Fortis Healthcare fortunes to get Malaysia's IHH boost with acquisition

Since gains may take a while to accrue, experts believe short-term investors should tender shares in the open offer

Malaysian group IHH Healthcare Berhad’s Rs 40 billion acquisition of Fortis Healthcare is expected to result in improved cash flow, better operating profit margins and new business opportunity for the Indian hospital chain.

Fortis, which has been under the regulatory scanner on charges of fund diversion, has seen its losses widen due to provisioning and its operating profit margins have trailed those of its peers in hospital and diagnostic business.

While the acquisition is expected to lead to synergies and savings in finance cost, procurements and maintenance, the tie-up will bring new therapies to Fortis, provide collaboration opportunities for its staff and increase footfalls.

In its investor presentation, IHH said it wanted to develop Fortis into a market leader. It said there was a potential to expand in international markets such as South and Central Asia and parts of Southeast Asia. However, IHH did not elaborate on global expansion.

IHH said it wanted to consolidate Fortis's diagnostic arm as a part of its larger global franchise. “This will help drive economies of scale and allow Fortis to capitalise on cost advantages relative to other regional markets by potentially centralising specific testing for IHH global network in India,” an IHH spokesperson said. Fortis' operating margins will get a boost with the acquisition of RHT’s assets. (Of the Rs 40 billion investment, Rs 26.50 billion would go towards the RHT acquisition).

India Infoline said Fortis' Ebit (earnings before interest and tax) margins were lower than Apollo Hospitals as trust costs of Rs 2.53 billion constituted significant portion of its operating costs. According to analysts, the trust costs add up to 30 per cent of operating expenses of its hospital business and 24 per cent of consolidated operating expenditure in Q4 FY18 and thus acquisition of RHT assets will reduce its expenses, improve margins and result in better valuations.

Muralidharan Nair, head-healthcare at consultancy EY, said Fortis integration with IHH would be smooth as Fortis management and board does not have any legacy issues. “IHH, however, should involve Fortis team members in the integration process. It should not impose its own style of functioning. I believe, IHH will bring rigour in business review and finance at Fortis,” he said.

Sandeep Bhasin, executive vice-president, market of India Infoline, said Fortis being one of the few tertiary care providers in India, it is not going to be difficult for IHH to turn it around given their experience in the sector. “Brands like this do not get created overnight, and patient footfall does not get affected thanks to some provisions in the balance sheet.” He said that the Luthra and Luthra report had brought out in open fund diversion and it is now known that the operations were not run in a cost-effective manner. “Once a credible management steps in, now that the former promoters are out of the scene, it would implement better cost management systems in place, and a turnaround would be within sight," he said.

However, the acquisition will not be without its challenges. Regulatory issues such as pricing of medical devices, government regulations etc are already impacting profitability of healthcare companies and impacting investor sentiments. So, any gains for Fortis may take a while to accrue.

Since IHH is also offering opportunity to investors to tender shares in an open offer, which will be at about Rs 170, about 15 per cent higher than current market price of Rs 147.80, for now it would be wise to encash the opportunity feel experts. S P Tulsian of sptulsian.com said investors should as of now focus on the open offer looking at the arbitrage opportunity which it is offering now.

Experts are of the view that there is lot of uncertainty around new write offs that can happen once new management takes control, hence G Chokkalingam at Equinomics Research too is of the view that investors would be better off tendering shares in the open offer.