Fortis Healthcare reverses its asset-light strategy
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The see-saw movement in Fortis Healthcare Ltd’s shares in the past two days should be enough to send investors’ blood pressure soaring. On Wednesday, its shares soared by 7.7% as the company announced that it would be buying back hospital assets that it had sold five years ago to a Singapore-listed business trust. On Thursday, however, its shares slumped by 6.8%, taking away almost all of those gains.
What could have made investors reconsider their view on Thursday?
By unwinding the structure, it goes back to what one could call an asset-heavy model. Religare Health Trust says, in its disclosure, that it got an unsolicited offer from Fortis to buy the entire portfolio of assets for Rs4,650 crore.
Why would Fortis willingly shift away from its asset-light strategy, one that has become popular among most hospital chains? Its statement says that the transaction will enhance value, and by unwinding the current structure, make it easier for investors to better understand the company’s business and financial performance. Also, it would save on the service fee and allied interest servicing costs.
After so many years, one would have thought investors should have become comfortable with the business structure. In fiscal year 2013, Fortis sold a pool of hospital assets to the business trust. In return, it would pay a service fee to the trust, be relieved of the asset burden on its books, thereby improving its return on capital.
Also, the advantages cited when the assets were transferred to the trust were that it provides additional capital, lowers overall debt and allows the company to focus on growth in a business that requires constant sources of funds for expansion. All of that gets turned on its head now. That could be a concern.
Funding comes next. For perspective, Fortis had net debt to equity of 0.2 times as of the June quarter, with gross debt of Rs2,192 crore. Out of the Rs4,650 crore consideration, the company will assume Rs1,152 crore as debt, and the rest will be as cash consideration. As of 30 June, it had cash and equivalents of Rs976 crore.
It intends to raise funds through a combination of equity and debt or quasi-debt. Once the capital structure is known, there should be more clarity on this aspect. Even if we assume a 50:50 split, it will mean a significant increase in debt. That could be another concern. Equity-raising could mean a significant dilution as well. But a part of the money will return to Fortis, to the extent of its stake in the trust.
What about the valuation? How it arrived at this value for the trust’s assets should become clearer when the company approaches shareholders for approval. For now, Religare Health Trust’s investor presentation offers some useful clues. Income generating assets contribute 92.7% of the portfolio, with greenfield establishments contributing the rest. The portfolio has risen considerably since listing in 2013, from 1,706 beds to 3,046 beds.
The net asset value (NAV) disclosed by Religare Health Trust shows that the portfolio which had a NAV of Singapore $685 million in 2013 has a NAV of S$ 696million in FY17. The FY17 number translates to Rs3,328 crore, using the exchange rate given in the presentation. Against that, Fortis is paying a premium of 39.7% and investors would be keen on knowing how the valuation was arrived at. It would be a small consolation that a part of the consideration will return to Fortis, on account of its stake in the trust.
Based on the first-quarter service fee, Fortis has said it can be expected to save Rs270 crore on an annualized basis and also save interest cost of Rs75 crore. But it also needs to service the capital it will raise to acquire the asset. Once the capital structure is known, the net savings can be estimated.
These issues could possibly explain why investors have had second thoughts on the transaction. Once they get clarity on these aspects, a different view may emerge. There is one event that is at present a matter of speculation, which is that news reports in the past have suggested that the promoters may be planning to sell Fortis. The return of assets back into Fortis may then be a necessary precursor to a transaction. If that is so, then the sale transaction will become more crucial in determining where investors stand.