This article first appeared in The Edge Financial Daily on September 19, 2019

IHH Healthcare Bhd
(Sept 18, RM5.75)
Maintain buy with an unchanged target price of RM6.40: IHH Healthcare Bhd announced a proposed acquisition of the entire issued share capital of Prince Court Medical Centre Sdn Bhd (PCMC) from Khazanah Nasional Bhd for RM1.02 billion.

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 the financing cost. The proposed acquisition is expected to be completed in the first quarter of 2020.

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

While PCMC’s earnings before interest, taxes, depreciation and amortisation (Ebitda) has been growing at a faster pace as compared to its revenue (two-year Ebitda compound annual growth rate [CAGR] 32% versus revenue CAGR of 11%) as a result of transformation initiatives undertaken to improve its Ebitda margin over the years (from 12% in financial year ended Dec 31, 2016 (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.

The proposed acquisition will allow IHH to strengthen its position in the Malaysian private healthcare segment, as well as broaden its service offerings and leverage on its wide network of hospitals.

Additionally, IHH will gain a qualified and experienced medical professional team offering a wide range of services.

We think the valuation is fair as the purchase consideration of RM1.02 billion represents the mid-point of the fair market value of between RM960 million and RM1.08 billion as derived by independent equity valuer PwC Capital, and is also lower than the seller’s original cost of investment of RM1.09 billion in August 2018.

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.

Based on an indicative interest rate of 4.13% on the borrowing of RM650 million, the interest expense for the acquisition is estimated to be RM26.8 million, which is slightly above PCMC’s FY18 core net profit of RM26 million.

Post-acquisition, IHH’s gearing is expected to increase from 0.48 to 0.51 times. Note that a one-off estimated expense of RM11 million relating to the proposed acquisition will be incurred upon completion of the transaction. — Affin Hwang Capital, Sept 18