1、Equity Research 17 May 2019 CORE Barclays Capital Inc.and/or one of its affiliates does and seeks to do business with companies covered in its research reports.As a result,investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.Investo
2、rs should consider this report as only a single factor in making their investment decision.PLEASE SEE ANALYST CERTIFICATION(S)AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 25.Restricted-Internal U.S.Life Science Tools&Diagnostics Lab Industry Update:Consolidation Catalysts Starting to Come Together As
3、 we digest 1Q19 earnings,we believe there were interesting signals from the lab industry which highlight the potential opportunity for industry consolidation for the national labs LabCorp and Quest(both OW).Lab industry consolidation has been a thesis for a long time given industry fragmentation and
4、 scale advantages inherent in the strategy.Coupled with PAMA reimbursement pressure,our view has been that broader access to national payors in 2019 helps remove a historical barrier to consolidation.We believe net share gains with national payors are back in focus as the national labs appear to be
5、leveraging their scale advantages amidst industry pressure.Notably,we believe that 1Q19 results already support the view that LabCorp and Quest should be able to collectively gain share against the rest of the industry following the opening of national payor networks in January.In 1Q19,Quest sized t
6、he net tailwind of payor shifts at around 1.5%revenue growth,or around$27mm.Quest noted that it initially gained share with UnitedHealth in January,which continued to build throughout the quarter.LabCorp sized the net headwind with managed care payor shifts as a 0.7%headwind to lab revenues or aroun
7、d$12mm.LabCorp noted that it initially lost share with UnitedHealth which then stabilized,while Aetna volumes built throughout the quarter.This implies that the national labs have collectively gained$15mm of share to start 2019.We estimate this represents 20bp of the“outside the hospital”lab opportu
8、nity on an annualized basis.In addition to the quantifiable share gains,we believe anecdotal commentary around building share with payors where each lab was previously out-of-network shows that there are incremental share gains coming from regional and hospital labs(its not just LabCorp vs Quest).Ou
9、tside of the national labs,the public regional labs have faced pressure to operations from PAMA and related commercial pricing reductions.At Bio-Reference Labs(part of Opko Health,not covered),revenues have declined steadily for the last three years.Increased losses over the past two quarters have b
10、een attributed to PAMA reimbursement pressure as well as commercial payor denials.At Enzo(ENZ,not covered),the clinical labs profitability has turned negative each of the last two quarters.We believe the relatively weaker regional lab results highlight the scale advantages inherent in the national l
11、ab business model which can be leveraged over time.Looking forward,we believe the implementation of UnitedHealths preferred lab network(PLN)represents an additional strategic positive for LabCorp and Quest.The national labs have commented there will be economic incentives for physicians and patients
12、 to choose preferred labs,which we view as a potential 2020 event.Dear Client:We appreciate your consideration in the Institutional Investor All-America&All-Canada Research Team 2019 Survey.To view our analysts,please click here.INDUSTRY UPDATE U.S.Life Science Tools&Diagnostics NEUTRAL Unchanged U.
13、S.Life Science Tools&Diagnostics Jack Meehan,CFA+1 212 526 3909 BCI,US Mitchell Petersen,CFA+1 212 526 3367 BCI,US Andrew Wald+1 212 526 9436 BCI,US Barclays|U.S.Life Science Tools&Diagnostics 17 May 2019 2 TABLE OF CONTENTS A Confluence of Factors Is Promoting Structural Shifts in the Lab Industry.
14、3 Laboratory Market Presents a Large Consolidation Opportunity.4 Background on the National Lab&Payor Relationships.6 2007 Case Study Shows How Regional Labs“Arbitraged”the Exclusive Lab Contracts.7 Turning to 2019,Early Signs Show a Normally Functioning Duopoly Has Gained Share.14 Conversely,Region
15、al Lab Results Have Been Mixed.17 Looking Forward,Preferred Lab Networks Represent Additional Share Gain Potential.20 Valuation:Room for Expansion If Consolidation Continues.22 Barclays|U.S.Life Science Tools&Diagnostics 17 May 2019 3 A Confluence of Factors Is Promoting Structural Shifts in the Lab
16、 Industry While this report focuses on payor network changes as a mechanism for share shifts,we believe there are several other dynamics that should promote share gains for the national labs.In our view,reimbursement pressure(Medicare,Medicaid,and commercial)will have an outsized impact on smaller i
17、ndependent laboratories with cost curve disadvantages to the national labs.Additionally,mechanisms designed to lower healthcare costs should favor the low-cost operators.We outline these other drivers below:PAMA Medicare Pricing Pressure:Through the Protecting Access to Medicare Act(PAMA),CMS is set
18、ting Medicare reimbursement to parity with commercial rates.The majority of routine laboratory codes are being cut significantly through this process,and the clinical lab fee schedule(CLFS)in aggregate is expected to be cut 30%from 2018-2020.We believe laboratory industry participants outside of the
19、 national labs are going to realize severe financial impacts from this reimbursement pressure.While LabCorp and Quest started this process with 12%Medicare laboratory exposure in 2018,hospital outreach and smaller independent laboratories have greater exposure,in the range of 30-50%(which can be con
20、firmed through our survey work).For more thoughts on PAMA,please see from 1/4/2018,“2018 Outlook:Stock Selection Critical as Operations and Sentiment Align”.Commercial Pricing Pressure:Based on feedback from lab directors and comments from public laboratory competitors(ENZ and OPK),we believe that c
21、ommercial payors are using PAMA(discussed above)as a mechanism to extract additional pricing reductions.We believe LabCorp and Quest are largely immune to this risk because theyve focused on de-linking their commercial contracts from Medicare pricing(in fact,LabCorp got a modest pricing increase in
22、its most recent renewal with UnitedHealth).Conversely,lab directors at regional labs have told us the negotiating process is much more challenging with labs sometime given a 24-hour window to accept an offer presented by the insurers.Preferred Laboratory Networks:While we discuss UNHs preferred lab
23、network(PLN)below,we believe its possible this model could be adopted by other commercial payors.By implementing a preferred network,payors can use physician and patient incentives to help drive volumes towards the lower cost providers(LabCorp and Quest).As background,hospital outreach laboratories(
24、$18bn of the market,see section below)have historically negotiated premium rates from commercial payors.We believe PLNs,along with pricing transparency and HDHPs(discussed below),will help drive volumes towards the low-cost providers.Pricing Transparency and High-Deductible Health Plan(HDHP)Utilizat
25、ion:Despite being a high-cost provider,hospital outreach laboratories have a significant portion of the laboratory market.If a patients physician is associated with a hospital network,the physician will often send their sample to the associated hospital laboratory.The consequence for patients is tha
26、t they face higher out-of-pocket costs if they use these laboratories.As pricing transparency improves,we expect patients to increasingly demand lower-cost options,resulting in lower out-of-pocket costs.As utilization of HDHPs increase,patients are responsible for a greater portion of their healthca
27、re costs,so the incentives to find the low-cost provider increase.Barclays|U.S.Life Science Tools&Diagnostics 17 May 2019 4 Laboratory Market Presents a Large Consolidation Opportunity Out of the$82 billion U.S.clinical laboratory market,we believe that$52 billion represents the primary addressable
28、opportunity for the national labs.Despite the dynamics listed above,the national labs only maintain a roughly 27%market share in the$52 billion laboratory testing market that lies outside of inpatient and outpatient hospital testing.In this portion of the market,LabCorp and Quest compete against sma
29、ller independent labs(27%),physician office labs(10%),and hospital outreach laboratories(36%).This suggests that there is a long tail of consolidation opportunities that we expect to play out over time.Share gains are attractive financially,with estimated incremental margins of roughly 50%.FIGURE 1
30、U.S.Diagnostic Testing Market($82 Billion,2018)FIGURE 2 U.S.Diagnostic Testing Market“Outside the Walls of the Hospital”($52 Billion,2018)Source:Company Documents,Barclays Research Source:Company Documents,Barclays Research Inpatient/Outpatient36%Hospital Outreach23%Independent Labs35%POLs and Other
31、6%Hospital Outreach36%Quest14%LabCorp13%Other independent labs27%POLs and Other10%Barclays|U.S.Life Science Tools&Diagnostics 17 May 2019 5 FIGURE 3 Summary of Laboratory Consolidation Thesis Source:Company Documents,Barclays Research Laboratory Market OverviewIndependent LaboratoriesLabCorp/QuestOt
32、her LaboratoriesMarket Size,2018($Bn)$30 billion,36%of market$19 billion,23%of market$14 billion,17%of market$14 billion,17%of market$5 billion,6%of marketDescriptionLaboratories located inside the walls of a hospital used to meet the needs of inpatient and outpatient admissions.With certain indicat
33、ions(i.e.infectious disease,hospital acquired infections),time-to-result is an important consideration,so having a lab on-site is critical.This portion of the market can be physically located in the same laboratory as the one serving inpatient and outpatient hospital operations.The difference is tha
34、t capacity is used to perform testing for volumes that come through physicians in the community.Relative to independent labs,these labs have negotiated premium rates with commercial payors.Leaders in the independent laboratory industry,with unmatched scale(roughly 10 x the size of the next largest p
35、eer)and breadth of menu.Commercial laboratories similar to LH and DGX that serve physician practices or hospitals in the form of reference testing.Relative to hospital outreach laboratories,these labs have thinner margins given lower levels of commercial reimbursement.Laboratories on-site at physici
36、an practices that are used to meet testing needs of the practices patient population.Test menus are generally limited(relative to reference or hospital labs)and tailored towards the specialty of the physician.ThesisWe dont view this as a primary addressable market for LH and DGX.Given that a signifi
37、cant portion of this testing is needed on-site to support the hospital,it would be difficult for the national labs to gain meaningful exposure.Hospital outreach laboratories are going to face a significant amount of operational pressure,which we believe will allow the national labs to take market sh
38、are in this segment.PAMA is going to negatively impact Medicare reimbursement(30-50%of revenue).On the commercial side,payors are getting more aggressive in rate negotiations.With an increased focus on cost(through pricing transparency,consumerism,or other mechanisms such as preferred lab networks),
39、there will be incentives to choose lower cost providers.LabCorp and Quest will have the opportunity to consolidate the laboratory industry that lies outside of the walls of the hospital.The national labs have major cost curve advantages relative to the rest of the industry.As discussed in this note,
40、strong payor relationships should promote share gains over time.Reimbursement pressure is going to lead to financial distress,which is going to facilitate organic or inorganic consolidation.PAMA is significantly reducing Medicare reimbursement and commercial payors are using this as a mechanism to e
41、xtract pricing benefits.With increasing reimbursement pressure,we believe time-sensitive testing will be decentralized,while less time-sensitive tests will be outsourced.With improvements in point-of-care technology,POLs are better able to serve patients quickly for necessary indications(i.e.respira
42、tory disease).OpportunityThe national labs have gained modest exposure to this segment through laboratory service partnerships and reference testing contracts.Laboratory service partnerships are where the national labs help to manage a hospital laboratory.Reference testing is used when a hospital ou
43、tsources a test it doesnt have the capabilities or capacity to run.The national labs should have the opportunity to organically and inorganically consolidate this portion of the market.While the headline market size is$19 billion,the opportunity is smaller when rates are applied to LH/DGXs fee sched
44、ule.Assuming rates at hospital labs are 2x higher than those at the national labs,the addressable opportunity is closer to$10 billion.LabCorp and Quest have an opportunity to gain share of a roughly$52 billion laboratory industry that lies outside the walls of a hospital.Collectively,the national la
45、bs have 27%share of this market.Reimbursement on incremental volumes would be reduced modestly(from the move to LH/DGX fee schedules),but we believe the addressable opportunity is still above$10 billion.Under the centralization/decentralization thesis,we believe the impact to LabCorp and Quest would
46、 be net positive given that outsourced volumes would likely go to one of the national labs.Type of LaboratoryHospital Inpatient/Outpatient TestingHospital Outreach LaboratoriesPhysician Office Laboratories(POL)Barclays|U.S.Life Science Tools&Diagnostics 17 May 2019 6 Background on the National Lab&P
47、ayor Relationships In October 2006,LabCorp announced that it would become the sole national provider of laboratory services for UnitedHealth,effective on January 1,2007.The contract term was for 10 years,but was extended by two years in 2011,causing it to end in 2018.While Quest was removed from in-
48、network status as of this date,many other laboratories gained or maintained in-network status with UnitedHealth.In March 2007,Aetna announced that Quest would become its exclusive national laboratory provider,effective July 1,2007.Similarly,LabCorp was removed from in-network status,while several ot
49、her providers remained.Over the course of the last ten years,these have been the only exclusive national laboratory contracts awarded.More recently,on May 24,2018,UnitedHealth announced long-term strategic partnerships with LabCorp and Quest,effective January 1,2019.The next day,Aetna announced that
50、 LabCorp would return to in-network status.Taken together,these announcements set up the return of the laboratory industry to a normally functioning duopoly starting in 2019.It is important to recognize that the market did not like the national exclusive contracts.Looking back at historical stock pe
