Imaging-center Valuation 2010: Post-reform Drivers

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While the industry landscape has certainly changed significantly since Radiology Business Journal published my article on this subject three years ago, the primary factors that drive the desire to complete transactions and the valuations remain largely intact.

There does, however, seem to be a different reaction to the latest dose of seismic change in the health-care industry. What we observed in the months leading up to and following the passage of the DRA in 2006 was a sort of paralysis in the market. Sellers were not willing to sell at valuations that reflected all, or maybe even any, of the changes in reimbursement resulting from the implementation of the DRA. On the other hand, buyers were not willing to buy at valuations that did not fully reflect changes in reimbursement.

Perhaps the relatively recent nature of the experiences of buyers and sellers through the DRA episode is providing the parties with some confidence to press on through the current episode of change.

Transaction Drivers

The primary driver of transactions and consolidation in the market seems to be reimbursement. Because fixed costs compose the most significant component of imaging operations, marginal players that are unable to make up for lower reimbursement with higher volumes might find a sale to be the most attractive (or even only) alternative. As we see it unfolding in the marketplace, pressure on reimbursement has driven freestanding or radiologist-owned imaging centers that are exploring alternatives to consider three primary options.

The first (and most popular) option is to sell to a hospital or hospital-based competitor. Through existing managed-care relationships, hospitals are typically paid much higher rates than their freestanding competitors. While, in most cases, this doesn’t result in increased value to the seller using fair market value as the standard of value, the business case for hospital buyers is a much easier case to make when it is time to procure the needed capital.

The second option is to sell to a better-positioned freestanding competitor. While it might be an option in some cases, its application appears to be much more narrow, for a variety of reasons. For example, there are often cultural difficulties associated with merging separate medical staffs to retain the volumes currently serviced by competitors. The business case is often less strong for this option because there is typically not the same differential in reimbursement levels between freestanding competitors that exists when comparing hospital rates to freestanding rates.

The third option is to form a freestanding joint venture with a hospital system. While achieving hospital-like commercial managed-care rates is not as likely in most cases, it is possible in some instances. At a minimum, partnering with a hospital system might be an attractive option for those not wanting to give up ownership of the technical component, if it offers at least some benefit or insulation in contracting with commercial managed-care payors. Due to regulatory restrictions, this is not usually an option for imaging providers that are referral sources.

Forward-looking Valuations

There are three generally accepted approaches to valuing a business: the cost approach, the market approach, and the income approach. The cost approach identifies the cost to recreate a business (or to accumulate, and place in service, the assets necessary to operate a business). The indication of value using the cost approach generally presents a floor, or minimum value, for an imaging business, but may still include consideration for intangible assets, such as certificates of need.

The market-comparison approach computes value by measuring the purchase price or publicly traded prices of similar companies as a multiple of revenues or earnings, which is then applied to the revenues or earnings of a subject company. The income approach projects a future income stream attributable to a business and then discounts those earnings back to present value.

While valuations typically rely heavily on historical information (in the market approach) and on development of projections (for the income approach), both are generally forward-looking approaches to value. In addition to adjustments for reimbursement or volume changes to the revenues and earnings of the company that are not reflected in historical data, the multiples applied should also reflect expectations for the company in comparison