Quest Diagnostics to Acquire Unilab for $900 Million

Quest Diagnostics Inc., the nation’s largest medical laboratory company, Tuesday agreed to buy California market leader Unilab Corp. for $900 million in cash and stock.

The deal is the latest sign of consolidation in the fragmented $35-billion medical lab test business. It will boost Quest’s share of the California market to 12% and create a company twice the size of its closest rival, Laboratory Corp. of America Holdings.

David Lewis, an analyst with Thomas Weisel Partners in San Francisco, said mergers are giving laboratory companies greater bargaining power with health insurers. And that is resulting in higher prices for medical tests.

Quest said improved pricing and reimbursement contributed to a 6.6% increase in average revenue per test in 2001.

But Lewis said it won’t be easy for Quest to raise prices in California, where managed-care companies control 48% of the state’s health insurance business. Managed-care firms account for 35% to 40% of Unilab’s test volume but only 10% to 15% of its revenue.

Unilab Chief Executive Bob Whalen said in a conference call with analysts Tuesday that the merged company will become less dependent on managed care as HMO enrollment declines. It fell below 50% in California in 2001 for the first time.

The Unilab acquisition is the third for Quest in six months. Its $500-million purchase of American Medical Laboratories, a company also coveted by Unilab, closed Monday.

Unilab’s failure to snag American Medical in the rapidly consolidating industry led to its deal with Quest, Whalen said. “We looked at going it alone and our options inside the state and outside the state ... we had an interest in AMI,” said Whalen. “When a company like that goes off the market, it limits your options.”

Medical laboratory companies offer more than 1,000 tests used to diagnose and treat disease. Routine tests include blood cholesterol-level tests, urinalysis and employment-related drug tests. The industry is benefiting from an aging population and development of sophisticated genetics tests.

Kenneth Freeman, chairman and chief executive of Teterboro, N.J.-based Quest, said the company expects to sustain 30% annual earnings-per-share growth this year and in 2003, despite the mergers. But the company said it probably will take on $1 billion in additional debt as a result of the Unilab and AMI deals.

Freeman told analysts that Quest expects to save $30 million by 2004 as a result of the Unilab deal. A portion of the savings will result from consolidating lab operations in California. Unilab and Quest each operate three full-service laboratories in the state. Quest said it had not worked out details of the consolidation, which would be led by Whalen.

Freeman said positions would be cut, but normal attrition should account for a portion of the reductions. Quest’s annual turnover in its Western operations is 10%, said spokesman Gary Samuels.

Unilab shareholders can elect to receive $26.50 in cash or the equivalent amount in stock or a combination of cash and stock. Kelso & Co., Unilab’s largest shareholder, has agreed to tender its 42% stake. The companies would not disclose if Kelso wants cash or stock.

The offer represents a 6% premium over Unilab’s closing price Monday and comes 10 months after Unilab went public at $16 a share in June.

Representatives of Unilab and Quest declined to comment Tuesday on any discussions they had before Unilab’s public offering. Whalen defended the modest premium offered by Quest as good for shareholders.

Whalen’s role with Quest beyond managing the consolidation was unclear Tuesday. Samuels said Whalen does not have a new title and will not be joining the Quest board.

Unilab is based in Tarzana and employs 4,000 people, mostly in California. It had a loss of $2.9 million, including one-time charges, on revenue of $390 million last year.

Quest had income of $162.3 million on revenue of $3.63 billion. Its shares fell $3.35 to $79.44 on the New York Stock Exchange.

Unilab shares rose $1.13 to $26.13 on Nasdaq. Its shares have surged in recent weeks from as low as $18.14 in March.

Samuels said Quest knew of no reason for the run-up. A spokesman for Unilab couldn’t be reached for comment.