GEM Healthcare - the largest Turkish hospitals looking to go public but will they?

Medical Park and Memorial IPOs in 2018

The shareholders of Medical Park and Memorial Hospitals are planning to divest some of their holdings in Turkish hospital chains through public offerings next year. Medical Park is reportedly looking to sell shares via an Istanbul listing while Memorial is weighing its options on whether to list the business in London. Medical Park and Memorial are two of the three largest private sector healthcare service providers in Turkey; the third one is Acibadem. Medical Park, Acibadem and Memorial command estimated 32%, 16% and 10% of hospital beds (2017E) operating in the private sector, respectively. Acibadem, majority-owned by IHH Berhad of Malaysia, was a public company itself before its stock was delisted following the acquisition by Abraaj Group, the private equity firm, in 2007. The only Turkish hospitals business whose equity is currently listed on a public exchange is Lokman Hekim, the nation's sixth largest hospital chain.

Private equity looking to sell is not a surprise

Private equity firms have heavily invested in the Turkish healthcare sector for well over a decade now. Their investments have changed the competitive landscape and helped raise the market share of private providers to over one-third of the industry from 20% two decades ago. Turkish healthcare industry has in fact become one of the fastest growing sectors across emerging markets along with India, SE Asia, and the Middle East. The PE plans to divest some or all of their Turkish assets to "lock-in" the gains are not out of ordinary. Our interest and hence the purpose of this short note is to provide some guidance earlier on as to how investors should treat these share offerings and explore equity valuations we should be expecting from the sales.

Valuation comps - Turkey

Our impression from what we have read or heard on the street is that the sellers are expecting multiples somewhat inconsistent with the sector outlook in Turkey and the broader GEM space. The investments in the GEM healthcare providers sector have diluted margins significantly and disappointed on payback timing. The earnings outlook looks uninviting. Market share gains driven by aggressive capital expenditures by both Turkish and GEM majors are now likely to decline in 2018 and 2019. We find the IPO valuations nearly three times as high as where Lokman Hekim shares are currently trading at unrealistic. Lokman is certainly smaller than the two IPO candidates by capacity and revenue with circa 4% market share in each; thus it may not be the ideal comp to use as a context. Yet, Lokman is the only company in the Turkish healthcare providers sector that potential IPO investors will consider using as a comp. Lokman also has dedicated international institutions among its shareholders, which makes it visible. Lokman is on potential investors' radar as the only company in an attractive industry. It would be premature to expect that potential sector investors will dismiss Lokman as a comparable for the forthcoming public offerings.

Valuation comps - GEM sectors

Looking for comps across GEM healthcare space, we find somewhat depressed or mixed valuations. The sector earnings have disappointed since 2015. Poor delivery by managements following some large greenfield investments and untimely acquisitions particularly in Asia but also in Europe have dampened the investor appetite. Share price performances of the GEM majors have lagged significantly other consumer sectors from 2016 onward. Institutional investors constantly seek and are prepared to pay for earnings enhancing investments by managements. GEM healthcare sector was no exception. The expectations were built rather high in the run up to and the immediate aftermath of investments with companies generally guiding with an upbeat tone. Yet, the shareholders have slowly taken note that these investments are unlikely to become earnings-accretive any time soon and have punished the managements by selling the stocks. The managements have then started downgrading their guidance.

IHH Berhad tops the list of GEM hospital chains failing to deliver on guidance followed by Mediclinic International and Life Healthcare Group, the two South Africa-based providers. IHH plans to expand further in SE Asia were received well by investors. The stock had a stellar performance in 2015 driven by the optimism before investments and acquisitions. Longer-than planned break-even in Hong Kong (Gleneagles), unsuccessful entry into the Chinese market and other delays started hurting the investor appetite. Shareholders grew inpatient about the projects while the stock itself has reversed the gains, declined and failed to stage any recovery since early 2016. Mediclinic International and Life Healthcare have similar stories. Mediclinic is still trying to digest its pricey Al Noor acquisition while. Life Healthcare is spending both money and management time to turn around Asian business.

Investor confidence remains low and most GEM money managers will probably wait longer before they reconsider their positions in the sector. The current valuations reflect the mood. Income statement charges, cash and non-cash, are likely to remain high across the sector for a while. Near-term earnings multiples appear punitively high while EBITDA-based multiples are below historical levels. Mediclinic shares are trading at 11.3-times on EV/EBITDA. The same multiple for Life Healthcare is a far less-demanding 7.9-times. IHH Berhad is on 16.6x. Lokman Hekim trades at 5x.

Read-across for valuation of Turkish IPOs

We have three points to make.

1. The first one is to highlight the striking similarity between the Turkish care providers and the larger GEM businesses. The top three companies in Turkey have all invested heavily in capacity in recent years growing bed-count by 10-15% a year for several years now. The sector investments have diluted margins significantly and earnings outlook is bleak. The three largest players have significant debt in their balance sheets with leverage ratios running above 5x. They have naturally reported EBITDA growth but the growth has come in at the expense of some serious margin dilution. There is no or little earnings near-term with uncertain outlook medium-term. Moreover, market share gains driven by aggressive capital expenditures are now likely to decline in 2018 and 2019. We would also expect slowdown in growth on high-end of the market, where the top three providers compete for the marginal patient. Overall sector trends and operating outlook in Turkey are not dissimilar to the broader GEM sector trends. Going out to pitch to sell shares at rich multiples to institutional investors who have already been let down by other players in the industry would not be an easy task. 
2. Second, there is a more relevant comp in IHH Berhad for IPO valuations of Medical Park and Memorial. IHH Berhad makes close to one-third of its revenues through Acibadem in Turkey. Generating well over 90% of its revenues from PMI and out-of-pocket patients, Acibadem operates a higher-margin business than its peers do. It indeed earns the highest margin among the larger Turkish providers. The sensible conclusion one should draw is that Acibadem commands a valuation premium to its peers in Turkish healthcare space. The irony is Acibadem actually dilutes group margins at IHH Berhad, the parent, which earns superior EBITDA margins both in Singapore and Malaysia. IHH's blended valuation multiples imply lower equity values for Acibadem, the Group's Turkish operation. On our estimates, Acibadem's "implied" EV/EBITDA multiple is circa 11x, which compares to Lokman Hekim's 5x.
3. Trading at the low-end of GEM healthcare providers valuation range, Lokman has a compelling investment case. The company has also been active in acquisitions past several years; but in its case, payback periods are shorter making the stock look more attractive on valuation, both on near-term and long-term earnings, especially in the run-up to equity offerings by competitors. 

Other risk sources for equity investors

The two IPOs being staged simultaneously is also a downside risk to valuations, which could dilute some of the value in both offerings. If investors start thinking that there may be some good reasons why private equity is trying to sell their stakes in two major Turkish providers, the IPO valuations may be to sellers' liking.

Yet another source of uncertainty for potential investors is the geopolitical risk. The region to the South of Turkey remains unstable, to say the least. Although there is no direct impact on operations in either of the two companies, unsettled Syria and Iraq do raise the equity risk premium for any Turkish company tapping investors. Moreover, the geopolitical risks in relation to Turkey's immediate neighbors will probably be with us for a while. It is not inconceivable that these two countries, in particular Syria, will have an authority vacuum or multiple authorities ruling over different parts of the region for a while longer. 

Appendix - Recent M&A and greenfield values

India - IHH paid INR 12.8 billion (circa RM 820 million or US$ 187 million) in a 100% cash transaction to acquire 73.4% stake in Global Hospitals in India. The transaction valued Global's equity at $232K per operational bed or 3.5x on EV/Sales. We do not have a comparable EV/EBITDA multiple for this acquisition.

Malaysia - The project cost based valuations in Malaysia are similar. We indeed estimate the average cost of IHH's capacity expansion and greenfield investments in Malaysia at EV $201K per bed. The EV/Bed based valuation range in the seven Pantai projects in Malaysia is from $67K to $304K. 

Turkey - Acibadem's investments in Turkey has an average project cost of $270K on EV to bed capacity. The costliest project appears to be Kartal Hospital in broader Istanbul region: $555K. The valuation range for the 6 recent Turkish projects is $98K to $555K. Most Acibadem projects cost between $250K and $350K on EV/bed.

UAE - The valuation for Al Noor's equity as implied by Mediclinic's acquisition was circa 17x on EV/EBITDA or 3.8x on EV/Sales.

Myanmar - In comparison, the cost of greenfield investments in Yangon is consistent with $280K per operational bed.