Curious case of Fortis Healthcare

Fortis has been in the news for all the wrong reason. Promoter siphoning money from the listed entity, SFIO investigation in progress, overcharging patent at their hospital etc. This list of the negative news is quite lengthy and hence it's reflected in share price correction recently. But there remain few strength of the Fortis business which makes me believe it should give good return from here.

Here are few of the thoughts on Fortis Healthcare worth reading:

1. Promoter discount has to be adjusted: Fortis valuation has been hit in last few quarters as the company was taking burden of crooked promoter. Now since Singh Bros is no longer in picture, company should be valued normally in the lines of Apollo and other South Asian hospitals.

2. Loss report in Q2 and Q3 should be temporary: This is the same company which was alleged to charge 17lakhs for a dengue patient in Delhi. It was also mentioned how they are overcharging from their pharmacy. Ironical that company who milk their patient so badly is reporting losses. This has to do with their outgoing promoter who has been accused of swindling money. Over the course of next year, profitability should return to normalcy.

3. Strength of the Business (Diagnostic and 2nd largest chain of hospital): Fortis remain 2nd largest chain of hospital in India. Beside that, they also own SRL diagnostics which is much higher valuation business. It also has operation outside India. Combined valuation should be done on revenue per bed basis for hospital business and EV/EBITDA for the diagnostic chain.

4. Restructuring of RHT: RHT owns the hospital run by fortis, this help Fortis to run an assets light model. Fortis even have cross holding in RHT. Since RHT has raised money in Singapore, their cost of capital is lower. They can charge lower annuity for their assets and hence this was win-win situation. Just that it leaves complex structure in place. When promoter integrity is in question, complexity makes it difficult to find out if fund are siphoned. Once new promoter comes in, even if company continues with RHT structure, it will be appreciated by market.

5. SRL diagnostics spin off: Fortis has announced spin off and separate listing of SRL in 2016.  Diagnostics business will be valued much higher multiple compared to full healthcare business. SRL is crown jewel in Fortis business. If management tries to de-merge it now, it will make Fortis standalone bit unattractive to incoming investors. Hence they may want to delay this exercise till the new investor is on board.

6. Investment Banking like transaction without banker: Singh Bros owned ~70% stake in the company 4-5 quarters back, which is now almost zero. Of this 17% is held by Yes bank, rest all is well distributed among institution and general public. When Bajaj Finance wants to raise 4,500 cr they assign three bankers, do roadshow and meet scores of investors. It is amazing to see Fortis is able to do similar exercise with open market operations, such a credibility of exiting promoter. There has to be good intrinsic value in the assets, however that assets hasn't shown desired profitability to reflect fair value.

7. New Owner: Last year, TPG, IHH were rumoured to be interested in buying Fortis stake from Singh Bros. Back then, transaction was assumed will be done at 250 per share. Since then hospital business has been impacted by due to government intervention on stent, knee transplant and controlling drugs prices. However, this has coincided with general re-rating of capital market. Similar kind of bid should again come for Fortis this time.
http://www.livemint.com/Companies/bv3FHECoo9GFHjgPBRIKTO/Singh-brothers-said-to-seek-Rs250share-to-sell-off-Fortis-H.html

8. Healthcare has very very long run way for growth: This shouldn't be doubt in anyone mind that quality healthcare services in India is limited to metros and Tier-1 cities. Things need to improve significantly to put India anywhere near to global standards. As disposable income increases many people will be able to afford quality healthcare services. All small clinics in nearby locality run primarily by reference than by credibility.

9. Valuation: Story for any company is not complete without thinking about valuation. Given so much noise related to accounts it is difficult to assign Fortis value based to published information. However, instead of going wild assumption on valuation, lets make it a simple case. Apollo hospital business (exl pharmacy) revenue stands at INR 2952cr while Fortis hospital business was tad lower at INR 2815 cr in the nine month ending December 2017. Fortis EBITDA was INR 395 cr while Apollo makes INR 332 cr. However, Fortis incur BT cost post EBITDA as well. Beyond that Fortis own SRL with EBITDA run rate of INR 175 cr, which should trade at 25x multiple, should fetch INR 4 - 4.5K cr valuation. While Apollo has Pharmacy business which generated INR 85cr in 9M'FY18. Apollo trades at ~15k cr mcap.

10. Will Fortis be sold off cheaply: IHH & TPG have already shown interest to acquire substantial interest in Fortis. From Fortis side, there was talk to infuse INR 4,000cr for RHT payment. If the dilution is done at current price, current shareholder has to part significant portion of value at Fortis due to dilution at depressed price. hopefully, any fresh funding should go through majority of minority test rather than making preferential allotment to any bidder.

Disc. : All information shared in the article is for information purpose only. This is not to influence any investment decision. Please take advise of your financial advisor before any investment.

Private sector bank gaining market share may not be desired beyond a point

Ever since RBI took constructive view on private banks and started giving license to new age private banks since 1990s, they are gaining market share. RBI gave licensee to ~10 banks since 1990, most of them are running successfully. During the same time, public sector banks "PSB" have also experienced significant increase in their loan book, however their market share is consistently reducing as private banks are slowly taking morsel away from PSB platter.

As the banking structure stands today, private banks own 30% of market share while the public sector banks own 70%. One will come across numerous reports that will say private sector will soon swap market share with public sector. Hence all market participants will bet on the HDFCs and Kotaks of the world, that they will continue to gain market share and it is fair to value well run private banks at 3-4x book value.

However, gaining market share beyond a point may not be desirable for private banks and gaining market share in the current borrowing habits of Indian corporate may backfire to them. 

I would put my argument in two parts, one where private banks should be happy not to take larger market share from PSB. Second changes in borrowing habits where private sector will want higher market share.

Obviously changing borrowing habits is like moving a mountain, so we will discuss the easier part first.

Let's look at why PSB enjoy larger loan books. It is not because they are very efficient in lending, where lending is done much quicker than private banks. Not even that private banks doesn't have reach beyond metros.... They may not have reached to the remote locations and villages but there are very much present in the tier 2/3 towns catering MSME borrowers. One reason might be that PSB offers slightly cheaper loan to different sets of risky borrower and that is because they are wrong is understanding the underlying risks and not able to price the risks properly.

PSB have larger loan book as it acts big daddy of Indian corporate, and keep giving loan to undeserving candidates. About 10% of the PSB loan books is recognised bad loan, actual number will be much higher than currently recognized. Every alternate quarter results PSB management rhetoric would be "worst is behind and now we should see improvement in assets quality".

Private banks own smaller but healthier loan book. Their market share is at 30% because they restrained themselves hitting bad pockets of Indian corporate. It's better to have 30% share with less than 2% NPA than to enjoy 70% market share with over 10% bad loan.

Another reason for low market share is active account management. If the business of borrowers deteriorate private banks are quick to ask for extra collateral to cover the risk. They may also get out of certain accounts before situation gets ugly. PSB in general, once given the loan is married to borrower. Borrower, might leave for London, but banks will cling to their properties in India as if they are the remains of their departed spouse.

So, this reading loan book market share is wrong. One should look at share of profit among Indian banks. Since last two years has been particularly bad for public banks, one can look at profit share of 10 years. Private banks must be already hitting 60-70% even in the longer time frame.

Now, let's look at difficult aspect, changing borrowing habits. Public banks should enforce borrowers to provide extra collateral when business starts turning south. Currently many thinks borrowing is gambling with downside protected. If the business does well, profit is privatized, otherwise losses are nationalized. PSB also give top up loans to defaulting borrowers just to keep the banks away from recognizing as NPA. However, it seems that certain Indian corporate, who are addicted to free loan from PSB, will be unwilling to bring extra equity/collateral to maintain their loan backed up by sufficient equity.

Private banks remains cognizant of the current situation and hence keeping smaller but healthy books. Investor are right that their market share will grow and but growing beyond a point where you start taking bad loan books from PSB will not be value accretive.

Just as RBI have been cautious in giving me licensee, there should be rationalising on number of PSB. But that can be a discussion material for another day.