This article first appeared in The Edge Malaysia Weekly on May 29, 2017 - June 4, 2017

IHH Healthcare Bhd’s 60% stake in Turkey’s Acibadem Healthcare Group was a cornerstone of its initial public offering in 2012. Bridging Europe and Asia, the Turkish venture was touted as a key strategic growth market for the hospital operator.

But while Acibadem’s expanding operations have shown promise over the past few years, revenue growth has been all but wiped out by foreign exchange losses.

In short, Acibadem’s RM2.62 billion worth of euro and US dollar-denominated loans have proved disastrous for its profit when matched with an income stream denominated in the ever-depreciating lira.

In the fourth quarter of last year, the currency mismatch resulted in a RM335.2 million unrealised forex loss. It pushed the group into the red for a shock quarterly loss of RM42.51 million.

It is not difficult to understand the decline in IHH’s share price in recent months.

Following the disappointing results, IHH’s management vowed to “de-risk” its forex exposure with a combination of hedging and debt refinancing.

Realistically, however, the group’s forex ailment is proving to be a chronic condition that is difficult to cure outright. There are only temporary treatments that can address the symptoms, and these can prove expensive.

In fact, these remedies are difficult to administer.

Case in point, management has not yet been able to refinance borrowings in lira as promised.

“Due to the Turkish referendum, we were unable to access debt markets to refinance some of our borrowings. The banks were not willing to lend due to the uncertainty,” IHH chief financial officer Low Soon Teck explains at a press conference after the group’s annual general meeting last week.

To be fair, IHH has little control over the circumstances that affect Turkey’s financial markets. Between the attempted coup d’état against Prime Minister Recep Tayyip Erdogan and his heavy-handed crackdown on dissidents, Turkish security forces have to contend with domestic tensions with Kurdish groups and threats by foreign militant organisations like the Islamic State.

Ironically, the referendum that will give Erdogan new-found executive powers is also seen as a stabilising force that is good for businesses.

“Now that the uncertainty of the referendum has passed, we can start talking to banks again,” says Low, who assures that IHH should be able to refinance some of its euro and US dollar-denominated borrowings in lira in the next few months.

However, there are severe limitations.

“The debt market in Turkey is very shallow. It is nearly impossible to issue long-term instruments. The banks are only willing to lend for 12 to 18 months. Furthermore, the amount you can issue is quite small, about €100 million to €150 million’s worth,” says Low.

The banks’ tolerance for single-client exposure is also very low, about €200 million at the most, he adds.

In contrast, Acibadem had RM2.06 billion worth of euro-denominated borrowings and RM564.18 million worth of US dollar-denominated debt as at Dec 31, 2016.

Furthermore, the cost will not be cheap.

The Turkish Lira Reference Interest Rate closed at 12.755% last Thursday. Even at a marginal spread above that rate, lira debt would be very expensive compared with the 3% to 5.25% interest rate that IHH currently pays on its euro and US dollar debt.

The short tenure of the debt also means that IHH will be constantly rolling over its debt — a potentially costly affair, given the volatility of Turkish rates.

The forex mismatch will also cost IHH.

In a report last month, the Economist Intelligence Unit (EIU) predicts that “the lira will depreciate against the US dollar to an annual average of 3.73, a fall of 19%”, amid further bouts of volatility.

The lira is currently trading at 3.56 to the US dollar. That represents a depreciation of almost 95% since IHH’s listing in July 2012. Against the euro, the lira has depreciated 80% in the same period, and 45% against the ringgit.

The lira’s depreciation has been the main cause of IHH’s forex losses.

“I am more sanguine than analysts,” says Low.

He asserts that the Turkish central bank is not given enough credit for its independence and its efficiency in managing the country’s money supply to balance inflation and growth.

Looking ahead, Low expects the central bank to have a bias towards increasing interest rates to rein in inflation, which hit 11.9% in April. In turn, this will help strengthen the lira a little.

That said, the EIU report flags Erdogan’s populist agenda as a risk that might keep interest rates low.

What can IHH do?

For starters, Low intends to uphold management’s promise to de-risk Acibadem’s exposure to non-lira debt.

However, it is neither sensible nor feasible to refinance all of Acibadem’s RM2.642 billion worth of debt.

“We will not refinance all our debt. Just the debt we need for working capital, so we can match the maturity of the lira debt with the purpose,” explains Low.

The limitations of Turkish banks means only about 30% of Acibadem’s debt can be refinanced, anyway.

IHH is also hedging all its debt obligations for the next 12 months to further reduce volatility, says Low.

At a glance, this means earnings will be relatively shielded from forex shocks this year. However, Low concedes the cost will be high.

“I can’t disclose our costs, but the cost of hedging is something that goes up exponentially, the longer it is for. Just look at the difference between nine-month and 12-month forward rates,” he says, noting that IHH is only using plain vanilla forwards and derivatives.

Low also says Acibadem has reduced its reliance on lira revenue streams via its investment in Bulgaria. Last June, Acibadem spent €125 million on acquiring four hospitals and four medical centres in Bulgaria.

“The patients there will pay in euros and help us reduce our dependence on the lira,” explains Low.

That said, it has also led to more euro-denominated borrowings for the group.

Hedging and refinancing will ease earnings volatility, but high finance costs are inevitable and will erode profitability.

Nonetheless, Low just considers it as the cost of doing business in an emerging market. “When you choose to invest in a market like Turkey, this is a cost you have to bear. The good news, however, is that we are past our peak financing needs.”

Over the past four years, Acibadem has opened two hospitals a year on average. Not only does this incur high start-up costs, it has also inflated borrowings.

However, IHH’s Turkish operations are also expected to change gear towards more organic growth in the coming years.

In simple terms, Acibadem’s finance costs may remain high but will not climb. Its top line, however, will continue to expand and potentially outweigh the finance costs.

It is worth noting that IHH’s inpatient admissions have seen the strongest growth in Turkey — averaging 13.5% per annum. In the fourth quarter last year, Acibadem hit a record of 60,470 inpatient admissions, almost double that in 2013.

If it weren’t for the 45% depreciation in the lira against the ringgit, Acibadem’s ringgit-converted contribution to the group’s revenue would be substantially higher than the current 35%.

“Don’t forget why we are in Turkey. In terms of the infrastructure, it is still the best in the region. For premium healthcare and healthcare centres of excellence, there is nowhere else to go. Places like Syria and Lebanon are still struggling to get on their feet while the Balkan states are too small to develop this sort of services,” Low explains.

Security threats and political uncertainty may scare off investors, but Low points out that it is part and parcel of everyday life for the people living there.

In fact, Low says, foreign patient numbers have not waned, now making up about 10% of admissions.

In summary, IHH can only minimise but not eliminate its forex risk. However, the investment can still bear fruit. But that will hinge on management’s ability to sustain revenue growth in the challenging environment.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.