Diagnostic Imaging Financial Due Diligence: 5 M&A Considerations

March 25, 2020

Consolidation within the healthcare services industry continues across multiple sectors. Private equity firms with large amounts of uninvested capital are increasingly looking to healthcare service businesses across many subindustries for investment, while health systems are seeking investment in outpatient businesses for integrated delivery models and payor pressure. This attention may increase transaction multiples for desirable investments, which in turn magnifies the effect of reporting mistakes and neglected risks on deal price. We’ve observed and advised clients on numerous risks in contemplated investments across many subindustries, and diagnostic imaging deals require unique focus to ensure you achieve favorable close terms and deal pricing. Based on our experience, here are five key financial due diligence considerations for your next diagnostic imaging acquisition:

1. Understand professional read fee agreements

The target may have professional read fee contracts with multiple radiology groups depending on the target’s geographic footprint. Be sure to understand the read fee rates in each contract and whether any change-in-control provisions exist, meaning the contract may have to be renegotiated post-transaction. Also, care must be taken to ensure any read fee arrangements with radiologists are within fair market value and appropriately accounted for on the subject business’s financials.

2. Test assumptions behind attorney lien revenue accruals and accounts receivable

Diagnostic imaging centers may have revenue from attorney lien scans (also known as letter of protection scans), which allow victims of personal injury to obtain medical care without having to pay until their case is settled. The imaging center does not receive payment until the subject case is settled, which can take several years. The lengthy collection cycle for attorney lien scans means that a target likely has a significantly aged attorney lien accounts receivable balance and that a target’s accrual methodology is likely based on data that is several years stale. Review target management’s methodology and accrual rates behind reported attorney lien scan revenue and accounts receivable for any outdated assumptions. Analysis such as a cash waterfall or a zero-balance account review should be conducted and compared to management’s estimates to gain comfort over reported attorney lien scan revenue and accounts receivable. Depending on management’s methodology of accruing for attorney lien revenue, earnings may be adjusted upward or downward.

3. New equipment is great, but the target’s P&L may not reflect run-rate maintenance expenses

The target recently upgraded several of their MRIs—great! However, consideration must be given that the new equipment may be under warranty or in a maintenance-free period, meaning the P&L may not accurately reflect the go-forward maintenance expense post-acquisition. Inquire about any equipment that is under warranty or in a maintenance-free period during management discussions to identify additional maintenance expenses that must be adjusted to reflect normalized earnings.

4. Consider the effect of deferred capital expenditures on deal price

Diagnostic imaging businesses are capital intensive with significant ongoing capital expenditure requirements. Having current equipment and software impacts a subject business’ ability to remain competitive in the marketplace through scan efficiency and maining scan volumes from referral sources. It is important to understand whether the target has deferred necessary capital expenditures such as replacing outdated equipment, neglected software upgrades, and overdue repairs. You may consider such deferred capital expenditures to be debt-like and use this information in your negotiations.

5. Implementation of appropriate use criteria (“AUC”) and clinical decision support mechanisms (“CDSM”) for Medicare Part B diagnostic imaging services

The Centers for Medicare & Medicaid Services implemented a voluntary program in July 2018 that required ordered Medicare Part B diagnostic imaging services to consider AUC through CDSM tools. Participation in this program will be mandatory in 2021. Consider what capital expenditures and training may be needed to prepare for the full implementation of this program in 2021. Depending on the target’s preparation for the implementation or experience with similar managed care programs, scan volume and reimbursement for governmental payors may be impacted.