Valuation of Imaging Centers: 2012 Outlook
If one were to chart trends in physician employment over the past 15 years, the result would closely resemble the recent wild swings seen in the stock market: significant peaks followed abruptly by equally sharp declines, according to Kevin McDonough, CFA, a senior manager for VMG Health (Dallas, Texas). He recalls his initial experience in the industry in the early 2000s, saying, “My indoctrination into the health-care industry came at a time when hospitals and health systems were divesting themselves of previously acquired practices in droves, following the physician–practice-management company and integrated-delivery network bust.” That trend has come full circle, McDonough observes; once again, the industry is seeing a tremendous amount of consolidation. At the heart of this consolidation is the acquisition of physician practices and physician-owned ancillary-service lines by hospitals. The driving forces for such consolidation are numerous. As hospitals continue to see their competitors securing referral sources in their markets, many believe that they have no choice but to make their own practice acquisitions, McDonough says. In addition to the pursuit of practice acquisition for defensive purposes, hospitals have increased their acquisition activity to position their institutions appropriately for the coming era of accountable care and shared-risk delivery models. All this has led to what McDonough calls the great reconsolidation in health care. On the physician side, he notes, physicians are seeking shelter from market forces, reimbursement cuts, and cost increases, and they are experiencing an increasing desire for work–life balance. Physician demographics are also experiencing a shift. “Generally, we have an aging physician work force,” McDonough says. “For physicians in the twilight of their careers, it is often attractive to seek out stability by selling to a hospital.” McDonough anticipates that nearly 25% of all specialists will be hospital employed by the end of 2012. Thus far, in this era of consolidation, McDonough has observed a relatively small number of radiology practices pursuing a hospital-employment strategy. What he has observed are “a huge number of transactions involving physician-owned imaging centers and hospitals/health systems,” he says. When the cuts to imaging mandated by the DRA went into effect, a trend began of physicians (and specifically, radiology groups) selling their freestanding imaging centers to, or developing joint-venture relationships with, hospitals—and McDonough anticipates that this trend will continue to gain steam in 2012. Basics in Valuation Health care is highly regulated, and hospitals working to acquire physician practices and physician-owned ancillary businesses often look to qualified appraisers to determine fair market value in order to remain compliant with Stark laws, anti-kickback statutes, and regulations governing excessive compensation for nonprofit entities. Although it’s often a necessary step, obtaining an accurate opinion of fair market value should not present an obstacle to consummating a transaction. “An accurate opinion of fair market value should be viewed as a price that will accurately compensate the sellers for the future earnings stream they are giving up,” McDonough says. In one recent example, a health system asked McDonough to assign a value to a three-center diagnostic-imaging provider. In this case, the health system sought to buy a controlling interest in the imaging centers, creating a joint venture whereby the hospital would control 51% and the radiology group would retain 49% ownership. Both the hospital and the owner (a radiologist) wanted to keep the centers as freestanding facilities, but the question of price remained. With growing volume, a solid referral base, new equipment, and strong operating margins, the radiology provider was considered by McDonough to be in favorable condition, but with two caveats: heavy debt and one severely underperforming site. Because of positive growth and strong operating margins (before debt service), the centers’ owner was hoping for a strong valuation to cover his high debt. “The company had centers operating at three sites. One center was very profitable, another was breaking even, and a third was losing a substantial amount of money due to poor volumes. That third center had been built in an area that, at one point, was up and coming, but the housing crash hit the area hard, and volumes never panned out,” McDonough explains. Given that the company had one highly profitable center, one breakeven center, and one big loser, the radiologist–owner believed that the $2 million operating earnings would really be more like $3 million, once unprofitable operations were consolidated into the profitable ones. Initially skeptical, McDonough asked the owner, “If consolidating operations makes so much sense, then why hasn’t it been done already?” The answer had two components. He says, “First, it was messy and costly to get out of the underperforming center’s lease; second, the owner believed the additional site might be attractive to a potential buyer.” McDonough, the hospital, and the radiologist–owner reached a compromise, assuming that a typical buyer would seek to maximize earnings by consolidating operations. In doing so, however, the imaging company would not be successful in transferring 100% of the volume from the unprofitable site, and some attrition would occur. Furthermore, the company would be saddled with ongoing costs related to the departed site, such as the lease, service contracts on the equipment, and selling the equipment at a loss. The 2012 Landscape The valuation process in 2012 is likely to reflect the same principles seen in McDonough’s example, with compromise and realism being the watchwords that both sides must honor. In the case of the imaging provider with solid operational and financial performance, but heavy debt, McDonough provided an accurate valuation that represented a reasonable compromise for both seller and buyer. “Ultimately, the owner was paid a fair amount for 51% of his company, although not as much as he had hoped for,” he says, “and the joint-venture entity is now a successful diagnostic-imaging provider in a major metropolitan area in the Northeast.” In “Monetary Decisions in Radiology Practice: Valuing Your Practice and Assessing Future Financial Trends,” which he presented at the RSNA annual meeting in Chicago, Illinois, on December 1, 2011, McDonough also notes that the range of acquisition multiples for imaging centers has significantly widened in recent years—a reflection, he says, of the varying performance of imaging centers in today’s unstable marketplace. “All imaging centers are certainly not created equal, with respect to valuation,” he observes. In 2012, the acquisition market will consist of diagnostic-imaging centers that can be readily divided into the haves and the have nots, McDonough notes. The have nots feature declining profitability; decreasing market share; location in a state without certificate-of-need requirements, giving them little protection from competitors; and outdated equipment. In the crucial realm of fair market value, the have nots often sell at close to book value, at depressed multiples of three to four times trailing EBITDA. At the other end of the spectrum, the haves consistently garner increasing or stable market share; have fared well, compared with competitors in the market; have up-to-date equipment; and have retained profitability, despite the reimbursement cuts of recent years. The haves typically are acquired at between 4.5 and six times EBITDA, and McDonough believes that these numbers will remain valid throughout 2012. Hospital administrators will probably continue to be on the lookout for opportunities to acquire radiology practices this year. According to McDonough, acquisitions will continue to bring many benefits to both sides, including a more secure and expanded referral network, better response to health-care–reform initiative, advantageous reimbursement from Medicare and from managed-care companies, increased pricing leverage, and an enhanced and well-diversified referral network. McDonough notes, however, that the decision to sell might not be right for all practices—especially since consolidation might very well hit critical mass in the not-too-distant future. “Many hospital systems are seeing losses mount, with respect to their employed-physician network,” McDonough says. He adds, though, that this time around, reconsolidation activity incorporates hard-won lessons from the 1990s. If the opportunity to pursue an acquisition or joint venture with a hospital or health system does not present itself, a consolation prize might be right around the corner, McDonough predicts. “We are observing the failure of a significant number of freestanding imaging centers, and those that survive could very well be in a position to expand their networks through acquisitions of their own,” he says. “It provides a lot of opportunity.” Greg Thompson is a contributing writer for ImagingBiz.com.