January 18, 2017 - 9:33pm EST by
2017 2018
Price: 6.10 EPS 0.31 0.41
Shares Out. (in M): 46 P/E 19.7 14.7
Market Cap (in $M): 284 P/FCF 5.3 5.1
Net Debt (in $M): 638 EBIT 73 80
TEV ($): 922 TEV/EBIT 12.7 11.5

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  • Highly Leveraged
  • Deleveraging
  • Regulatory Headwinds
  • Regulatory Change
  • deepvalue



Investment Thesis: RadNet is a good business trading at a cheap valuation - currently trading at 6.7x 2016e FCF. The Company is a dominant player in the freestanding diagnostic imaging industry. This is a defensive business which should continue to organically grow in the low-to-mid single digits and generate strong cash flow – which will likely be used to pay down debt and make acquisitions. The opportunity exists because of the uncertainties around the outcome of the Affordable Care Act under the Trump administration, 8 years of continually declining reimbursement rates by Centers for Medicare & Medicaid Services (CMS) and the company’s debt level (currently at 4.7x net debt to 2016 EBITDA).

Going forward, growth should continue to be moderate – 0-2% volume growth complemented by 1-3% pricing growth from private insurers – with upside from industry consolidation (which is not in our numbers). This is a high fixed cost business with high incremental margins on additional volumes. The company targets less than 4x leverage by the end of 2017 while still growing the business through non-organic venues. RDNT has ~$30M of accounts receivables that were not collected in Q3 due to a retroactive rate increase negation with one of its large payor in the east coast - we expect this will be collected in Q4 and used to pay down debt.

Business Overview: RDNT is a freestanding outpatient imaging center. The company operates 306 centers (in CA, DE, FL, MD, NY, NJ, RI) in which it provides imaging services like MRI, CT, ultrasound, X-ray, mammography, etc.

  • Imaging Equipment Count by State:
    • CA: 659 
    • MD: 437
    • NY: 416
    • NJ: 119
    • DE: 56
    • FL: 23
    • RI: 16
  • Payment By Modalities:
    • MRI: 34.8%
    • CT: 15.8%
    • PET/CT: 5.0%
    • X-ray: 9.2%
    • Ultrasound: 12.3%
    • Mammography: 16.5%
    • NucMed: 1.2%
    • Other: 5.2%
  • Payor Mix:
    • Commercial Insurance: 55%
    • Medicare: 21%
    • Capitation: 12%
    • Workers Comp/Personal Injury: 4%
    • Medicaid: 3%
    • Others: 5%

Their scale and operating model enables them to be the low-cost provider – a critical advantage in a cost sensitive third-party payor system. RDNT benefits from 1) its regional density, 2) its negotiating leverage with private insurers and equipment suppliers, 3) its quality equipment and radiologists, 4) its superior margins and 5) its ability to provide capitation services.

How do they make money?  Generally speaking, a physician will refer a patient to go to RDNT and get the needed imaging (i.e., MRI, CT, X-ray). RDNT’s technologist will prepare and perform the required exam. RDNT’s contracted radiologist will then interpret the image and create a report that will be sent back to the referring physician. Once the report is delivered, they will bill the insurance company. RDNT offers this service at a fraction of what hospitals charge (~$3K vs ~$0.5K for an MRI at RDNT). Historically, hospitals got away with charging such higher rates because insurance companies wanted to remain “in-networks”. Insurance companies are willing to pay high rates for ancillary hospital services like imaging in order to extract lower “in network” rates on more frequent and more expensive operations like surgery.  The cost of operating and staffing hospitals with 24-hour availability is also much higher than freestanding centers that are open ~8am–6pm.  Given the option, both payors and patients (with lower deductibles) would prefer the lower cost providers like RDNT.

The company generates its revenue from fees charged for the diagnostic imaging services performed at its facilities.  RDNT’s key value propositions are:

-    For the patient: Convenient one-stop shops (multiple locations and multi-modalities) and quality service at a much lower cost. Easier to access (vs a large hospital with large parking lot, with multiple wings and floors). Primary drivers of patient choice are 1) referring physician preference, 2) location, 3) reputation, 4) accepted insurance, and 5) technology. RDNT is also a cheaper option for patients that are paying out of pocket.

-  For the physician: High quality and efficient imaging service, best equipment/technology and relationships with expert radiologists. Referring physicians primarily care about the quality of interpretations, followed by - turnaround time, reputation, location, and insurance plans accepted.

-     For the payor: Significant cost savings compared to hospital imaging centers (which are ~3x-4x higher). RDNT is also the only imaging center to provide exclusive managed care capitation arrangements with medical groups.

Given the decade-long reimbursement rate cut (more on this below) from CMS, diagnostic imaging centers have generally been out of favor for investors.  In the meantime, RDNT has prospered at the expense of smaller, less capitalized imaging centers. The three primary advantages of RDNT’s business model are:

(1)    Regional Rollup Strategy: In addition to organic growth, RDNT acquires smaller “mom-and-pop” operators at 3-4x EBITDA. Why? About 10-15 years ago, when the reimbursement rates for imaging were more attractive, several (~6,000) small imaging centers were started by entrepreneurial physicians. Given the current economics – where CMS has been cutting rates over the past 8 years – these centers are struggling to stay solvent. Thus, some of these centers are approaching RDNT to be acquired. RDNT has acquired over 135 centers since 2011. This “buyer’s market” has and continues to present RDNT with an opportunity to acquire centers at ~3-4x multiples. While the stated deal multiples are low, it’s worth noting that RDNT invests capex, post-acquisition, buying advanced imaging modalities (MRI, CT and PET/CT) into the acquired (which might be a single or two modality) centers.  This capex is one of the reasons that historical FCF has been low and debt paydown has been slow. Excluding this growth and post M&A capex, maintenance capex should be ~$30M a year.

Post-acquisition, by adding different/advanced modalities into these centers, RDNT can drive more volumes and quickly realize revenue and margin synergies. In addition, leveraging its scale and concentrated regional network, RDNT has the strategic advantage to renegotiate rates with insurance providers, purchasing equipment at a discount, and having a large enough presence to potentially provide capitated business.

They typically take out a turn of EBITDA worth of cost synergies on the centers that they acquire. Fundamentally – they can offer the same service at a lower price (they have scale – buy machines at a discount; they have location – more convenient; they have larger facilities which allow for higher returns on capital since they absorb more volume; they can leverage their relationships with hospitals and doctors; and they can leverage insurance provider to negotiate higher rates.

Over the past decade, revenue and cost synergy benefits were offset by CMS rate cuts and growth investments. In a relatively flat reimbursement environment, we expect to see margin improvements.

(2)    Scale and Multi-Modality: RDNT’s scale coupled with its multi-modality (MRI 35% of revenue, CT 15%, PET/CT 5%, X-ray 10%, Ultrasound 12%, Mammography 15%, Others 8%) strategy offers revenue diversification and enables centers to meet different needs (i.e., MRI, CT, X-ray) of referring physicians. By having multiple modalities, RDNT can meet the different needs of a physician in one center and become the imaging center of choice for that physician. This is key because most of RDNT’s volume come from physician referrals. Physicians care about report quality and getting their patients scheduled as fast as possible. Patients care about cost, convenience and quality service. Insurance/payors care about the cost of imaging. As RDNT continues to consolidate this fragmented market, it will have more centers near its patients, schedule more imaging and provide reports to physicians promptly, as well as provide significant saving to the payor system.  

(3)    Capitation Business: RDNT is the only imaging service provider with exclusive capitated program (12% of revenue) with prominent medical groups in CA. Management is currently in active discussions to expand its capitated business to the east coast market – we expect to see these discussions come to fruition over the next 3-9 months. Growing capitated business provides RDNT with revenue stability and predictability – an important factor given the company’s current leverage. In addition, capitation pulls more non-capitated business from the same physician referring community, improves margins/cash flow over time with efficiency and most importantly it serves as a strong competitive advantage. With reimbursement coming from cost-conscious insurance companies, having exclusive capitated contracts will essentially force other centers to ask for higher co-pay. In addition, the monthly recurring revenue with help improve working capital by eliminating invoicing and collection issues.

How does capitation work? A commercial payor (i.e., United Health, Aetna, etc.) pays doctor groups a capitated monthly payment (e.g., $100 per-life-per-month) to assume all healthcare related services to its members. The doctor group then syndicates all radiology/imaging services to RDNT and pays RDNT (e.g., $10 per-life-per-month) to undertake this risk. RNDT collects the flat monthly rate and provides radiology services to the covered lives as needed. RDNT needs to understand the cost/volume and price appropriately to manage patient demand and utilization of its centers. These contracts typically have annual rate increases built in and can typically be renegotiated every 2 years.

A Decade of Rate Cut on Medical Imaging:  Shortly after the Deficit Reduction Act of 2005 (DAR), CMS proposed a rule to cut reimbursement rates for medical imaging services. These changes were focused on Medicare Physician Fee Schedule (MPFS) and the hospital outpatient prospective payment system (HOPPS). Over the past decade the medical imaging has seen over a dozen cuts – examples below:

2006:  25% cut to technical component (TC) in the Physician Fee Schedule (PFS) for a second imaging procedure within a family of codes

2007:  CMS caps the TC of the PFS to the HOPPS rate for the same procedure, when the former is higher

2010: 50% cut to TC of the PFS within family of codes (up from 25%) for a second imaging procedure.  CMS also raised the utilization rate to 90% from 50%

2011:  50% cut to the TC in the PFS for 2nd procedure across a family of codes

2012:  25% cut to the professional component (PC) in the PFS for a second imaging procedure

2013: 25% cut to the TC of certain cardiology procedures when with ophthalmology procedures in the PFS; 25% cut to the PC and 50% cut to the TC to multiple physicians within the same practice for a second imaging procedure in the PFS; and cut the capital interest rate from 11% to a sliding scale of 5.5-8%

2014: CMS raises the utilization rate to 90% (up from 75%)

2016 / 2017:  No material cut


We are not calling the bottom of the CMS rate cuts.  It’s hard to say what CMS will do going forward but it’s clear to see that RDNT provides an essential service at a lower cost and doctors / physicians are relying more on imaging – both to protect themselves from lawsuits and to provide quality care. If rate cuts are behind us, RNDT should prosper as it leverages its scale; and if CMS cuts rates going forward, RDNT should be able to continue to consolidate the industry at an attractive valuation.

In addition to RDNT’s superior model consider the following headwinds and tailwinds:


Freestanding Diagnostic Imaging Market TAM (per management) of $100B: 40% of imaging is currently serviced by freestanding centers like RDNT.  60% serviced by hospitals which can be ~3-4x more expensive. Driven by more cost sensitive payors and well-informed patients, this mix is shifting towards the lower cost providers like RDNT. In addition, hospitals are increasingly outsourcing their non-core services. Evidenced by the number of hospital JV arrangement with RDNT and other providers, we think this trend presents addition opportunity for dominant providers like RDNT to grow and take market share. 

Dominant in its Markets: RDNT competes in 7 geographic markets. It is by far the largest freestanding outpatient imaging center in its markets. This strong regional presence enables leverage over commercial insurance payors, suppliers and competitors.

Barriers to Entry: Scale and payor relationship should help for now, but we think the true barrier to entry is the growing capitated business. With reimbursement coming from cost-conscious insurance companies, having exclusive capitated contracts will essentially force other imaging centers to ask for higher co-pay (e.g.,  If a patient goes to an out-of-network imaging center – he/she may have to directly pay the difference in cost – also known as balance billing – to the imaging center). Other imaging centers lack the scale/concentration to get capitated contracts. The imaging center business has also been out of favor and not growing fast enough to attract new competition or PE consolidators that would want to get scale and capitated contracts. This creates a meaningful barrier to entry.

Rate Renegotiation: RDNT’s scale and concentrated regional networks are enabling the company to renegotiate rates with different insurance companies. In its 3Q call, management noted that they completed a negotiation with a large payor that resulted in a material rate increase. This rate increase will retroactively be applied from July 1, 2016. While rates are negotiated by modality, we estimate a blended rate increase to be ~4%-6%.

Capitation Business: RDNT has over 40 capitated medical groups in California and is in active discussions to expand this offering into the east coast. Under this exclusive capitated program (currently 12% of revenue), RDNT receives a per-member-per-month fixed price for exclusively providing outpatient imaging to over 1,500,000 lives in CA. Capitation eliminates costs associated with collections, billings, etc. Expansion into the east coast market will be a big win for RDNT.

Capital Allocation: Current focus is to pay down debt to ~4x 2017 EBITDA. Management has historically allocated capital to acquisitions at relatively higher multiples. However, recent past acquisitions has been attractive. We believe RDNT will return to its acquisition mode in 2017.

Growing Demand: Aging population, growing population, employed population, focus on early detection and preventative services, and doctor’s reliance on imaging should continue to increase the demand for RDNT’s services. RDNT is seeing stronger same-center volume growth for its higher margin, advanced modalities (MRI up 2%, CT up 3.9% and PET/CT up 6.3%)

Key Imaging Modalities:

-          RDNT’s key diagnostic imaging modalities, count, and their unit cost:

§  MRI (~230 machines): Costs from $0.6M to $2.5M

§  CT (~145 machines):  Costs from $0.3M to $1.2M

§  PET (~45 machines): Costs from $0.8M to $2.5M; PET/CT: from $1.1M to $2.8M

§  Nuclear Medicine (~50 machines): Costs from $0.3M to $0.4M

§  X-ray (~395 machines): Costs from $0.1M to $0.44M

§  Ultrasound (~500 machines): Costs from $0.1M to $0.25M

§  Mammography (~260 machines): Costs from $0.25M to $0.4M

§  Fluoroscopy (~105 machines): Costs from $0.1M to $0.4M

-          Age: Average age of MRI and CT units is less than 6 years and PET is less than 4 years

-          Useful life: Average useful life of MRI, CT and PET units is typically 10 years

-          Key Location: ~660 modalities in CA, 415 in NY, 437 in MD and 120 in NJ

-          Suppliers: Primary suppliers of equipment include GE, Hologic, Phillips, Hitachi and others

-          Payment of Method:  Cash and capital leases with purchase options

-          Maintenance Capex: ~$30M per year


Cost Cutting: RDNT has outlined multiple cost saving initiatives that can benefit margins. With CMS reimbursement rate being flat in 2016/17, we should see some margin improvement in 2017.

Owner / Operator:  Founder and CEO of the company owns 13% of equity.  Overall, insiders own 20% of equity. In this environment, particularly with the current leverage of the company, it comforts us to see management with meaningful equity ownership.

Valuation: RDNT performed 5.6 million imaging procedures and generated $890M revenue in 2015. For 2016, management guided a 10% revenue growth, 15% EBITDA margin, and $45M of FCF ($0.97 FCF per share) at the mid-point. FY 2016 guidance implies TEV / EBITDA of 6.9x and FCF multiple of 6.9x.


Headwinds to consider:

Affordable Care Act: RDNT along with the industry has benefited from ACA over the past few years. RDNT enjoyed same-center growth of 2.4% in 2013, 7.3% in 2014, 5.5% in 1q15, 7.6% in 2q15, 5.3% in 3q15 and 3.0% in 4q15. We estimate that ACA accounted for ~5% of the same-center volume growth. Our view is that a complete repeal of ACA will obviously impact the business. However, the more likely outcome will represent an amendment to the current ACA or a replacement option that will continue to provide coverage and should not adversely impact RDNT’s business in the long term. Most of the ACA volume increase experienced by RDNT was via Medicaid in CA; we think it’s unlikely that this population loses its medical support.  However, if the Trump administration repeals ObamaCare, we estimate that it can impact up to ~5 – 10% of RDNT’s volume. Our estimate is based on the same center volume growth in 2014-2015.

Price Taker: CMS sets the reimbursement rate for Medicare/Medicaid imaging (~23% of revenue). Rates have declined since 2007 but have stabilized in 2016. CMS provided its final ruling on 2017 Medicare reimbursement rates and based on RDNT’s internal analysis, should be neutral to 2017 results.

2017 ACA Rate Increases: With the expected ACA insurance premium increases in 2017, more participants could / should select high deductible (low premium) plans.  This could result in patients – in effort to avoid higher deductibles – delaying or ignoring none-critical visits to physicians.

Eventual Volume Constraint: This is a good problem to have. Given a limited number of machines and centers, we think RDNT could eventually reach its limit on its ability to service an increase in demand without expanding its centers or buying more equipment, both of which require additional investment. They do have the option of opening late or on weekends.

Highly Levered: Managements current priority is to de-lever.  The company should generate ~$45M in free cash flow in 2016 – most of which should go to pay down debt ($8-$9M in Q4). Going forward they should be able to pay north of $20-$30M of debt a year. They refinanced their debt on July 1, 2016 and will not have any debt maturity until 2020. Assuming a modest growth in EBITDA gets us to ~4x leverage on 2017 EBITDA. RDNT has ~$30M of account receivables that were not collected due to retroactive rate increase negations in Q3’2016 – we expect this will be collected in Q4 and used to pay down debt.

Economic Downturn: During an economic downturn, patients may defer or avoid elective visits to their physicians. This will result in lower volume for RDNT. Higher unemployment rate could lead to more unisured lifes and fewer visits to physician / RDNT as well.



-     Announcement of capitation business with major a health group in the east coast

-     Additional JV arrangements with major hospitals and health systems (either in CA or NY/NJ market)

-     Expansion of BreastLink business into the New York and New Jersey markets

-     Increased same center volume in Q4 resulting in increased gross and EBITDA margins

-     Capital allocation: Further debt pay down – preferable to ~4x 2017 EBITDA (management’s target ratio)

-     Capital allocation: Make accretive acquisitions in 2017 – preferably larger acquisitions


-     Further reimbursement rated cut by CMS.  Final rates for 2017 are flat.

-     New administration repeals Affordable Care Act without a viable alternative

-     Economic deterioration – high unemployment rate which leads to less insured lives

-     High leverage – Recently refinanced its debt (6/2016).  Currently at 4.7x 2016 EBITDA

o   First Lien (L+3.75%): Due on 9/2020

o   Second Lien (L+7.00%): Due on 3/2021



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


Key Catalysts:

-     Announcement of capitation business with major a health group in the east coast 

-     Additional JV arrangements with major hospitals and health systems (either in CA or NY/NJ market)

-     Expansion of BreastLink business into the New York and New Jersey markets

-     IOrganic Growth: Increased same center volume in Q4 resulting in increased gross and EBITDA margins

-     Capital allocation: Further debt pay down – preferable to ~4x 2017 EBITDA (management’s target ratio)

-     Capital allocation: Make accretive acquisitions in 2017 – preferably larger acquisitions


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