Imaging-center Valuation 2010: Post-reform Drivers
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 with expectations for the market. In the income approach, expectations for changes in reimbursement or volume are factored directly into the projections constituting the discounted–cash-flow analysis. Valuation Drivers In addition to being the primary driver of transactions, expected changes in reimbursement are a very important driver in the valuation of an imaging center. The other important value drivers include volume and capital needs. Reimbursement: There is much talk about the changes (primarily negative) in Medicare reimbursement resulting from health-care reform. In any event, while changes in Medicare reimbursement are important—and should be considered in the development of projections used in the income approach, in particular—the potential changes in commercial managed-care reimbursement might have a much more dramatic impact. Because some commercial managed-care contracts are either directly tied to the Medicare Physician Fee Schedule or seem to follow in some fashion, changes in Medicare reimbursement might end up affecting the entire payor mix. Volume: As we consider the impact of health-care reform on reimbursement, it is also important to realize that these reimbursement changes don’t happen in a vacuum. Ultimately, reimbursement cuts experienced by all might, in some cases, create volume winners. With the possible demise of some of the more marginal centers (or even referral-source imaging) in certain markets, those centers that are strategically positioned may stand to gain significant volumes. This potential should be recognized in developing projections for imaging-center valuations. Volume projections for freestanding imaging centers should also recognize that in comparison with hospital competitors, the value proposition to commercial managed-care payors is very favorable for freestanding imaging providers. Conversely, hospitals should recognize their relative competitive position in projecting both volumes and reimbursement when building their business cases. Of course, favorable demographics and the strong overall increases expected in imaging utilization generally support growth rates in excess of population increases. Capital needs: While the overall pace of equipment purchases might have slowed for many, capital needs continue to be a primary factor in the valuation of imaging centers. Generally speaking, the centers we have worked with over the past several years now anticipate being able to stretch the expected useful life of their equipment (and in particular, high-end equipment) beyond the five to seven years that they had traditionally used as a guideline before implementation of the DRA. In addition to considering normal replacement increments for equipment, it is also important to match projected capital needs with projected volumes, market share, and competitive position. It is essential to evaluate these drivers and how they relate to one another in imaging-center valuations. An accurate valuation considers not only the appropriate impact of changes in reimbursement, but also the impact of other value drivers and of the totality of individual facts and circumstances. While our experience indicates that the strategic value of imaging centers to hospitals, in particular, is very high, an accurate valuation might be essential to completing a transaction. Todd Sorensen, AVA, is a partner in VMG Health, Nashville, Tennessee, a venture-capital company.