Fortis-Manipal deal fails to cheer investors as valuations disappoint

The Fortis Healthcare merger news was made late Tuesday evening and the stock dropped 13.5 per cent to close at Rs 125.80 on Wednesday. A key reason for the disappointment is the valuation of Fortis’ hospitals business, which the Street believes is unfavourable for shareholders.

The deal involves merger of Fortis’ hospital business into Manipal Hospitals. Despite being a larger entity, the business is being valued at a lower price. The total deal value is about Rs 150 billion, wherein Fortis’ hospital business is valued at Rs 50 billion and Manipal Hospitals’ at Rs 60 billion; funds worth Rs 39 billion will be infused in the combined entity by the promoters, Manipal Hospitals and global private equity firm TPG-backed funds.

Fortis, operating 31 hospitals, being valued lower than Manipal with 14 hospitals, has not gone well with the Street. Fortis, for instance, clocked Rs 28.15 billion in revenue over the first nine months of FY18, compared to Rs 11.6 billion by Manipal.

However, the latter is far more profitable than Fortis’ hospital business, which is also facing some investigations. Overall, the per-share value of Fortis’ hospital business works out to Rs 96.2, says the management. Analysts say this is lower than the market expectation. G Chokkalingam, managing director of Equinomics Research & Advisory, says the valuations don’t seem in favour of Fortis’ investors. Not surprisingly, the stock fell sharply.

As part of the deal, the shareholders of Fortis Healthcare will continue holding the shares in the residual entity. For every 100 shares in Fortis Healthcare, the shareholders will also be issued 10.83 shares of the resultant Manipal Hospitals (combined hospital businesses of Fortis and Manipal), to be listed later. 

The Rs 39-billion investment by the promoters of Manipal Hospitals and TPG Capital (owns 20.7 per cent stake in Manipal Hospitals) will go to funding the acquisition of 50.9 per cent stake in the SRL (20 per cent from Fortis Healthcare and 30.9 per cent from others) and RHT assets, all of which will be held under Manipal Hospitals. So, existing Fortis shareholders will continue to benefit from ownership and growth in these businesses.

Fortis’ management says the company’s operating profit margin of about 6.5 per cent will get a significant boost (Rs 2.5-3 billion or 500 basis points) after the acquisition of Singapore-listed RHT Health Trust. Including these gains (assuming Fortis had acquired RHT on its own) would have pushed up its operating profit margin to 11-12 per cent, closer to Manipal's 16 per cent. But, as analysts at Nomura had earlier said, Manipal facilitating the RHT acquisition through equity funding would be positive and Fortis' balance sheet is not strong enough to carry this large transaction on its own. In other words, shareholders are paying a price for this. 

Fortis shareholders, though, could draw solace from being part of a larger and more profitable hospital chain. Fortis has installed capacity of 4,685 beds, while Manipal operates 2,973 beds and another 3,413 teaching beds. Nomura also says Manipal has a strong record in operating large tertiary care hospitals. Cleaner and more focused promoters should also command better stock valuations.