LabCorp and Quest prepare for year of M&A as price cuts hit small labs

Dive Brief:

LabCorp and Quest Diagnostics have predicted 2019 will be a year of consolidation and M&A as price cuts put hospital outreach labs and regional players under financial pressure.
Both companies object to the cuts, which LabCorp's CEO called an "unjustified overreaction by the government," but also think they will create opportunities to consolidate the currently fragmented industry.
With both LabCorp and Quest doubtful that relief to offset the Protecting Access to Medicare Act (PAMA) cuts is imminent, they are gearing up to capitalize on the structural changes to the market that could result.

Dive Insight:

The clinical laboratory industry spent 2018 fighting the reimbursement reductions mandated by PAMA but ended the year with little to show for its efforts. As it stands, a lawsuit challenging PAMA is stalled because the justice department lacks resources to file briefs during the government shutdown. The shutdown has affected other chances for companies to interact with the government, too.

"There's nobody to talk to at CMS," LabCorp CEO Dave King said at a question and answer session at the J.P. Morgan Healthcare Conference. "The likelihood we're going to get any near-term [PAMA] relief is probably small."

With Quest CEO Steve Rusckowski also "planning for the worst," both the big national players in the U.S. clinical lab testing market are entering 2019 braced for the impact of PAMA and the business opportunities it may create. PAMA wiped around 7% off the fee schedule in 2018 and will take 10% more out this year, King said.

The cumulative effect of the cuts, coupled to growing acceptance that PAMA may be here to stay, could trigger an uptick in consolidation and M&A. Such changes have long been foreseen because hospital outreach and regional specialty labs' lower margins make them more vulnerable to the cuts than LabCorp and Quest.

"I don't know a marketplace where you take out half the profit without structural change. That benefits the leader. And we're the leader. We see tremendous opportunity for us to consolidate," Rusckowski said at a separate session at JPM.

Quest made a clutch of acquisitions last year but overall the level of activity was lower than was expected by some people, including the CEO of LabCorp. King expressed surprise "at the lack of deal flow" in 2018, noting that he saw little in the way of "PAMA-driven acquisitions." One explanation, put forward by King, is that the industry was "watching and waiting" while the lawsuit and legislative reform efforts advanced.

With those efforts stalling, the anticipated wave of PAMA-driven consolidation may be unleashed.

"I think you'll start to see more deal flow just based on both hospital outreach and smaller labs coming to the realization they just don't have enough scale to think about being in the business in the long term," King said.

Quest thinks it can add 2% or more to its growth by picking off some of the 2,000 hospital outreach labs, as well as regional specialty testing centers. The flipside of the situation is that while the PAMA cuts will hit smaller players hardest, they will still hit the big national testing businesses. That will create a pricing headwind in 2019 and beyond.

"It's hard to grow revenue when you're taking the reimbursement reduction from what I view as an unjustified overreaction by the government to a flawed pricing survey," King said.

Rusckowski also spoke out against the reimbursement reduction, arguing that the government failed to collect the right amount of data and thereby skewed prices "to a much lower rate than" Quest thinks is appropriate.

The reimbursement reduction will drag on Quest in 2019 but, while for LabCorp it is one of several headwinds, Rusckowski thinks the overall balance of burdens and opportunities favors his company. Notably, Quest now has access to 43 million more insured patients as a result of the deals it struck with UnitedHealth and other companies last year.

Quest thinks the revised deals create a $4 billion annual revenue opportunity that it plans to capture a growing piece of in the coming years. Some of those gains will come at the expense of LabCorp, which was previously the sole provider to United and last year cited the early loss of business to Quest as a factor that forced it to cut its outlook for 2018.

The question going into 2019 is how much United business Quest can win and over what timeframe. LabCorp is fighting to keep hold of the business while advancing programs it hopes will offset the losses, such as its partnership with Walgreens.