Further Consolidation in Anatomic Pathology
Executive Summary
Dianon System's purchase in June of UroCor was hardly surprising, coming after three years of discussions between the two companies. The purchase of UroCor, a disease management company, will fortify Dianon's already strong franchise in urology clinical diagnostics testing. The deal, a stock-for-stock transaction valued at about $180 million, merges two complementary businesses, offering opportunities for synergies and leveraging of operations.
Dianon Systems Inc. 's purchase in June of UroCor Inc. [See Deal] was hardly a surprise, coming after three years of on-again-off-again discussions between the two. Dianon, a highly successful anatomic pathology laboratory, can make its already strong franchise in urology even stronger with the addition of UroCor, a disease management company focusing on complex urological disorders that got its start providing diagnostic services.
The deal, a stock-for-stock agreement valued at about $180 million at the time the companies announced the transaction, merges two highly complementary businesses, offering opportunities for synergies and leveraging of operations, says Kevin Johnson, Dianon's CEO and president. Both firms focus on outpatient anatomic pathology, which involves getting samples from specialists and manually examining tissues and cells in them to diagnose or characterize diseases.
Both Dianon and UroCor, founded in the 1980s, adopted strategies aimed at meeting the demands of managed care organizations. Dianon, which got its start in urology testing, quickly branched out into a broad range of anatomic pathology services focusing on genetics and oncology, on the assumption that an expansive portfolio would be more appealing to managed care organizations. It has done well, with long-term earnings growth of more than 30% and top-line growth of more than 20%; in the first quarter of 2001, for example, net income grew 63%, from $1.3 million to $2.1 million, while revenues increased 21%, from $22.1 million to $26.8 million, based on same-store sales. In a slowly consolidating industry, it has been one of the key acquirers, careful about costs and operating discipline and maintaining high-quality service. (See "Consolidation in Diagnostics: AmeriPath vs. Dianon,"IN VIVO, March 1998 [A#1998800070.)
UroCor, on the other hand, became vertically integrated, building a sales force with the intention of selling a range of tests, therapeutics, and database-driven outcomes to urologists. While the bulk of its revenues comes from testing services, it has teamed up with several pharmaceutical companies to sell their drugs to US urologists: Zeneca Pharmaceuticals [See Deal], a division of AstraZeneca PLC ; Shire BioChem Inc. , a division of Shire Pharmaceuticals Group PLC ; and most recently Bioniche Life Sciences Inc. , a Canadian company that is using UroCor to distribute sodium hyaluronate (Cystistat), a treatment for interstitial cystitis, in the US [See Deal]. Some of these deals, including those with Shire BioChem and Zeneca, terminated early—for example, Shire BioChem didn't have enough supply of Pacis BCG, a bladder cancer drug, to give to UroCor.
But at the time, the concept made sense. UroCor grew sales to $47.6 million in 1998, partly as a result of various alliances. With hindsight, however, disease management focused on one disease state was problematic. UroCor revenues for 1999 slid to $45 million, and it had sizable losses from special charges related to restructurings. The company recovered somewhat in 2000; it had a loss of $4.9 million, but its revenues were up 16%, to $52.6 million. UroCor would have been profitable if not for a charge stemming from the $9.8 million settlement of a US government case charging it with Medicare billing fraud settlement.
By diverging from its core diagnostic competencies, UroCor got a bit lost, says Johnson: it was too small to make an impact in pharmaceuticals and, ultimately, its strategy presented a challenge for winning managed care contracts. Dianon hasn't decided what it will do with UroCor's therapeutics portfolio or deals, Johnson adds.
The acquisition will give Dianon combined revenues of $80-90 million in urology, a $600 million market from which it currently derives more than 30% of its revenues, Johnson estimates. Both companies do the basic urology tests, including prostate biopsies, urine cytology, and kidney stone analysis, with different nuances. UroCor, for example, has a predictive algorithm for prostate cancer, UroScore, which Dianon plans to add to its menu.
Moreover, the sales forces can be integrated, expanding Dianon's presence in the urology office and giving it access to the more than 5,000 urologists currently served by UroCor; two-thirds of urologists will use the combined company's services, although not all will use all of the services, says Johnson. The combination will also have a stronger technological and scientific expertise and will give Dianon a strong competitive advantage in contracting with managed care organizations—Dianon now has access to UroCor's contracts and vica versa, for example.
Dianon has a strong presence in the Northeast and Southeast, while UroCor is a factor in the mid-West. At present, Dianon plans to maintain UroCor's centralized laboratory in Oklahoma City—where UroCor is headquartered and conducts the bulk of its testing—and can now incorporate information from UroCor into its cancer databases, which are among the largest cancer diagnostics databases in the US. At the same time, Dianon can achieve cost savings by eliminating redundancies in management.
Changes at UroCor, including a new senior management team and resolution of the federal billing fraud charges, enabled the deal to go forward at this time, says Johnson. Michael George, UroCor's CEO, who will leave after the deal closes, adds that merging the companies made more sense than continuing to compete.