Buyers, sellers alike need valuation data for best deal

Diagnostic imaging centers have experienced significant ownership changes over the last few years. Radiologist affiliation arrangements, hospital joint ventures, mergers and acquisitions, as well as other creative equity sharing activities, have come to be viewed as key to capital formation strategies necessary for succeeding in the highly competitive diagnostic imaging center industry. At the core of each of these transactional activities is financial valuation.

Financial valuations performed by a professional valuation expert serve a number of important functions for owners and potential buyers of diagnostic imaging centers. For owners, these findings may help avoid potential legal difficulties related to federal regulations, such as anti-kickback, Stark, and IRS private inurement issues.

For potential buyers, these expert functions include the disclosure of facts and establishment of an asking price. It is important that owners and potential buyers understand the valuation process; however, many stakeholders fail to take the time or effort to learn the basics of this process.

When beginning a valuation of a diagnostic imaging center, it is imperative to specify the standard of value. The standard of value defines the measure of value and, ultimately, the valuation process. A stakeholder, federal law, or valuation professional may set the standard of value. As diagnostic imaging center transactions are often subject to federal regulations, the usual standard of value is fair market value, which is normally defined as the price at which an asset would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

DIFFERENT APPROACHES

Once the standard of value is identified, the valuation process may begin. A professional and thorough valuation process will typically consider three valuation approaches: asset, income, and market.

• Asset approach. The asset approach includes an itemized valuation of all of the center's current, fixed, and intangible assets. Such assets to be valued include a center's imaging equipment, other medical equipment, furniture and fixtures, and any intangible possessions the center may have. The sum of the individual asset values represents the total value of the center.

This approach has significant limitations, as it does not directly take into account the long-term history of the center or the center's outlook for generating a future profit. This approach is normally effective only if the center being valued is a startup or lacks a stable history of earnings.

• Income approach. The income approach is based on a center's ability to generate cash. It requires a projection of the cash flows the center is expected to generate for some period into the future. These cash flow projections are then discounted to their present value using a rate of return that accounts for the time value of money and the appropriate degree of risk inherent in the projections themselves.

The fair market value of a center's total invested capital-the center's debt and equity capital-is the sum of the present value of the discounted cash flows and the terminal value at the end of the projection period. To arrive at an indication of a center's equity value, the center's debt must be subtracted from its total invested capital.

Since the value to a buyer of any center rests upon future benefits to be received, the income approach is recognized as a prudent and sound valuation tool. Inherent in the use of the income approach is a thorough understanding of the financial and economic conditions in which the center operates.

• Market approach. The market approach measures the value of a center by comparing it with the value of other, similar centers. This is accomplished by using comparative company and/or transaction data, in much the same way as real estate is commonly valued. A center's value is based on the going concern prices for similar centers, adjusted to take into consideration differences as well as similarities.

EMPIRICAL EXAMPLE

The income approach frequently provides the most reliable estimate of value for a center, as it requires extensive research, analysis, and forecasting of the center's revenue, expense, and cash flow activities. The discounted cash flow method of the income approach is typically one of the primary methods that is used to value diagnostic imaging centers. Discounted cash flow allows the valuation expert to work with detailed assumptions regarding volumes, reimbursement levels, payer mix, competition, staffing levels, medical supply costs, occupancy costs, capital expenditures, and working capital.

A detailed demonstration of the income approach is beyond the scope of this article, but the market approach can more simply provide a compelling value indication, as it uses observable market data to derive an indication of value. The following simplified example shows how this approach is used to value a diagnostic imaging center.

The market approach use two methods: comparable company and comparable transaction. The first, the comparable company method, derives value through the prices at which shares of capital stock of reasonably comparable companies are trading in the public market, while the comparable transaction method derives value through the transaction price at which similar companies have been acquired. Both methods use market information to develop value measures that will be applied to the center's data to reach an estimate of value for the center.

Generally, a value measure will be a multiple computed by dividing the price paid for a comparable center by some relevant economic variable. The most frequently used economic variable is earnings before interest, taxes, depreciation, and amortization (EBITDA). Once a value measure is developed based on a review of comparable transactions, it is multiplied by the subject center's economic variable to arrive at a total invested capital value. The value for a center of using the comparable transaction method of the market approach is summarized in Figure 1.

Figure 2 displays several total invested capital to EBITDA multiples (i.e., value measures) for transactions involving diagnostic imaging centers between January 2003 and October 2007, using publicly disclosed financial information.

As demonstrated in Figure 3, we assume the above transactions are comparable and it is determined that the median total invested capital to EBITDA multiple is the most appropriate metric in valuing your center. If your center achieved $1 million in EBITDA over the last 12 months and carried $500,000 in debt, to estimate your center's equity value (on a marketable, controlling basis), you would multiply $1 million by 5.4 (the rounded median TIC to EBITDA multiple obtained in Figure 2) and then subtract $500,000 to arrive at a value of $4.9 million.

This example is highly simplified and intended only to provide a cursory illustration of how to value a center based on the comparable transaction method of the market approach. Many other factors, including transactions comparability, profitability, and risk profile, for example, should be considered. Furthermore, the value indication provided by the market approach should be considered in conjunction with value indications provided by the income and asset approaches.

Clearly, the valuation of a diagnostic imaging center is not an exact science. While basic guidelines and formulas are used to estimate values, many circumstances that have an impact on a center's value must be assessed. These include regulatory issues such as the outlook for Medicare reimbursement rates within the industry. A valuation professional can assist in analyzing such issues and assessing their impact on value.

Mr. Almiro is a director at FTI Consulting in Chicago. He can be reached at 312/252-9303 or jason.almiro@fticonsulting.com.