College of American Pathologists
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  IVD, imaging firms peg fortunes on consolidation






June 2007
Feature Story

Anne Paxton

Snapped up by Fortune 100 corporations, the object of billion-dollar bidding wars, chalking up new mergers and acquisitions seemingly every week. Can this really be the in vitro diagnostics industry?

IVD companies 15 years ago were an industry “in the doldrums,” says Robert DeCresce, MD, chair of the Department of Pathology at Rush University Medical Center, Chicago. “You wouldn’t have seen anybody from the outside wanting to even get involved, because the diagnostics industry was not considered dynamic and profitable. Most of the consolidations were done for survival purposes because no one was getting the kind of margins they wanted.”

But Wall Street takes a different view today. “Now people are saying, Wow, this industry could be really good and help us use health care as an engine to drive our company forward,” Dr. DeCresce says. Several leading hospital imaging equipment makers have scored major acquisitions of diagnostics companies in the past few months:

  • General Electric Co. paid $8.13 billion to Abbott Diagnostics for Abbott’s i-Stat point-of-care diagnostics business and primary IVD business. GE preceded this acquisition with the purchase of Amersham, a British diagnostic imaging and life sciences firm, in 2004 for $9.5 billion.
  • Siemens Medical Solutions, part of German multinational Siemens AG, paid $5.21 billion to acquire Bayer HealthCare Diagnostics and $1.86 billion for Diagnostic Products Corp. In May, Siemens hired a former head of General Electric HealthCare Biosciences, Peter Loescher, as its new CEO.
  • In another high-ticket diagnostics merger, in late May Cytyc Corp., which makes the ThinPrep Imaging System, was acquired by diagnostic imaging maker Hologic Inc. for $6.2 billion. Earlier, Cytyc paid $450 million for Adeza Biomedical Corp.

Meanwhile, the CEO of Dutch multinational Royal Philips Electronics—along with GE and Siemens the third major global hospital imaging equipment manufacturer—confirmed to the German press that Philips was considering several acquisitions up to the multi-billion dollar level.

The surge in mergers is strikingly different from others that have occurred over the past two decades, industry analysts suggest, partly due to the state of the economy.

“There’s a tremendous liquidity in the marketplace, a lot of capital available and a lot of cheap debt,” says Joseph Migliara, private investor and CEO of JMM Enterprises, Owings Mills, Md. And “when you have companies like Abbott and Bayer divesting, it starts a little bit of a bandwagon.”

Abbott was “clearly heading in a different direction with more pharmaceutical intensity rather than diagnostics, while GE really wants to trade up in some of its portfolio, and Bayer has always been criticized for having an odd corporate structure with chemical and pharma and diagnostics,” says Migliara, who was formerly president of North American operations for market research firm NFO Worldwide.

“So you have unique events that came together, but they’ve also gotten many other companies to look at possible consolidation approaches.”

Migliara is not sure why GE’s acquisition of Abbott Diagnostics was structured so that Abbott retained its two high-value properties—diabetic glucose testing and molecular diagnostics. “Molecular seems to fit well with the idea of individualized medicine, which is possibly where Abbott is going. But as for the diagnostics, Abbott may just have been fatigued. It’s been beaten up by the FDA, its margins have been shrinking, and the environment for some of its core tests is pretty price-sensitive.”

Whether GE will be able to make Abbott’s FDA problems disappear is not clear. “I’m sure that GE, with its Six Sigma quality-improvement approach, thinks it can improve overall quality and reject rates and things like that,” Migliara says. With its massive financing arm as well, GE’s ability to integrate imaging, information technology, and laboratory, and to sell across platforms, is probably going to be its strong suit, he believes.

The acquisition pattern at Roche Diagnostics shows it also is continuing to head more into the molecular area, Migliara says. “That’s where they’ve got strength and certainly a great footprint. Their core laboratory business is really mundane stuff, and I see them heading more to the higher value-added areas—primarily molecular.”

The acquisition trend may not bode well for clinical laboratories, Migliara says. “On the hospital side, we’ll have to see how these post-acquisition corporate structures play out. The GEs and Siemenses of the world clearly want to integrate laboratory and information platforms. They’re not quite bypassing the laboratory or pathology, but when it comes to brand choice, smaller laboratories could be a little bit disenfranchised.”

Anthony P. Bihl, Siemens Medical Solutions Diagnostics’ chief executive officer, has the perspective of both the acquirer and the acquired—since he was president of Bayer HealthCare Diagnostics until Siemens bought it.

“One of the core businesses of Siemens Medical Solutions is imaging diagnostics; we’re also a market leader in health care IT, and we are developing biomarkers in molecular imaging spaces,” Bihl says. “So we see a strong synergy with the laboratory diagnostic business” via the recent acquisitions. “Siemens had a very strong backbone of IT, so if you combine that with in vitro diagnostics, you’ve got the whole puzzle complete.”

In Bihl’s view, the industry had been ripe for another wave of consolidation, with information technology the main impetus. At Bayer, “we were getting a very clear message from the market that we had to do much more in IT, to play a stronger role in connecting the data from our systems into the hospital information system.”

The long-term logic that brought Siemens and Bayer together, he says, was this: “Yes, today we know the results from the CT scan and the immunoassay test exist out there in information systems in the hospital, but the issue is how we bring them to the clinician to interpret them more quickly, make diagnoses, and take action.”

The other company Siemens acquired, DPC, was a strong leader in immunodiagnostics, and saw that it needed to expand and work with more automation, Bihl says. DPC viewed joining with Siemens as “a very interesting strategic opportunity to take it to the next level.”

With its new acquisitions, Siemens plans to provide a “very workflow-based solution, pretty much across the continuum of care, that will help to run the full health care enterprise.”

Bayer has also started making acquisitions in pharmaceuticals and brands in consumer care, including the German pharmaceutical company Schering AG, Bihl says. The company “strategically decided to stay very focused on consumer health care, including diabetes, and move out of professional diagnostics.”

“What’s happening now is not something I would exactly call ‘consolidation,’” Dr. DeCresce says. “These are buyers that have not traditionally been involved in the diagnostics industry.” For example, many private equity companies were looking at DPC before Siemens acquired it, and Dr. DeCresce believes even more private equity buyers will be involved in diagnostics in coming years.

The mergers that occurred in the diagnostics industry until recently often were justified under what he calls the “two drunks theory”: “You have two companies that aren’t doing well, each one is leaning, and you hope if you throw them together they’ll stand up straight.” If that didn’t apply, there was also the more traditional prescription of “buy the company, fire all the sales people, and lower costs.”

Today, the bids that Beckman and Inverness made when competing for BioSite have made people sit up and take notice. Inverness is paying $92.50 per share; BioSite’s first quarter 2007 earnings per share were $0.66 on revenues of $83.7 million. “Those prices are unheard of for a company with those kinds of sales,” Dr. DeCresce says.

Certain segments of diagnostics are quite profitable, and companies may mistakenly believe the whole industry is that way. “I look at our laboratory and we’re spending far more money in microbiology than we’re spending in the chemistry lab, because of new tests with very high margins,” he says.

Clearly Abbott, since it sold everything to GE except its POC glucose and molecular diagnostics, sees those two units as the strong growth part of the business, Dr. DeCresce says, while GE sees Abbott’s diagnostics as fitting in nicely with the global health care enterprise. “I think they see some synergies by coming in. I don’t know if they exist or not.” Since GE did not acquire the two areas with the greatest growth, Dr. DeCresce speculates that GE sees the POC i-Stat business as able to be molded in some way to fit with GE’s monitoring business.

He agrees that the whole trend points to less competition. “You really need a scorecard. Look at Corning, Bayer, Roche—all those mergers have clearly decreased competition. I think over time there is just so much product that can be sold, and there were probably too many vendors before.”

The consolidation now occurring typifies a trend in a lot of health care industry sectors, says Jack Shaw, executive director of Joint Venture Hospital Laboratories, Allen Park, Mich., a network of nine Michigan health systems. “Large companies realize they need to have all the pieces that the hospitals want, a comprehensive menu of services and products, to be most valuable in the market and to attract purchasers.”

Shaw views GE’s purchase of Abbott’s diagnostics business as a market grab decision. “They’re looking to get the most synergy for their overall operations. And taking a competitor out of the market, just as Quest Diagnostics recently did by buying Ameripath, has great value.” At the same time, U.S.-based companies are increasingly better acquisition targets these days because of the drop in the dollar’s value against world currencies, he points out.

He forecasts two potential challenges for the reshaped IVD market. “The hospital industry is very specialized and the companies will have to learn how to maneuver in that particular industry. Capital is a very prized commodity in the hospital, and the laboratory is often at the lower end of the list in being able to get capital out of their organization.” That—and the swift obsolescence of technology—tends to make laboratories favor reagent rental purchases over straight capital purchases.

From the hospitals’ standpoint, Shaw says, “obviously new, larger, and fewer companies in the market are going to make negotiations tougher. There will be a little less competition, and because of that you can’t play one company off the other.”

It’s not necessarily terrible for the laboratory business to be seeing this level of consolidation, says P. Thomas Hirsch, president of Laboratory Billing Solutions, Portsmouth, NH. “I’m sure GE and Siemens and others are saying we have an elderly population, and there will be more testing and diagnostics, and maybe this is a decent space to be in. The bigger laboratories like LabCorp and Quest will demand better pricing on instrument systems, but I suppose dealing with single customers and having your platforms in their labs is attractive.”

He suggests perhaps GE and Siemens are trying to consolidate their sales efforts. “They’re already selling all this heavy artillery, the x-rays and MRIs and other systems, and probably thinking, why don’t we sell diagnostics as well?”

Clearly, instrument systems cost hundreds of millions of dollars to develop, test, and get approved, and selling instrument platforms to hospitals is a long process, “so you’ve got to have staying power, you still have to be a large company,” Hirsch says. “But there are still huge opportunities in the laboratory business for people to start up and provide a service. It’s still a local business.”

The emergence of Internet portal services like Atlas, 4medica, and Dx Port, which provide front-end and back-end systems for physicians to connect to the Internet, indicates there are fewer barriers to startups, he adds.

Ironically, the industry is changing as the very result of the success of its current business model, says Brian R. Buxton, principal and co-founder of Easton Associates, LLC, New York, NY. “For years, the industry has pursued a ‘better test’ business model—better, more accurate tests to deliver more clinical value. But by now, large swaths of tests are very, very good—and they’re not going to get that much better. It’s hard to argue a complete blood count or chemistry panel done on an Abbott system is better than one done on a Bayer system, and the same argument goes for a large percentage of tests today.”

“As a result, revenue growth of these tests and their instruments has slowed, and the diagnostic companies now manage this business very carefully with sales force tracking, group purchasing contracts, bundled pricing, and so on. Now we see a new model emerging, the ‘better infrastructure model.’”

Under this model, what counts is the hospital buyer’s ability to integrate diagnostic instruments and test results with the hospital infrastructure—hospital IT systems, treatment pathways, purchasing, equipment financing, GPO contracts, service and technical support.

“The value of diagnostics,” Buxton says, “has become system performance: How quickly and how cheaply can diagnostics deliver data to the IT system and put test results into a pathway or an algorithm to facilitate a treatment decision?”

In his view, this is a major step forward in the sophistication of the companies that, he says, “we used to call diagnostic companies but should now call diagnostic information solution companies.” This is a business characterized by tighter margins, slower growth, better control over operating costs, and the ability to integrate solutions across different domains. “And GE and Siemens excel at this business model,” he says. That is why they now have entered the diagnostics business.”

On the other hand, the “better test” model still has good years ahead of it in specific areas like molecular testing and anatomic pathology—areas in which tests with substantially better results than other tests remain possible.

Buxton cites Genomic Health’s Oncotype Dx and XDx’s AlloMap molecular expression test as examples. AlloMap is a genomic test that replaces a biopsy taken of a transplanted heart. “Obviously, threading a catheter and taking a cardiac biopsy is an expensive and invasive procedure; the AlloMap is a simple blood test that replaces that procedure and can identify a potential transplant rejection in time for a change of medications to improve the odds of success, at a tremendous clinical and financial benefit.”

In many testing areas, “there are still important differences in accuracy and performance, ease of use, and impact on treatment; there’s a way to argue convincingly that one test is better than another—this is what used to characterize immunochemistry and hematology,” he says. As a result, the molecular diagnostics sector is growing at a rate of more than 15 percent annually—much higher than the five to six percent growth of the central lab businesses acquired by Siemens and GE, Buxton points out. (Siemens also acquired a significant molecular business as part of the Bayer transaction.)

With time, Buxton believes, purchasing decisions within molecular testing will turn on “real estate”—square feet of countertop and floor space in the hospital. “These molecular diagnostic labs and hospitals are doing tests that are so important they can pretty much have whatever they need in the way of space. And they may have two or three or four systems—one each from Bayer, Roche, Abbott, and ABI—even though the menus overlap. Eventually the vendor with the biggest portfolio is likely to come out on top, because hospitals can get a complete solution, single-vendor platform.”

Other analysts think there is a sea change of a different kind in the industry. The assessment of Bruce Friedman, MD, active emeritus professor, Department of Pathology, University of Michigan Medical School, Ann Arbor, in a presentation at the 2007 Lab InfoTech Summit, was: “We have two global corporations betting $25 billion on the convergence of imaging with molecular diagnostics.”

Will their wager prove to be a mistake?

“I think for sure GE and Siemens will try to integrate diagnostic radiology with diagnostic laboratory information,” Migliara says. “I’m not sure it’s a compelling clinical story, but from an information point of view, and perhaps including other parameters like pharmacy data, they could be delivering information more quickly.”

Diagnostic information and imaging information really aren’t distinct sets of information and they need to be communicated in joint ways, Shaw says, “so you don’t have laboratory information, for example, being reported and then completely siloed from the imaging information.”

Companies that can help meld those together will appeal to hospitals and payers, he says. “The bottom line is it’s all about IT, and it’s all about reducing costs. The providers who can control their costs better are going to be successful.”

Dr. DeCresce does not foresee radiology and pathology actually merging. “Lots of pathology is now done by people sticking needles in ultrasound-guided or CT-guided biopsies. I think image-related telepathology is going to grow, but I don’t think that’s the same as radiology imaging. They’re different disciplines at the moment—one is patient-intensive while the other is specimen-intensive. So it will be a ways down the road until their training makes it possible.”

In the business end, he adds, radiology “tends to be extremely technology driven. It’s leapfrog technology, and images drive sales there. For the laboratory, the motivations for buying things are much more workflow and operational issues.”

Buxton is skeptical that in vivo imaging and in vivo diagnostics could really integrate. “It’s theoretically possible, but I think more than 10 years in the future. In the most obvious disease—cancer—where both modalities are used, they are used at completely different times.”

“If you talk to either the pathologist, the radiologist, or the surgeon, they’re not putting the two types of information together at the same time*#8212;sequential process.”

The real probability is less that the two specialties might somehow merge into a department of diagnostic radiopathology, Buxton says, “but rather that you’ll have simply infrastructure integration of radiology information, pathology, IT, treatment algorithms and pathways by the hospital system.”

Consolidation could have a negative impact on innovation in the industry. “A lot of small companies are successful because they are totally focused on a live-or-die technology, and they get in the market and they have to commercialize it,” Migliara says. “So you wonder, if they continue to get gobbled up because they need distribution or because they need follow-on capital or just need to compete, does that make innovation tail off?

“Once they get absorbed into large mega-companies like GE, will they still have the same drive and commitment and fervor? It’s hard to sustain that within a large company.”

Hirsch, on the other hand, predicts innovation will continue to thrive. “This industry has been consolidating all along for the last 15 years, and we’re seeing it a little more acutely on the diagnostic end. Yet you still see a lot of new companies coming, which means new technologies and new ways to look at treatment. It’s still a growth industry with dynamic things going on.”

There is wide agreement that sales of diagnostic equipment in the United States will not grow nearly as much as those in Asia. Says Migliara: “The large developing markets such as China, India, and Vietnam will be a huge play, with centralized government buyers, and a company like GE has the resources to totally finance these mega-purchasing contracts if necessary. And companies with total integrated solutions like Siemens and GE will have stronger opportunities there.” In the Asian market, Buxton says, private labs are few, and the preference will be for low-cost solutions, which again gives larger companies like Siemens and GE an edge.

But there’s no such thing as a sure thing. “Ten years ago, anyone in the diagnostics industry wished they weren’t. But they couldn’t get out because no one would buy their business,” Dr. DeCresce says. “Now, outside companies are seeing diagnostics as a way to make money.” The Siemens and GE purchases suggest that “people are looking at diagnostics as a long-term higher-valuated proposition, and not just a bunch of glucoses and BUNs done in a central laboratory.”

“As outsiders they may turn out to be really wrong and have wasted a lot of money,” Dr. DeCresce says. “But they probably will bring a very different view to the industry.”

Anne Paxton is a writer in Seattle.


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