IHH Healthcare (IHH) announced a proposed acquisition of the entire issued share capital of Prince Court Medical Centre Sdn Bhd (PCMC) from Khazanah Nasional Bhd for RM1.02bn. While we are positive on the acquisition over the medium to long-term, contribution from the acquisition is likely to be minimal in the near-term given financing cost. The proposed acquisition is expected to be completed in 1Q20. Maintain BUY with an unchanged TP of RM6.40.

A Strategically Located Private Medical Hospital

Incorporated in 2002 and strategically located in the ‘Golden Triangle’ area of Kuala Lumpur, PCMC owns and operates a 277-licensed bed private healthcare facility offering a wide range of medical, surgical and hospital services including, among others, burns management, cancer, gastrointestinal diseases, interventional cardiology, in vitro fertilisation, nephrology, occupational health, orthopaedic and rehabilitation medicine.

More Room for Growth Via Cost Synergies…

While PCMC’s EBITDA has been growing at a faster pace as compared to its revenue (2-year EBITDA CAGR 32% vs. revenue CAGR 11%) as a result of transformation initiatives undertaken to improve its EBITDA margin over the years (from 12% in FY16 to 17% in FY18), PCMC‘s EBITDA margin of 17% is still significantly lower than IHH Malaysian operations’ 29% as it is reaching structural limitation as a standalone single hospital, unlike the economies of scale IHH is able to derive having own a wide network of hospitals. Hence, by integrating PCMC’s existing business functions, systems and personnel with IHH’s established shared services and business functions structure that services its existing hospital network in Malaysia, there is plenty of potential headroom to grow via medical supply procurement and cost synergies. PCMC has a similar revenue intensity, occupancy and payer mix as compared to IHH’s flagship hospitals in Klang Valley.

… and Revenue Synergies

The proposed acquisition will allow IHH to strengthen its position in the Malaysian private healthcare segment and will allow IHH to broaden its service offerings and leverage on its wide network of hospitals. In addition, IHH will gain a qualified and experienced medical professional team offering a wide range of services. IHH also plans to develop centres of excellence such as oncology, cardiology, bone and spine centre for PCMC, and deepen the level of speciality and clinical outcomes for patients to drive revenue intensity, which is in line with IHH’s existing hospital network’s strategy.

Fair Valuation Comes With Valuable Asset

We think the valuation is fair as the purchase consideration of RM1.02bn represents the mid-point of the fair market value of between RM0.96bn and RM1.08bn as derived by the independent equity valuer, PwC Capital and is also lower than the seller’s original cost of investment of RM1.09bn in August 2018. In addition, the implied EV/EBITDA multiple of 22x and EV/bed of RM3.7m falls within the range of implied EV/EBITDA multiples of selected previous transactions of between 11x to 24x, and within the range of implied EV/bed of selected precedent transactions of between RM1.0m to RM6.1m (Fig 1). Moreover, PCMC is strategically located in Kuala Lumpur’s “Golden Triangle” of which the market value of the land and building stands at RM800.0m as at 20 August 2019, based on independent property valuation by Knight Frank using cost approach.

A Debt-free Profitable Private Hospital

PCMC is a debt-free profitable operating hospital, with a reported RM260m revenue, RM44m EBITDA and RM51m net profit in FY18. Stripping off the writeback of deferred tax of RM25m, FY18 core net profit came in at RM26m. Its FY18 revenue and EBITDA represent 13% and 8% of IHH’s FY18 Malaysian operations’ revenue and EBITDA respectively. However, in term of the entire IHH group, PCMC’s revenue, EBITDA and core net profit contribution to the group are only around 2%.

Near-term Contribution Likely to be Minimal

While we are positive on the proposed acquisition given PCMC’s strong and reputable brand and the potential headroom to grow the hospital via cost and revenue synergies, the contribution from the acquisition is expected to be minimal in the near-term after taking into account the financing cost for the acquisition. IHH is currently working on the scenario of funding 64% of the purchase consideration via bank borrowings. Based on an indicative interest rate of 4.13% on the borrowing of RM650m, the interest expense for the acquisition is estimated to be RM26.8m, which is slightly above PCMC’s FY18 core net profit of RM26m. Post-acquisition, IHH’s gearing is expected to increase from 0.48x to 0.51x. Note that a one-off estimated expense of RM11m relating to the proposed acquisition will be incurred upon completion of the transaction.

Disposal by Khazanah Given the Change in Its Refreshed Mandate

Recall that PCMC was acquired by Khazanah from Petroliam Nasional Berhad (Petronas) in August 2018. According to a statement by Khazanah, the disposal decision was made given the recent change in its refreshed mandate and will provide it with the liquidity for its future investment capital requirements. The sovereign wealth fund is confident that PCMC will further benefit from IHH’s wealth of experience in providing premium healthcare, whilst solidifying IHH’s position as a leading healthcare operator, where the sovereign wealth fund remains as a substantial shareholder with a 26% stake.

Maintain BUY With An Unchanged TP of RM6.40

As the earnings contribution from the proposed acquisition is likely to be minimal in the near-term, we maintain our earnings estimates at the juncture, pending completion of the acquisition and more details on the hospital. Barring unforeseen circumstances and pending regulatory approvals, IHH expects the proposed acquisition to be completed in 1Q20. We maintain a BUY call on IHH with an unchanged TP of RM6.40. Going forward, we believe that IHH should continue to deliver stronger earnings, underpinned by i) organic growth from existing operations, ii) narrowing losses from GHK as a result of operating leverage, and iii) improvement in Fortis’ profitability. Downside risks: currency risk, higher-than-expected start-up expense, and potential new pricing controls in key markets.

Source: Affin Hwang Research - 18 Sept 2019