Forced to enter Chapter 11 bankruptcy to reorganize its highly leveraged finances just a few years ago, Primedex Health Systems Inc. is now poised for national expansion and a turnaround that not only could grow profits but could move its stock from behind the counter.

The Los Angeles-based operator of 62 California medical diagnostic imaging centers earlier this month announced its acquisition of Dallas-based Radiologix Inc. which operates 70 similar facilities in 11 states. The deal is valued at $208 million, which includes the assumption of $170 million in Radiologix debt. If ap-proved by shareholders, the combined companies will be known as Radnet Inc., taken from the brand name of Primedex’s imaging centers.

The acquisition is causing more stir in the credit market, where both companies sell their debt, than in the equity markets. Primedex was trading at $1.74 over the counter on July 12 showing little movement since the June announcement with Radiologix at $3.10 on the American Stock Exchange. Wall Street equity analysts don’t actively cover either firm.

But Primedex officials, who plan to apply for an Amex listing for Radnet after the deal closes, are hoping that perception will change. With 132 centers, Radnet would be the nation’s largest fixed site imaging center operator, with more than $400 million in annual revenue, and the best pure play in that sector, with a significant share of the California and Maryland markets. Outside of mom-and-pop operators, most other imaging center chains are subsidiaries of other companies. While Radiologix does have California centers, they tend to be in different markets than Primedex’s.

“It’s an outstanding fit when you look at the dots on the map, and really rounds out our portfolio in California,” said Chief Financial Officer Stolper.

Howard Berger, Primedex’s chief executive officer and a company founder, will be chairman and chief executive of the combined company. Sami Abbasi, Radiologix’s current chief executive, will be vice chairman.

Positive leverage


Analysts say the combined companies, both of which already have a fleet of modern equipment, will improve their purchasing leverage with suppliers and negotiating leverage with payers.

“From the business perspective, (the deal) is very positive,” said Cheryl Richer, a Standard & Poor’s credit analyst, who has a “B” rating on the debt of Radnet Management Inc., the Primedex subsidiary that operates its centers. “It creates a larger, more geographically diverse company. In addition, they’re incurring barely any incremental debt.”

GE Healthcare Financial Services, which has a long relationship with Primedex, is providing $405 million financing for the transaction, including a $45 million revolving credit facility.

In March, GE was the lead party in issuing the company $161 million in senior secured debt to refinance nearly all of its existing debt. Stolper said the deal enabled the company to replace very short-term heavily amortizing debt with longer-term, interest-only facilities, and helped set the stage for the Radiologix acquisition.

“It’s a financing we’ve been working toward for several years,” Stolper said. “This essentially allows the company to keep more of its cash, or accelerate our growth. That’s really what’s going to take our company from being a regional player here in California to a much more relevant national player.”

In addition, Stolper noted that medical imaging is becoming more sophisticated and costly at the same time it’s becoming a much larger part of overall health care spending, due to a greater focus on preventative medicine. “The industry trends are in our favor,” he said.

Industry research firms estimate that annual industry growth for new PET imaging services positron emission tomography that can detect biochemical changes in the body caused by cancer and other diseases is growing at 20 percent a year. That compares with 8 to 12 percent growth for older technologies such as CT, or computed tomography, scans.

The deal, though, is not without its risks for Primedex. Diagnostic imaging centers operate in a capital intensive, high fixed-cost industry that requires significant amounts of capital to fund operations. In addition, center operators are under increasing competition from their own customers, as falling equipment prices enable physician practices to offer their own basic imaging services.

“The pie is growing,” Richer said. “The problem is that there have been more entrants who want a slice of that pie.”

Government savings


The industry also faces downward price pressures. The Medicare program on Jan. 1 will slash payments for medical imaging to comply with deficit reduction legislation passed by Congress. While only 15 percent of Primedex’s business comes from Medicare, it comprises up to 25 percent of Radiologix’s.

Company officials expect the combined company to take a hit to earnings before interest, taxes, depreciation and amortization, of $16.8 million in 2007 because of the reimbursement cuts, though there are moves in Congress to repeal that portion of the legislation.

“The cost savings are a big component here, as the price pressure increase,” said Mike Highsmith, a high-yield research analyst for Wachovia Securities who covers Radiologix. “To the degree that you can merge and eliminate duplicative overhead expensive at the home office that is a key positive.”

One of Primedex’s greatest strengths in its revenue base has been concentration in California’s managed care market. Around 28 percent of its business comes from capitation, in which physician groups subcontract with Radnet centers at a set fee per patient to provide imaging services for HMO patients. In addition, multiple locations in the same market make it more convenient for doctors to refer their patients.

Radiologix has had troubles over the last several years with acquisitions intended to expand its geographic reach but left them thinly covered in certain markets, Richer noted.

“What you really need to be successful in this business is to have a regional presence, with a lot of convenient locations, and to be known in the market so you get the referrals,” he said. “You’re better off being well known in two markets, than a small player in 50 states. It’s very much a relationship business.”