Lack of Investment in Imaging Equipment Might Contribute to Accelerated Consolidation

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Colin McDermottFew would disagree that it’s increasingly difficult to operate as a freestanding imaging-service provider. Reimbursement continues to face pressure, patients have become more savvy regarding their copayments, and increased competition from hospital operators has caused industry participants to become intensely focused on cost efficiencies. We have entered an environment where economies of scale and focused expertise will correlate with enhanced competitive advantages; consequently, we find evidence of increased partnerships and consolidations. One factor that stands to accelerate the partnership/consolidation trend is often left out of the conversation: The impact of the recession on capital investment in imaging equipment might soon create accelerated market activity, however. Over the past several years, the industry has announced several notable partnerships. Examples of imaging chain–hospital partnerships include those of Alliance HealthCare Services (Newport Beach, California) and Emory Healthcare (Atlanta, Georgia); RadNet (Los Angeles, California) and Barnabas Health (West Orange, New Jersey); and Texas Health Resources (Arlington, Texas) and Envision Imaging (Mansfield, Texas), among others. As a testament to a potentially increased imaging chain–hospital partnership trend, Larry Buckelew, interim CEO of Alliance HealthCare Services, says, “In this environment we’re in, we’re finding hospital partners more interested than they’ve ever been before.” The most notable freestanding transaction occurred in July 2012, when Insight Imaging (Lake Forest, California) acquired the majority stake in Center for Diagnostic Imaging (Minneapolis, Minnesota) for $231 million. While the industry continues to consolidate, smaller freestanding facilities are generally focused on trying to maintain their market share and profits. The response to industry headwinds varies by service market, but evidence points to the potential for the industry to reach a turning point during which partnerships/consolidations accelerate due to the lack of capital investment in equipment in recent years. Reduced Capital Expenditures Investment in the imaging industry has been extremely sluggish in the years since the economic downturn of 2008. As Figure 1 demonstrates, the North American market for imaging systems is down approximately 25% from its peak in 2005. Access to capital and economic uncertainty were factors contributing to a declining market during this period; however, imaging-system sales were already on the downward path beginning in 2006. In addition, many top North American manufacturers have continued to face declining sales of imaging equipment in 2013. Howard Berger, MD, CEO of RadNet, notes, “Conversations that we’ve had with all the manufacturers are telling us of enormous decreases in outpatient-imaging sales.”
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Figure 1.
As Figure 1 shows, imaging-system sales peaked in 2005–2006. If we assume that the average useful life of equipment sold during this period was eight years, we are heading into 2014 with a large group of operators with aged equipment.
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Figure 2.
The total number of imaging centers has yet to decline to a number commensurate with the underinvestment in imaging equipment seen since 2006. As Figure 2 demonstrates, the number of single sites, as a percentage of total centers, has remained relatively constant, at approximately 30%, since 2006. In 2012, the fragmented industry had approximately 1,900 single-site operators, and the average imaging-center chain had only five freestanding sites. Equipment obsolescence and functionality are major concerns for any business that relies on critical technology for operations. Given the pressures of lower reimbursement, expense inflation, and regulatory utilization requirements, freestanding operators will soon face the following options regarding their aged equipment; they can: • spend hundreds of thousands of dollars to replace or refurbish aged imaging equipment, and try to operate in a changing competitive environment; • continue to operate, for as long as possible, with older equipment—until additional industry clarity is achieved (if ever); • partner with other regional operators or hospitals and address capital requirements; or • sell operations. Ultimately, the underinvestment in equipment over the past several years could create a catalyst for accelerated consolidation. The Hospital Side As a corollary, the hospital industry has already been experiencing a similar dynamic. Over the past several years, the industry has been deferring capital expenditures in return for higher cash flows. According to a proprietary August 2012 report from Moody’s Investors Service, aggregate hospital capital spending has not quite reached the peak seen in fiscal 2008, and the average age of plant has increased accordingly. This underinvestment in plant, property, and equipment has amassed into a currently immediate need for major capital infusion. Several health systems are now looking for capital partners committed to building new facilities and to updating equipment. We expect the same dynamic to apply to the imaging industry. Berger describes a potential upcoming turning point in the industry: He says, “I think, over the next three to five years . . . the lack of capital spending . . . [is] going to have substantial impacts in the industry and cause only the strong to survive. I don’t believe the smarter operators are going to wait until the ax falls. They are likely either to sell or consolidate with other players . . . at a much brisker pace than [at] perhaps any time that I’ve seen in the history of . . . this business.” Conclusion The evidence suggests a strong potential for an accelerated pace of consolidation and partnerships in the industry, driven by underinvestment in capital equipment. As would be expected, operators able to achieve size and scale—and the ability to reinvest in their operations—will be the most successful in navigating the current operating environment. The smaller freestanding operators should evaluate their options when large equipment purchases come due, and they should be cognizant of any market signals that might indicate a rapidly changing local competitive landscape. Colin McDermott, CFA, CPA/ABV, is a senior manager with VMG Health, a national health-care transaction advisory and valuation company. Corey Palasota, CFA, is a manager with the company. The authors welcome your questions and comments at colinm@vmghealth.com and coreyp@vmghealth.com.