Sunday 3 February 2008

Wockhardt Hospitals - IPO Review


Investors can refrain from subscribing to the initial public offer of Wockhardt Hospitals being made at a price band of Rs 220-260 per share (revised).

Even at the revised offer price, the offer appears expensively valued vis-À-vis sector leader, Apollo Hospitals.

Wockhardt Hospitals is the fourth largest player in the Indian healthcare sector with a presence in western, southern and eastern India.

It plans to scale up its operations to 3,500 beds by 2010, from around 1,400 currently.

Wockhardt Hospitals focusses on tertiary care clinical areas such as cardiology and cardiac surgery, orthopaedics, neurology, urology, nephrology, critical care and minimally invasive surgery.

Wockhardt’s current earnings rely significantly on three out of its total of 15 facilities (one hospital in Mumbai and two in Bangalore contributed 69 per cent of income in nine months of FY-07).

Overall, the occupancy rates are at about 57 per cent; with occupancy at some of the facilities set up over the last couple of years yet to pick up to healthy levels.

With the company in a heavy investment phase, investors should expect lower profit realisations and relatively low return on capital in the initial years (7.5 per cent in nine months ended December 2007).

With the reduction in the size of this offer (from Rs 778 crore to Rs 652 crore at the higher end of price band) and aggressive plans to ramp up capacities over the next few years, further debt or equity offerings to raise more capital cannot be ruled out.

At end of December 2007, the company’s internal accruals stood at Rs 10 crore, which cannot make up for the shortfall.

Wockhardt Hospitals’ current earnings are relatively small; translating into per share earnings of Rs 0.9 (on post-offer equity base) for the nine months of FY2008 ended December 31, 2007.

It currently owns/operates 15 hospitals (1,400 beds), having invested Rs 370 crore in capex in recent years. Plans are afoot to add another 2,127 beds through six brownfield hospitals (operated/managed by company or group companies on long-term agreements with original infrastructure owners) by end-2008 and four greenfield (to be entirely built by company) by end-2009.

Two-thirds of the net IPO proceeds, after deducting issue expenses and corporate purposes, will be used to construct and expand these 10 hospitals.

The remaining sum may be used to prepay short-term loans. Such prepayment, if it materialises, could significantly reduce the high leverage in the balance-sheet (debt-equity ratio, including short-term debt, may be significantly reduced from 3.8 currently).
Performance

Wockhardt Hospitals’ network spans ten super-specialty and five regional specialty intensive care unit (ICU) hospitals with an 18 year track record and expertise in minimally invasive surgery (up to 10 per cent of surgical operations performed in FY07).

Wockhardt plans to leverage on these to reduce average length of stay (the turnaround time, which is crucial to realisations) and maintain revenues per bed of Rs 24 lakh per year.

Wockhardt’s strategy revolves around garnering in-patient revenues by focussing on areas such as secondary care and advanced tertiary care; both of which have strong growth prospects and potential for high margins. Personnel being critical to hospital business, attrition is a key risk.

However, Wockhardt Hospitals claims a 99 per cent retention rate (last 12 months) for its workforce of 160 full-time specialists. The attrition rate was 20 per cent for resident doctors.

With operating margins of 20.8 per cent in the last nine months, the company’s margins are among the highest in the listed hospital space.

The company’s ability to ramp up occupancy would be crucial to prospects, as it has greater dependence on its core in-patient business (75 per cent of revenues) for revenue than peers such as Apollo, which has a pharmacy and medical BPO business as well.)

Going forward, a higher reliance on brownfield expansion may provide some relief as brownfield hospitals are typically asset-light and allow a quicker payback period, provided occupancy rates are healthy. Litigation risks to seven of the present and proposed facilities also exist.
Valuation

The company’s valuation at an enterprise value (EV) multiple of about 44 times its estimated FY-08 EBITDA (earnings before interest, tax, depreciation and amortisation) appears expensive. Apollo Hospitals, with 7,000 beds under operation and a more diversified profile, commands an EV/EBITDA multiple of around 20 times on FY-08 earnings while Fortis Healthcare enjoys around 42 times.

While Apollo enjoys strong brand equity, Wockhardt Hospitals also enjoys reasonable recognition in regions where it has been in operation for more than 8-10 years.

Given that the company is foraying into Tier-II cities (Madgaon, Nasik, Ludhiana, Jabalpur, Bhavnagar) packaging and pricing may be more important than the brand.

Taking into account the long gestation period in the hospital business and prospects for steady, rather than spectacular growth in earnings, the asking price for the offer appears stiff. It also does not offer any comfort on execution-related risks.