Laboratory Investing. Opportunities in a changing healthcare environment

Laboratory Investing Opportunities in a changing healthcare environment November 15, 2012 Contents I.  Industry Overview II.  Key Emerging Trends I...
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Laboratory Investing Opportunities in a changing healthcare environment

November 15, 2012

Contents I.  Industry Overview II.  Key Emerging Trends III.  Investment Opportunities A.  Industry participants vs. capabilities for services B.  Expected responses vs. capabilities for services C.  Investor risk preferences D.  Prior Performance

IV.  Conclusion

I. Industry Overview •  Laboratories, are in a period of increasing change: §  The ever increasing cost of healthcare §  The Affordable Care Act, other legislative and regulatory initiatives §  The economy

•  The US spends ~ $7,000 per capita or ~ 2x other advanced countries, such as the UK and Japan, without measurable improvements in results •  Spending is a significant, growing and expected to be 20% of the economy by 2021: §  In 2011 the CBO estimated a $2.6 trillion increase in spending over nominal GDP growth over the

next decade which represents 6.8% per annum growth, 30 basis points more per annum than before the passage of the Affordable Care Act

I. Industry Overview continued •  In the private sector, healthcare spending at these levels is not sustainable §  The Bureau of Labor Statistics (BLS) reports that since the early 1980s growth

in healthcare costs has outpaced wages by 2.5x §  Employers continue to shift cost to employees §  The private sector has been cross subsidizing government healthcare programs through higher commercial rates as the government’s programs pay at or below provider costs

•  This dynamic will result in increasing pressure from the private sector on commercial payors to lower costs, impacting providers, while the continued cost shift to individuals is, economically, analogous to a tax which slows consumption andgrowth of the GDP

I. Industry Overview continued •  The public sector, as well, cannot sustain spending at these growing levels §  The largest payor, Federal and State governments, are growing as a proportion of healthcare

spending and expected to reach 54-55% of total spending by the end of the decade §  An aging population, Medicaid expansion and increasing coverage subsidies

•  The economics are unfavorable: healthcare spending grows faster than the economy while tax receipts grow in proportion to GDP §  Sustainable government funding is dependent on the ability to either shift funding from other

programs/services and/or borrow

•  Government’s overextended finances will eventually impact the ability to borrow as federal debt now exceeds $16 trillion

I. Industry Overview continued •  The need to promote economic growth and significant fiscal pressure will necessitate the government to reduce healthcare spending •  As a result, providers will face increasing revenue pressure as all payors – government and commercial – seek to reduce costs •  Efforts to reduce cost will come under increasing pressure as payor finances, particularly government, deteriorate

I. Industry Overview continued •  In this environment, laboratories and other providers need three capabilities for success 1)  Cost management

Offset declining reimbursement 2)  Innovative new products/services §  To generate new revenues and strengthen quality §  Add value to healthcare decision making 3)  People management §  To lead a team through challenging times and foster innovative thinking § 

•  We will explore why laboratories – with effective leadership – have the potential to be successful in this environment

II. Key Emerging Trends •  Historically, laboratories have been a dynamic, innovative and a growing healthcare services sub-sector §  Impact: laboratory testing is at the core of clinical care as it enables ~ 70% of medical decisions §  §  §  § 

and will remain essential in the future Volume: an aging population drives increasing demand for laboratory testing and demand will continue to increase Innovation: New tests and techniques are, relatively, in-expensive to develop and can be quickly deployed such as the growth of genetic and esoteric based testing Scale: Laboratories represent ~ 2.5% of all healthcare expenditures and are not the primary focus of policymakers Business practices: Growth via acquisitions, joint ventures, new tests and techniques and improving services

•  These historical characteristics provide laboratory leadership and managers the experience to be successful in a more challenging environment

II. Key Emerging Trends continued •  Financially, laboratories will need lower costs as well as new revenues •  Laboratories have the ability to reduce operating costs §  Acquisition integrations and capacity rationalization §  Leveraging information technology to improve production, billing and §  §  §  § 

communication with clients Integrating laboratory design, technology and new instrumentation to speed sample through-put from accessioning to result delivery Training to strengthen phlebotomist productivity Utilizing joint ventures, contracts, etc. with hospitals to promote operational efficiency in the acute care setting Greater operations discipline

II. Key Emerging Trends continued •  Additionally, laboratories develop new sources of revenue §  Genetic testing is expected to grow 26% from $1.5 billion to

§  §  §  § 

$4 billion by 2015 and these tests are generally reimbursed at higher rates Disease management Solution based reimbursement Hospital laboratory management Rx joint ventures and outsourcing

II. Key Emerging Trends continued Revenue Growth of Publicly Traded Labs 8.0%

7.0%

7.0%

6.1%

6.0% 5.0% 4.0%

5.8%

5.4% 5.4% 4.7%

4.0% 3.1%

3.0%

2.3% 2.2%

2.0% 1.0% 0.0% 2003

2004

2005

2006

The Year 2012 is annualized through June 30, 2012

Source: Laboratory Economics

2007

2008

2009

2010

2011

2012

II. Key Emerging Trends continued First-Half Revenue 2012

First-Half Revenue 2011

Reported Change

Pro Forma Change

Quest Diagnostics

$3,843,300

$3,724,778

3.2%

1.0%

LabCorp

$2,846,700

$2,432,000

17.1%

1.0%

Sonic Healthcare USA

$404,000

$395,700

2.1%

2.1%

Bio-Reference

$313,307

$259,317

20.8%

20.0%

Myriad Genetics

$262,742

$209,786

25.2%

25.2%

Genomic Health

$116,098

$100,656

15.3%

15.3%

NeoGenomics

$30,771

$19,271

59.7%

59.7%

Enzo Clinical Labs

$29,365

$26,087

12.6%

12.6%

Psychemedics

$13,106

$12,228

7.2%

7.2%

Combimatrix

$2,575

$2,172

18.6%

18.6%

Total 12 Companies

$7,861,964

$7,181,975

9.5%

3.1%

Total 10 (excluding Quest and LabCorp)

$1,171,964

$1,025,197

13.9%

13.5%

Company

Source: Laboratory Economics

II. Key Emerging Trends continued •  Revenue growth has slowed in recent years due to economic conditions, reimbursement pressure, etc. – but remains positive •  Quest and Labcorp had organic growth of ~ 1%, in the first half of 2012 and this growth was driven by volume while cost control increased profitability •  Other players, such as Bio-Reference and Myriad, had significantly stronger revenue growth which was driven by new tests and volume §  BioReference – launched OnkoMatch, Inherigen and GenCerv §  Myriad – companion diagnostics, such as BRAC Analysis & HRD for PARPs, drive growth

•  The first half of 2012 highlights the key trends discussed – price pressure, increasing demand, cost control and innovation

II. Key Emerging Trends continued Stock Price 9/14/12

Stock Price 12/31/11

2012 price change

Market capitalization ($ millions)

Enterprise Value/ EBITDA

Price/ Sales

Bio-Reference (BRLI)

$28.14

$16.27

73%

$779

8.9

1.2

CombiMatrix (CBMX)

$0.68

$2.00

-66%

$7

NA

1.5

Enzo Biochem (ENZ)

$1.96

$2.24

-13%

$76

NA

0.7

Genomic Health (GHDX)

$32.96

$25.39

30%

$1,003

58.6

4.4

LabCorp (LH)

$90.99

$85.97

6%

$8,726

8.2

1.6

Myriad Genetics (MYGN)

$27.53

$20.94

31%

$2,249

9.5

3.6

NeoGenomics (NGNM)

$2.62

$1.40

87%

$118

26.0

2.1

Psychemedics (PMD)

$11.10

$9.10

22%

$59

8.9

2.3

Quest Diagnostics (DGX)

$61.54

$58.06

6%

$9,770

8.6

1.3

A$13.24

A$11.28

17.3%

A$5,237

10.1

1.5

$11.28

19.3%

$2818

17.35

2.02

Company (ticker)

Sonic (SHL:AU) Unweighted Averages

$27.12

*Medtox was acquired by LabCorp on July 31 for $27 per share. Sonic: 1.03 A$ per US $ for un-weighted average

Source: Bloomberg

II. Key Emerging Trends continued •  8x – 12x EBITDA is the historical rule of thumb for public laboratory valuations •  The industry is trading tightly in the lower half of the historical range and is bookended by LabCorp at 8.2x and Sonic at 10.1x §  Excludes Genomic Health & NeoGenomics, who are enjoying multiples that reflect expectations of

rapid earnings growth and cash generation

•  One implication of the valuation multiple is that the market believes the prospects for the industry remain generally consistent with the past •  Currently, it is fair to argue that so far the market is pricing laboratories similar to the past even with the well known industry and economic challenges ahead of us

II. Key Emerging Trends continued •  Growth continues as laboratory industry revenues are expected to exceed $100 billion before the end of the decade •  What is the best way to participate in this vital sector that has the ability to control/reduce costs, utilized new tests and techniques to generate new revenues and has developed some leaders/managers schooled in these areas? •  The structure of the industry and diversity of the players provide unique investment opportunities in publicly traded laboratories that we will explore among: §  Large and Mid-Sized National Laboratories §  Specialized Laboratories §  Suppliers

III. Investment Opportunities •  Cost Management, Innovation and Management Quality are key capabilities for success in today’s marketplace § 

Leadership or, more precisely, the leadership team needs to include laboratory operating and new product development expertise

•  All of these capabilities are necessary for successful industry participants, while their impact on value creation will vary based on scale For example, in August of this year Myriad discussed a several products that could elevate sales by ~ $50 million or 10% of total revenues over several years… §  This same deployment at Quest, the largest participant, would represent only ½ of 1% of total revenues …. Differently, to have to have the same effect on revenue growth, Quest would need to have ~ 15 product sets of similar market potential § 

•  As a result, an interesting matrix regarding impact develops over which capabilities will have the strongest impact for investors…

III. Investment Opportunities continued A. Industry Participants vs. Capabilities for Success

The largest national laboratories §  Quest §  LabCorp

The mid-size national laboratories §  BioReference §  Sonic

The specialized laboratories §  NeoGeonomics §  Genomic Health §  Myriad Genetics

Suppliers §  Life Technologies §  BD §  Thermo-Fisher §  Danaher

III. Investment Opportunities continued

A. Industry Participants and Capabilities for Success

Cost Management Large National Laboratories

þ

Midsized Laboratories

þ

Specialized Laboratories Suppliers

þ

Innovative New Products

Management Quality

þ þ þ

þ

þ

þ

III. Investment Opportunities continued

B. Expected Response and Capabilities for Success

Quest & LabCorp

Sonic & BioReference NeoGeonomics, Genomic Health & Myriad Genetics Life Technologies, BD, Thermo-Fisher & Danaher

Cost Management

Innovative New Products

Consolidator

Aggressive

Aggressive (law of large numbers problem)

Yes

Weak/Moderate

Weak/Moderate

Yes

Moderate

Aggressive

No

Aggressive

Aggressive

N/A

III. Investment Opportunities continued C. Investor Risk Preferences Corporate Restructuring & Process Improvement

Clinical New Product Development

M&A and Corporate Activity

High

Moderate

High

Sonic & BioReference

Moderate

Weak/Moderate

Moderate

NeoGeonomics, Genomic Health & Myriad Genetics

Moderate

Very High

Low

Life Technologies, BD, ThermoFisher & Danaher

Moderate

Moderate

Very High

Investment Risk

Quest & LabCorp

0 6-Sep-12

6-Jul-12

6-May-12

6-Mar-12

6-Jan-12

6-Nov-11

6-Sep-11

6-Jul-11

6-May-11

6-Mar-11

6-Jan-11

6-Nov-10

6-Sep-10

6-Jul-10

6-May-10

6-Mar-10

6-Jan-10

6-Nov-09

6-Sep-09

6-Jul-09

6-May-09

6-Mar-09

6-Jan-09

6-Nov-08

6-Sep-08

6-Jul-08

6-May-08

6-Mar-08

6-Jan-08

6-Nov-07

Percentage

III. Investment Opportunities continued D. Prior Performance National Laboratories

200

180

160

140

120

100 S&P 500

80 DGX LH

60 BRLI

40

20

0 6-Sep-12

6-Jul-12

6-May-12

6-Mar-12

6-Jan-12

6-Nov-11

6-Sep-11

6-Jul-11

6-May-11

6-Mar-11

6-Jan-11

6-Nov-10

6-Sep-10

6-Jul-10

6-May-10

6-Mar-10

6-Jan-10

6-Nov-09

6-Sep-09

6-Jul-09

6-May-09

6-Mar-09

6-Jan-09

6-Nov-08

6-Sep-08

6-Jul-08

6-May-08

6-Mar-08

6-Jan-08

6-Nov-07

Percentage

III. Investment Opportunities continued D. Prior Performance continued Specialty Laboratories

300

250

200

150

S&P 500

MYGN

100

NGMN

GHDX

50

0 6-Sep-12

6-Jul-12

6-May-12

6-Mar-12

6-Jan-12

6-Nov-11

6-Sep-11

6-Jul-11

6-May-11

6-Mar-11

6-Jan-11

6-Nov-10

6-Sep-10

6-Jul-10

6-May-10

6-Mar-10

6-Jan-10

6-Nov-09

6-Sep-09

6-Jul-09

6-May-09

6-Mar-09

6-Jan-09

6-Nov-08

6-Sep-08

6-Jul-08

6-May-08

6-Mar-08

6-Jan-08

6-Nov-07

Percentage

III. Investment Opportunities continued D. Prior Performance continued Suppliers

140

120

100

80 S&P 500

60 BDX LIFE

40 DHR

20

III. Investment Opportunities continued

Different Perspective for Investors… Laboratories have a need for speed to — Deliver cost management & innovation at a faster rate than declining reimbursement Existing Book of Business

Revenue Growth

Revenue Growth

Expected Result Growth & Profitability

Quest & LabCorp

Defend (cost management)

Innovation (new products)

Acquisitions (new product $, scale for efficiency)

Modest, Increasing Profitability

Sonic & BioReference

Defend (cost management)

Innovation (new products)

Acquisitions (new product $, scale for efficiency)

Moderate, Increasing Profitability

Develop (support new products) High Risk

Innovation (new products)

Acquisitions (research, clinically driven)

Fastest, based on new tests

Defend and develop

Innovation and vertical penetration

Research and strategic acquisitions

Moderate to fast growth and consistent profitability

NeoGeonomics, Genomic Health & Myriad Genetics

Suppliers

IV. Conclusion •  Laboratories and all providers will face increasing reimbursement pressure §  Healthcare expenditure growth needs to be reduced

•  Laboratories can meet patient needs and generate positive returns §  Relatively inexpensive, clinically critical service, demand growth, etc…

•  Managements have experience in cost management and innovation §  A decade plus of restructurings, consolidations and new product introductions §  The ability to move with speed…

IV. Conclusion continued •  Investors can participate based on desired risk appetite §  Largest national laboratories: greater impact from cost management,

financial policy. Medium risk and low to medium return §  Specialized laboratories: greater impact from innovation, consolidation. Highest risk, highest performance potential §  Suppliers: an opportunity to participate in consumables, instrumentation, etc. which is tied to growing volume. Lowest risk and solid performance

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