Imaging investors watch rollup reform progress

July 29, 1992

Medical imaging investors are closely following efforts by federaland state lawmakers to reform financial rollups. While rollupabuses have largely occurred outside the imaging center industry,legal reform efforts could limit a promising channel for

Medical imaging investors are closely following efforts by federaland state lawmakers to reform financial rollups. While rollupabuses have largely occurred outside the imaging center industry,legal reform efforts could limit a promising channel for physiciansto divest themselves of joint-ventured centers.

Used primarily in the real estate and oil and gas industries,rollups are transactions in which a number of small limited-partnershipinvestments are merged, or rolled up, into one large, publiclytraded company.

Although no company in the medical imaging industry is believedto have completed a rollup, at least one transaction is in theplanning stages. Diagnostic Health of Birmingham, AL, is negotiatinga rollup with about 35 independent imaging centers (SCAN 4/8/92).

Rollups are particularly attractive to firms like DiagnosticHealth that are trying to forge independent imaging centers intonational or regional chains. A rollup would allow a company toacquire independent centers without putting up the huge amountsof capital required to purchase a large number of centers at themultiples of price over earnings that many are asking for.

"The cash needed to acquire these interests is significant,"said Nathan Kaufman, president of the Kaufman Group, a San Diego-basedmanagement consulting firm, and former president of the centerbusiness of Medical Imaging Centers of America. "Rather thansimply acquiring each one and then going public, it would makesense to develop a critical mass by pooling interests with otherimaging providers."

Rollups have acquired a shabby reputation in industries wherethey are more common, however, because of what rollup opponentssay are egregious abuses of small investors. Those abuses haveprompted lawmakers and regulatory agencies to propose reform regulationsthat could kill enthusiasm for the mechanism in medical imaging.

Rollup opponents charge that limited partners are sometimesforced into deals by general partners, who often receive heftymanagement fees for completed rollups.

Because rollups sometimes involve financially shaky limitedpartnerships, the stock of rolled-up companies is often poundedonce it arrives on the public market. One investor who testifiedat hearings in California said that the value of her investmentin a real estate limited partnership plunged from $200 a unitbefore a rollup to $80 a unit after the transaction was completed.It later dropped further, to $20 a unit.

"There have been cases where a general partner forcesa complete change in structure, from a low-risk investment toa high-risk investment," said David O'Bryon, president ofthe American Association of Limited Partners, a trade associationlobbying for changes in rollup regulations.

Rollup reform efforts have focused on the federal level. TheSecurities and Exchange Commission enacted rollup reform regulationslast year, but Congress has gone a step further with House andSenate bills that would create more stringent requirements. Eachbill has passed its respective chamber.

The legislation would strengthen disclosure requirements, improvecommunication between limited partners, and give new rights todissenters opposed to the rollup of their partnerships.

Those provisions have raised the ire of Sen. Phil Gramm (R-TX),who has waged a single-handed but effective battle against rollupreform. He has labeled the bills as special interest legislationthat would give limited partners rights not enjoyed by other investors.Gramm is using a parliamentary maneuver to delay the formationof a conference committee to reconcile the House and Senate bills.

The delay in getting federal rollup reform passed has promptedat least one state legislature to act. A rollup reform bill passedthe California Senate this month and is headed for the state Assembly.Other states considering legislation include Texas and Massachusetts.

ALTHOUGH IMAGING CENTER COMPANIES are monitoring the developmentof rollup reform, the types of rollups legislators are most concernedabout are fundamentally different from those that would occurin medical imaging, according to Kaufman.

"There are two types of rollups: a general partner rollingup limited partners and independents rolling into a larger company,"Kaufman told SCAN. "The legislation is targeted at the firsttype."

It could affect the industry nevertheless. Charles Booth, seniorvice president of Diagnostic Health, believes rollup reform couldput the brakes on a promising means of divestiture for joint-venturedphysicians.

"It could foreclose a very attractive option for physicianswho are having to exit imaging centers they are involved with,"Booth said. "It will make it harder for them to find a pathout of centers."

Booth finds it ironic that the federal government is forcingphysicians to divest through the promulgation of safe harborsregulations while making it harder for them to do so with rollupreform.

"We have one agency encouraging doctors to get out of(joint ventures), and another that's making it more difficultfor doctors to get out," he said.

Management consultant Henry F. Keller of the Keller Companyin Weston, MA, believes that the legislation, if passed, won'thave much of an impact on legitimate investors in the imagingindustry. Keller was formerly president of Merrill Lynch's centerbusiness before most of those partnerships were sold to Raytellast year (SCAN 12/25/91).

"What's under scrutiny are transactions where no new valueis added, existing value is destroyed, and newcomers are basicallystealing a big chunk of action from existing investors,"Keller said.

The best way for a company to protect itself when consideringa rollup is to access good counsel to ensure that the deal isfair and does not violate the law.

"From a business standpoint, there are ways to acquirecompanies, whether partnerships or not, and to merge and combinethem, without violating this legislation," Keller said. "Ifyou have good counsel there's no reason why you should be preventedfrom combining or merging companies."