Center market awaits federal health-care action

Funds for imaging center acquisitions have tightened as investorspull back and scope out the potentially radical changes in U.S.health-care delivery due for disclosure by the Clinton administrationin May. With imaging center operating profits under pressure andfewer buyers chasing physician partnerships, sell-out prices havedropped this year.

"Every center we have looked at has had declining revenuesand profits," said Ronald J. Latta, vice president of theHouston investment banking firm Healthcare Capital Group. "Becauseof competition, volumes are down. Reimbursement is down. Managed-carecompanies have become very aggressive in negotiating lower costdeals."

Well-run imaging sites should not be stampeded by market conditionsand self-referral restrictions into selling for prices set atlow multiples of pre-tax earnings, said Leo J. Borrell, managingdirector of Healthcare Capital. Centers with sound clinical andpractice fundamentals are apt to outlast sites that have reliedon referring owners to the detriment of equipment and servicequality.

"The doctors who have good centers don't want to disposeof them because they know that other centers without their qualitywill not be available (in the future) for their patients,"Borrell said. "First provide good patient care, and thenthe value will be there and that will be realized and appreciated."

Healthcare Capital closed the sale last year of two Houstonimaging centers to Diagnostic Health of Birmingham, AL. The Greenparkcenters, one MRI-only and one multimodality, were owned by twoseparate physician groups.

Diagnostic Health originally planned to launch its center acquisitiondrive with a stock exchange offering that would fold multiplecenters into the company in an exchange of stock for partnershippositions (SCAN 4/8/92). But the firm has decided to start purchasingcenters using private financing prior to an IPO.

Diagnostic Health is currently in registration with the Securitiesand Exchange Commission for its exchange offer and cannot commenton corporate issues, according to senior vice president CharlesBooth. He could confirm, however, that five centers have beenpurchased by the firm to date.

IMAGING CENTER PRICE MULTIPLES appear to be dropping, from fourto five times pre-tax earnings late last year to the current levelof three to four times, Booth said. He has not seen a dramaticdecline in earnings, however.

"They (center earnings) seem to have flattened out,"he said. "We haven't seen large declines. There was a droplast year compared to the year before, but that has not continuedthis year. (Earnings) have stayed fairly steady at the centerswe have seen, but at that lower level."

It is surprising how little the threat of federal self-referrallegislation sponsored by Rep. Pete Stark (D-CA) has impacted imagingcenter activity, Booth said. The proliferation of state laws ismaking center operations and acquisition more complex, however.

Almost half of the states have or are working on bills thatrestrict or ban referring-physician ownership in imaging and othermedical centers. The Georgia legislature, for instance, passeda self-referral bill last month that is awaiting signature bythe governor, Booth said. A severely restrictive bill has alsobeen introduced in Texas.

The proposed Texas law in its initial form would force physiciansto sell their center interests by September for cash, said HealthcareCapital's Latta. Other states, such as Florida, that originallyshut off exit routes for doctor owners later relaxed the restrictions.

"It (the proposed Texas legislation) would mean doctorscan't take debt or stock," Latta said. "They would haveto sell out completely for cash and close the deal in four orfive months. That is insane. There is a slim chance for passage."

Penalties in the Texas proposal are also more severe than inother states, Booth said. They include:

• a $15,000 fine per violation, with each patient referreda potential violation; and

• a $100,000 penalty for anyone participating in a schemeto avoid the impact of the law.

Physicians are concerned about disclosure requirements in manyof the state referral bills, Booth said. Disclosure can placea considerable burden on the doctor. The Georgia law, for instance,requires written disclosure to patients about the ownership interestof the physician. Florida requires that the referring doctor providethe patient with names, addresses and imaging fees for two competingfacilities.

Variations in state legislation also mean headaches for facilitiesoperating across borders, Booth said. A center in Alabama mighthave a referring-physician owner across the border in Georgia.If a violation of the Georgia law occurs relative to that physician,the center could not be held in violation since it is locatedin Alabama.

"There are a lot of gray areas," Booth said.

If the current Stark bill is passed, it would not necessarilysupersede the state laws, he said. In that case, the most stringentrules would hold sway. Federal and state laws would have to becompared item by item to determine the final enforcement outcome,thus dramatically increasing the complexity of center operationsfor physician partnerships.

The government activity most affecting center acquisitions,however, appears to be the imminent revamping of federal health-careregulations.

"Investors are uneasy about lending for something thatmay be affected by Clinton's health plan, so a lot has sloweddown right now," Booth told SCAN. "If anybody had aclear source of funds and unlimited funds, they could go out andbuy a whole lot of centers at this time."

While fewer groups are actively looking for center acquisitions,sale opportunities continue for good center businesses, Lattasaid.

"There are still groups out there aggressively acquiringcenters and paying a good amount of cash for them, anywhere froma third to three-quarters (of the total price)," he said.

BRIEFLY NOTED:

• American Shared Hospital Services of San Francisco underwenta restructuring of operations earlier this year in the face ofa highly competitive mobile MRI market and a large loss for fiscal1992 (end-December). Two northern and southern business zoneswere created with operations and marketing responsibilities transferredfrom headquarters to the regional level.

ASHS continues to negotiate with its creditors and hopes toreap lower interest payments this year. A semiannual interestpayment was missed in October and the firm does not expect tomake the payment due this month. Lease payments on a large portionof the company's imaging equipment have also been suspended asbetter terms are negotiated.

"We had significantly lower MRI revenues during 1992,as several major customers chose to use their own in-house equipmentand other alternatives, rather than renew when our contracts expired.This market softness and change was felt by most companies inour industry," said chairman Ernest A. Bates.

ASHS saw revenue drop 17% last year, from $59.6 million in1991 to $49.3 million. Most of the decline came from lower MRIservice revenue. The firm lost $9.5 million in 1992, comparedwith net income after a gain for extinguishing debt of $2 millionin 1991. The loss in 1992 was exacerbated by a write-down in thevalue of older scanners amounting to $3.5 million.

The imaging services firm expects to reduce operations staffby 25 positions this year, with a resultant savings of $875,000,the firm said. Costs will also decline after the reduction ofcentral management staff in the restructuring process. ASHS willalso try to trim costs by renegotiating equipment maintenancecontracts. Outside the restructuring, president Marla R. Thomashas left the firm, with chairman Bates taking over temporarilyas president.

On the bright side, an expanded sales and marketing efforthas resulted in the signing of service contracts valued at $400,000per month, which commence now through the second quarter of thisyear. The company also points to its MRI fleet of predominantlystate-of-the-art 1.5-tesla scanners, many of them GE Signas. ASHSalso initiated its second Elekta Gamma Knife radiosurgery servicecontract with the University of Southern California in Los Angeles.

• Health Images executive vice president Perry Polsinelliwas hired away by imaging services competitor Mobile Technologyof Los Angeles last week. Polsinelli will remain in the Atlantaarea serving as vice president of technical service and development.A prime objective of MTI in hiring Polsinelli was to reduce themaintenance cost on its fleet of over 100 MRI scanners, accordingto president and CEO Joseph W. Cilurzo.

Polsinelli was instrumental in developing HI's MRI serviceprogram, both for its own centers and as a third-party serviceprovider focusing largely on the installed base of TechnicareTeslacon MRI systems. He moved to HI seven years ago from Technicareafter Johnson & Johnson closed down that medical imaging systemssubsidiary. HI manufacturers its own MRI system based in parton J&J technology.