Building The No 3 Diagnostic Imaging Player

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Brokers highlight deregulation and scale benefits from the potential merger of Integral Diagnostics and Capitol Health.

-Integral Diagnostics and Capitol Health intend to combine and become No 3
-Brokers highlight scale and deregulation benefits
-Management details significant pre-tax cost synergies
-Integral’s share price strength will help the merger succeed

By Mark Woodruff

Shareholders on both sides will prosper from the potential tie-up between Integral Diagnostics ((IDX)) and Capitol Health ((CAJ)), according to stockbroking analysts, with the combined entity becoming a clear number three player in the Australian Diagnostic Imaging sector.

Integral’s management team anticipates -$10m of annual pre-tax cost synergies within the next two years and double-digit pro forma EPS accretion in FY25. Macquarie concurs, forecasting EPS accretion for Integral in FY25 and FY26 of 12% and 11%, respectively, on a full year run-rate basis.

Importantly, this EPS accretion does not value any revenue synergy upside as a result of the transaction, highlights Jarden.

As the industry transitions to a deregulated magnetic resonance imaging (MRI) licensed market, Jarden believes a merger would benefit both companies competitively and provide scale advantages. Integral’s national market share would increase to 12% from 8%, and it would operate the largest network of 68 clinics in Victoria.

Combining the two operators would provide a significant boost to Integral’s partially licensed/unlicensed MRI fleet, notes Ord Minnett, as Capitol has 10 partially licensed and 14 unlicensed MRIs. These will experience a funding step change with forthcoming deregulation in July 2025 and July 2027.

From July 1, 2025, all partial licenses will become fully reimbursable “bulk billed”, explains Jarden. Similarly, unlicensed MRIs become fully reimbursable from July 1, 2027.

By mitigating balance sheet pressure for Integral and being fairly priced for shareholders of Capitol, the transaction benefits shareholders of both parties, agrees Canaccord Genuity. Merger synergies are also considered important in what is becoming an otherwise more competitive market with the looming deregulation.

Integral owns and operates radiology practices in Victoria, Queensland, Western Australia and New Zealand, while Capitol’s strong Victorian market position (46 clinics), efficient operating model and MRI fleet makes it a potential target for a range of strategic and private equity suitors, suggests Ord Minnett.

Post merger, Integral’s Victorian presence would more than double, providing scale on par with the market dominant I-MED Radiology Network, while in Western Australia the merged entity would be larger than I-MED.

Scale and regulatory hurdles 

Scale is the most significant and obvious benefit of this proposed merger, suggests Wilsons, as the combined entity size of around 130 Australian clinics will match the 130 for Lumus Imaging, owned by Healius ((HLI)), but still falls well short of I-MED’s network of more than 240 clinics.

Despite greater size, Wilsons doesn’t anticipate the merged entity would strike trouble with the ACCC on “monopolistic or dominant” grounds, because the combined clinics in any state of Australia would not be materially larger than the incumbent I-MED network.

Regulatory hurdles to deal completion are not a major risk, according to Canaccord, since Integral’s exposure is concentrated across more regional areas in Victoria, whereas Capitol’s clinics are more metropolitan.

This broker anticipates Capitol’s clinics will be largely leveraged to drive volumes at Integral centres of excellence.

The conditional, non-binding merger proposal involves the provision of 0.12849 Integral Diagnostics shares per Capitol Health share, or $0.326 per share, which represents a 33% premium to the last closing Capitol share price.

The newly formed entity would be owned by shareholders of Integral and Capitol in the ratio of 63/37%.

Should the proposed merger succeed, Macquarie notes Integral’s leverage would fall to circa 2.6 times from around 3 times as at December 2023, and provide management with greater flexibility for further growth initiatives.

Completion of this all-scrip deal will, however, be predicated on a supportive Integral Diagnostics share price, according to Ord Minnett, which notes a -4% share price retreat on the day of the announcement. This broker is not ruling out a superior offer from a third party.

Barring such competing offers or trouble with the regulator, management at Integral expects the transaction to be complete in around the next three months.

The savings

The -$10m of pre-tax cost synergies within the next two years alluded to by management should arise from headcount, indirect procurement (IT, labour hire etc.), and savings on costs associated with maintaining an ASX listing, explains Canaccord.

Integral anticipates the majority of these synergies will be realised in FY25, and the full amount after two years (FY26).

The analysts at Canaccord also envisage room for further synergies, courtesy of Ai innovation and teleradiology in the longer-term. Macquarie expects Capitol to benefit from Integral’s capabilities in both these technologies.

Slight concerns for Integral

While longer-term policy changes around MRI deregulation may mitigate Integral’s prior competitive moat, Canaccord believes management should be able to retain pricing power in certain jurisdictions, particularly Queensland, by maintaining a focus upon a high level of clinical expertise.

The market is also slightly dubious around whether Integral should be pursuing an acquisition, let alone one as large as Capitol, prior to restoring its operating margin profile, explains the analyst.

As part of a management call after the acquisition announcement, Integral noted an improving earnings margin in the second half and a gradual reduction in the net debt/EBITDA ratio.

Brokers leave their respective 12-month target prices for both companies unchanged, awaiting a binding offer before making any changes, with the exclusivity period for due diligence set to lapse on July 15.

The average target price of four covering brokers updated daily in the FNArena database for Integral Diagnostics is $2.35, suggesting -6% downside to the latest share price. There are two Buy (or equivalent) ratings, one Neutral and one Underweight.

Three Buy-rated (or equivalent) brokers researching Capitol Health have an average target of 31c, implying just over 5% share price upside.

Outside of the database, Canaccord Genuity, Wilsons and Jarden have Hold (or equivalent) ratings for Integral, and an average target of $2.27.

Wilsons, Canaccord and Jarden have ratings for Capitol Health of Market Weight, Buy and Neutral, respectively, and the same 27 cent target price.

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