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Merge sues rival for allegedly smearing image

Merge Healthcare alleges a rival in the medical imaging business has poached nearly 40 accounts in part by misleading them about the stability of the Chicago-based company as it explores a potential sale.

Downers Grove, Ill.-based Medstrat false claims and unfair business practices have caused Merge to lose revenue that “could reach tens of millions of dollars,” according to a lawsuit Merge filed on Nov. 14 in U.S. District Court in Chicago.

Losses like that would be significant to Merge, which reported net sales of $60.4 million in the third quarter ending Sept. 30. The company's chairman and controlling stock holder is Michael Ferro, the lead investor in the parent company of the Chicago Sun-Times.The lawsuit is the latest concern for Merge. In an already competitive environment, Merge faces a shrinking customer base as hospitals and physician groups continue to consolidate. Bigger providers would have more bargaining power over prices for Merge's products and services, while lower reimbursement rates could hamper some providers' ability to buy those services and products, analysts say.

With the lawsuit, Merge admits a competitor is trying to disrupt the company.

“This is one of many potential risks facing Merge, and subsequently their investors,” Deepak Chaulagai, a senior research analyst in health care at Minneapolis-based Dougherty & Company LLC, said of the lawsuit.

In a statement, a Medstrat spokesman called the lawsuit “baseless.”

“We intend to aggressively defend ourselves without distracting from the important services we provide to our orthopedic partners,” he said.

Merge's third quarter net sales were about $2 million short of analysts' expectations of around $63 million. The company's net loss of $3.8 million was nearly four times the loss in the year-earlier period.

Analysts say Merge has been slow to gain traction on its shift earlier this year to a subscription-based revenue model. That generates less revenue up front, but likely will drive higher long-term value. Merge executives hope to increase subscription and other revenue sources to more than 70 percent of revenue over the next few years, they said during a Nov. 1 earnings call to discuss third-quarter results.

Medstrat and Merge are fighting over orthopedic practices that use a Picture Archive and Communication System, a combination of hardware and software that allows providers to electronically store and share medical images, such as X-rays and MRIs. The system replaces hard-copy images and helps cut costs by reducing the number of redundant tests.

Merge first learned of Medstrat raiding PACS customers in April, with emails and advertisements that falsely stated that Merge planned to replace PACS with a new product, which would require a difficult and costly transition, the complaint says.

In September, Merge said it had appointed New York-based investment bank Allen & Co. to evaluate strategic alternatives.

Then Medstrat upped the ante, sending a marketing email that questioned Merge's stability and trumpeted the Chicago company's plan to sell itself or combine with another firm, the complaint says. Meanwhile, Medstrat also touted its ability to convert Merge clients.

“Why go through more pain? Converting is simple,” said the email, which was included in the lawsuit

One of Merge's lawyers, Michael Summerhill, a partner at Chicago-based Freeborn & Peters, said the complaint is intended to ensure that Medstrat fairly portrays Merge.

“It's inaccurate for Medstrat to say that because Merge has engaged an investment bank, therefore Merge is unstable,” Mr. Summerhill said.

Since 2010, Medstrat has taken nearly 40 former Merge clients, Merge said in the lawsuit. Medstrat's monthly service fee is 20 percent to 30 percent less than Merge's, the lawsuit notes.

Merge's stock price closed at $3.28 on Monday, down 51.5%, from a year-high on Feb. 28 of $6.76 a share.
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