked fast to ink this deal to ensure it would not lose another large contact to LabCorp. Both labs are currently doing business with Humana (HUM), Cigna (CI), and WellPoint (WLP).
It appears as though neither lab is looking to get into a price war at this point in time, since they are not underbidding each other to win exclusive, multi-year deals. Rather, they are busy renegotiating current deals while extending their maturities. Thus, we think commercial reimbursement ought to remain mostly stable through at least the end of 2012.
The Industry Outlook
There is a lot to be excited about when it comes to the future of Quest and LabCorp, and our outlook for both is relatively rosy. Hospitals across the country are continually moving from testing in house to using commercial labs. This trend benefits the hospitals, because they can greatly reduce costs and focus more on patient care, and it is an obvious boon to the two labs. Next, the main aim of healthcare in the United States is gradually moving from treatment to wellness, so the prevention and early detection of disease is critical. This means there will be more blood work and testing done per patient. The growing and aging population will also increase the number of tests being performed. Finally, the diagnostic and esoteric testing done by these labs is constantly being refined and targeted, which is helping to start the advent of personalized medicine and enabling physicians to make more informed therapy decisions.
There will likely be more than a few bumps in the road, however. There is a tremendous amount of pressure on Capitol Hill to lower overall healthcare costs and make budget cuts to Medicare and Medicaid. One idea that is being tossed around is implementing a co-pay for lab services. The idea is somewhat impractical and would be very inefficient, in our view, considering about three-fourths of the samples are taken by a third party and shipped to a testing facility. Thus, labs cannot ask to be paid a co-pay when patients come to provide samples. It is worth noting, however, that labs are one of the few Medicare providers that do not currently face a co-pay, but we expect Congress will ultimately figure out another way to generate some savings from the labs.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.