Theranos Is Toast, It's Time To Look At The Duopoly Of Diagnostic Testing

| About: Quest Diagnostics (DGX)

Summary

Large and growing market. Aging of America and more personalized medicine requires more tests.

Established networks of labs across the country.

Barriers to entry.

Theranos, a unicorn that's run afoul of the government, has demonstrated how difficult the business of lab testing is to get right. The new less expensive testing methodology that Theranos was pioneering may or may not work. Convincing regulators that it does work and that the tests are being done correctly is a difficult task. With that background, it's difficult to imagine a new lab starting to challenge the existing duopoly.

Current Marketplace

The market for lab testing is currently dominated by hospitals and doctors' offices. These are generally less efficient than the two dominant independent labs. As insurance providers and other reimbursement agents continue to look for areas to cut cost without compromising quality diagnostic testing is one area where there's a readymade solution.

The independent lab testing marketplace is dominated by two large testing companies Quest Diagnostics (NYSE:DGX) and LabCorp (NYSE:LH). Tests can cost up to 3 times more in the hospital. Both companies continue to roll up competitors to add to their scale. Each company has boosted its presence in esoteric tests which tend to require more specialized staff.

Scale is a big advantage for each of these companies. Quest Diagnostics annually services 1 in 3 adult Americans and 1/2 of physicians and doctors. While LabCorp processes 470,000 specimens a day.

LabCorp's recent acquisition of Covance (closed in February, 2015) has expanded the scope of LabCorp's testing to include clinical trials for drug manufacturers. This includes services from safety tests to the clinical trials. LabCorp has leveraged its data base of patients to help drug companies find the right patients to add to clinical trials. This is especially useful for the testing of rare and orphan treatments.

Quest has acquired Ameripath, Athena and Celera which has boosted its footprint in esoteric testing (although it still lags LabCorp).

Quest and LabCorp are well positioned to benefit from the long-term tailwinds of an aging population and the push towards more personalized medicine. Each will require more testing. As reimbursement levels are lowered, hospitals and doctors will look to outsource the testing. Quest and LabCorp should be able to control cost through advantages of scale to stay ahead of the reimbursement decline.

Trade

I think either company will perform well going forward. LH is currently trading at a slightly cheaper forward PE (12.9) vs. DGX (13.9). DGX has a dividend yield of a bit over 2% and LH doesn't pay a dividend. I think both companies offer an attractive entry point at current price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.