Fortis board has accepted IHH’s offer to acquire a 31.1% stake through a INR40bn (RM2.4bn) preferential allotment for a INR170/share which will subsequently trigger a mandatory public open offer for up to 26% of the outstanding shares. This offer effectively values Fortis at 22.3x FY03/18 EV/EBITDA (vs IHH’s 22.8x FY12/17 EV/EBITDA). The entire acquisition cost is projected to total up to RM4.3bn. Net gearing to range between 0.14x -0.23x depending on the acceptance levels of the open offer. Forecast is unchanged pending deal completion. We are positive on this acquisition; however we note that the gestation period for this acquisition remains opaque at this juncture amidst the backdrop of regulator investigations into alleged fraudulent transactions at Fortis. Maintain HOLD and our SOP derived TP of RM6.33.

The deal. Fortis’s board has accepted IHH’s offer to acquire a 31.1% stake through a preferential allotment of Fortis shares at a price of INR170/share (c.RM9.98). Subsequently, the preferential allotment will trigger a mandatory open offer to acquire up to 26% of the outstanding voting shares from the public as per the domestic regulations. Upon successful completion of both tranches of the transaction IHH will become the single largest shareholder in Fortis with a 57.1% stake (see figure #2). In the long run it is expected that Fortis will be rebranded into the groups Gleneagles chain. The acquisition is expected to be completed in 4Q18.

Fortis Malar. The Fortis open offer will also trigger an open offer to acquire up to 26% of Fortis Malar shares (4.9m shares) at a price of INR58 (c.RM3.40). Assuming full acceptance, the offer will potentially cost RM17m in total. Fortis Malar Hospital is a Chennai based 170 bed specialist hospital acquired by Fortis in 2008. Both Fortis and Malar will remain listed post acquisition.

Valuation. The offer implies that IHH values Fortis at 22.3x FY03/18 EV/EBITDA inline with IHH’s FY12/17 EV/EBITDA of 22.8x. Extending IHH’s implied enterprise value of INR105bn (RM6.1bn) results in an acquisition EV/EBITDA of 22.2x and 16.2x for FY19-20 based on Bloomberg consensus. At INR170 per share, the offer price is a premium of 19.5% to the closing price on 12 of July. We are neutral on the valuations as the group (i) did not “overpay” for a scalable asset, (ii) a proper due diligence was undertaken and (iii) a bidding war had precipitated for the asset. Nonetheless the valuations are not “undemanding” either given that Fortis is a “distressed asset”.

Impact to net gearing & earnings. The entire acquisition cost is projected to total RM4.3bn assuming the open offer for Fortis is fully accepted. The proposal will be funded via a combination of external borrowings (RM1.6bn) and internally generated funds (RM2.7bn). With RM6.1bn cash and net gearing of 0.03x as at 1Q18, IHH will be able to complete the acquisition comfortably. We expect net gearing to range between 0.14x-0.23x depending on the acceptance levels of the open offer. Our proforma calculation implies that our FY19 EBITDA will potentially be enhanced by c.8.6% upon consolidating Fortis’s FY03/18 operating EBITDA (4.7bn INR/ RM276m) into our forecast. India’s contributions to group revenues are projected to increase to 24% from 6% currently.

Our view. This acquisition marks IHH’s entry into northern India where it was previously absent (see figure #3) and manifests a transformational opportunity to widen IHH’s presence in its 4th home market. Considering that India’s public healthcare system is relatively underfunded (c.1% of GDP) and insurance penetration rates are low (<15% of the population), this move presents an extremely scalable opportunity of ready brownfield assets ripe for expansion in the most underserved healthcare infrastructure region in India (see figure #4).

The crown jewel. We understand that eventually IHH will consolidate SRL (56.5% subsidiary of Fortis) into its larger global labs franchise with a view to eventually spin it off in future. The business from Fortis hospitals itself only accounts for c.20% of SRL’s revenue. We believe there is much room to scale the business given that the diagnostics industry in India is fractured and underserved. SRL’s 3 year CAGR on revenue stood at 9% and EBITDA at 18% (FY17 EBITDA Margin: c.19.8%).

Post-acquisition. Immediately IHH intends to improve operational and profitability metrics in near term, having been impacted by the “destabilization” associated with the previous promoters which has resulted in Fortis lagging its peer’s margins by 5- 6% in both the hospitals and the diagnostic business. IHH also intend to see through the purchase of RHT (total acquisition c. INR46.5bn or RM2.7bn), which will results in significant rental savings and improve cash flows (INR3.4bn or RM200m per annum). Apart from that IHH is also looking at optimizing Fortis’s financing costs by 2%-4% by leveraging on IHH’s credit profile.

Forecast. Unchanged Pending Completion of Deal.

Maintain HOLD, TP: RM6.33. Maintain our HOLD call and SOP based TP of RM6.33. Our TP implies FY19-20 EV/EBITDA of 16.6x-14.4x. Whilst we are positive on this acquisition and appreciate IHH’s track record of turning around assets and improving operational performance, we note that the gestation period for this acquisition remains opaque at this juncture amidst the backdrop of regulator investigations into alleged fraudulent transactions at Fortis.

Source: Hong Leong Investment Bank Research - 16 Jul 2018