Fortis Healthcare - Will It Fortify Your Portfolio?

Over the last two years, even as India Inc. has been busy cutting down on its investment plans and fighting a slowdown, one company has been acquiring international assets very aggressively. Just around a decade old, the acquisitions made by this company are so many that it gives a feeling that almost half of its revenues are acquired rather than organic. We are referring to the Singh brothers promoted healthcare company, Fortis Healthcare, whose ambitions are so far reaching that it has even proposed to raise money in Singapore via the IPO route.

Fortis Healthcare came up with an IPO in 2007, which was oversubscribed by 2.78x. Its shares, however, tanked seven per cent on debut and underperformed over the next two years. The stock is currently trading below its issue price. After the IPO, the company also came up with a rights issue of shares and has even raised a huge debt, including one through the issue of foreign currency convertible bonds worth USD 100 million. Most of the money raised earlier has been used for acquisitions as well as to repay its debts.

Though the series of the acquisitions have increased its revenues, the company’s profitability has not lived up to the expectations. Investors may be wondering if this is the right time to invest in the scrip, as the acquisitions may pay off later. Here are some answers.

The Business

Started in 2001 with just one hospital in Mohali, Fortis now manages 75 hospitals and over 12000 beds across 10 countries. Before its IPO, in 2005, the company had acquired the Escorts chain of hospitals. After the IPO, the company has acquired at least one company each year. This aggression is clearly reflected in its topline, which crossed the Rs 3000 crore mark in FY12.

It is worthy of note that the business structure of Fortis has been changing ever since its inception. The current business structure of the company is quite a complex one, as a series of international acquisitions have completely changed the way it conducted business to start with.

Currently (as per the June 2012 quarter results), 52.5 per cent of its revenues come from its international operations and the remaining 47.5 per cent come from its domestic business.Besides operating hospitals, Fortis also forayed into the diagnostics business after it acquired SRL in 2011. This has helped improve its presence internationally too. The company now has diagnostics businesses in Dubai and Singapore, hospitals in Sri Lanka, Vietnam, Hong Kong and Singapore as well as dental care businesses in Australia, New Zealand and Canada.

Back in the year 2010, when its debt crossed Rs 5000 crore, it managed to repay most of this by raising money via the preferential allotment route and also by coming out with a rights issue. This again equipped it to borrow more for future acquisitions and new Greenfield projects.

Acquisitions

Over the past four years, the company has undertaken some notable acquisitions. In FY10, Fortis acquired 10 hospitals for Rs 889.5 crore from the troubled pharma company Wockhardt. This deal made Fortis Healthcare a significant player in the domestic healthcare market, with its revenues rising by 49 per cent in the immediate year of acquisition.

In the same year again, it acquired a 23.9 per cent stake in Singaporebased Parkway Holdings (PHL) for USD 685.3 million (Rs 3128 crore). This would have given it a large presence in the Asian countries, but in July 2010, the company exited this business by selling its stake at a profit of Rs 342 crore.

In May 2011, the company diversified into the diagnostics business, acquiring a majority stake in SRL (managed by the Singh brothers) for an aggregate amount of Rs 803 crore. Through this acquisition, Fortis integrated backwards in terms of acquiring the capability to conduct diagnostics tests. It gave the company access to the UAE market, which is expected to grow by 16 per cent in the next few years. Fortis also got access to the domestic diagnostics market, which is currently fairly unorganized.

Undaunted by the global slowdown, Fortis went in for another big ticket acquisition in 2012, when it acquired Singapore-based Fortis Healthcare International Pte (owned by the same promoters but not treated as a group company) at a valuation of USD 665 million. This acquisition, which is yet to show full year results, has given Fortis access to many territories.

This year again, Fortis acquired RadLink-Asia Pte for a consideration of USD 50 million. Fortis funded these series of acquisitions either with the proceeds of the rights issue or with the debt it raised, which resulted in a higher interest outgo and lowered the company’s earnings. Its promoters also carried out a preferential allotment and put money into the business to fund these acquisitions. Though these acquisitions helped the company show robust topline growth, it did not translate into an equivalent bottomline growth. In fact, it was only in the June quarter of FY09 that the company reported its first ever quarterly profit in almost a decade.

Financial Performance: Looking Unstable

The company’s revenues, which stood at Rs 11 crore in FY2002, crossed Rs 3000 crore in FY2012. It reported losses for seven years in a row in the beginning, and only thereafter did it start reporting profits. The gross block of the company has also grown to Rs 10000 crore as at the end of FY12.

However, the profits made by the company in the last four years are not consistent. In FY10, its profits were up 295 per cent and in FY11, this grew by 95 per cent.For FY12 however, the profits declined by 51 per cent. Thanks to the equity dilution, its earnings per share did not grow in line with the net profit growth. Besides, the operating profit margins have also shown high variability, and with the new acquisitions, it is very difficult to forecast its margins in the future.

Reeling Under Debt

High debt is another concern for Fortis. According to its FY12 annual report, its total liability was Rs 8344 crore, with a debt-to-equity ratio of 2x. In FY12, its interest cost soared by 19 per cent and 3/4th of its profit before interest and tax went towards interest payment. Besides, its current market cap of Rs 4215 crore is half of its total liabilities, which again, is not a very healthy sign.

Near-Term Hiccups

The proceeds from the proposed Singapore IPO will mainly be used to clear the liability of five per cent cumulative preference shares as well as for its working capital needs. The IPO will also bring down its debt-to-equity ratio, with further equity dilution. If the IPO fails, the company will have a pending liability of Rs 14.37 crore for each year from 2009 to 2012 (amounting to Rs 57.48 crore) and a final payment of Rs 129.37 crore in October 2013. These deferred payments also carry an interest of over 12 per cent.

Besides, FCCBs worth USD 100 million will be due for conversion from 2013 to 2015. If the bonds get converted, an additional 2.6 crore new equity shares will be created, indicating a seven per cent equity dilution. The current share price of Rs 104 is way below the conversion price of Rs 167. If the bonds fail to convert, they will be redeemed at a 103 per cent premium to their face value. With the current northward exchange rates and low share price, shareholders will take a hit either way.

Though the company has acquired many businesses, it has not shown consistent positive results over the years. It has also not declared any dividend despite being profitable for the last four years. The question remains as to whether shareholders have garnered any returns (except for the rights issue holders).

One must also take into consideration that the promoters of Fortis have diverse interests ranging from healthcare to finance to life insurance. In 2008, its promoters sold their stake in Ranbaxy to Japanese company Daiichi Sankyo. What happened to the share price of the Ranbaxy thereafter is history.

On the valuations front, its EV/EBITDA of 22x is in line with its peer Apollo Hospitals. Apollo, however, has been consistent performer in terms of profits and dividends; it also has a lower debt-to-equity ratio, which makes the valuations of Fortis expensive. For shareholders in the company there is a further risk of equity dilution, and hence, in future, the EPS may come lower than expected. Considering all these factors, we would recommend that investors exit this counter and look for better investment opportunities.