By Andrew Colbert

An abundance of capital available in the health care space has investors searching for hot opportunities. Hospital-based radiology groups have historically flown under the radar of investors, but the sector is starting to garner increased attention due to the convergence of industry tailwinds.

Key trends making radiology attractive
The radiology sector is both large and fragmented, two attributes that create tremendous opportunity for growth. In terms of size, the current annual hospital-based professional radiology market is an approximately $18 billion industry with expected 2 percent annual growth. Much of this growth is driven by technological advances that are increasing the number of cost-effective applications for diagnostic imaging and demographic trends. For instance, the over- 65 population, which was found to use 2.5 times more radiology than those under 65 by Radiology Business, is expected to grow 60 percent by 2030, according to U.S. Census 2014 national projections.



In terms of fragmentation, the largest independent hospital-based group has around 130 radiologists, which accounts for less than one-half of 1 percent of the nation’s more than 30,000 radiologists, meaning there are tremendous opportunities to gain economies of scale through consolidation. The majority of groups across the country are small and lack the back office capabilities and infrastructure that are required for success in today’s environment.

At the same time, health care reform is driving changes to care delivery and reimbursement models focused on improving outcomes, decreasing costs and increasing value for consumers. The focus continues to shift toward prevention and lower-cost care settings, and away from the traditional “fee-for-service” compensation model. One of the biggest opportunities presented by these reforms is an increasing focus on hospital-radiologist alignment models that push radiologists to more clearly define and demonstrate quality and be more proactive and consultative in the patient care process.

This will enable hospitals to be more efficient with better outcomes, and radiologists to focus exclusively on providing value-added, high-quality, 24/7 subspecialty services (such as a brain MRI at 2 a.m. being read by a neuroradiologist). But that doesn’t mean strategic growth through investment is a quick decision for radiology groups. There are a variety of alternative options to consider and numerous factors that can affect valuations and a successful deal closing. How can radiologists ensure their business is an attractive investment, and what should investors look for when evaluating potential platform investments?

From the provider’s perspective: An overview of strategic alternatives
The most crucial time for a practice to consider seeking investors or selling the practice is in the growth stage, when there is still substantial growth ahead of the company. While it may seem counterintuitive to consider financial options when the company is on an upswing, this is the time when companies can leverage future growth to ensure continued shareholder value creation. It’s also the time in a company’s life cycle where the company will have the most negotiating leverage in structuring a deal with a potential investor or buyer.

Radiology platforms that are well positioned in the market can consider a number of strategic investment and sale options, but they boil down to four main alternatives: sticking with the status quo; merging; seeking a private equity investment; or selling the practice. The first option — sticking with the status quo — minimizes disruption and preserves partner distributions, but presents two main concerns: potential threats from well-capitalized competitors; and limited financial resources to invest in required infrastructure and/or scale the business.

The second scenario is a practice merger with another provider group. This scenario has the potential to build scale, improve competitive positioning and increase access to liquidity options (debt availability, multiple expansion, etc.). Concerns with this option include the challenges inherent in integrating practices and governance issues due to an additional ownership base and limited resources to drive growth strategy (both in terms of financial and human capital).

Scenario three — taking a private equity investment — typically allows for shareholders to take some “chips off the table” while participating in future growth. This also increases resources to accelerate growth strategy (both financial and human capital) and brings additional advisors with guidance and strategic relationships to the table to help drive growth. The most commonly cited concern with private equity investments is discrepancies between the perspectives of legacy and new owners who may have differences in strategic vision and financial return objectives.

The final scenario for consideration is the sale of the practice. This option presents significant shareholder liquidity and premium valuation, offers additional resources to drive practice growth and strengthens a company’s market position from increased scale. It also has potential upside opportunities through stock and/or growth incentives. Challenges in this scenario include a reduction in annual distributions, differences in long-term strategic vision between the buyer and the seller and technical integration issues. A sale also leads to shareholders relinquishing ownership and a transition to an employee model, which requires full alignment of incentives going forward.

In scenarios two, three and four, choosing the right partner is crucial. Promising partnerships should promote business growth by allowing greater flexibility in changing environments and assist in faster growth, while at the same time presenting opportunities to bolster the management team and increase investment in technology and infrastructure to drive efficiency. The ideal partner will increase the company’s financial stability by creating a stronger mix of growth capital and liquidity, generating opportunities for upside potential and increasing adaptability of the business model. While price is an important factor, equally important should be considerations such as the partner’s experience growing similar businesses, relationships with hospitals and other industry players, commitment to service quality and patient care, preservation of physician culture and long-term employment and the ability to minimize competitive issues and disruptions to ongoing business.

Practice vs. platform
Physician groups need to appreciate that there are a number of key factors that differentiate practices from platforms. To command a premium valuation, physician groups must distinguish themselves as a true platform, built for scale and commanding strong growth potential that investors find desirable. Investors and buyers looking for attractive radiology sector “platforms” determine valuation based on the following key attributes:

Market dynamics: Attractiveness of the market and growth opportunities for the company, as well as where the company is positioned in the competitive landscape.
“Best of breed” perception: “Stickiness” and quality of hospital and client relationships, clinical capabilities and quality measurements, technology investments in data analytics and workflow and the ability to navigate the transition to value-based reimbursement. Is the company perceived as a leader in the market?
Company financials: A company with proven financials, including historical and projected revenue growth and a strong revenue mix/ diversification, will command a significantly higher valuation.
Management team: A strong management team with depth of experience and promising administrative staff and mid-levels will positively influence the valuation a company receives and its attractiveness to investors. Is the management team backable by outside investors?
Preparation: On average, about 20 percent of a company’s value is driven by the organization’s ability to clearly and concisely tell its story to investors. This includes effectively positioning the company in the market, sharing the company’s growth story and creating a bulletproof accrual basis financial model. This is where the importance of choosing an investment banker with a proven track record of advising radiology groups is critical to success.

Best practices to achieve an optimal outcome
While any transaction is a complicated process and no two situations are the same, there are some key steps companies can take to increase the likelihood of success.

The first stop on the road map is choosing the right advisors. In addition to an experienced investment banker (ideally one who has deep experience advising other radiology groups), the team should include an attorney with M&A experience who specifically understands the complexity of management services organization structures, as well as an accountant or tax expert with national scope.

As a second step, the company should complete a strategic objectives assessment with its advisers to evaluate various transaction alternatives, and work with its investment banker to build a detailed financial projection model that will hold up to intense investor scrutiny. Deal structures should explore near-term versus long-term liquidity, go-forward role, incentives and commitments of management and founders and corporate governance structure and rights of retained ownership, if applicable. Together, the team should determine a list of potential partners that share a common vision and strategy with the practice.

Next — and arguably most importantly — is creating a compelling story that highlights what differentiates the company or platform from other radiology groups in the market. In addition to sharing the positives, the team should create a list of potential issues that may arise in the due diligence process and develop strong responses to get ahead of any potential investor concerns.

Finally, companies need to ensure their house is in good order. This means organizing contracts and preparing a master summary; reviewing all legal, financial and operational documents to ensure consistency and completeness; and preparing for detailed reviews of human resources policies and benefits, technology infrastructures and billing and coding procedures. This is an unprecedented time for growth in the radiology industry. With investors paying attention, now is the time for radiology groups to understand their valuation, review their alternatives and explore opportunities to strengthen their market position.

About the author: Andrew Colbert is a managing director and founding member of Ziegler’s Healthcare Services & IT Corporate Finance Practice. Colbert has represented seven radiology groups on innovative transactions. He specializes in advising physician groups on strategic and financing alternatives, including mergers and acquisitions, capital-raising transactions and partnership development.