Imaging center acquisitions inch ahead as 1995 Stark deadline approaches

Physician owners seem to be awaiting better offers

There hasn'tbeen much fury in the storm of imaging center acquisitions forecastfor this year. Although referring-physician owners face federaland state deadlines to divest their ownership interests, buyingactivity has remained light, according to industry participantsinterviewed by SCAN.

Center sales appear stalled by a combination of tight imagingservice market conditions, financial uncertainty regarding thevalue of future center revenues, and restrictions on the typesof payments that can be made to physician owners.

Approximately 800 diagnostic imaging centers in the U.S. withreferring-physician ownership must find a way to buy out theirdoctor owners by the start of 1995 or face the loss of all Medicareand Medicaid business. This deadline, which holds for a varietyof referring-physician-owned medical centers, was inserted intoCongress' Omnibus Budget Reconciliation Act of 1993 by Rep. PeteStark (D-CA) (SCAN 8/25/93).

Center buyouts are taking place, but slowly, and on an individualbasis. Hospitals have been major participants in the acquisitionsthat have occurred to date. There has been very little activityinvolving the purchase of groups of centers, either on the partof existing center chains or outside investors.

The pace of acquisitions may pick up in the third quarter ofthis year. There has been some movement over the last month ortwo, imaging executives report. Referring-physician owners havebeen increasing their active solicitation of bids. Asking pricesappear to be dropping somewhat.

The question remains, though, whether most centers under Stark'sdeadline will rush to sell by year's end. A preview of this runto the divestiture wire was seen in Florida last month, wherecenters faced a state-legislated Oct. 1 deadline to sell out referring-physicianowners or risk losing all types of insurance payments.

While there was some pickup in center acquisition activityin Florida last month, buyers remained wary of that market, particularlybecause of a cap on procedure reimbursement included in the reformlegislation. However, one Florida multicenter leveraged buy-out,which closed at 20 minutes to midnight on Sept. 30, offers hopethat outside investor groups will find a will and a way to takeadvantage of imaging center purchase opportunities.

Consolidated Technology Group of New York City purchased ninecenters, seven of which are in Florida, for $27 million, out ofwhich $21 million was paid in the form of subordinated notes.How Consolidated plans to get around restrictions in the federallegislation on the use of debt to pay referring-physician ownersis the question of the day for other potential center buyers.

There is more to this story than number crunching and legalmaneuvering. The struggle to make deals under deadline is takinga personal toll on many U.S. doctors.

"It is intense out there. There is a lot of anger,"said E. Larry Atkins, president and CEO of imaging center firmAmerican Health Services of Newport Beach, CA. "I guess ithas dawned on (physician owners) that they are literally beingforced out."

AHS is working with the referring-physician investors in eightof its 32 imaging centers to reach agreed-upon ownership valuations.It will then buy them out for cash. The firm expects to completethese buyouts by the Jan. 1 federal deadline. All of AHS' centersare sited on hospital campuses and usually involve some form ofhospital participation.

Supply-side economics. Whether physician-owned centers areon the sales block or not is a matter of degree rather than astraight decision by doctors to sell or not to sell. Many physicianowners continue to hold off from aggressive soliciting of bidsin the face of a paucity of potential buyers.

"I am not aware of any physician-owned imaging centersthat are not for sale. However, there aren't many buyers out therenow," said Charles Booth, a Birmingham, AL-based consultantand former senior vice president and general counsel for centerfirm Diagnostic Health. "I don't see a panic situation onthe part of the doctors who own these facilities, but there issome sense of urgency. In many cases their delay in selling isnot of their own accord."

Health Images of Atlanta, the largest imaging center company,provides a prime example of buyer reticence. While the firm willconsider acquisition opportunities when they mesh well with itsexisting chain of 42 centers in the U.S. and U.K., it is not activelybuying physician-owned independents, said William A. Wilson, presidentand CEO. From what HI can see of the market, however, there isnot much increased solicitation of purchase bids by centers.

"There may be a few more centers available because ofthis (Medicare) legislation," he told SCAN. "I don'thave a sense that there is a tremendous rush to sell, however."

The lack of center sales activity is downright puzzling consideringthe size of the business involved, Atkins said.

Estimating average imaging center annual revenues at about$3 million, the 800 physician-owned centers would account forabout $2.5 billion in total revenue, he noted. With physicianlimited partnership participation in these 800 centers estimatedat 25% to 40%, doctors under deadline would account for $1.2 billionto $1.5 billion in annual center revenue.

Assuming a 20% pre-tax profit (cash flow) on this revenue anda conservative purchase price of 2.5 times cash flow, "Thatis a half a billion dollars of equity that is supposedly goingto change hands," Atkins said.

The 800 centers under legislative pressure to sell might bebroken into three categories, he said:

**Some centers are selling, mostly to neighborhood hospitals;

** Centers with non-recourse financing, i.e., where the ownersare not personally responsible for a default on financing, mayanticipate closing the doors on Dec. 31 and turning the keys overto their lender; and

** A relatively small portion of centers will be picked upby existing imaging center chains.

While there has not been a great increase in center purchasingactivity in the second half of 1994, many centers were restructuredand purchased during the past two years, said Scott M. Raymond,director of The MR Cooperative of Solana Beach, CA. Of these,most were sold to hospitals or radiology groups.

Hospitals are the largest purchasers of physician-owned imagingcenters, Booth agreed.

"Some of the hospitals were part of the (center) ventureand had an ownership interest in it," Booth said. "Othershad the facilities on their campus and did not want anyone elsecoming on (site), so they preferred to buy it themselves. Someare acquiring centers as a means to deal with the (state) certificate-of-needissue when they can acquire a facility rather than having to geta CON approved for their own."

American Health Services is providing its hospital partnerswith the option to buy into the referring-physician stake if theydesire, Atkins said. Some have opted to do this, some have not.

Referring physicians have become more realistic about the priceprospects for their centers over the past few months, Atkins said.Asking prices appear to be dropping from around four to five timesannual cash flow to multiples of three to three-and-a-half.

"That is still too rich," he said "I haven'tseen a lot of movement (in response to the lower asking prices)."

Centers with a legitimate business are maintaining prices atthree to three-and-a-half multiples, agreed Lon W. Gillette, seniorvice president of acquisitions for Prime HealthCare of Rosemont,IL. Prime HealthCare was set up this year by Prime Capital, amajor imaging financing firm, to build a network of centers throughacquisitions. Financing has been raised but no acquisitions haveyet been closed.

Bottom feeders seeking budget prices of two times earningsor less for imaging centers will not have much luck in the market,Gillette said.

"When you get down to that level, centers generally haveassets, including accounts receivable, that are worth as muchor more. In the worst case, they can run to the end of the yearand just not do Medicare or sell their assets," he said.

In many cases, life without Medicare payments is not a viableoption, Booth said.

"Some may be in communities where (forgoing Medicare patients)may be a successful way to operate," he said. "In mostcases, though, the margins are so narrow and the Medicare populationsso significant that, when you lose the Medicare population, youclobber your bottom line."

Continued next issue: How Consolidated Technology's nine-centerFlorida acquisition slipped in under the deadline.