Imaging centers prove attractive buy for HealthSouth in Health Images bid

December 18, 1996

Center consolidation continues with USDL deal to buy American SharedConsolidation of the imaging center business took on new dimensionsthis month with the signing of two major acquisition agreements.Both combinations signal a broadening of how

Center consolidation continues with USDL deal to buy American Shared

Consolidation of the imaging center business took on new dimensionsthis month with the signing of two major acquisition agreements.Both combinations signal a broadening of how imaging center firmswill define themselves in the future, and also point to continuedhealthy demand for center acquisitions. New players in the marketshould complement the purchase activity of the few major centerfirms dominating the market at present, and will push center valuationsup, if only slightly.

The larger of the two deals involves a relatively new playerin medical imaging, HealthSouth of Birmingham, AL, a diversifiedoutpatient healthcare service provider. HealthSouth has agreedto acquire imaging center powerhouse Health Images of Atlantafor $270 million in stock and assumption of debt.

The purchase of Health Images does not represent HealthSouth'sfirst move into medical imaging. The firm branched out from rehabilitationtherapy into outpatient surgery through acquisitions over thepast several years. Then, in November of last year, HealthSouthbought center firm Diagnostic Health, also of Birmingham.

Russell Maddox, former Diagnostic Health president, is nowpresident of HealthSouth Diagnostic Centers, a division of thelarger firm operating 18 facilities, 14 of which are medical imagingcenters. Even with Health Images' 55 imaging centers, includingsix in the U.K., the imaging business will constitute only a smallchunk of HealthSouth's over 1000 medical facilities nationwide.

Although neither company is discussing details of the agreementbeyond initial formal statements, Health Images indicated in aForm 8-K filing with the Securities and Exchange Commission thatits chairman, president, and CEO Robert Carl will function asa consultant with a non-compete agreement for three years followingthe effective date of the sale.

USDL to scoop up American Shared. In the second deal, fast-growingcenter firm U.S. Diagnostic (USDL) of West Palm Beach, FL, signeda tentative acquisition agreement with mobile imaging providerAmerican Shared Hospital Services of San Francisco. This wouldmark USDL's first major move into the mobile/shared service sideof the industry. The firm talked with mobile giant Alliance Imagingof Orange, CA, this fall, but that deal fell through (SCAN 9/11/96).

American Shared runs 28 MRI systems, the majority of whichare truly mobile units that move on a regularly scheduled basis,according to Richard Magary, senior vice president of administration.The firm also operates about 15 CT scanners, along with some mobileultrasound and SPECT systems and stationary cardiac cath labs.Some radiology management contracts will also go to USDL in thetransaction.

American Shared chairman and CEO Dr. Ernest Bates will purchasethe firm's radiosurgery and HMO insurance businesses as part ofthe final closing. The radiosurgery business consists of two installedElekta Gamma Knife systems under the auspices of GK Financing,a joint-venture subsidiary with 19% ownership by Elekta's U.S.company.

USDL values the American Shared purchase initially at about$15 million, plus the assumption of some debt to MRI vendor GEMedical Systems, according to USDL president Joseph Paul.

"It is contingent upon restructuring the debt of $35 millionwith General Electric on what we would consider to be favorableterms," Paul told SCAN.

While American Shared still holds this leasing-related obligationto GE, the firm did finally get out from under its heavy loadof senior subordinated debt, which totaled $30 million in 1988,Magary said (SCAN 4/24/96). GE helped restructure some of thatdebt in 1995 and is currently a shareholder in American Shared.

Healthcare chains branch out. While single moves do not a trendmake, HealthSouth's play for Health Images makes so much sensethat it seems to portend fundamental changes to come. Healthcaremega-firms in a variety of service areas may be eying medicalimaging as one more item to place in their portfolios for saleto managed-care and other primary healthcare providers.

"A lot of organizations in healthcare are looking to increasethe range of services they provide. Certainly that is the casewith HealthSouth adding imaging," said Helen O'Donnell, healthcareanalyst with PaineWebber in New York City. "I assume we willsee other potential buyers emerge over time as well."

Growth in the healthcare business overall has slowed, she said.This makes providers eager to integrate their services and offermore one-stop shopping to managed-care groups.

The Health Images purchase marks the first time that outsidehealthcare players have shown a real interest in this industry,agreed Richard Zehner, chairman, president, and CEO of AllianceImaging. They see consolidation opportunities and reasonable prices.More big players from the outside may be on the way, he said.

But this trend may not happen all at once, cautioned USDL'sPaul. His firm, by far the fastest growing center company, isnot looking to expand beyond imaging. Diversifying may make sense,he said, but it has to be accompanied by strong management expertisein running the different types of businesses.

USDL's takeover of American Shared, if completed, could pointthe way to more merging of mobile and center operations into singleimaging service providers, said Joseph Cilurzo, president andCEO of Mobile Technology (MTI) of Los Angeles. MTI itself hasgone through a major financial and operational restructuring,which has positioned the company to play a role in the industry'sconsolidation, he said.

Those who are looking to take over mobile businesses are doingit for more strategic reasons than in the past, when many aimedat a quick consolidation fix through reduced overhead, Cilurzosaid.

"There is a stronger business rationale for the combinationsnow," he said.

Although mobile routes by their nature don't fit well intocapitated contracts, MTI has signed a number of nonexclusive contractswith managed-care groups, which are looking to fill in gaps betweenfixed imaging sites on a cost-effective basis, he said. Centerfirms may want to use mobile systems to fill these types of geographicniches when catering to their managed-care customers.

"There is always going to be a place for mobile, especiallyin the rural, under-100-bed type of facility," Paul said."There is also a place for it in various (certificate ofneed)-regulated states where you cannot add a fixed-site MRI."

Although USDL plans to make money running the mobile routes,a more attractive part of the American Shared deal comes fromits over 150 hospital relationships, many of which might be convertibleover time from mobile to fixed-site imaging centers, he said.Another attraction of American Shared is its ability to chargea premium in fee-per-scan arrangements, due to the high qualityof its imaging equipment, he said.

Aiming for 300-center imaging chains. USDL currently owns 115imaging centers, 96 of which were picked up this year. The companyhopes to continue the pace in 1997 and reach about 300 centersin 18 months, Paul said. This would match the level of centersHealthSouth has indicated it is aiming at over a similar timeperiod, he said.

A number of companies should have about 250 to 300 imagingcenters in the next few years, said William Farrell, presidentand COO of Medical Resources of Hackensack, NJ. Medical Resourcesowns 38 centers but is on the hunt for new acquisitions and expectsto remain among the top of the pack, he said.

Although many individual centers and some multicenter groupsremain to be picked up, HealthSouth will have to work hard tomatch the business value of its Health Images acquisition, hesaid. Some 96% of the Health Images facilities overlap with HealthSouthrehabilitation and surgery locations, according to the two companies.The therapy groups will provide a natural new source of referralsfor HealthSouth imaging centers.

"HealthSouth and Health Images seem to be a beautifulfit," Farrell said. "The transaction made a lot of sense,but I don't know if there is another entity that HealthSouth willcomplement so well."

As more players enter the market for imaging-service acquisitions,both mobile and fixed, valuations are likely to increase, althoughthere will still be plenty of good buys.

"Clearly, whenever you have more competition for the sameamount of centers, prices are going to creep up," Paul said.

Medical Resources has not seen an increase in the multiplesof earnings before interest and taxes (EBIT) paid for centersover the past 18 months, Farrell said. However, the current levelof two to four multiples of EBIT is higher than the level of twoyears ago and will likely rise to as high as five times EBIT forthe right centers in the near term, he said.

Many in the industry are looking at the vigor of USDL and thenew energy of HealthSouth as signs of exciting times to come.

"1997 will be a very interesting year, not just for Alliancebut for everybody," Zehner said. "We might see somereal money come in the business."