Mergers and Acquisitions in Dx Space Drop Sharply in 2018

NEW YORK (360Dx) – Mergers and acquisitions in the diagnostics space slowed sharply in the past year as the number of M&A deals declined 45 percent year over year to 32 in 2018 from 58 a year ago.

The figure includes purchases made by clinical reference laboratories and diagnostic companies. Included in the analysis are deals broadly in the in vitro diagnostic, molecular diagnostic, and non-molecular IVD spaces, such as immunoassays and clinical chemistries. In most cases, only acquisitions of an entire company, rather than assets of a company were included, though in some instances, such agreements were included if they were of a significant size.  

The reason for the sharp decline is unclear, but Jonathan Norris, managing director at Silicon Valley Bank, said that there may be a dearth of mature companies with mature technologies available as attractive M&A targets.

Speaking about both the life science tools and diagnostics space, he said, "It feels like to me that you really need scale and that's probably what [buyers are] looking for, and that's very hard for a venture-backed company to get to."

As a result, one of two things can happen. "Either the early-stage companies will continue to grow and get to a scale where the big players can't ignore them anymore," or a potential buyer will feel pressure to grow and expand and "show broad outreach in different areas, [compelling] them to buy those companies," Norris said. "Or, they're going to get that pressure even earlier and then start to look for companies that are either just getting into revenue or have such compelling technologies they can't afford not to pick that up as either an opportunistic or defensive play."

The latter has not happened yet, he said. Instead, potential buyers are waiting for companies to get to scale. "Every time you acquire an early-stage technology, that means you're going to be spending your own capital to develop and push that particular product or technology along until they get to profitability. So, that is a drag on overall profitability of the company.

"And I just I feel like I'm not seeing the balance shift towards trying to acquire new, early-stage technologies right now," he said.

Add to that the well-documented challenges of getting reimbursement for diagnostic tests, and even a company with truly innovative technology may have trouble finding an M&A suitor. The conundrum is that once a company with transformative technology becomes successful, even profitable, they may become too expensive to acquire, said Mark Massaro, an analyst at Canaccord Genuity.

He pointed to the example of Exact Sciences, which has a market capitalization of nearly $7 billion, a number that puts it out of reach as an M&A target for many companies.

"Even a company like Guardant Health [whose market cap is approaching $3 billion] … any company that would buy them potentially could either disrupt the culture or send the company in the wrong direction," Massaro said. "So, I think a lot of these early-stage companies like a Guardant are definitely better suited to be run by the company's founders than letting executives from [an acquiring firm] coming in and potentially doing serious damage to the strategy."

Instead of being acquired, Guardant took the path of going public this year, and Massaro said that while the number of such IPOs remained small in 2018, there were enough to suppress the number of M&A deals. The other significant IPO in the diagnostics space the past year was for Siemens Healthineers, which was spun off by Siemens as a separate business.

Additionally, the stock market in early "and even later 2018 was marked by such bullishness, [that] private companies did not think there was a rush to transact.  A number of market strategists saw at least two more years of economic expansion to start 2018," he said.

Even with fewer total M&A deals in the diagnostics space, Massaro said that 2018 shouldn't be viewed as a disappointing year for M&A. "To me this felt like a relatively normal year for M&A," he said, noting that the multiples on deals were "higher than in prior years."

In particular, he pointed to the $2.4 billion that Roche paid to buy the remaining shares of Foundation Medicine it didn't already own. Other deals in 2018 that fetched hefty price tags include Bio-Techne's acquisition of Exosome Diagnostics for up to $575 million, Sonic Healthcare's proposed buy of Aurora Diagnostics for $540 million, and Myriad Genetics' $375 million buy of Counsyl.

But, Massaro acknowledged, "Maybe you could argue [the number of M&A deals is] a little disappointing given tax reform could have resulted in more deals."

Norris also noted that a few deals with high valuations skewed the overall valuation picture. Removing the big outliers from the picture, "the values are really down," he said. In 2017, four deals crossed the $1 billion valuation threshold, compared to just one in 2018.

"The M&A activity … just doesn't balance out and … we've been talking about over time whether we're going to see some new players come in to make acquisitions in the sector, and we just really haven't quite seen it yet," he said.

What PAMA effect?

One expected driver of acquisitions in 2018 was the Protecting Access to Medicare Act, which took effect on Jan. 1, 2018 and reduced Medicare reimbursements for many non-molecular tests. But in actuality, PAMA's effect on M&A during the year was muted.

In 2017, Quest Diagnostics announced or completed 12 deals, or 21 percent of the total acquisitions in the diagnostics space, in anticipation of PAMA. In 2018 Quest bought three companies.

Meanwhile, Eurofins bought two labs, and Laboratory Corporation of America and Aurora Diagnostics each acquired one firm.

To be fair, aside from the sale of whole companies, there were a number of asset sales as hospitals and other organizations carved out the laboratory part of their businesses under the pressure of lower reimbursement rates brought on by PAMA. Quest was the most acquisitive among the major labs as it bought the lab services, or other lab assets, of Boyce and Bynum; Hurley Medical Center, and Marin General Hospital.

Quest and its subsidiaries also acquired several non-lab businesses throughout the year, including the US lab business of Oxford Immunotec, the assets of Provant Health, and Mobile Medical Examination.

"Quest has had this very disciplined acquisition strategy going after hospital outreach business, and boy, have they strung together one deal after another," Massaro said. "A lot of them are small, but in aggregate they add up to over 2 points of growth."

Meanwhile, Quest's largest competitor, LabCorp, mostly sat on the M&A sidelines. Its only lab acquisition in 2018 was of Sciformix, a company that provides pharmacovigilance and regulatory solutions for biopharmaceutical and medical device clients. Rather than pursuing M&A, the firm completed several deals to provide services to other labs, including agreements with the Mount Sinai Health System, Appalachian Regional Healthcare, Unilabs, and Baptist Health.

One reason for the limited effect of PAMA, according to Massaro, may be a lack of knowledge on the part of hospital executives about the legislation. He pointed to a recent survey done for Quest which found that nearly 80 percent of hospital executives were at best only "somewhat familiar" with the legislation: 45 percent said they were "not at all familiar" with PAMA, while 33 percent said they were "somewhat familiar."

"To me that is just mind blowing," Massaro said. He predicted once hospitals see their full-year 2018 and first quarter 2019 financials and figure out the effect of the PAMA cuts, M&A could accelerate in the reference lab space.

"There's no reason to think that both Quest and LabCorp won't consolidate the market [in] more of a significant manner in 2019 especially in terms of dollar terms," he said. Particularly for LabCorp, "there's an opportunity to do some larger deals. … For whatever reason, they've not been as aggressive, so, especially with LabCorp's stock as depressed as it is today, I would think that management should be keenly aware that they need to be more aggressive in the marketplace." 

Quest Chairman, President, and CEO Steve Rusckowski has also said that moving forward, the firm remains committed to M&A. "We believe the market will continue to consolidate and, therefore, afford us an opportunity to accelerate growth," he said during Quest's third quarter earnings call.

Two industry experts, though, told 360Dx that the pipeline for hospital outreach acquisitions could begin to decelerate.

"I don't know how much more is left to sell as far as the outreach business," said David Nichols, president and founder of lab services consulting firm Nichols Management Group. "There are transactions underway, but I would assume that will probably plateau."

Lale White, executive chairman and CEO of health information technology company Xifin, added that there seems to be an increasing shift in interest toward joint ventures as opposed to an outright sale of outreach labs. "I think health systems are really looking toward the future and they are trying to preserve their control over the lab more than they used to," she said.

What's ahead?

Aside from Quest and LabCorp, other companies that could be active as acquirers in the coming year include Roche, Abbott, Danaher, and Thermo Fisher Scientific. Roche and Abbott, Massaro said, lack "a multiplex syndromic approach to diagnosis and multiple targets at once in a significant scale," and could be on the lookout for a company, such as GenMark Diagnostics, that would fill that gap. T2 Biosystems, he added, could also be an acquisition target for Roche and Abbott.

Danaher, meanwhile, is on pace to have more than $15 billion of cash available for M&A and has said that it has about 200 potential targets in its pipeline. "There has not been this much capacity since Danaher's acquisition of Pall in 2015," Cowen and Co. analyst Doug Schenkel wrote in a research note following Danaher's analysts' day meeting in December. "While management did not signal that any deal was imminent, we would be surprised if there were no deals in 2019."

Among companies that offer testing solutions, Massaro said that Quidel could be on the radar of several potential suitors, such as Roche and Danaher, especially if Quidel's stock continues to be depressed. The company's shares have plummeted since a court said last month it would rule portions of an agreement related to a lawsuit between Quidel and Danaher business Beckman Coulter to be void as a matter of law.

Massaro said, however, that he believes that the drag on Quidel's stock is temporary, and he anticipates the company will win the case on appeal. Quidel, he added, has signaled it could be looking to fill out its technology portfolio by acquiring other companies, and he pointed to OraSure Technologies as a possible acquisition target.

In particular, OraSure's molecular collections business — "a really strong grower," according to Massaro — would be attractive to any potential acquirer. In Q3, that business was up 37 percent year over year.

In the past there had been talk of Chinese firms gobbling up firms in the life science tools and diagnostics markets. That has not happened, though, and Massaro doesn't see it happening in 2019.

"I feel like Chinese companies having to compete with Roche, Abbott, Danaher, and Thermo Fisher – those are big bad companies that are hard to compete with on the M&A side," he said. "I would continue to think that those four companies consolidate the space faster than any Chinese player. That stuff could change, but I just don't see a whole lot of compelling buyers in China to do that."