Are You Considering Selling Your Imaging Center or Practice? Or Merging With Your Healthcare System? Part 1 of 2

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Are You Considering Selling Your Imaging Center
or Practice? Or Merging With Your Healthcare
System? Part 1 of 2

• Richard S. Cooper, Esq.
• McDonald Hopkins LLC
• 600 Superior Avenue, E., Suite 2100
• Cleveland, OH 44114
• [phone]
• rcooper_at_mcdonaldhopkins.com
• mcdonaldhopkins.com

Kirk A. Rebane, ASA CFA Haverford Healthcare
Advisors 43 Leopard Road, Suite 102 Paoli, PA
19301 [phone] krebane_at_haverfordcapital.com
haverfordhealthcare.com
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• Learning Objectives

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• Outline a plan to develop a strategic framework
  to identify high potential arrangements, and use
  set processes to execute the integration strategy
• Explain the various impacts of health reform and
  ACOs on radiology and imaging providers and their
  catalyst for transactions
• Articulate strategic advantages and opportunities
  that can flow from the relationships forged
  through such transactions
• Develop a strategic framework to evaluate the
  merits of alternative buyers/partners,
  transactions and structures

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• General Business Issues that Drive a Radiology
  Organization to Consider a Sale or Merger

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• Improving market share to better leverage payor
  contracts
• Benefitting from economies of scale
• Increasing access to capital and technology
• Expansion of service lines
• Improved recruiting
• Ability to sub-specialize
• Ability to afford sales and marketing
• Ability to cross-train personnel
• Access to new customers and business

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• Macro Industry Drivers of Transactional Trends

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• Factors contributing to the record levels of
  healthcare industry MA activity and valuations
• Aging of the population In 2009, there were 39.6
  million people over age 65, representing 15 of
  the U.S. population and 1/3rd of healthcare
  consumption. By 2030, those over 65 years old
  will increase to 72 million.
• Diagnostic imaging remains an extremely valuable
  service that represents a very small percentage
  of healthcare expenditures, but influences a very
  large percentage of physician decisions.
• Despite years of consolidation, the diagnostic
  imaging industry remains highly fragmented.

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• Economic recovery Transactions that had been
  delayed by the recession have created a pent-up
  demand for acquisitions by buyers and an
  over-supply of willing sellers. The credit
  markets are continuing to thaw.
• Sellers will be motivated to sell prior to tax
  rate increases capital gains tax rates revert
  from 15 back to 20 on January 1, 2013. In
  addition, the 2010 healthcare reform legislation
  included an additional 3.8 Medicare Tax
  surcharge on investment income, so the capital
  gains rate will actually be 23.8.
• Big pharma, other large healthcare companies and
  foreign companies are entering/re-entering the
  domestic healthcare industry by paying top dollar
  for acquisitions.

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• New technologies are creating new markets.
• Private equity is attracted by the industrys
  strong fundamentals and the non-cyclical nature
  of the industry. 12 of private equity deals
  completed in 2011 were investments in healthcare.

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• Healthcare reform has created the need whether
  real or perceived for consolidation of
  providers and service lines into healthcare
  systems.
• Radiologists who are increasingly challenged by
  their private practices financial situation are
  turning to their hospitals in search of clinical
  integration, operational combinations and even
  employment.
• Not-for-profit hospitals have been experiencing
  extreme pressure on operating and non-operating
  cash flows, and have faced increasingly
  restrictive and expensive tax-exempt debt. Many
  hospitals continue to operate with negative
  margins.

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• Proposed budget cuts total more than 125 billion
  to 360 billion from Medicare, Medicaid and other
  health programs over the next ten years, forcing
  hospitals to continue to look for new sources of
  revenue.
• Traditional operational strategies to improve
  liquidity and generate capital, including revenue
  cycle improvements, expense reduction programs,
  operational efficiency efforts, and deference of
  capital expenditures, have been fully implemented
  in many cases there is no more cash to squeeze
  out for many hospitals. In addition, deferred
  capital investment in plant and IT will need to
  be satisfied at some point some cost cuts are
  unsustainable.

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• Not-for-profit hospitals that are not looking at
  expansion as the solution to healthcare reform
  instead are increasingly looking to capitalize on
  the hidden value in their non-core assets, such
  as the imaging center operations, with an
  objective of raising much-needed cash.
• The allocation process for scarce capital
  resources (including cash capital, management
  resources capital and space capital) can result
  in the classification of imaging operations as
  non-core.

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• Hospitals are seeking to monetize non-core and/or
  underperforming assets and service lines
  throughout joint ventures or outright sales
• Generates immediate and substantial cash proceeds
  for a healthcare system
• Can reduce a health systems ongoing cost for
  ancillary services
• Allows for the redeployment of capital both
  financial and human capital into more optimal
  strategic areas for the system
• Ensures the ancillarys offerings will be at the
  technological cutting edge
• Enables the avoidance of capital investment in
  the ancillary
• Preserves employment in the community, often
  critical to a mission statement
• Maintains or improves current service levels
• Lets management focus on core assets/business of
  the institution

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• From a buyers perspective, former hospital
  assets or service lines can be attractive for
  several reasons
• Third party specialty operators can often operate
  businesses more efficiently and profitably, with
  no degradation in quality, than a hospital
• Third party specialty operators often have lower
  cost structures, primarily due to wages and
  benefits
• Third party specialty operators often have a
  clinical expertise, and can demonstrate better
  clinical outcomes at lower costs than hospitals
• Hospital-oriented assets or service lines often
  benefit from a continuing referral stream of
  business
• The third party acquirer can still benefit from
  trading on the goodwill and name of the hospital,
  proactively through co-marketing and co-branding
• Therefore, we anticipate that healthcare industry
  deal activity and valuations will remain at their
  current high levels for the foreseeable future

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• The Impact of Healthcare Reform on Radiology and
  Imaging Transactions and Joint Ventures

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• Regardless of the ultimate fate of the Affordable
  Care Act, healthcare reform is becoming a
  powerful catalyst for consolidation and
  integration in the healthcare industry.

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• Healthcare reform will impact consolidation in
  several key areas
• Decreasing revenues Payment rates will decrease,
  indirectly encouraging consolidation by forcing
  healthcare participants to find new ways to
  decrease costs and increase negotiating clout
  with both suppliers and payors
• Increasing costs The cost of doing business will
  increase as healthcare entities spend more on
  compliance, technology and physician employment
• The ACO-type of model will encourage network
  formation and greater clinical integration by
  rewarding integrated healthcare systems that can
  reduce costs and improve quality
• Independent healthcare entities may have
  restricted access to payor contracts and patient
  populations

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• At least for now, the ranks of the insured are
  expected to rise dramatically as the political
  uncertainty over healthcare reform slowly
  changes. Focus on population management will
  drive providers to consolidate in order to
  integrate services, generate economies of scale
  and minimize leakage out of the system.
• The rise of ACOs due to healthcare reform are
  causing healthcare systems to acquire ancillaries
  and physician practices in an attempt to broaden
  and fill-out service line offerings and to
  ultimately create one-stop-shopping providers.

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• Historical reimbursement cuts, expected lower
  reimbursements in the future and tighter control
  over utilization have weakened the financial
  performance of many current industry providers.
  Finding a partner or a suitor may be the only way
  to salvage the business.
• Early detection can reduce downstream healthcare
  costs. Therefore, diagnostic companies such as
  imaging centers are seen as valuable components
  of an overall healthcare organizations strategic
  plan.

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• Providers must demonstrate to both government
  payors and commercial payors that they can
  provide high-quality care at a lower cost. There
  is a paradigm shift toward outcome measurement
  and evidence-based medicine. Such efforts will
  require not only a diverse array of service
  offerings within an organization, but also the
  financial strength and breadth of management to
  analyze and demonstrate outcomes.
• Larger organizations that have greater critical
  mass will be able to compete more effectively in
  this environment
• Larger entities can spread fixed costs over a
  broader revenue base
• Larger entities will have better access to
  affordable capital
• Larger entities will be better able to develop
  sophisticated systems that can measure quality
  and allow for sharing of best practices

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• Successful Transaction Requirements

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• Successful organizations understand their
  options, have developed a strategic framework to
  identify high potential arrangements and use set
  processes to execute the integration strategy
• Take an inventory of non-core and/or
  underperforming assets and service lines
• Determine the strategic implications of disposing
  of, or entering into a joint venture on, the
  identified assets and/or service lines
• For those assets and/or service lines that
  survive the strategic test, conduct a preliminary
  valuation in order to quantify the monetization
  opportunity

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• From a sellers perspective, it is important to
• Find the partner or buyer which is best able to
  meet your organizations strategic objectives
• Maximize the value and purchase terms of a
  transaction
• Minimize organizational disruption during the
  sale process
• Structure a process that facilitates regulatory
  approval
• Consummate a transaction which leaves a service
  line consistent with your mission statement

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• From a buyers perspective, it is important to
• Find the target best able to achieve your
  organizations strategic objectives
• Obtain the best possible price and deal terms
• Consummate a transaction which results in an
  organization consistent with your mission
  statement

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• The selling process should include
• An assessment of all strategic options
• Transaction planning and strategy development
• Development of acceptable confidentiality
  agreement
• Development of confidential information
  memorandum
• Development of acceptable buyer list
• Information exchange coordination and process
• Proposal evaluation and negotiation
• Due diligence coordination efforts
• Negotiation of definitive purchase agreements and
  ancillary agreements

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• The buying process should include
• Development of acquisition target criteria
• Transaction planning and strategy development
• Development of acceptable confidentiality
  agreement
• Target identification
• Assessment of strategic and financial
  implications to your organization with respect to
  each identified target
• Financing analysis
• Valuation and transaction structuring
• Development and negotiation of offer
• Due diligence coordination efforts
• Negotiation of definitive purchase agreements and
  ancillary agreements

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• Transactions Overview

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Type of transaction
Options Description Full Liquidity Future Control
Capital raise Raise money to expand No Yes
Recapitalization Sale of partial percent Some Some
Sale with equity Sale to larger company and reinvest Significant Minimal
Sale of 100 percent Sale of company Yes No
Joint venture Strategic partnering usually no take-out event No Depends on ownership percentage and terms
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Type of buyer
Type of Buyer Future Involvement Deal Terms Confidentiality Financing Other
Financial Consulting or employment required Equity reinvestment typical Price may be limited by available funds Rigid structure Less of a concern unless similar portfolio companies Cash flow Focused More certain to close Increased capital can aid growth and competitiveness Preserve name and legacy
Strategic Employment not required or shorter period May value higher based on synergies Tougher terms Greater concern Revenue Focused Less certain to close Greater disruption to business via transition Greater economies of scale benefits
Management Employment not required Flexible on terms and structure Less of a concern Limited financing Less certain to close Least disruptive
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Asset vs. stock
Type of Deal Buyer Perspective Seller Perspective Other Considerations
Asset Purchase Only assume specific liabilities Write-up value of assets get tax deduction Requires wind-up of business Greater tax on proceeds Transfer of licenses may be prohibited Use of 338(h)(10) election
Stock Purchase Greater liability risks may lead to lower value Better tax treatment Better liability protection Easier to execute Requires greater buyer due diligence
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Auction vs. targeted sale
Process Pros Cons Other Considerations
Auction Better value Better terms Loss of confidentiality Disruption to business Use of advisors and their skills
Targeted Synergies Less leverage Financing
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• ASRT Code
• VAD0052056
• AAPC Code
• 26338HKFCB