Sector Watch: Diagnostic imaging

To many, a picture is worth a thousand words. For Virtual Radiologic Corporation (Nasdaq: VRAD) and NightHawk Radiology Holdings (Nasdaq: NHWK), two of the nation’s leading diagnostic imaging companies, a picture can be worth a thousand diagnoses.

Diagnostic imaging, which allows doctors to “see” inside a patient’s body using images, is forecasted to grow in volume 15% annually to over 500 million procedures by 2009, according to business research and consulting firm Frost & Sullivan. Although there is increased demand, the number of radiologists is growing only 2% annually, and hospitals and clinics must rely on third-party contractors to supplement their in-house radiology staff and assist with around-the-clock coverage, which is great news for Virtual Radiologic and NightHawk.

Newly public Virtual Radiologic is the second largest U.S. provider of diagnostic imaging services. Its customers include radiology practices, hospitals, clinics and imaging centers. The company employs board-certified radiologists and provides its services nationwide and around-the-clock through a scalable communications network based on an encrypted broadband Internet connection and proprietary workflow management software. Virtual Radiologic currently has 121 radiologists under contract.

Its radiology practice and hospital customers pay the company directly; the small cap doesn’t rely on third party reimbursement. Diagnostic imaging services are provided to 457 customers and 787 medical facilities, including 736 hospitals (13% of all U.S. hospitals). Over the past year, customers under contract have grown 35% and medical facilities served has increased 32%. Same-site volume growth averaged 24% in 2005, 20% in 2006 and 17% in the first nine months of 2007. Contract renewals are high, at 98%. 

Between 2004 and 2006, Virtual Radiologic’s revenues grew more than three-fold to $54 million from $13 million. The company’s revenues grew 127% year-over-year in the first nine months of 2007 and net income (before preferred dividends and redeemable convertible preferred stock accretion) increased to a $2.2 million gain from a $1.8 million loss. The company closed an initial public offering of 4.6 million shares at $17 per share in November. Analysts expect Virtual Radiologic to be profitable in 2008 and to produce 25% annual growth over the next five years. My $22 target for Virtual Radiologic Corporation compares with Tuesday’s closing price of $16.19. Over the last 52 weeks, shares have ranged between $16.04 and $26.97.

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