Fortis Healthcare: A bid for beds at right price

The company now has 3 options in response to Khazanah’s bid, with each one having a bearing on its valuation.

The $839-million bid by Malaysia's Khazanah for raising its stake in Parkway Holdings to a controlling 51 per cent from 23 per cent at present is a potential game changer for Fortis Healthcare. It may well prove to be a road block for the fast-paced growth track of the Indian company and, at the very least, test the deftness and maneuverability of the management.

Fortis had acquired a majority 25.27 per cent stake for around $685 million. Now, its management has three choices — to tender, to counter-bid or to just maintain the stake. Each of these options will have a bearing on its valuation in the market.

In case the management tenders, they will stand to make around Rs 700 crore. This could ease the pressure on its balance sheet, as the debt-to-equity ratio, at 2.8 times, is rather stiff. While the market will react favourably in the short term, Fortis will lose an opportunity of creating an international footprint and a scale of around 12,000 beds.

A counter-bid could saddle Fortis with a white elephant. A counter-bid is possible as the debt-to-equity ratio is set to go down to 1:1 by June, when Rs 1,700 crore of warrants get converted. Also, the debt amount is set to nearly halve from Rs 4,200 crore to Rs 2,300 crore. With this, Fortis will be able to fund the bid, expected to be worth around Rs 4,000 crore.

Also, the promoters are flush with funds from the Ranbaxy stake sale to Daiichi Sankyo. However, the valuation (enterprise value) of the Parkway acquisition would then work out to about Rs 4 crore per bed — much more than the Rs 75-85 lakh-per-bed valuation norm in India. Analysts reckon the optimal break-even valuation, even for a premium international business like Parkway, is around Rs 1.5 crore per bed.

Operating with large capital costs will entail a higher interest outflow and an equity dilution. This will have an impact on the earnings growth and, thereby, the share price. Contrarian views justify the high valuation, as the average room rent per bed at Parkway is also four times that in India and it has consistently generated operating profit margins of around 25 per cent.

And, then, there is the third option — to stay put and watch how Khazanah’s plans unfold, followed by a decision on an alternative course of action with other shareholders. For now, all eyes are watching which way the dice rolls.