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DGX to Buy UMass Medical Lab (revised)

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Leading diagnostic tester Quest Diagnostics (DGX - Analyst Report) is keeping at par with its Merger and Acquisition (M&A) strategy which the company expects to remain as its key driver of growth. Recently, as part of this strategy, the company teamed up with Central New England’s largest health care system UMass Memorial Health Care to purchase its clinical outreach laboratory.

Although financial terms of this definitive purchase agreement were not disclosed, Quest Diagnostics expects the transaction to be completed in the next 3 months, subject to certain customary regulatory clearance. The diagnostic testing stalwart expects the incorporation of the clinical outreach laboratory to add 1% to the company’s consolidated revenues in the next fiscal with no bottom-line impact. However, the company expects this transaction to be accretive to its earnings per share (EPS) in fiscal 2014.

Quest Diagnostics expects this acquisition to establish a long-term relationship between the two organizations. The plan states that Quest Diagnostics' full-service laboratory in Cambridge and its Athena Diagnostics specialty neurology testing subsidiary in Worcester will be moved to a centrally located new facility in Massachusetts.

The company expects this facility, after being fully operational in next 18–24 months, to perform the testing currently performed at UMass Memorial's Worcester-based outreach laboratories as well as Quest Diagnostics’ Cambridge and Athena.

Per the plan, UMass Memorial will be taking a financial stake in the new entity that would develop and operate a leading-edge laboratory in Massachusetts in the future. Both the organizations expect this advanced laboratory service to include a number of benefits like higher quality service, expanded information connectivity options, and reduced laboratory testing costs.

Quest Diagnostic believes that the impending acquisition is in sync with its goal to create the company’s planned 'lab of the future' which will help it increase long-term growth opportunities and increase shareholders' value.

Our View

We believe that the M&A decisions perfectly match the company’s current growth strategy. We expect capital deployment to continue into the faster-growth esoteric markets. We assume this recent endeavor could very well turn around the company’s fortune going ahead. However, more light on this matter is still awaited.

Concerns linger about the soft industry trends due to a decline in physician office visits, the ongoing margin trends and the company’s lower-than-expected fiscal 2012 guidance. However, we hold a favorable view regarding the company’s recently announced (on October 11, 2012) major organizational restructuring in order to increase operational efficiency and restore growth.

According to the company, these structural changes will eliminate 3 management layers representing 400-600 management positions by the end of 2013, thereby making an annualized savings of $65 million.

We anticipate that this organizational structure developed by the company’s new CEO, Steve Rusckowski will run successfully adding further synergies to the company’s ongoing $500 million restructuring initiative associated with its Invigorate program. We strongly expect these to improve margins in the upcoming quarters. So, it may be a good bet for investors seeking growth over the longer term.

We are impressed with Mr. Rusckowski’s leadership style along with his key areas of development including operation and execution. In this regard, we are of the opinion that Mr. Rusckowski should utilize his experience in operational excellence over a long time.

However, the current price is not a good entry point for short-term investors as the ongoing issues like weak volume growth, flat pricing, low organic revenue and challenging underlying market conditions may compel it to lose some market capitalization in the near term. Moreover, the competitive landscape remains tough with the presence of peers like Laboratory Corporation of America Holdings (LH - Analyst Report). We currently have a ‘Neutral’ recommendation on Quest Diagnostics.

(Note: We are revising this article to correct an error. The original article, published yesterday, Oct. 22, 2012, is not to be relied upon.)

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