Investors can refrain from subscribing to the IPO of Fortis Healthcare being made in the price band of Rs 92-110 per share. The company is a leading player in the nascent healthcare services market that has high growth potential. However, the litigation that threatens the company's continued operation of its largest property — Escorts, Delhi — casts a cloud over the earnings prospects. The offer pricing, which is rich vis-à-vis its peers, also does not build in a sufficient discount for this risk. Investors can, thus, wait for greater clarity on the litigation status before investing in the stock.
High-growth business
Despite being a relatively recent entrant to the healthcare space, Fortis has used acquisitions and investments to build a strong reputation in specialised areas such as cardiac care and orthopaedics, and a sizeable scale of operations in this business. Fortis Healthcare now controls a network of 12 hospitals, of which seven are owned and the rest are under management contracts; these are located mainly in and around the National Capital Region. It also recently charted a foray into Western India by acquiring a stake in Mumbai-based Hiranandani Healthcare. The owned hospitals include Escorts Heart Institute and Research Centre (EHIRC) in Delhi, other Escorts hospitals in Amritsar and Faridabad and the Fortis Hospitals in Amritsar, Noida and Mohali. The company also operates 16 satellite "Heart Command Centres" in other hospitals. EHIRC enjoys a very strong reputation in cardiac care for its skilled doctors and efficiently-run operations. Future plans include greenfield projects in Jaipur, Delhi and Gurgaon, to scale up the current bed capacity of 1,800 by another 750 over the next two years. Plans are also afoot for further geographic expansion through acquisitions and management contracts.
Demand prospects for healthcare services appear strong in the light of higher longevity and the demographic shift in the Indian population and acute shortage of hospital infrastructure (a deficit of 7.5 lakh hospital beds is estimated over the next six years). A rising incidence of lifestyle diseases and increasing penetration of health insurance, suggest that service providers may enjoy strong pricing power in the years ahead. Fortis Healthcare, as one of the two leading players in the domestic healthcare space, given its strong brand equity, is well-placed to capitalise on this opportunity.
Financial prospects
The hospital business is highly capital-intensive, with a new facility usually taking a five-six year gestation period to break even at the net profit level. Apart from revenue per bed, profitability of a hospital depends, to a large extent, on the level of occupancy and the average length of stay for patients. Higher occupancy and a lower length of stay contribute to higher asset turnover, leading to better operating profit margins. Given that Fortis made its first foray into the healthcare space in 2001, its facilities, with the exception of the key Escorts facilities, are fairly new and, therefore, have relatively low occupancy levels at present. Only three of Fortis' nine key facilities — Escorts Delhi (84 per cent occupancy), Escorts Faridabad (81 per cent) and Fortis Mohali (78 per cent) — had occupancy rates of over 70 per cent in FY-06.
On a consolidated basis, Fortis Healthcare reported revenues of Rs 384 crore and cash profits (before goodwill amortisation) of Rs 40 crore for the nine months ended December 2006; but made losses of Rs 72.8 crore at the net level due to interest costs, depreciation and amortisation. The average occupancy rate across Fortis' facilities is 52-per cent, the claimed break-even level. In the coming years, operating leverage could work in Fortis' favour if the facilities at centres such as Mohali and Noida manage to further ramp up their occupancy rates. Assuming this is managed, both revenue and operating profits for Fortis could expand strongly over the next couple of years (a turnaround at the net level may still be a couple of years away on account of goodwill amortisation and interest costs).
Risks
Though the business offers the potential for strong growth, there are a few risks that investors have to factor into the equation. The key risk to Fortis' operations arises from the litigation surrounding EHIRC and its subsidiaries. EHIRC is currently involved in legal proceedings that challenge its initial incorporation as a company and its acquisition by the Fortis group. The company's right to operate its Delhi facility on leasehold land has also been disputed by the lessor — the Delhi Development Authority. But an adverse result could hit Fortis' operations, as the Escorts' facility account for over 40 per cent of the company's bed capacity, over 60 per cent of revenues and a major portion of operating profits.
Business risks surrounding Fortis' operations arise from its ability to retain its skilled workforce and attract new patients at its smaller centres. Apart from this, a significant proportion of corporate clientele could result in pricing pressure as such clients may try to wrangle better rates. Given the aggressive expansion plans, there are significant execution risks to the revenue and profit projections.
Valuation
In the light of the above risks, the offer pricing does not allow much margin of safety for investors in the IPO. At the higher end of the price band, the offer values Fortis Healthcare at an enterprise value multiple of about 20 times its estimated EBITDA (earnings before interest, tax, depreciation and amortisation) for FY-08; this represents a premium over the current valuation of Apollo Hospitals — the only comparable player in the healthcare space. Apollo has a much larger scale of operations and offers greater earnings visibility than Fortis, given its more mature operations, though its growth trajectory may be lower than Fortis over the next couple of years. Investors can closely watch the stock and revisit it post-listing, once the litigation issues are sorted out.
Offers details: This book-building offer seeks to raise Rs 423-506 crore, at a price band of Rs 92-110. The offer proceeds will be deployed mainly in the construction of new hospital facilities at New Delhi, apart from retiring preference capital and debt on the balance-sheet. The promoters, mainly from the Ranbaxy group, will hold 68.09 per cent of the post-offer equity.