Historical Review of Mergers and Acquisitions in Diagnostic Imaging
From the go-go years to the present, acquisition strategies in the outpatient diagnostic imaging field have not always worked As we sit on the precipice of a meltdown in the credit markets, I am reminded of a quote from Winston Churchill: “Those who forget history are bound to repeat it.” In 1998, a hedge fund called Long Term Capital Management (LTCM) bought securities using approximately $30 of debt for every $1 of equity, and eventually owned a portfolio valued at $125 billion (not including its assets off the balance). Later that same year, the Russian bond crisis set off a chain of events that precipitously reduced the value of LTCM’s portfolio, quickly eroding its equity value and thereby requiring massive write-offs. The Federal Reserve invited the large Wall Street companies to its headquarters to devise a bailout strategy, for fear that the failure of LTCM would negatively affect the credit markets. Does this sound familiar yet? As a result, 13 companies participated in a $3 billion bailout of one hedge fund. The only two companies that did not participate, because it was too risky, were Bear Stearns and Lehman Brothers. Had the heads of these two companies dusted off the credit analysis used in evaluating the LTCM bailout and applied it to their own balance sheets in 2008, they might very well be going concerns today. Merger-and-acquisition activity in the diagnostic imaging industry has often suffered from the same selective amnesia. Perhaps the repetition of some bad history can be avoided through the review of mergers and acquisitions in diagnostic imaging over the past 15 years. The timeline from 1993 to 2008 (see figure) is divided into five distinct periods: the go-go years, the Balanced Budget Act and multiple arbitrage fallout, the days of cheap credit, the DRA and the overbuilding hangover, and the revenge of the operator. 1993 Through 1997 The go-go years: The original Stark law was enacted in 1989 and prohibited self-referrals only in clinical laboratory services. In 1993, an amendment was made to the Stark law (Stark 2) that went beyond clinical laboratory services and into several other health care services, most notably diagnostic imaging. With the stroke of a pen, Congress unwittingly catalyzed the creation of the modern diagnostic imaging industry.
The need for industry consolidation has never been greater; diagnostic imaging unit growth is increasingly scrutinized, radiology benefit managers are gaining more influence, and reimbursement cuts always loom. To succeed, diagnostic imaging companies need programs of mergers and acquisitions to increase their regional market presence and squeeze operating efficiencies out of the system.When looking at an acquisition, the operator first asks whether the target fits into its business strategy. With the ever-increasing influence of radiology benefit managers and continued pricing pressure from managed care payors, diagnostic imaging companies need to cluster their centers in geographically defined markets in order to maintain some balance of power. In addition, hospital companies, hoping to diversify their revenue bases in the outpatient sector, are expanding their footprints within their markets by acquiring diagnostic imaging centers. Financial engineering and multiple arbitrage, while nice to have, no longer drive the acquisition decision. Today, operating strategy and market presence do. This new era is made evident by the two most notable transactions in the sector this year: Memorial Hermann Healthcare System’s acquisition of River Oaks Imaging and Diagnostic and CML HealthCare’s acquisition of American Radiology Services. Memorial Hermann, which is one of the largest hospital systems in Houston, acquired River Oaks to increase its presence in the diagnostic imaging market, thereby providing its patients with a greater number of access points. CML, a Canadian company, obtained an important beachhead in the US diagnostic imaging market through the acquisition of American Radiology’s cluster of Maryland centers. While financial metrics were important in these acquisitions, they were not the only considerations. For another bright spot in this era, private equity companies are hoping to re-enter the industry, since they believe in the long-term viability of the industry and its need for consolidation. This time, however, they are focusing their due diligence on operational efficiencies and growth strategies, not just short-term financial synergies. Conclusion The need for industry consolidation has never been greater; diagnostic imaging unit growth is increasingly scrutinized, radiology benefit managers are gaining more influence, and reimbursement cuts always loom. To succeed, diagnostic imaging companies need programs of mergers and acquisitions to increase their regional market presence and squeeze operating efficiencies out of the system. Over the years, there have been acquisition strategies that have worked and others that have not. Those that have not have typically been based solely on financial metrics, such as multiple arbitrage or interest-rate synergies. There has also been a temptation to acquire diagnostic imaging businesses using too much debt. Just because the bank is willing to lend it does not mean it is the proper amount. Remember Lehman Brothers and Bear Stearns. The companies that will be able to navigate in the ever-changing sea of diagnostic imaging are those that can grow through acquisition, but focus first on operational integration and synergies. If those are done properly, creating value will surely follow over the long term.