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COVID-19’s Impact on Imaging Operations and Valuations
The defensive measures that the federal and local governments have taken to combat the rapid progression of the Coronavirus Disease (“COVID-19”) in the United States has had a significant impact on diagnostic imaging centers (“Imaging Centers”), along with every sub-sector within the healthcare industry. This article shares VMG Health’s outlook on both short and long-term operational risks facing Imaging Centers and addresses how these factors may affect impending valuations. It should be noted that this is a very fluid time and viewpoints can quickly become antiquated.
First, it is important to consider the relevant published guidance regarding prioritizing medical care. On March 18th, the Centers for Medicare & Medicaid Services (“CMS”) announced at the White House Task Force Press Briefing, “all elective surgeries, non-essential medical, surgical, and dental procedures be delayed during the 2020 Novel Coronavirus (COVID-19) outbreak” consistent with Centers for Disease Control and Prevention (“CDC”) guidelines. CMS proposed a tiered framework to prioritize care and to protect against further spread of the virus. Subsequently, the American College of Radiology (“ACR”) published guidance related to COVID-19. Per the guidance, “The ACR fully supports and recommends compliance with the Centers for Disease Control and Prevention guidance that advises medical facilities to “reschedule non-urgent outpatient visits.” This includes non-urgent imaging and fluoroscopy procedures, including but not limited to: screening mammography, lung cancer screening, computed tomography (CT), ultrasound, plain film X-ray exams, magnetic resonance imaging (MRI) and other non-emergent or elective radiologic and radiologically guided exams and procedures. Radiologists should work with their referring physicians to review and reschedule such exams.” We have seen this guidance play-out real-time with our Imaging Center clients as many had already begun rescheduling truly elective procedures and performing medically necessary/urgent procedures only. On April 16th, the White House released guidelines for “Opening Up America Again.” Based on the guidance provided, this will be a three phased approach whereby if certain gating criteria are met by states and regions, they can begin to open up the healthcare industry to elective scans. The first phase will include opening up outpatient facilities while phase two will be to open up inpatient facilities.
Imaging Centers have long been desirable for radiologists, health system, and corporate investors because they tend to generate consistent cash flows and distributions. In addition, increased payor pressure, pricing transparency, and CMS guidelines have created a shift in volume from hospital-based imaging to truly freestanding imaging centers. It is important now more than ever for valuation firms to be diligent when examining the historical and future operations of an imaging center with management because these discussions will be invaluable in analyzing the probability of projected outcomes. While undertaking a valuation during this pandemic can prove challenging due to the uncertainty, cash flow and risk of achieving the projections can be appropriately managed in the short and long-term to derive a value that is reflective of these challenging times.
As it relates to expected cash flow generation and related projection risk, COVID-19 will undoubtedly impact both. Although expected cash flow and projection risk are related, we will address them separately starting with the impact to cash flow:
Expected Short-term Cash Flow Impact (6 months or less):
- Collectively, the points addressed in this section are likely to create discussion on whether transactions should be suspended for a period of time while the markets stabilize and there is a clearer outlook on the normalcy of elective procedure volume. Conversely, in certain scenarios, it may be appropriate or necessary to move forward with providing a valuation of an Imaging Center and reflect these relevant risks.
- Decrease or complete removal of elective procedures. Presently, Imaging Center leadership, radiologists, referring physicians, and patients are making the subjective determination of which procedures to postpone and which to schedule. Certain Imaging Centers may see less impact due to the focus on more urgently required scans and COVID-19’s impact on their specific marketplace, while other Imaging Centers may be impacted greatly due to the high focus on scans deemed more truly elective. Anecdotal evidence from our clients suggest scan volume is currently 50-80% below expected levels with certain Imaging Centers effectively shutdown.
- The duration of cash flow disruption is critical. Does business interruption last 2 weeks or does it last 2 months or longer?
- The scale of cash flow reduction will also be impacted be geography. In locations where non-essential travel outside of the home is restricted, there will be greater reduction in volume versus markets with less stringent restrictions. Concentrations of COVID-19 will also differ by location which will result in geographical variations.
- Levels of bad debt are expected to increase as patients seek to defer payment due to pervasive financial pressures.
Long-term impact on Imaging Operations (6 months or more):
- For nearly all Imaging Centers, postponed elective scans are expected to eventually return. However, the rate at which these postponed scans are recaptured will depend on each individual center and their capacity. Most likely, these scans will be recaptured over an extended period.
- Local economic impacts will result in higher unemployment and longer-term impact to historical payor mix.
- Many Imaging Centers will require short-term credit facilities to survive. Imaging Centers have relatively high fixed costs relative to other healthcare subindustries due to their capital-intensive nature. Imaging Centers are required to cover rent, maintenance contracts, and equipment lease expenses while the cash received from patient services is likely dwindling due to a reduction in volumes. Over the long-term, these Imaging Centers will be required to service this credit, thus reducing cash flow.
- Imaging Centers that can, may participate in government programs. Certain portions of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) have effective loan and grant programs for healthcare providers. The timing of receiving the grants may be uncertain and the loans will require repayment.
- Reduction in consumer spending – due to increased levels of unemployment and destruction in personal wealth, consumers may delay having elective scans/procedures for an extended period of time that they otherwise would have had pre-COVID-19.
In addition to more discrete, quantifiable impacts to value, unknown risks exist that present challenges to projecting distinct financial and operational forecasts. The immeasurable risk factors that affect value include:
- The potential that the duration of volume impact of the pandemic materially exceeds that which is projected in the value.
- Potential (or likelihood) of a resurgence of the outbreak following what is hopefully an initial containment.
- Level of disruption to supply chains impacting personal protective equipment (“PPE”), drugs and medications and other supplies necessary for everyday imaging operations.
- Capital market and the availability of debt. Given the capital-intensive nature of imaging centers, how will the availability of debt and terms around the debt be impacted for equipment purchases and buyers in transactions?
- Timing of the economic return to “normalcy.” How long will COVID-19 prevent Imaging Centers from performing elective scans/procedures in the short-term and how long will the return to pre-COVID-19 operations take?
- Buyers appetite for risk and required returns. Have the volume impacts and stock market volatility adjusted market participants view of imaging industry risk leading them to demand higher rates of return resulting in lower transaction values?
These immeasurable risk factors are best accounted for in the discount rate as a valuation expert will be unable to discretely capture the inherent risk in the projected cash flows. Given the extent of these uncertainties, the risk profile of an Imaging Center investment at the present time should be considered elevated.
As the pandemic continues to unfold and federal and local policies change, COVID-19 will undoubtedly continue to impact the short-term and long-term operations of an Imaging Center. The COVID-19 impact will not be identical for all Imaging Centers due to specific risk factors, geographical market dynamics, and the respective valuation date. Therefore, determining the known or knowable COVID-19 facts and circumstances as of the valuation date as well as examining the probability of short and long-term risks with management will be the foundation to appropriately projecting an investor’s future returns.