Labcorp To Spin Off Clinical Development Business

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Deal Overview

On July 28, 2022, Labcorp (NYSE: LH, $257.94; Market Capitalization: $23.3 billion), a leading global life sciences company, announced that its Board of Directors authorized a plan to spin-off Clinical Development business into an independent, publicly traded company.

Post spin, Labcorp (Stub entity) will retain its laboratory business comprising of routine and esoteric labs, central labs, and early development research labs. The Clinical Development business (NewCo.) will operate as Contract Research Organization (CRO
CRO
) providing Phase I-IV clinical trial management, market access, and technology solutions to pharmaceutical and biotechnology companies.

LH expects to effect the transaction through a distribution of a dividend of the Clinical Development business’ shares to LH’s shareholders. The transaction is intended to be structured as tax-free for US federal income tax purposes. Post spin-off, LH will continue to be publicly listed on the New York Stock Exchange, whereas NewCo. will also be a newly listed public entity. The transaction is expected to be completed by the second half of 2023.

Post spin-off, Adam Schechter will continue his position as Chairman and Chief Executive Officer of LH, while the company name and leadership team of NewCo. will be announced later. LH will continue to be headquartered in Burlington, North Carolina.

Jones Day and Hogan Lovells are serving as legal advisors, while Barclays, Evercore
EVR
, and Goldman Sachs & Co. LLC are acting as financial advisors for the transaction.

In 2021, LH initiated a strategic review of its business after activist investment firm Jana Partners pressurized company’s management to conduct strategic review of its policy because it considered the company to be undervalued. The company ended the review in December 2021 but did not come out with the outcome of the reorganization of the business. However, the company’s board approved distribution of dividend to its shareholders and authorized a $2.5 billion buyback program.

Deal Rationale

Labcorp’s laboratory business has a different capital structure requirement, and equipment needs, when compared with the clinical development business, which is mainly people centric. Both the segments also cater to different markets. In FY21, the diagnostic business contributed ~64% of revenue, mainly catering to the North American market, whereas the clinical development division contributed ~36% to the revenues, which was equally split between the US and the rest of the world. Post spin off, both the companies will continue to explore new markets independently with tailored made capital structures with a focus on targeting growth and enhancing shareholder value. Additionally, the clinical development business will have a big advantage as the new clinical development entity will retain access to Labcorp’s vast health and clinical data insights, which they would look to monetize by providing support to their customers operating in the pharmaceutical and biotechnology business.

Post separation, the Labcorp stub entity will continue to focus on core diagnostics services and will strive to expand its routine and esoteric labs, central labs and early development research laboratories network outside the US. Notably, the diagnostic business is poised for a mid-single or higher digit revenue growth in the coming years, as the division’s global addressable market is poised to grow at a CAGR of ~10% from +$150 billion in 2022 to ~$250 billion by 2026E. On the other hand, the clinical development sector also offers a compelling growth opportunity as addressable market in the US ($25 billion) is poised to grow at a CAGR of ~6% from 2022-2030E. Accordingly, the segment is expected to deliver high single-digit revenue growth going forward. The clinical development business is lucrative in terms of margin and grows very quickly. During the pandemic, it was disrupted, however, it has seen a resurgence in demand as drug makers and governments started investing in newer treatments. Moreover, recently companies in the sector have witnessed several multi-billion dollar M&A deals, signifying the huge potential for business growth in the future.

Management considers that the separation shall bring differentiated and compelling investment opportunities based on each company’s particular business model. It anticipates that post separation the two companies will be better positioned to be more appropriately valued by the investor community based on the appropriate set of peers.

Overall Results

2Q22 Results

Revenue for the quarter fell 3.7% YOY to $3.7 billion (-1.6% vs. consensus), largely attributed to decline in organic revenue (-3.4%) and foreign currency translation (-1.1%), that partially offset by gain on acquisitions net of divestitures (+0.8%). The organic revenue was impacted by decrease in COVID-19 PCR and antibody testing (COVID-19 Testing). Further, segment wise adjusted sales fell 4.7% and 2.9% in Diagnostics and Drug Development, respectively.

Gross profit decreased 11.2% YOY to $1.1 billion, while the corresponding margin contracted ~256 bps to 30.4%, ~78 bps ahead of its consensus. Adjusted operating income decreased 21.9% YOY to $656.1 million beating its consensus by 8.0%, while the corresponding margin eroded ~406 bps to 17.7%. GAA
GAA
P Earnings before income taxes declined 26.8% YOY to $476.4 million (-21.6% vs. consensus), while the corresponding margin shrunk by ~406 bps to 12.9%. Adjusted net income declined by 23.7% YOY to $459.4 million (+5.8% vs. consensus), while the corresponding margin came at 12.4% (2Q21: 15.6%). Adjusted EPS came in at $4.96 (2Q21: $6.13) also comfortably beats consensus of $4.70.

Outlook

For FY22E, management has lowered its outlook and expects revenues to decrease between 2.0% to 6.0%. Segment wise Diagnostics revenue is expected to decline in range of 9.0% to 13.0%, while Drug Development revenue is expected to grow between 1.5% to 3.5%. Adjusted EPS guidance has been raised to $19.00 to $21.25, where as Free Cash Flow
FLOW2
guidance kept unchanged at $1.7 billion to $1.9 billion.

Company Description

Labcorp (Parent)

Labcorp is a global life science company, based in the US. The company was formed by merger between National Health Laboratories (NHL) and Roche Biomedical Laboratories (RBL). Its business is divided into two segments: Labcorp Diagnostics (Dx) and Labcorp Drug Development (DD) that offers diagnostic, drug development, and technology-enabled solutions for patients. Currently it has operations in more than 100 countries and employs over 75,500 employees.

NewCo. (Spin-Off)

NewCo. will be a global Clinical Research Organization (CRO) offering wide range of services including full-service delivery of Phase I-IV clinical trial management, market access and technology solutions to pharmaceutical and biotechnology organizations.

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