Quest Diagnostics Opens Its Wallet One More Time

By Stephen D. Simpson, CFA | March 22, 2011 AAA

Quest Diagnostics (NYSE:DGX) is certainly not shy about spending shareholders' money to expand its business opportunities. Quest's latest deal, announced Friday morning, will have the company paying $8 per share in cash to acquire all of Celera (NYSE:CRA), a small company with a focus on molecular diagnostics and cardiovascular tests.

The Terms of the Deal
Quest Diagnostics will be paying $8 per share for Celera, a deal that has a sticker price of $671 million but a net cost of $344 million. Moreover, given the tax credits, loss carry-forwards, and capitalized R&D at Celera, the effective price of the deal will be even lower. Nevertheless, the deal represents a nearly 28% premium for Celera, nearly five times trailing sales, and a little more than four-and-a-half times forward sales.

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At these prices, Quest is paying a premium similar to what Clarient received from General Electric (NYSE:GE) and superior to the deal Genoptix struck with Novartis (NYSE: NVS). Still, it might be a sobering reminder to MDx fans that the days of companies paying 10 times sales for molecular or esoteric test technology is long past.

What Quest Diagnostics Is Getting
As a national testing giant competing with Lab Corp (NYSE:LH), Quest is very much interested in getting as many proprietary tests under its roof as possible. To that end, Quest has operating leverage and scale that may allow it to do more with Celera's assets than Celera ever could.

Somewhat like Human Genome Sciences (Nasdaq:HGSI), Celera started out as a company looking to exploit the opportunity (and investor enthusiasm) in sequencing, genomics and proteomics around the turn of the century. Like so many other companies, though, Celera found that it couldn't quite make a go of it with its original business plan.

While some of these companies turned to their own technology to develop drugs, Celera turned toward testing (and split from Applied Biosystems, which merged with Invitrogen to become Life Technologies (Nasdaq:LIFE)). Even then, it was the acquisition of Berkeley HeartLab which really transformed the company and gave it a platform of cardiovascular tests that comprise most of its current value. Now the company offers a platform of testing services that includes advanced LDL/HDL testing, as well as tests for gene variants than can predict increased risk of heart disease, heart attack, aneurysm and so on.

Is This a Fair Deal?
I suspect that long-time Celera bulls will be disappointed with this deal. Cardiovascular molecular diagnostics is really just getting started and there are some big hopes for tests like Celera's KIF6 test. If everything had worked out according to plan, Celera could have been a mid-teens stock in five or six years.

On the other hand, not a lot has gone to plan for Celera. The company has worked with Abbott Labs (NYSE:ABT), a major diagnostics player, for years and the partnership has not brought great success to either company. On top of that, there is some doubt in the medical community about whether Celera's tests (including the KIF6) are all that useful. Add all of that to near-term challenges from the economy (fewer doctor visits and lower test volumes) and Celera was a company with some meaningful challenges.

The Bottom Line
Quest is clearly willing to play for the future. After buying AmeriPath, the company was willing to shell out nearly seven times sales ($740 million) to Thermo Fisher (NYSE:TMO) for the Athena Diagnostics unit. That is expensive, but if Athena's focus on neurological diagnostics can lead to good tests for Parkinson's, Alzheimers, and so on, it will be well worth it. That same logic applies to this Celera deal - cardiovascular molecular diagnostics is not a game-changing opportunity for Quest today, but it could be in the future and that is a gamble the company is willing to take.

While Celera shareholders may hope for a better bid, one is not likely to come. In the meantime, Quest shareholders may well wonder how much more buying Quest wants to do - cancer diagnostics would be a natural target, but how much debt does the company really want to take on in its search for the next great test? (For related reading, see Glaxo And Human Genome Find Rare FDA Success.)

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