Why Hospitals Buy Imaging Centers

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elliott_jeterWhile hospitals have always been significant players in the market for freestanding imaging centers, volume for hospitals purchasing all or part of the ownership interest in freestanding imaging centers has increased dramatically over the past few years. For hospitals already involved in joint ventures with physicians or entrepreneurial companies, we have seen a flurry of transaction activity around hospitals buying out their joint-venture partners.

In many cases, hospitals desire to maintain consistent subspecialized professional coverage across all inpatient and outpatient radiology. This is not only beneficial from a quality standpoint, but also may allow the hospital strategically to expand opportunities for the radiologists with whom it maintains exclusive arrangements

todd_sorensenWhile the benefits of a transaction are mutual, discussions are most often initiated by the freestanding imaging center’s owners, consisting of radiologists, referring physicians, and even entrepreneurs. The effects of reimbursement cuts; increasing regulatory restrictions on the operation of referral-source imaging; lack of access to credit; the hassle of running a small business; and large, pending capital requirements for equipment have driven many freestanding imaging centers’ owners from a position of strength to one of weakness, relative to hospitals.

Hospital Motivation

Hospitals are not defensively entering the game simply as a meek reaction to an inquiry, to gain more imaging volume. Instead, there has been a real sea change in the competitive landscape for outpatient imaging services, and hospitals are aggressively stepping into the void—to take advantage of what could be a rare business opportunity to capitalize on their relative strategic strength.

Reimbursement Advantages

Mirroring the negative impact of the DRA and the negative impact that it has had on freestanding imaging centers’ financial performance, the primary, immediate financial driver of hospitals’ desire to purchase freestanding imaging centers (or even additional ownership in existing ventures) lies in the differential between the forms of reimbursement that hospitals typically receive. While this can vary widely based on individual markets, freestanding imaging centers typically receive commercial/managed-care reimbursement equal to 110% to 150% of Medicare rates. Hospitals often receive commercial/managed-care reimbursement equal to 60% to 90% of hospital charges—with hospital charges often representing 300% to 500% of Medicare rates.

In many instances, hospitals may generate commercial/managed-care reimbursement at 200% or more of the rates that a freestanding imaging center achieves. Hospitals may generate reimbursement increases of 20% on commercial/managed-care business, even in the most conservative instances. Even in the environment of limited capital availability for acquisitions, the relatively short payback periods projected for these acquisitions makes them easy to sell to hospital executives.

Mitigating Factors

Hospital motivation is present, in spite of several other challenges weighing against these transactions. Despite the fact that many freestanding imaging businesses can be very profitable, the significance or materiality of these profits to the totality of a hospital’s financial health is minimal. Even if the hospital is able to garner increases in reimbursement from restructuring the imaging center as a provider-based outpatient hospital department, there are additional costs that can (and probably will) mitigate the effects of reimbursement increases.

Due to the equipment-upgrade cycle, hospitals are most likely to acquire huge, largely unplanned, and perhaps hidden capital-expenditure requirements. Freestanding imaging businesses often underinvest in IT, creating the need for hospitals to increase the quality and upgradability of information systems. In addition, hospitals must ensure compatibility with hospital information systems, the integration of which might be a large expense that could mitigate reimbursement gains.

The postacquisition transitions of freestanding imaging businesses ultimately result in due-diligence surprises. These are not unusual in health-services transactions, and surprises are exacerbated by the often abbreviated (and outsourced) due-diligence process. Normal surprises include underestimated capital expenditures, unreliable referral sources, or undercompensated employees.

Strategic Implications