Twice bitten, ready for more

Its third acquisition, Fortis Healthcare has sewn itself a nice deal by acquiring Wockhardt Hospitals’ 10 facilities

In line with its policy of growing via the inorganic route, Fortis Healthcare paid just over Rs 900 crore to add 10 hospitals of Wockhardt Hospitals to its healthcare chain. The acquired hospitals, which includes two green-field ones are located in Mumbai (2), Bangalore (5) and Kolkata (3), will increase Fortis’ network to 38, just shy of healthcare market leader Apollo Hospitals’ chain of 40. This acquisition is the third in the eight-year history of Fortis Healthcare and follows those of Escorts Heart Institute (Rs 580 crore) in Delhi and Chennai-based Malar Hospitals (Rs 34 crore). The acquisitions were part of the company’s plan to have 6,000 beds (just over 3,000 before the acquisition) and reach revenues of $1 billion or Rs 5,000 crore (Rs 631 crore in 2008-09) by 2011-12. Given the acquisition, the Fortis management is likely to rework the targets.

The deal benefits
The key benefit for Fortis is the pan-India presence which it was lacking with most of its major hospitals operating in the NCR region at Delhi. With this, it spreads out and strengthens its presence in south, east and western parts of the country. While geographic diversification is a plus, the company was more keen on a brown-field acquisition as setting up new ones (green-field) would mean a long gestation period with attendant headaches of construction delays, approvals and land acquisition issues.

The new hospitals give Fortis the benefit of scale, which can help bring down the cost in areas such as medical equipment, helping the company save about 5-7 per cent in overall costs. Another area Fortis stands to gain from is on the profitability front. Wockhardt’s operating margins at around 20 per cent are the highest among the large hospital chains with Fortis and Apollo trailing way behind at 14 per cent. The acquisition will help push up this number to about 17 per cent.
 

TAKING A LEAP AHEAD
Valuations	FY 09		FY 10E
	Fortis	Apollo	Fortis + Apollo	Wockhardt
Sales	631	1614	1,303	1,937
Operating profit	85.0	227.0	185.0	290.5
Net profit	21.0	102.0	60.8	148.5
P/E (x)	123.7	31.7	59.2	21.4
E: Estimates                                                  Source: Companies, analyst reports

Fair valuation?
Analysts say that Fortis paid a premium (the market was expecting it to be in the Rs 650 crore range) for the acquisition. This was due to the fact that eight of the ten hospitals are up and running and will help immediately add to the consolidated entity’s cash flow. On the back of this brown-field acquisition, the Fortis management is confident of making profits in the first year itself and says that the deal will be EPS accretive.

However, the premium means that the payback period might extend just a wee bit. Says an analyst, “If the deal was struck at the market expected price, then Fortis would have recovered the money in about five years. At the current cost and if the acquired hospitals are able to maintain an Ebidta of 20 per cent, it will take about seven years.” Considering the delays that plague a green-field project, a premium for a well-known brand name was probably justified, believe some analysts.
 

EYEING THE TOP SLOT
Operations	Fortis	Wockhardt	Total	Apollo
Number of Hospitals*	28	10	38	46
Number of beds**	3,278	1,902	5,180	8,000
Doctors	912	674	1,586	2,000
Nurses/Paramedics	3,892	1,295	5,187	3,000
* Owned and managed ** Beds for Wockhardt includes two greenfield projects Source: Companies, analyst reports

Hurdles?
Being capital intensive in nature with green-field projects taking about three years to breakeven, Fortis needs healthy internal accruals and debt to fund its expansions. The company intends to use Rs 350 crore of the Rs 1,000 crore rights issue which is likely to hit the market over the next couple of months to fund the acquisition, while the rest is likely to come from debt.

With debt of about Rs 450 crore and a debt to equity ratio of under 0.5, the hospital chain has scope to borrow. While funding might not be an issue, integration could pose a problem. Though the entire Wockhardt team including the current CEO is moving to Fortis, one will need to see how soon and successfully Fortis is able to integrate the processes and manpower across locations.
 

GOOD CATCH
Acquisition	Fortis	Wockhardt**	Apollo
Enterprise Value (Rs cr)	2,958	909	3,568
Ebidta margins (%)	13.5	20.5	14.0
EV/Ebidta (x)*	46.0	14.2	16.0
EV/Bed (Rs lakh)	90	48	45
P/BV (x)	2.4	-	2.4
Valuation and revenue numbers are for FY09 *Post acquisition, EV/Ebidta is estimated at 21 times **Fortis management estimates EV/Ebidta at 8.5 times for FY10 for the acquired assets Source: Analyst Estimates

Valuations
Analysts say that both Apollo and Fortis are in a phase of their business cycle where profitable growth is a given. Most of the Fortis’ large facilities, be it in Mohali, Noida, Vasant Kunj and La Femme (Delhi), Jaipur and Amritsar, fetch operating profit margins in excess of 20 per cent. With additional departments being added in some of these facilities and profitability maintained over the last few quarters, expect margins to stabilise at current levels for these hospitals. Analysts believe that among the laggards Malar Hospitals, Chennai (OPM, 10 per cent), Escorts, Faridabad (OPM, 15 per cent) are likely to see an improvement in their margins as the facilities stabilise.

The company is setting up three green-field facilities (all in the NCR region) currently with the largest being the ambitious 1,000-bed Medicity project in Gurgaon to be built at a cost of Rs 800 crore. While the company will see a jump in revenues as these facilities come online in phases, higher costs could keep operating margins under pressure till 2010-11.

At Rs 112, the scrip is trading at around 21 times EV/Ebdita based on FY10 estimates and post the acquisition, and thus reflects a premium over Apollo which is more diversified with a chain of pharmacy stores and quotes at around 16 times. While current valuations look expensive, the valuation gap between the two could narrow as Fortis’ new hospitals stabilise and margins perk up by 2010-11. In simpler terms, the market is already discounting the future well in advance.