Our Point of View on Fortis-Religare Health Trust Deal Kapil Khandelwal QuoteUnquote with KK www.kapilkhandelwal.com

1. Is the Street overvaluing Fortis-
Religare Health Trust deal?
When I was invested in an asset-light chain of day-care surgery
centers in India, investors were giving a premium valuation to asset-
light business models as those provided high Returns on Capital
Employed (ROCE).
The investors in a race to acquire Fortis Healthcare Ltd are looking
to fund the hospital chainʼs acquisition of Religare Health Trust
(RHT), a Singapore REIT vehicle, at premium valuations. Why this
googly?
As Indiaʼs first dedicated healthcare infrastructure fund, Toro
Finserve LLP believes that investors and the Street are blindsided by
what is coming!
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2. In 2012, Fortis announced spinning off its hospitals (operational and
greenfield) into RHT. Fortis raised Rs 2,260 crore by listing RHT,
retaining an about 28% stake in RHT. As per Fortis, the rationale for
floating RHT was to use it as a long-term finance vehicle,
deleverage teh balance sheet, allow Fortis to focus on its core
activity of providing healthcare services. Fortis used a majority of
the proceeds to repay debt (about Rs 1,350 crore) and invest in its
subsidiaries.
Fortis agreed to pay a fixed plus variable hospital service fee (rent)
as consideration to RHT. In November 2017, Fortis announced its
plan to re-acquire hospitals of RHT for Rs 4,650 crore. As per Fortis,
the acquisition of hospitals was to improve its balance sheet,
increase profitability by eliminating the service fee and consolidate
its business for better valuation by raising equity and debt.
There is something amiss. Letʼs take each reason point by point:
Improving balance sheet: Fortisʼ acquisition by any of its suitors
may require multiple regulatory approvals. There is also a pre-
condition that Fortis acquires RHTʼs hospitals first and receive
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3. equity infusion from its acquirers. In that case, the following
financing option will prevail:
As of 31 December 2017, Fortisʼ net debt to equity was 17.8%, (gross
debt was Rs 1,799 crore and cash reserves Rs 460 crore). After the
transaction, there will be a significant increase in debt from Rs 1,799
crore to Rs 5,989 crore. This includes current debt, new debt and
assumed debt from RHT. This should be a huge concern to
investors as the balance sheet worsens significantly.
What happens when new investors infuse equity? The new investors
are expected to infuse only Rs 1,500 crore to Rs 2,000 crore in
equity, thus diluting existing investorsʼ equity. The rest of the
transaction will be financed by debt. Therefore, in the best-case
scenario, the debt increases to Rs 4,449 crore, worsening the
balance sheet.
Improving profitability: One might argue so what if the debt
increases. Profitability and the asset value also increase, one might
say. On profitability, Fortis maintained it can save Rs 270 crore on an
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4. annualised basis and allied interest of Rs 70 crore. But it also needs
to service the capital it will raise to acquire the hospitals. And
assuming debt at an interest rate of 9.5% per year against the
hospitals they acquire, Fortis will have to pay an incremental interest
of Rs 398 crore (Rs 58 crore higher than service fee savings).
Fortis will be worse off on profit-after-tax basis after acquiring RHT
hospitals. So, the argument doesnʼt hold that incremental debt
servicing may not be as much when new investors infuse equity.
However, equity infusion is not free! Current investors will definitely
have to dilute their stake in Fortis for new equity infusion. This is
more expensive than taking on debt and, again, is not a great
outcome for existing Fortis investors.
Street analysts believe that Fortis listed RHT at about 14% rental
yield in 2012, which was expensive and hence Fortis needs to
unwind this deal, increasing profitability. These analysts forget that
Indian 10-year government securities in 2012 were trading at about
9% and that some of the hospitals transferred to RHT were not
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5. stabilised or were under development and warranted higher yields.
Today, to unwind that deal they want to buy the hospitals at 7.3%
rental yield (Rs 340 crore/Rs 4,650 crore) when the Indian interest
rates have bottomed out. This is nothing but a perfect case of ‘Buy
High and Sell Lowʼ.
Consolidate holdings for better valuation: Fortis maintains that,
by acquiring RHT hospitals for Rs 4,650 crore, the valuation impact
will be higher than the original purchase value. It means either RHT
is not being priced correctly in Singapore or Fortis can find certain
“synergies” to justify valuation.
Clearly, there is no case for synergies here and the current
enterprise value of RHT of about Rs 4,215 crore at approximately
8.1% rental yield in Singapore is fair if not marginally high. Fortis is
paying a premium of about 10% to buy the hospitals at a rental yield
of about 7.3% for Rs 4,650 crore, which is very expensive.
Why does Fortis believe it can get a better valuation? Street analysts
told us that earnings before interest, tax, depreciation and
amortization (EBITDA) will improve by Rs 340 crore (service fee
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6. saving) while the cost of acquisition is below EBITDA.
Applying industry-wide EBITDA multiple of 20 times should increase
the valuation to Rs 6,800 crore whereas Fortis is only paying Rs
4,650 crore for the hospitals. We are aghast at this view, assuming
that investors donʼt understand what they are buying for the
investment they have made.
In reality, the Street is valuing hospitals at Rs 6,800 crore i.e. at 5%
rental yield (Rs 340 crore/Rs 6,800 crore) when the actual value is
Rs 4,215 Crore at 8.1% yield (discussed above). So a premium of
about Rs 2,600 crore is being achieved by simply changing
ownership of hospitals. How easy!
The Street is failing to see how this transaction negatively impacts
the balance sheet: with increased leverage, profitability is getting
worse as there is no real service fee savings against incremental
interest payments to be paid by Fortis and valuation improvement is
nothing but betting on investorʼs irrationality.
Contrary to the Streetʼs view, the transaction is being closed not for
sound financial reasons but for other qualitative factors that are not
articulated. Letʼs understand, Indian healthcare companies trade at
highest multiples in the world and are one of the most expensive
propositions from international investorsʼ perspective.
Moving forward, the Streetʼs notion of valuing Indian healthcare,
with healthcare REITs in India, needs to shift. Else, risk capital will be
scarce to come by for Indian healthcare operators.
Update: On 31 May, Fortis Healthcare informed stock exchanges
that a wholly owned unit, Fortis Healthcare International Ltd, had
sold 18.2 million units of Religare Health Trust for SGD 13.65 million,
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7. that is at SGD 0.75 per unit, to Mahesh Udhav Buxani (12.2 million
units) and Splendid Asia Macro Fund (6 million units).
Why would Fortis Healthcare sell units of RHT to third parties when
it has entered into a definitive agreement to acquire all the
outstanding units of RHT at a significant premium over itʼs listed
price and the above transaction price? How does that make sense?
What are we missing here?
Additionally, a quick web search revealed that Buxani also holds
1.91% of Religare Enterprises Ltd, a related company of the erstwhile
promoters of Fortis Healthcare! The transaction is classified in the
filings as non-related party transaction, but is it really?
Kapil Khandelwal and Tapan Bhatt are managing partners at
healthcare infrastructure fund Toro Finserve.
*This article has been updated to add information about Fortis
Healthcare selling units of Religare Health Trust.
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8. Fortis changes tack again, buying
Singapore trustʼs assets for $711 mn
Fortis Healthcare Ltd plans to acquire the entire portfolio of
Singapore-listed...
Religare Health Trust names Gurpreet
Dhillon as CEO
Religare Health Trust (RHT), a wholly owned subsidiary of Delhi-
based Religare...
TPG-backed Manipal revises offer for Fortis
Hospitals, SRL
Manipal Hospital Enterprises Pvt. Ltd, backed by private equity firm
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9. TPG, ...
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