PAMA Looms Large as Clinical Labs Drive M&A Activity in Diagnostics Space in 2017

NEW YORK (360Dx) – With an anticipated buyers' market resulting from the Protecting Access to Medicare Act, Quest Laboratories went on a spending spree in 2017, announcing or completing 12 acquisitions during the year, or 21 percent of all M&A deals in the diagnostics space, making it the most acquisitive firm in the sector, according to an analysis by 360Dx.

In total, there were 58 deals in the diagnostics arena, including 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.  

Many of the purchases during the year were tuck-ins, but a handful have the potential to open or expand new markets for the buyers, such as Abbott's $5.3 billion buy of Alere, completed in October, which increases Abbott's footprint in the molecular point-of-care testing space. Other notable deals in 2017 included PerkinElmer's buy of Euroimmun for $1.3 billion, which closed last week; Konica Minolta's acquisition of Ambry Genetics for up to $1 billion; and Quidel's $680 million acquisition of Alere's Triage MeterPro cardiovascular and toxicology business and its B-type naturietic peptide assay business.

According to Mark Massaro, an analyst at Canaccord Genuity, the diagnostics M&A market remains mostly focused on the molecular space versus the non-molecular space. In particular, he said, at some point in the not-too-distant future, the diagnostics space will move to using next-generation sequencing technologies, which could add a new wrinkle to deals moving forward.

"Yes, molecular is certainly front and center, [but] I think in the back of people's minds, people are eyeing what Illumina is doing to bring down the cost of sequencing," he said in an interview. "Ten years from now … I can confidently say that a lot of the things that are being done on PCR today will be done on something else."

However, a major driver of M&A activity during the past year was the expected effect of PAMA, which didn't become finalized until November but had an impact throughout 2017. Lower reimbursement for more routine testing had been expected to result from the legislation, with smaller labs anticipated to suffer the most from the changes. That led to increased acquisition opportunities for larger labs — notably Quest and Laboratory Corporation of America — who had the scale, a heterogeneous patient mix, diverse payor mix, and wide set of available tests to better absorb the reimbursement blows from PAMA.  

According to William Quirk, an analyst at Piper Jaffray, "PAMA establishes well-defined reimbursement levels" for the large labs doing the most routine testing. Meanwhile, for specialty labs, the PAMA rates "reflects what they are receiving from private payors. As such, it should lead to more reimbursement predictability, particularly for the specialty labs," he said in an interview.

In November, the American Clinical Laboratory Association sued Acting Secretary of the US Department of Health and Human Services Eric Hargan seeking to delay implementation of the PAMA rates, among other things. ACLA's success is uncertain, but if the rates go into effect on Monday as scheduled, for some labs, the predictability that would follow makes them more attractive acquisition targets, Quirk said, while for other labs, the mottled reimbursement environment could be enough to spook them into merging with a larger partner. As Barclays analyst Jack Meehan wrote in a report almost a year ago, "Ultimately, we believe smaller labs with outsized Medicare exposure will be consolidated over time (either organically or inorganically), benefitting LabCorp and Quest as the industry leaders."

Quest was especially busy in the M&A space in 2017. Among its purchases were Cleveland HeartLab, and Med Fusion and Clear Point. The latter two deals will form Quest's precision oncology center of excellence.

While Quest busily consumed smaller regional labs and hospital outpatient labs, LabCorp took a more muted approach, completing three deals during the year. Its biggest acquisition was a buy not of a lab but of specialty contract research organization Chiltern for $1.2 billion, one of the largest deals by a player in the diagnostics space in 2017.

While the purchase was not of a pure diagnostics player, LabCorp officials said that it would help the company carry out plans to expand its companion diagnostics operations, a strategy that also includes its existing Covance business, as well as a dedicated CDx lab, which opened in North Carolina in June.

Its two acquisitions in the clinical lab space were of Pathology Associates Medical Laboratories and the assets of Mount Sinai Clinical Outreach Labs.

The largest deal during the year was Abbott's acquisition of Alere, which took more than a year and a half to complete. Abbott originally announced its intention to buy Alere in February 2016, but then sought to terminate the deal following a number of worrisome developments, including the elimination of billing privileges from the US Centers for Medicare & Medicaid Services for an Alere division, and the permanent recall of an important Alere product platform. The US Department of Justice also investigated Alere for its sales practices and dealings in Africa, Asia, and Latin America.

Eventually, though, Abbott went ahead with the purchase, but lowered the price it would pay from $5.8 billion to $5.3 billion.

Other companies that went on a buying spree in 2017 include Eurofins, which built out its network of labs by acquiring seven businesses in the human health space during the year. Meanwhile, Unilabs made five deals, and Aurora Diagnostics completed four purchases.

Another blockbuster deal that could have implications in the diagnostic testing space is CVS' proposed $69 billion purchase of Aetna. CVS Health President and CEO Larry Merlo said that the firm will experiment with multiple new healthcare service offerings, including lab services, and some industry observers said the acquisition could result in some basic lab services flowing away from traditional lab providers to the CVS pharmacy setting.

Such synergies are already under way at other retailers as a result of deals forged with labs. In the past year, LabCorp reached an agreement with Walgreens to provide more healthcare services, such as routine testing, in the retailer's stores, while Quest and Walmart also announced a similar deal.

Canaccord's Massaro added that the PAMA rates, if unchanged, could spur on M&A in the clinical lab space in 2018 and beyond.

The rates are already bad for 2018 to 2020, and they get worse for 2021, 2022, and 2023, he noted. Reductions in Medicare reimbursements for any test is limited to no more than 10 percent for each of the first three years of PAMA, but that figure increases to 15 percent for each of the three years afterward. "If it's going to get worse, and I'm a mom-and-pop lab in the Midwest, and I have no economies of scale, I'm exiting the business," Massaro said. "I think these rates are pretty bad, and I think it will lead to Quest and LabCorp going out and rescuing some of these labs."

In addition to the clinical labs, he said that molecular diagnostic vendors Illumina and Qiagen could look to advance their sequencing technologies into new disease areas, such as infectious disease, raising the possibility of M&A. He also mentioned Roche, Thermo Fisher Scientific, and Hologic as potentially active buyers in the coming year. And among the diagnostics firms that bear keeping an eye on as possible acquisition targets, according to Massaro, are Two Pore Guys, GenMark Diagnostics, Natera, Genomic Health, Meridian Bioscience, and Orasure Technologies.

Another firm that could make a splash is Danaher, which historically has been an active acquirer, but which laid low in 2017 following its $4 billion acquisition of Cepheid in late 2016.

A month ago, Danaher company Beckman Coulter went to court to affirm its rights to sell a natriuretic peptide assay directly to its customers. The assay is currently sold exclusively by Quidel following its acquisition of Alere's BNP assay business. After Beckman Coulter announced the lawsuit, Quidel disclosed that Danaher had made inquiries about buying the BNP assay business.

Some, including Raymond James' Nicholas Jansen saw the lawsuit as a bid by Danaher to nudge Quidel into selling it that business. "[W]e saw the [announcement of the lawsuit] as potentially being a negotiating tactic to acquire the asset from Quidel directly," he wrote in an investment note, adding "Danaher is using the courts and threats to go direct as a means to put pressure on Quidel's board to accept a price closer to the deal multiple vs. what they are actually worth to Danaher (double-digit multiple)."

Larger picture, Cowen analyst Doug Schenkel added that following Danaher's investor day presentation two weeks ago, he views the company's M&A capacity as "replenished." He estimated the firm has between $5 billion and $10 billion in funds available for potential acquisitions. During the firm's presentation, Schenkel said, "[m]anagement was clear that the balance sheet is now in a position for the company to deploy a significant amount of capital to M&A."

Top M&A Deals in the Dx Space in 2017