Trends and Issues in JVs Between Health Systems and Imaging Center Companies
Colin ParkKevin McDonoughConsistent with the observed trends affecting our national health-care market, the diagnostic-imaging industry has been acutely affected by the forces of consolidation. The number of transactions involving diagnostic-imaging centers has grown consistently over the past five years. Most recently, transactions involving the formation of joint-venture arrangements between health systems and large companies operating multiple freestanding imaging centers have become popular. The underlying driving forces—for both health systems and imaging-center companies, in pursuing such arrangements—are the desires to position their entities better (from economic and quality perspectives) and to protect their existing diagnostic-imaging business from current and future competitive threats. Understanding these factors is critical to anticipating and addressing potential challenges and issues in the pursuit and formation of such joint-venture arrangements. Driving Forces For many health systems, pursuing a joint-venture relationship with an imaging-center company is a response to reimbursement pressure from third-party payors and to the loss of procedural volume to more affordable care settings (their freestanding competitors). The steering of diagnostic-imaging volume away from hospitals is being driven by patients (who are increasingly responsible for a greater share of their health-care costs), referring physicians, and insurance companies (through the increasing prevalence of radiology benefit managers). Pairing up with an imaging-center company and offering a more affordable freestanding option in their markets often combine to enable health systems to recapture or retain some lost patient volume. In addition, health systems historically have had problems managing imaging departments efficiently and effectively, and they find it advantageous to capitalize on the expertise and experience of larger independent imaging companies, as well as the operational efficiencies that they have achieved. For imaging-center companies, partnering with large health systems creates access to a much larger capital base, making it less of a struggle to invest in the cutting-edge imaging technology needed to remain competitive. If, as is likely, the health system is a former competitor, a joint venture creates a much stronger market position by locking in referrals that might previously have gone elsewhere. Last (but far from least), health systems typically have more clout in payor negotiations, meaning that the imaging-center company might be able to access the more favorable rates afforded to its hospital peers. With something to be gained on both sides of the transaction, it’s not difficult to see why these joint-venture arrangements have been gaining in popularity. They bring with them a host of associated challenges, however. Issues to Consider Before any joint venture goes through, the assets from both sides of the deal need to be valued. While this sounds simple enough, it can create complications when one party has significantly more to bring to the table than its partner-to-be has. Depending on what assets or business units are being contributed to a joint venture, one party might need to kick in significant cash to bring equity ownership to acceptable levels after the transaction. If that cash contribution becomes too high, the party responsible for such a payment might find the arrangement unpalatable. Therefore, careful consideration must be given to which assets or business units are to be contributed. A joint venture between a health system and an imaging-center company raises one major question, early on: how to handle each party’s most valuable asset—the employees. Will all staff become employees of the newly formed joint venture? If so, would this make unwinding the arrangement exceptionally difficult? Ease of unwinding should be a key consideration for both parties as they work to establish the joint venture. This issue is further complicated by what can be wide disparities between the compensation, benefits, and time off customarily offered by the two parties, as well as by potential union considerations. Often, we see the two parties choose to retain some separation between their respective staffs. Certain staff members might remain as employees of the health system or imaging-center company, with their services (and costs) passed through to the newly formed joint venture. This might be of particular importance if either party relies significantly upon its staff to serve not only the joint venture’s operations, but other proprietary operations (such as the professional practice’s operations, for example, if the imaging center is wholly owned by a radiology practice). Managed-care Contracting A stronger position in negotiating with managed-care companies is likely to be a motivating factor for both parties to the joint venture, but this cannot be approached haphazardly. If, for instance, the health system has recently completed its managed-care negotiations, and its cycle for contracting is two years, then the new joint venture will not be in an advantageous position to go back to the payor looking for higher reimbursement rates—and it will suffer from lower rates for two long years. In an environment where many of these arrangements cannot be guaranteed to last longer than four to five years, this is no small obstacle to the long-term success of the partnership. As is popular in many joint-venture arrangements, a management contract (with a related management fee) often will exist between the new joint venture and a managing entity. Typically, most direct-management personnel and expertise reside with the imaging-center company. This might lead to the belief that the management fee should benefit the imaging-center company exclusively. The reality, however, is that the newly formed joint venture will benefit greatly from the ongoing support of the health system (in managed-care contracting, for example). As a result, the management structure has to be analyzed to determine each side’s contribution percentage. Reaching an equitable agreement about how much each aspect of management is worth is critical to establishing a joint venture that is satisfactory to both parties. Opportunity Costs Although there is significant upside potential, embarking on a proposed joint venture does have opportunity costs for both sides. Both are forgoing complete ownership of their diagnostic-imaging strategy and economic benefits. Health systems are potentially exposed to significant reductions in reimbursement. Patients of the previously independent imaging center might no longer view that venue of care as a low-cost alternative to a hospital imaging center. This could result in a decline in volume for the once-freestanding location. The decrease in volume could then, in turn, reduce the number of interpretations that radiologists perform, decreasing the professional fees received. These opportunity costs must be carefully weighed by both sides. Exit Strategy A clear and well-documented exit strategy should be built into any new joint venture. Such arrangements are being driven by very specific market factors that might change and shift in the near (or more distant) future. For instance, health systems might seek the unwinding (or restructuring) of such arrangements if they become integrated with enough referral sources for even the lower cost of service at freestanding centers to be no obstacle to gaining or sustaining market share. Both parties should build unwinding provisions into their new joint ventures to ensure that their assets are protected and that they can readily continue operations—even after the partnership has been dissolved. Kevin McDonough, CFA, is a partner with VMG Health, a national health-care transaction and advisory company. Colin Park is a manager with the company.