Imaging Center Valuation: What is Your Facility Worth?
While recent imaging center deals indicate valuations all over the board, there are reasons why some centers command top dollar and others reflect fire-sale prices. Easy answers to the question of imaging center valuation abound, but are they the right answers? Los Angeles-based RadNet’s market value of invested capital (MVIC), defined as the sum of the market value of debt and equity, represents 10 times the trailing 12 months’ earnings before interest, taxes, depreciation, and amortization (EBITDA). Should your facility also be worth a 10 times the trailing 12 months’ EBITDA? Assuming that Wall Street continues to value a public company at a given figure after the acquisition, an acquisition at half of that figure results in an addition of the acquisition price times the target EBITDA in value for the public company. As long as public companies continue to operate the target businesses at similar levels of profitability and the arbitrage (the difference between the public company’s multiple and acquisition multiples) holds, the value proposition is strong. For your imaging center, though, this means that its value as a multiple of EBITDA is more than likely to be something significantly less than RadNet’s multiple. Perhaps, then, the recent acquisition of MedQuest, Alpharetta, Ga, and its 95 imaging centers by Novant Health, Winston-Salem, NC, can be used as a guideline for the value of your facility. In August 2007, MedQuest announced that it would be acquired by Novant for more than $400 million. Novant’s assumption of MedQuest’s debt ($360 million) and additional cash ($45 million to $80 million) represent a multiple of approximately 12 times the trailing 12 months’ EBITDA. Novant is a not-for-profit integrated delivery system with hospitals, physician practices, and imaging centers that provide services to residents in counties reaching from southern Virginia to northern South Carolina. While there certainly must be significant strategic value to Novant’s acquisition of MedQuest—given that a significant portion of MedQuest’s centers are located in the states of Virginia, North Carolina, and South Carolina (where Novant has a significant market share), where certificates of need (CONs) are relatively difficult to obtain—it seems to be only a remote possibility that the fact pattern in this transaction and these strategic considerations should be applied to your particular center. The experience of VMG Health, Nashville, Tenn, in imaging-center transactions indicates that most smaller singleor multiple-facility transactions occur at a price range of three to five times the EBITDA. As such, VMG Health would generally view Novant’s purchase of MedQuest at 12 times the EBITDA as an outlier, rather than a relevant guideline transaction. From this initial discussion, then, one presumes that the value of your imaging center as a multiple of EBITDA is likely to be something significantly less than the multiples of the publicly traded imaging companies, is probably something significantly less than the multiple paid by Novant for MedQuest, and may be in the range of three to five times the EBITDA. This leaves us a fairly broad range of multiples that might be applied to your imaging center. Where does the value of your imaging center lie within this range? Based on recent experience, it is not unusual for the effective multiple resulting from a comprehensive valuation of an imaging center to be above or below this range. Some of the factors to be analyzed in determining the value of an imaging center. Valuation Approaches A multiple of EBITDA is not the only approach, and may not even be the most relevant approach to be relied on in forming an opinion of value. Generally accepted valuation practice requires consideration of all relevant approaches to value. In performing a valuation analysis, three generally accepted methodologies are considered: the cost approach, the market approach, and the income approach. The cost approach takes into consideration the cost of replicating a comparable group of assets or a business with the same level of utility. The market approach estimates value by comparing the value of similar businesses traded in a free and open market with the value of the subject asset. This value can be estimated by adjusting the market value of the similar assets or businesses for qualitative and quantitative differences. The income approach estimates value by analyzing historical financial information in order to estimate the future level of cash flows generated by an asset or group of assets. The present value of these future cash flows represents value to an investor. Once the appropriate return is estimated, the cash-flow stream is then discounted (or capitalized) to present value using the investor’s appropriate rate of return. The cost approach is most often used in situations where the levels of projected earnings or cash flows of the imaging center used in the application of the income approach and/or the market approach yield a value that is less than the value of the tangible and identifiable intangible assets. Tangible assets include equipment and net working capital. Identifiable intangible assets include items such as CONs and trade names. In the context of the cost approach, identifiable intangible assets may have value if they are transferable and separately marketable. The methodology most commonly used in the application of the cost approach is the buildup methodology. Using this methodology, the balance sheet or book value of the portfolio of tangible and intangible assets is adjusted to represent the value of the assets either in place and in use or, perhaps, in orderly liquidation. Within the cost approach or buildup methodology, the process of adjusting the individual assets or groups of assets may, in practice, involve the application of all three approaches to value. Should the total indicated value found through the application of the cost approach be less than the indicated values from the application of the market approach and the income approach, a valuation opinion may not place any reliance or weighting on the indicated value from the cost approach. Should the total indicated value from the application of the cost approach exceed the indicated values from the market approach and the income approach, however, a valuation opinion may rely solely on the indicated value from the cost approach. In the valuation practice of VMG Health, the application of the income approach in valuing imaging centers most commonly takes the form of the discounted cash-flow methodology. Using this methodology, the total value of a business is based on the projected cash flows of the business, discounted back to present value at the investors’ required rate of return or discount rate. Cash flow equals net income plus depreciation and amortization, minus capital expenditures and incremental working capital. While noncash charges such as depreciation and amortization and incremental working-capital requirements are indeed drivers of cash flows for imaging centers, the impact of these items on cash flows is fairly minimal, and is generally less variable from center to center, relative to net income and capital expenditures. As for any business, net income for imaging centers is driven by volumes, pricing (or reimbursement levels, in the world of health care), and operatingexpense levels. When projecting volumes, pricing, and operating-expense levels that in turn determine net income levels, the valuation analyst has to avoid the trap of simply looking at each of the inputs in isolation, without consideration of how the assumptions made might affect the other inputs. For example, while the market for total MRI may be growing at population growth plus 6% to 9%, can the imaging center’s facility and existing equipment accommodate the level of growth needed to maintain market share? Perhaps, to achieve this growth, the center will need to extend its hours or purchase additional equipment. With this caution in mind, the figure (page 51), while not exhaustive, represents some of the primary factors to consider in analyzing historical data and projecting volumes and reimbursement by modality. Capital Expenditures Another factor that has a major impact on the projected cash flows of this relatively capital-intense business is the level of capital expenditures. Two centers with the same level of net income may have vastly different cash flows and valuations, depending on where they are on the timeline of equipment purchases or replacement. An imaging center that has recently purchased equipment may have a significantly higher indicated value from the discounted cash-flow method than an imaging center that is using equipment that is approaching the end of its useful life. Once again, the level of capital expenditures included in the projections must be consistent with the volume projections. Some of the factors to be analyzed in determining the value of an imaging center. In addition to the importance of properly reflecting capital expenditures in the defined projection period (typically five years), it is critical that capital expenditures in the terminal year reflect levels that allow the imaging center to maintain volumes in perpetuity. In a discounted cash-flow model, the present value of the first five years typically represents 50% of the total indicated value. The remaining 50% of the total indicated value is the present value of the terminal year. Accordingly, the level of capital expenditures in the terminal year is critical to an accurate indication of value. Another factor to be considered in the projection of capital expenditures is the presence of equipment operating leases in the operating-expense profile of the imaging center. While some imaging centers that VMG Health has valued have consistently maintained rolling operating leases that are included in the operating expense profile (and plan to continue to maintain operating leases, going forward), others have modified equipment-leasing or purchasing plans based on changes in reimbursement and the competitive environment. If an imaging center plans on purchasing the equipment at the end of the operating lease, the purchase price must be reflected in projected capital expenditures. It should also be noted that since operating lease expenses are included above the line in the operating expense profile, the resultant indication of value may be somewhat distorted as a multiple of projected EBITDA. Because the income approach, and specifically the discounted cash-flow methodology, provides a framework for quantifying expected changes in volumes by modality, reimbursement by modality, and the operating-expense profile and capital expenditures, VMG Health believes that the indication of value derived from the income approach is superior to that derived from the market approach. As a result, the company typically relies primarily on the income approach in forming its valuations. Since VMG Health is relying on the income approach as the primary indication of value for an imaging center, it is generally reliant on the market approach as a secondary indicator. The effective MVIC/EBITDA multiple for the valuation of an imaging center typically falls within the range of three to five, but it is not at all unusual for the effective MVIC/EBITDA multiple from the indication of value produced by the discounted cash-flow method to be distorted due to specific facts and circumstances that can be accounted for in the application of the income approach. While EBITDA is often used as a proxy for cash flows and MVIC/EBITDA multiples are the most common measurements used in the imaging sector and other sectors of health care, caution is called for in using this simple application, for a variety of reasons. Historical or even projected EBITDA for a given imaging center may not be representative of long-term, sustainable cash flows. Required capital expenditures are a significant consideration in the valuation of an imaging center. EBITDA, by definition, does not include any consideration of the relative level of required capital expenditures. Other common adjustment considerations in analyzing historical and projected EBITDA include future reimbursement changes (generally downward) not reflected in historical EBITDA, the possible absence of maintenance costs for equipment under warranty, and operating leases. There may be substantial differences in the risks associated with achieving projected EBITDA levels when comparing an imaging center with a publicly traded imaging provider or a selected guideline transaction. The growth implied by a given MVIC/EBITDA multiple may not be representative of expectations for the subject imaging center. In regard to the potential differences in risk and growth and their impact on valuation multiples, one might compare the single-period component of the discounted cash-flow method that is used to calculate the terminal value. Where cash flow is projected to grow at a constant rate, value equals cash flow divided by the capitalization rate (the discount rate minus the growth rate). A multiple is simply the inverse of the capitalization rate. The multiple is inversely related to the discount rate and positively related to the growth rate. It is essential to match the discount rate to the earnings stream being capitalized. To be applied to EBITDA, the discount rate would be converted to a proper discount rate for EBITDA. In this case, value is determined by dividing EBITDA by the EBITDA discount rate minus the EBITDA growth rate. Assuming that the percentage relationship between cash flow and EBITDA remains constant when comparing the subject imaging center to a guideline transaction, the multiples provided by the guideline transaction can, theoretically, be applied. Based on VMG Health’s experience, however, the relationship between cash flow and EBITDA may vary substantially. If cash flow for the subject is a different percentage of EBITDA, as often will be the case, the multiple of EBITDA would also need to be adjusted using either cash flows or EBITDA. In addition, there is no mechanism to adjust for differences in the timing of required capital expenditures or growth that can be accommodated by the discounted cash-flow method using a multiperiod model. VMG Health has concluded that the income approach is generally superior to the market approach and is, more often than not, relied on as the primary indication of value. What is your facility worth? It is worth the present value of future cash flows, which may or may not be in the range of three to five times the EBITDA. A comprehensive valuation analysis that takes into account the specific facts and circumstances of your center, performed by an independent third party, may be the best place to start.