[IDXX – IDEXX Labs] Priced to Win

People love their pets.  That’s obvious not merely in our impulse to anthropomorphize them but to increasingly care for them the same way we do human members of our families.  American pet owners used to really only took their pets to clinics to treat obvious physical symptoms, but they’ve increasingly been hitting up the vet for regular preventative check-ups and non-symptomatic diagnostic testing.  The amount that Americans spend on veterinary services has compounded 60% faster than Personal Consumption Expenditure over the last 40 years and the oft-made claim that millennials are even more willing to spend on their pets than generations before certainly jives with my own experience. The global market for companion animal testing and software and Idexx’s share therein looks something like this:

Of the 200mn pet clinic visits in the US each year, only 41% include a diagnostic test of any kind (fecal, heartworm, allergies, infectious disease, hematology, chemistry, etc., either in-clinic or at a reference lab) and less than 14% include a chemistry panel (blood work), compared to nearly 1 out of 3 visits at Idexx’s top decile customers, suggesting significant penetration opportunity just within the company’s existing US clinic base. In developed international countries, spending on pet diagnostics comes to around $4/pet, or between 3% and 12% of average clinic revenue, compared to $14/pet in the US…so, simplistically, if the standard of vet care overseas matched that of the US, the international market would be nearly 4x the size of the US rather than 1/2.  Europeans actually spend more money each month on their dogs than Americans but when it comes to vet care, most of the world is about 15 years behind the US, with diagnostic testing mostly reserved for pets showing explicit symptoms of illness (rather than for preventative care).

While cultural differences often render cross-country penetration comparisons moot, Idexx’s international pet diagnostic spending has been converging to US levels for years.  Organic growth in recurring companion animal revenue internationally has outpaced the US in each of the last 6-7 years with each of Latin America, Asia Pacific, and Europe each posting stronger revenue CAGRs than the US (on a constant currency basis) since 2012, suggesting that perhaps the vet spending gap is indeed a surmountable issue pertaining to education rather than an intractable one tied to culture. Idexx is the undisputed king of companion animal diagnostics, spending 5x more R&D and generating 2x the revenue as its 3 largest peers (Antech, Heska, and Abaxis) combined. 

Abaxis, a point-of-care diagnostic equipment and consumables rival, generates less than a quarter of Idexx’s CAG non-reference lab revenue; Heska, even less. Idexx offers diagnostic testing through 3 “modalities”:

1/ Rapid assay (12% of LTM revenue): these are single-use hand-held test sticks marketed under the “SNAP” brand that can test for heartworm, cat HIV, and pancreatitis, among other infectious diseases.  Here’s what a typical one looks like…

…so, kind of like an at-home pregnancy test.  While management refers to this as a recurring consumable, historically there have been no meaningful switching costs to this product, which has been subject to price competition and significant market share shifts, and were the least differentiated solutions that Idexx had on offer.  But then a few years ago, and this will make more sense as you read on, the company launched its SNAP Pro “analyzer”, a device (pictured below) that activates the SNAP stick and captures, processes, displays, and uploads the results under the patient’s profile in the Idexx’s VetLab Station.

Pairing the rapid assay stick (see it there in that cavity?) with this hardware analyzer basically delivers the same kind of productivity benefits – smoother workflow, less setup time – as the in-clinic analyzer and turns a pure, commodified disposable into more of a razor to the razor blade.  SNAP Pro itself doesn’t introduce new capability to the assays and frankly, doesn’t really seem all that technologically novel.  But integrating these consumables makes them much easier to sell as part of a bundled in-clinic solution, which when paired with Idexx’s vigorous direct sales effort over the last few years, has reversed the rapid assay revenue declines experienced in 2015.

2/ Reference labs (33%): clinics send patient blood, urine, and fecal samples to one of Idexx’s 70 reference labs through courier or overnight delivery for analysis and for most tests, receive results the same or next day.  Reference labs can run any test that can be done in-clinic, and then some.  This is a scale business with high fixed costs, 97% retention rates, and ~60% contribution margins, so it perhaps comes as no surprise that the industry operates as a mostly cozy duopoly between Idexx and Antech, a reference lab owned by VCA that generates ~70% the revenue of Idexx’s reference lab business.  With its recent acquisition of VCA, Mars (yes, the candy company) now owns close to 2,000 vet clinics, ~7% of the 26k in America, prompting some concern that this vertically integrated hospital chain will divert all lab work to Antech and that pet hospital consolidation, more generally, will lead to upstream price pressure for labs. But pet clinic consolidation has been ongoing for decades and Idexx’s lab business has taken price every year since at least 2005.  The difference in the degree of consolidation at these two parts of the value chain – hospitals and labs – is still glaringly stark.  Idexx and Antech control 80% of the reference lab business [Abaxis sold its reference lab business to VCA in 2015 for $21mn].  Corporate entities, on the other hand, collectively control somewhere between 15%-20% of US pet hospitals and Mars, the single largest owner claims just 7%.