LabCorp’s purchase of LipoScience for $85m in September was just the warm-up act. The company has now made a $6.1bn move on Covance, which it says will create the world’s leading healthcare diagnostics company.
That is debatable: both companies are service providers rather than developers of in vitro diagnostics products, and the combined entity is therefore not a competitor to Roche and the rest of the top companies in the IVD market. In reality this is more likely to be a defensive move by two companies facing payment pressures from hospitals and the US government, sluggish testing volumes, and potentially damaging regulatory changes.
Covance shareholders will receive $75.76 in cash and 0.27 LabCorp shares for each Covance share they own, which was equivalent to $105.12 per Covance share before LabCorp opened down 8% this morning. The CRO’s shares are up 26% in early trading today. Covance shareholders will end up in possession of 16% of the new company.
The price is around 13.3 times Covance’s EBITDA over the 12 months to September 30, the companies say, and excluding one-off costs the transaction will be accretive to LabCorp’s adjusted EPS in 2015 before synergies. LabCorp believes it can realise annual cost savings of more than $100m within three years of closing the deal in the first quarter of 2015.
LabCorp will finance the deal with a combination of cash on hand, including Covance’s overseas cash, as well as debt from BofA Merrill Lynch and Wells Fargo Bank.
Scratch any recent billion-dollar merger and tax motives appear beneath the surface. On a conference call LabCorp management said that because more than 50% of Covance was based outside the US, the CRO’s overall tax rate was lower than the mainly US-based LabCorp’s 35% liability. Therefore, “LabCorp’s overall tax rate will come down as well.”
This is not an inversion deal, but it seems as if no company in the medtech sector will consider a takeover unless it can point to some kind of tax advantage.
Range of customers
Another factor that made Covance attractive is its international base. Covance has labs in Geneva, Indianapolis, Shanghai, Singapore and Tokyo, to capitalise on the shift to emerging economies (EP Vantage interview – Covance puts the pieces of the puzzle together, November 29, 2013). The combined company will draw around 20% of its revenue from outside the US after expanding its testing services into new markets.
But the main rationale is to provide a bulwark against the market pressures LabCorp and Covance face. They say that the combined company will derive its revenue from “managed care (32%), pharmaceutical and biotech companies (29%), commercial customers (22%), Medicare/Medicaid (12%), and private patients (5%)”.
This mix of hospitals, government and private insurers and citizens will provide some relief from squeezes in particular sectors. For example, while hospitals have been consolidating, allowing them to drive harder bargains on the prices they pay for testing services, the US and European economies have been recovering from recession, enabling governmental programmes and health services to spend more freely. Individual patients have more money in their pockets, too.
The combined entity will also have established relationships with all of the top 20 pharmaceutical companies, LabCorp says. The idea is that combining Covance’s patient monitoring and LabCorp’s tests will enable it to provide contract research services more quickly and cheaply to its big pharma clients.
Combating low prices, cutting tax and accessing non-US cash: LabCorp and Covance might not strictly be medtech companies, but their motives for merging are extremely familiar.