Wall Street Perspective-Where Is the Investment? What Is the Future as Defined by the Venture Capitalists and Analysts? Where Are They Putting Their Money?, The

Archives of Pathology & Laboratory Medicine, May 2008 by Bonello, William

By way of background, I am an equity analyst, and I follow publicly traded health care stocks and attempt to evaluate whether they are good investments or not. What I certainly cannot speak to is the financial return of the individual technologies discussed at this conference and whether they make economic sense as investments for a hospital or laboratory. It is way beyond my capability.

With that in mind, the stock market really tends to under appreciate the value of anatomic pathology. In the eyes of the stock market, for example, Dianon (Stratford, Conn), an anatomic pathology provider, was worth no more in November 2002 than it was in November 2001. Similarly, in the eyes of the stock market, Ameripath (Palm Beach Gardens, Fla), another anatomic pathology company, was actually worth less in March 2003 than it was back in June 2002. Those companies were actually bought out at huge premiums, which the investors in the stock market may have missed, so the stock market has not been very good at predicting the value of anatomic pathology. In June 2001, Dianon actually bought UroCor at a 31% premium to what the publicly traded stock price had been.

In November 2002, LabCorp (Burlington, NC) turned around and bought Dianon at a 16% premium to what the stock price had been. In March 2003, a private equity firm, Welsh, Carson, Anderson & Stowe, turned around and bought Ameripath at a 30% premium to what it was trading at. Interestingly enough, even after those takeouts at relatively significant premiums, the stock market still did not ascribe much value to anatomic pathology based on the price performance of the acquiring company from the time the acquisition was announced to the time that the acquisition closed. In the eyes of the stock market, buying UroCor was not necessarily a great thing for Dianon to do. In the eyes of the stock market, LabCorp acquiring Dianon was also not perceived as a real positive, and most recently, in an acquisition that you may be familiar with, Quest's (Lyndhurst, NJ) recent purchase of Ameripath was actually perceived by the marketplace as a big negative. The stock prices indicate that the market was not really good at predicting the value that anatomic pathology would add to these large laboratory companies.

Figure 1 shows Dianon's stock price from the time it closed its acquisition of UroCor through the next 5 months, and Figure 2 shows LabCorp's stock performance from the time they closed the Dianon acquisition until today. Obviously these are not the only reasons those stocks traded up, but I believe that the addition of the anatomic pathology components did help to drive a lot of economic value at those companies and subsequently stock market return.

Look at how Welsh Carson performed, the private equity firm that bought Ameripath back in March 2003. They bought it for a little more than $800 million and 4 years later sold it for $2 billion to Quest Diagnostics.

Why does the market not seem to ascribe a lot of value to anatomic pathology? I think there are a handful of beliefs that the marketplace subscribes to. One is a widespread conception that you cannot manage doctors. I think, to some degree, that comes from the failure of the physician practice management industry from a publicly traded company standpoint.

Two, there is clearly a perception in the stock market that laboratory tests are a commodity, your lipid panel versus someone else's lipid panel. What is the difference? I do not think they differentiate between an anatomic pathology test and a clinical laboratory test, whether one is less of a commodity than the other.

Three, there is clearly a perception in the stock market or among investors that managed care has the upper hand relative to health care providers, particularly in this space, and so there is continued concern about pricing pressure.

Four, there is a concern that Medicare will not tolerate high margins. If any laboratory providers do start to make a significant amount of money, what is inevitably going to happen is that they are going to see their Medicare reimbursement cut, and it will not be a good investment.

Five, and most importantly, there is a perception that the promise of new tests is mostly hype. This is the point that I want to discuss in light of the topic of this conference.

During the last 7 or 8 years, those of us who have followed the laboratory industry have heard a lot about the promise of new technology. Back in 2000, we heard a lot about the marriage of diagnostics and therapeutics, that being the promise of the future, and the example that was always given was the HER-2/neu test and the connection with trastuzumab (Herceptin; Genentech, South San Francisco, Calif). Now in 2007, we hear about the promise of companion diagnostics and the example that is given is the HER-2/neu test and the marriage with Herceptin.

Second, we went through a phase where we heard a lot about genetic tests for the screening of colon cancer, improved genetic tests for the screening of colon cancer that never really quite took off. We heard about proteomic tests for the screening of ovarian cancer, and we did not necessarily see that take off a lot either. It is my opinion that today when you look at the stock prices of the publicly traded laboratory companies, and there are really only a handful of them now, they probably do not reflect a lot of premium for new technologies. I am not sure whether they are not ascribing tremendous value to the promise of anatomic pathology.