Complex rollup planned to launch center chain

April 8, 1992

Efforts are under way to build a nationwide chain of imaging centerspositioned to meet the needs of large managed health-care providers.Plans for a chain that would optimally number over 100 centershave been 18 months in the making. The chain should hit

Efforts are under way to build a nationwide chain of imaging centerspositioned to meet the needs of large managed health-care providers.Plans for a chain that would optimally number over 100 centershave been 18 months in the making. The chain should hit the groundrunning this year with 30 or more imaging centers in tow, accordingto Russell H. Maddox, president and CEO of Diagnostic Health.

The Birmingham, AL, start-up firm is negotiating with about35 independent imaging centers as part of an effort to includethese centers in a sophisticated form of financing called a rolluptransaction, he said.

This will apparently be the first time that a rollup transactionis attempted in the medical field. It has been a financial mechanismheretofore used primarily in the oil and gas industry, Maddoxsaid.

The rollup will involve simultaneous acquisition of a groupof independent imaging centers and launching of an initial publicoffering (IPO) by Diagnostic Health. Once a price for an individualcenter is negotiated, a contract will be signed between the physicianowners and Diagnostic Health that promises payment to the centerowners in the form of stock in the publicly held company. Untilthe actual rollup occurs, the physicians will maintain ownershipand receive all revenues from their center, he said.

All of the center contracts involved in the rollup will beplaced in one prospectus transaction underwritten by several majorWall Street firms, he said. The underwriters will take that prospectusand, in one day, roll it into an IPO. On that day, DiagnosticHealth will take ownership of the centers and the doctors willreceive ownership in the newly public company.

"Because of the fact that the former equity owners ofthe centers will be owners of the company, it qualifies as a tax-freeexchange," Maddox said.

Once Diagnostic Health has become public and taken over thefirst group of centers, it will fit within the $50 million nettangible assets criterion of the federal safe harbor rules limitingreferring-physician ownership of medical facilities, he said.

A rollup transaction will be used to acquire the centers because:

  • it seems unlikely that enough cash could be obtainedto purchase so many centers at the multiples of price over earningsthat many are asking for; and

  • doctors are looking for ways to stay involved withtheir centers while not having to pay heavy capital gains taxes.

Maddox has teamed up with Richard M. Scrushy, chairman andCEO of Healthsouth Rehabilitation, as the two principal investorsin Diagnostic Health. The firm is supported by a group of privateinvestors, including venture capital firm New Enterprise Associatesof Baltimore, Maddox said.

To date, a total of $5 million in equity has been raised tosupport the organizing effort. Diagnostic Health also has a $10million line of credit and has arranged a $50 million credit linecontingent on the IPO completion, he said.

Both Maddox and Scrushy are experienced health-care entrepreneurs.Maddox founded Russ Pharmaceuticals in 1980, nurtured the firm'smain product--a narcotic analgesic--from $5600 to $42 millionin annual sales, and sold the company to a larger firm two yearsago. Healthsouth Rehabilitation is one of the largest companiesinvolved in outpatient rehabilitation. The Birmingham companystarted with $50,000 in annual revenues and is now about a $500million company, Maddox said.

DESPITE A BARRAGE of federal and state efforts to restrict orban referring-physician ownership in imaging and other medicalcenters, the medical imaging industry remains one composed predominantlyof physician-owned, independent mom-and-pop shops. It is due fora shakeout, he said.

No one center chain has much over a 2% market share nationwide.Small numbers and limited geographical reach make it harder togain cost economies and offer package deals to large, nationwidehospital chains, he said.

"The (imaging center) industry is fragmented all over thecountry," he said. "Nobody can go to, say a large HMOlike Kaiser, and offer scans in particular parts of the countryover a large (patient) group for a certain number of dollars andsupport this."

Although no one is sure what the critical mass is for a nationwideimaging center chain, Diagnostic Health expects the number willbe something over 100 centers dispersed in targeted regions acrossthe country.

Most existing center firms that are purchasing independentshave neither differentiated themselves nor developed their imageas a major health-care company, Maddox contends. Too much attentionis paid to the financial details of acquisitions and not enoughto long-term strategic vision, he said.

"In this business, everybody has had their vision wrappedaround trying to do deals with the doctors and locking in on that,"he said. "I am not sure they really understand how to gothe other way--how to run a company and concentrate on serviceto the referring physician and the patient."

Physician owners are eager to pass on their efforts to anorganization with a long-term strategy as a health-care provider,he said.

"People forget that physicians, early on, financed this(development of outpatient imaging centers) because hospitalsand others could not. They took the risk. There were hospitaladministrators scared to death that the (MRI) technology wouldbecome outdated like CT," Maddox said. "Sure physicianswant good value for the equity in their facility. But they wanttheir center to go to somebody they feel will still provide theservice and be there when all this is over."

Diagnostic Health will value centers according to their fundamentalcompetitive strengths--not just because of cash flow due to thecurrent referral structure. Centers that ask for prices of fivetimes cash flow or more might be worth the investment if theyhave the right components, such as a good location, the rightequipment and good quality people, he said.

"I don't want a center located 20 miles outside a citybecause somebody's granddaddy owned the land and they built itthere knowing that they had a lead-pipe cinch for referrals. Idon't think that kind of center will survive," Maddox said.