Investment Highlights

• We maintain our HOLD recommendation on IHH Healthcare with a slightly lower FV of RM5.50 (from RM5.53) based on DCF (WACC 8.3%; terminal growth rate 3.5%).

• We also take this opportunity to recalibrate our financial model and cut earnings forecast for FY19F, FY20F and FY21F by 1.0%, 7.2% and 10.6% respectively. Earnings forecasts were reduced as we anticipate slightly longer gestational period for its recent acquisitions. We have not accounted for Prince Court’s earnings impact in our forecasts.

• IHH announced on Bursa Malaysia that through Pantai Holdings Sdn Bhd, it has entered into a conditional share purchase agreement with Pulau Memutik Ventures Sdn Bhd (a subsidiary of Khazanah Nasional) to acquire the entire issued share capital of Prince Court Medical Centre Sdn Bhd (PCMC) for a cash consideration of RM1.02bil. 2. PCMC is a 277-licensed bed private healthcare facility located in the “Golden Triangle” of Kuala Lumpur. In FY18, PCMC recorded a revenue of RM260.0mil and EBITDA of RM44.0mil, translating to an EBITDA margin of circa 16.9% which is lower than IHH’s EBITDA margins of between 21 and 25%. PCMC’s core net profit of circa RM26.0mil is roughly 2.5% of IHH’s FY18 core net profit. The acquisition in expected to be completed by 1QFY20.

• The key takeaways from yesterday’s teleconference briefing are as follows:

1. The key rationales behind the proposed acquisition are the strategic location and to further strengthen IHH’s position as the leading healthcare provider in Malaysia.

• PCMC’s location in the “Golden Triangle” of Kuala Lumpur is expected to allow the group to further capture premium and corporate clientele within a 2km radius.

• The acquisition is expected to complement its market positioning in the Malaysian operations and its existing hospitals in Klang Valley, gain a larger share of the medical tourism market, enables broader service offerings and cross sell its services to its existing customers and gain qualified and experienced medical professional team across a wide range of services.

• IHH aims to leverage its established management and administration capabilities in order to drive synergies and achieve better economies of scales in its operations in Klang Valley. Hence, we can expect EBITDA margins to gradually improve on the back of streamlined operations post-acquisition.

2. The cash consideration is based on the mid-point range of PwC’s fair market value range for PCMC from RM0.96bil to RM1.08bil. PWC’s fair value for Prince Court is based on DCF valuation. Based on the latest quarter financials, IHH has an ample cash balance of RM5.0bil to fund the acquisition. However, in order to maximize the leverage in its balance sheet, the group is looking into a combination of internally generated funds and bank borrowings.

3. A termination clause was included allowing IHH to terminate the SPA prior to the completion of the proposed acquisition should there be any change relating to drug price controls which would impact the FY18 EBITDA of PCMC by at least 25%. This is in order to mitigate the risk of a potential adverse impact from an introduction of price control on drugs.

• We are neutral on the acquisition as we believe the impact will be minimal. Its implied EV/EBITDA of 21.9x is quite high when compared with IHH Group’s 23.1x and Fortis’ 22.5x despite PCMC being a standalone hospital. The acquisition is expected to drag IHH’s earnings in the immediate term as PCMC’s earnings contribution of RM26.0mil will not be enough to cover the net financing cost of the acquisition. We estimate IHH’s net gearing in FY20F to go up by 0.03x to 0.36x. The implied PE is 39.2x.

• We like IHH for its: (1) strong prospects in the private healthcare sector backed by rising affluence and the aging populations; and (2) its position in the premium segment of the private healthcare sector, translating to high EBITDA margins of over 20%. However, we are wary of the geopolitical risks from its Turkish and China operations due to volatile currency and political climate, which is reflected in our estimated WACC of 8.0%.

• We expect the group to continue to grow on the back of sustained demand growth in all of its markets, expansion in multiple countries, continuous improvement in patient admission volumes, improved revenue intensity with more complex case and case mix, better operating leverage and tighter costs controls. However, these will be partly dragged by the possible impending drug pricing controls, pre-operating and start-up costs of new operations and wage inflation.

Source: AmInvest Research - 18 Sept 2019