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Outreach Lab Acquisitions Slow to Develop Despite Continued Pricing Pressures

NEW YORK – With simpler acquisitions largely done, the larger labs may be in the next phase of their acquisition strategies — deals that require more labor and sweat.

During Quest Diagnostics' recent Q3 2019 earnings call, Chairman, President, and CEO Steve Rusckowski noted that while the company's lab "acquisition pipeline remains strong … most deals in our pipeline are taking more time to develop than they have in the past."

He cited the greater "complexity" of the acquisitions Quest was currently pursuing, saying that "conversations with hospital systems are getting broader," and added that hospital CEOs are interested in how the company "can help them with professional lab services and taking on more of their reference work."

As a result, Rusckowski said, "proposed relationships take longer to develop."

David Nichols, president and founder of lab services consulting firm Nichols Management Group, suggested that this shift to more complex deals could indicate that the large national labs have completed many of the smaller, simpler acquisitions that were available and are now moving to explore more larger, more complication opportunities.

"I would surmise that some of Quest's [current] activities are with larger health systems, so those are inherently more complex," he said. "I think it is just their mix of opportunities have changed."

"They've learned a lot from some of their initial smaller joint ventures or acquisitions, and they are now pursuing larger ones and more complex ones that take a lot more time," he said.

Nichols noted that on the whole, he expected the lab business would continue to see a slight trend toward hospital or smaller independent labs outsourcing or selling their business to large national firms, but that it would not be a dramatic one.

While many observers expected implementation last year of the Protecting Access to Medicare Act (PAMA) to drive a spate of acquisitions in the industry, the effect has been relatively muted. In 2018, Quest made three acquisitions, down from 12 that it announced or completed the year before. This year, the company has tended toward forming partnerships with hospital labs rather than acquiring them outright, entering agreements to provide testing and lab management services to Georgia-based Houston Medical Center and Perry Hospital, Regional Medical Center of Orangeburg, South Carolina, and Catholic Health Services of Long Island.

Jeff Myers, vice president of consulting services at healthcare consulting firm Accumen, said that the projected impact of PAMA on hospital outreach was perhaps overblown in the years running up to the law's implementation, providing national labs with "an opportunity to acquire some outreach assets."

Laboratory Corporation of American acquired one lab business, Sciformix, in 2018. It has been quiet this year, as well, with its most notable lab acquisition being the purchase of the diagnostic clinical laboratory testing business of South Bend Medical Foundation.

On LabCorp's Q3 earnings call, Chairman and CEO David King said that in its second year of implementation "the dynamics of PAMA are becoming much more well recognized in the marketplace," suggesting that this could lead to increased interest among hospital and small independent labs to partner with or sell to the company.

Myers said, however, that he believed that on the hospital outreach side, labs would remain reluctant to sell even as reimbursement cuts from PAMA continue.

He noted that while PAMA "has been a headwind" for hospitals, they continue to receive favorable pricing from private payors, with many getting "as much as one-and-a-half- to two-times what independent commercial labs see for the same test."

And while PAMA and other pressures in the market will likely drive down that favorable pricing in coming years, many health system executives view it as "financially beneficial to hold on to that premium rate for as long as possible," Myers said, noting that while some financially strained hospitals may need the influx of cash that the sale of an outreach lab can provide, systems in that position often don't have outreach programs that are attractive acquisition targets.

"And hospitals that have attractive outreach programs, often don't really need the cash," he added.

Myer said that further disincentivizing hospitals from selling is the fact a national laboratory like Quest or LabCorp will value an outreach acquisition based on the lower payment rates they can expect to receive.

He gave the example of a hospital outreach lab that was doing $10 million in business.

"That lab might be worth $10 million to the hospital in terms of revenue, but it might be worth only $8 million in revenue to a national lab," he said. "And any kind of acquisition price would be based off that $8 million."

Myers predicted, however, that hospital outreach labs would see dramatic price cuts over the next decade, citing factors like the push towards price transparency, higher levels of patient exposure to testing costs, and moves by private payors like Anthem to bring hospital rates into line with those of large independent labs.

He said, though, that he didn't believe these cuts would lead to a dramatic uptick in outreach lab sales, suggesting that many health systems would continue to provide outreach services for reasons including maintaining physician satisfaction and continuity of patient care.

Myers said that rather than straight acquisitions, the industry could see more joint ventures, which could allow hospital labs to preserve more control over their lab operations while shifting toward new, lower pricing over a period of years.

Nichols said that joint ventures have in the past proven a successful approach for national labs to establish relationships with health systems that would not sell their lab businesses outright. He cited as an example Quest's ongoing joint venture with the University of Pittsburgh Medical Center.

"Some large institutions [like UPMC] would not sell, so then the fallback for the large national laboratory was, well, if you won't sell, then let's work together," he said.