IHH has made several revised offers for a stake in Fortis (India’s 2nd largest hospital chain). Its newly revised offer encompasses a binding (INR650 Crore) and non-binding (INR3350 Crore) portion at a price not exceeding INR175/share. This effectively values Fortis at 24x EV/EBITDA compared to IHH’s 19.4x (FY18).We expect this offer will trigger a GO and net gearing to increase to 0.14x-0.4x. Maintain Hold and a TP of RM6.07.

The proposal. Over the course of the past few weeks, IHH has made several revised offers to the board of Fortis Healthcare expressing its interest in “participating in Fortis and its affiliates”. IHH’s initial non-binding offer was for INR4000 Crore (c.RM2.4bn) in totality for an equity portion of Fortis via a preferential issue and allotment of equity shares at INR160/share (c.RM9.42). This equity injection is for the immediate liquidity requirements for working capital, short term funding requirement, the RHT (Religare Healthcare Trust) buyout and infrastructure work. The offer price has since been revised however we understand that IHH’s absolute total value of the investment (INR4000 Crore) is fixed.

The target. Fortis Healthcare Ltd is the 2nd largest hospital chain in India which encompasses both hospital and the diagnostics business. It operates a network of 34 hospitals with over 4,600 operating beds, employing over 2,600 doctors and 6,500 nurses. Its 3 year CAGR on revenue stood at 3.9% and EBITDA at 23% (FY17 EBITDA margin: 7.9%).

The crown jewel. SRL Limited, a 56.6% subsidiary of Fortis is primarily involved in providing diagnostics services and is amongst the leading diagnostics chains in India with a significant market share. It has a network of 356 laboratories and 5,245 collection points as of FY03/17. SRL dominates the public-private partnership space in Indian diagnostics with partnerships in 3 states with a population catchment of c.240m people (Uttar Pradesh, Himachal Pradesh & Jharkand). Its 3 year CAGR on revenue stood at 9% and EBITDA at 18% (FY17 EBITDA Margin: c.19.8%).

The initial offer. IHH’s initial offer (16th April) was rebuffed due to its non-binging nature. It is understood that due to the influx of offers, the board of Fortis has appointed an expert advisory committee to review all “binding offers” on 26th April and will convene on the 10th May to consider offers.

The revised “partially binding” offer. Under the terms of the newly revised offer, this will be divided into a binding and non-binding potion. For the former, IHH is willing to inject INR650m Crore (c.RM380m) of primary equity without due diligence and immediately acquire 2 board seats, subject to (i) IHH being given confirmation to carry out immediate legal and financial due diligence, (ii) receipt of applicable approvals from Fortis shareholders and regulators and (iii) the end use of the immediate equity infusion to be discussed with IHH’s nominees on the board of Fortis. For the non binding portion of the revised proposal, IHH will infuse INR3350 Crore (RM1.97bn) though a subsequent preferential issue and allotment, subject to satisfactory completion of due diligence at a price not exceeding INR175/share (c.MYR10.30 based on the enhanced offer).

Valuation. The enhanced offer implies that IHH values Fortis at 24x EV/EBITDA (based on Bloomberg consensus) which is a premium to IHH’s FY18 EV/EBITDA of 19.4x. The offer will amount to a 31% stake of equity in Fortis on an enlarged share basis; this represents a controlling stake in the hospital chain.

Our view. According to several media sources (local and India), there are up to 4 binding offers on the table for the Fortis board to consider (TPG & Manipal, KKR, Hero

Enterprise and IHH). Considering such public interest in Fortis, we do expect a bidding war to precipitate. At the implied valuation of 24x EV/EBITDA we remain neutral on this pending greater insight from the due diligence, albeit with a negative bias as this represents a premium of c.24% to IHH’s 19.4x FY18 EV/EBITDA.

GO to be triggered. We understand that IHH’s offer for the 31% stake will trigger a mandatory general offer. Our pro-forma calculation implies that at INR175 per share, the remaining 519m of Fortis shares outstanding would be worth INR9134 Crore (RM5.4bn) which would bring the value of this whole exercise to RM7.8bn.

Impact to net gearing. With RM6.1bn cash and net gearing of 0.03x as at FY17, IHH has the balance sheet strength to undertake the acquisition but will have to gear up to complete the entire acquisition. We expect net gearing to increase to 0.14x assuming IHH’s investment into Fortis is limited to their offer for a 31% stake whilst a GO could potentially increase net gearing to 0.4x.

Synergy. In terms of synergistic benefits to the group, we believe that the acquisition of Fortis would complement IHH’s existing presence in India which is currently concentrated in the southern regions (recall they acquired Global Hospital - 73.2% stake and Continental hospitals - 51% stake in 2015). Currently India comprises of only 1% EBITDA contribution as at FY17. We believe this acquisition will propel IHH’s geographic and earnings footprint in the sub-continent in the midterm.

Not in pole position. We are of the opinion that TPG and Manipal might have the edge as they have been in earlier discussions with Fortis. This puts them at a significant advantage as discussion have been on going at the board level coupled with the fact that Manipal is a local entity.

Forecast. Unchanged pending further concrete announcements.

Maintain HOLD, TP: RM6.07. We maintain our TP based on SOP which implies FY19-20 EV/EBITDA of 16.6x-14.8x

Source: Hong Leong Investment Bank Research - 8 May 2018