Radnet (RDNT) is the opportunity to invest in the largest network of free standing imaging centers (approx 200) in the United States. It's a roll-up play run buy smart, and savvy bankers and doctors that has done a good job of clustering centers to achieve economies of scale. While the company is highly levered we think that if appropriately sized within a portfolio the position offers an exciting risk reward opportunity as the company has stated its intent to de-lever and has the prospect to deliver multi-bagger returns over the next 5 years. We believe the biggest risk to the story was the impending refinancing of its large debt which was completed recently and now one of the key risks to the equity holders in the near term has been addressed.
Two factors are contributing to the low valuation of Radnet, an industry out of favor, dislocation in the credit market and the high leverage of the business. We think for the patient investor Radnet is well positioned to weather these two factors and equity holders will benefit over time as the company pays down debt and does accretive acquisitions. I think equity holders will make between 2-3X over the next 2+ years.
Description of the Business
In short Radnet runs free standing imagining centers where patients go to get a variety of tests, under a variety of different possible imaging technologies. This where you go to get an X-ray, a MRI, a mammogram etc. Think of this as a Lab Corp type business that is focused on imaging. The business is very capital intensive, thus clustering centers, achieving scale to ensure high levels of utilization is important. Radnet focuses on making sure they have good relationships with doctors, are convenient for patients, and has great and long-term relationship with vendors (e.g GE).
The industry is very fragmented and Radnet has chosen to focus in only a handful of states. Given the tough economy as of late they have also had the opportunity to acquire mom and pop providers at very attractive valuations. While operating the business efficiently is very important, capital structure and financial engineering of a company like this is equally important. Radnet is able to negotiate great terms with vendor GE for both financing of machines, service of contracts and also tap the institutional capital markets. These are both things that smaller shops can't do effectively. They have also diversified both payor mix and technology (types of procedures) to minimize exposure to any fluctuations in either so those two spaces.
Radnet, given its size is also able to get into the capitiated contacts which means they basically insure patients in imaging. They get paid a fix price per month, per patient by some large HMO's and then handle all the imaging needs. In general this theoretically exposes them to unlimited usage, but in reality they schedule such visits in a way to make sure that it doesn't cannibalize other revenue. These are great arrangements since it allows a baseline of recurring revenue and usually is provided within the excess capacity of the operation. Such arrangements really do a great job of amortizing the fixed carrying cost of the business.
What is going on in the industry?
- Volumes are down for the first time in a decade
- Fewer people working leads to fewer insured
- Recommended Mammogram age has been increased from 40 to 50
- More gate keeping to imaging by HMOs
- Overcapacity in the industry on advanced modalities (type of imaging)
- Uncertainty over future healthcare legislation
These are all transient factors.
The economy will return, the US population will age and overcapacity will correct itself. All of these conditions will take time to correct but they will happen and this will drive volumes higher.
Valuation
Based on 2009 number Radnet is producing about 106 mm of EBITDA which against their debt of 490 mm is about 5X leverage, which I granted in this environment is a lot.
With the equity trading at about 100 mm I think you are getting compensated for the risk. The company also holds about 200 mm in NOLs which should shield a good amount of earnings but I am always skeptical of giving NOLs too much value given their uncertain nature.
Market Cap 100 mm
Net Debt 490 mm
EV = 590 mm
Trailing EBITDA = 106 mm
Trailing Pre-tax FCF = 25 mm
EV/EBITDA = 5.5 X
Market Cap/pre-tax FCF = 4.0 X
They have a good amount of NOLs so I think you will see some tax shielding for the next few years of a large amount of their NI.
Management owns about 25% of the equity so I think they are very incented to make sure that they strike the appropriate balance between growth and de-levering. The CFO has refinanced and re-termed the debt at probably the hardest point in the company's history at attractive terms, so I believe he will be able to do it again if need be. The company has grown 4x over the last 5 years and says it wants to grow 2X over the next five. Presumably as the ratchet down growth and cash flow will go to paying down debt. Equity holders will do well as the de-leverage, at least a double and probably more.
Less risk than meets the Eye
The imaging market is very large, it is very fragmented and as the largest payer in this market I think Radnet is in a position with vendors that they won't let them go under. I also think that the business has enough stable FCF to start to de-lever and provide very attractive returns to the equity holders if management wants to (which I believe they do). Sure I am nervous about the debt, but given it has been re-financed through 2018 I think management will do the right thing given their economic incentive to do so. With Mark Stopler at the helm of the CFO seat and a stated strategy of de-leverage I think he is capable of delivering on that mandate. While I wouldn't make this a 20% position in my portfolio I think a modest position in portfolio could provide excellent risk adjusted returns over the next 5 years
Good presentation @
http://www.radnet.com/pdf/investor_presentation.pdf