Australian Clinical Labs to re-assess growth strategy after ACCC denies Healius merger proposal

About Australian Clinical Labs Limited

Australian Clinical Labs Limited (the Group, ASX: ACL) is a leading Australian private provider of pathology services. The Group was formed as a spin-off of Healthscope’s Australian pathology business in 2015 and listed on the ASX in May 2021.

ACCC rejection of ACL takeover offer

In March 2023 ACL launched an unsolicited and highly conditional ‘all scrip’, off-market, reverse takeover offer of ASX-listed Healius Limited (Healius, ASX: HLS). Healius provides diagnostic imaging, IVF centres, day hospitals and pathology services. An ‘all scrip’ reverse takeover occurs when a smaller company seeks to takeover a larger company by offering shares in the newly created merged entity as purchase consideration to shareholders of the larger company. The merger rationale of a reverse takeover is that the two companies have the potential to be worth significantly more together than as separate, standalone entities. The Healius board considered the offer to be inadequate and opportunistic and rejected the takeover offer on the grounds it would unfairly transfer value from Healius shareholders.

The takeover offer was conditional upon Australian Competition & Consumer Commission (ACCC) approval. In December 2023 the ACCC announced its decision to oppose the proposed merger on the grounds that it would substantially lessen the competition in Australian pathology services markets. The ACCC believes that a merger would allow ACL and Healius to reduce services and raise prices. Accordingly, ACL formally withdrew its takeover offer for Healius on 22 December 2023.

Implications for ACL

ACL is the third largest owner of Approved Collection Centres (ACC) where pathology specimens are taken from patients and delivered to laboratories by courier. The two larger players are Healius and  Sonic Healthcare. Similarly, in terms of market capitalisation, ACL at $0.6 billion, ranks third behind Sonic ($15 B) and Healius ($1 B). This market position explains why ACL’s growth strategy in 2023 was to acquire Healius because it is at risk of falling into the deadly middle ground, where a business is neither big, nor niche. Big players succeed through scale and operational efficiency while niche players can differentiate themselves and provide a personal, localised and specialist service offering. Those in between are attacked from above and below, making meaningful and ongoing profitable headway more difficult.

ACL must seek to avoid this middle ground by considering smaller ‘bolt-on’ acquisitions or ‘tuck-ins’ that provide for incremental revenue and profit growth, rather than a ‘quantum leap’ growth strategy. ACL successfully acquired Medlab Pathology for $70m in 2021 that doubled its market share in NSW to 20.4 percent and to 6.5 percent market share in Queensland. Acquiring smaller pathology practices and leveraging existing technology and ACL’s fixed cost base should generate higher incremental earnings.

What’s next for ACL?

In its FY2023 results presentation in August 2023, ACL referred to new Approved Collection Centre openings and acquisitions in specialist and general pathology, especially in NSW growth corridors and targeted revenue growth in Queensland.

ACL has a conservatively geared balance sheet (implying no planned capital raisings anytime soon) and an impressive profit-to-cash conversion ratio of 80 percent, which supports ongoing shareholder dividends. Its ongoing digitisation program is supporting more efficient back office and superior patient outcomes, especially its Integrated Laboratory Information System, making ACL the only national provider with one LIS across the country.

ACL shareholders can look forward to consistent earnings and revenue growth as it provides specialty medical services to an ageing population in an industry that is tightly regulated and where the barriers to entry are high.