|Greg Henderson, Senior Financial Analyst, VMG Health|
Nationwide, imaging operators are beginning to feel the impact of reimbursement cuts from the 2014 Medicare Physician Fee Schedule (“MPFS”) primarily associated with Computed Tomography (“CT”) and Magnetic Resonance Imaging (“MRI”) modalities. The reimbursement changes reduce the technical component of imaging reimbursement in 2014 for MRI and CT from approximately 25 percent to 30 percent and 8 percent to 11 percent, respectively, depending on the types of scans performed.
For Single Site Operators (“SSO”) and Multi-Platform Operators (“MPO”) which rely heavily on government payors, these reimbursement changes have the potential to adversely impact profitability and sustainability in 2014 and beyond. As a result, it is conceivable to predict the number of acquisitions of the SSO, and potentially MPO, will accelerate over the next 12 to 18 months as operators are challenged with maintaining margins with a high fixed cost, high capital business model.
The following discussion highlights the potential risks each of these operators face in the changing landscape and illustrates the potential impacts to profitably and the likelihood of consolidation.
Single Site Operators
The single site operator, defined as both freestanding and in-office, faces the greatest impact from the 2014 Medicare reimbursement cuts should its payor mix rely heavily on government payors.
As an illustration, consider an SSO with a scan mix of 35 percent MRI, 15 percent CT and 50 percent ultrasound and x-ray. The average payor mix observed in VMG’s internal transaction database is approximately 30 percent government payors (Medicare, Medicaid, Tricare), approximately 35 percent commercial payors, and approximately 35 percent other payors (managed care, self-pay, etc.). All else equal, the decrease in MRI and CT reimbursement could potentially have a negative impact to earnings of greater than 55 percent.
Coupled with the high fixed cost nature of the business, future capital requirements and the access to said capital, the slightest variability in an SSO’s business model can create dramatic impacts to underlying earnings and business value.
The potential impact is magnified under this scenario due to the realization that as compared to a reduction in volume whereby certain variable expenses trend with the level of scan volume, a reduction of reimbursement is a direct hit to the operator’s bottom line.
Based on VMG’s 2014 internal diagnostic imaging database, the median SSO operates at a 19 percent EBITDA margin with approximately 33.4 percent of total operating costs designated as fixed. Compared to the MPO where fixed costs represent approximately 24.4 percent of total operating costs, the SSO has marginal operating error when faced with reimbursement cuts.
The potential impact to reimbursement also affects the SSO’s access to capital to maintain and or enhance equipment and technology. Over the last 24 months, VMG has valued over 50 SSOs with the average age of major imaging equipment in the range of approximately 7 to 9 years, highlighting the need for many of these SSOs to consider replacement. Replacement is sourced either through internal equity or debt financing, and given the potential for lower profit margins and a marginal industry outlook for the SSO, the likely result will be a higher cost of debt (when able to debt finance) and or more reliance on the SSO’s internally generated equity; likely a depletion of retained earnings or a capital call from the independent owner. The inability to leverage purchases with favorable credit will drive down returns and increase investment risk should reimbursement impacts continue.
The SSO does have opportunities to combat reimbursement pressures by increasing scan volume and renegotiating rates with commercial payors given the trend towards consumer driven health plans. Of course the former requires an agggressive short-term investment in advertising and marketing; however, if implemented correctly, with a focus on primary referral base and new providers, long-term success stave off pending reimbursement pressures. Alternatively, commercial payors are continuing to look for opportunities to decrease the cost of services to the payor population and given the increase in consumer driven health plan; SSOs can make strong arguments for increase in commercial reimbursement rates given their lower cost structure compared to a hospital based provider.