By Geetanjali Kedia

Narayana Hrudayalaya is entering the primary market on Thursday 17^th December 2015, with an offer for sale of upto 2.45 crore equity shares of Rs. 10 each, in the price band of Rs. 245 to Rs. 250 per share. Offer for sale by promoters comprises 17% of the issue, with balance 83% being offered by PE investors JP Morgan and Pinebridge. Representing 12% of the post issue paid-up capital, issue will raise Rs. 601 crore and Rs. 613 crore at the lower and upper price band respectively, and will close on Monday 21^st December.

Narayana Hrudayalaya, promoted by renowned cardiac surgeon Padma Bhushan Dr. Devi Shetty, operates 23 hospitals, 8 heart centres and 24 primary care facilities in India, with a mix of ownership, revenue share, lease and management contracts. Company currently operates 5,442 beds with potential to reach 6,600 beds, with key presence in Karnataka and East India. Cardiology and cardiac care accounting for 54% of revenue stream.

Despite the large number of facilities, only 3 hospitals in NH Health City Bangalore and Bypass Road Kolkata, aggregating to 36% of the bed capacity (1946 beds of 5,442), together account for 58% of FY15 revenues, depicting concentration of earnings. In the past, in places such as Orissa, West Bengal and Malaysia, company has not completed construction of hospitals within the stipulated time period post land allotment, which may lead to confiscation of land. This indicates delay in execution capabilities on the management’s part.

For FY15, although consolidated total revenue rose 23% YoY to Rs. 1,372 crore, EBITDA declined 4% YoY to Rs. 137 crore, leading to an EBITDA margin of 10%. Due to loss of Rs. 25 crore posted by 1.5 year old associate hospital in Cayman Islands, FY15 bottomline was in the red, with net loss of Rs. 11 crore. For H1FY16, revenue stood at Rs. 789 crore with EBITDA at Rs. 92 crore (EBITDA margin 11.8%) and net profit after associate share at Rs. 12.49 crore (net of Rs. 13 crore share of loss of associate), leading to an EPS of Rs. 0.62, on equity of Rs. 200 crore. Net margin for H1FY16 stood at 1.6% which has, for the past 3-4 years, always been in the sub-4% range.

As of 30-9-15, company’s net worth stood at Rs. 781 crore, with gross debt of Rs. 338 crore and cash and equivalents of Rs. 44 crore, leading to net debt of Rs. 294 crore. Of the current equity of Rs. 204 crore (post conversion of optionally convertible debentures in early December 2015), promoters hold 66.85%, which will decline to 64.85%, post IPO. 3 investors - Pinebridge (through Ashoka Investment and Ambadevi Mauritius), JP Morgan and UK’s CDC hold 29.85% stake, whose combined holding will shrink to 19.85% post IPO. Pinebridge and JP Morgan holding 21.96% stake at present, are part-exiting their 8 year old investment with IRR of just ~13% pa, reducing holding to 11.96% post IPO.

Exactly a year ago, in December 2014, CDC had invested Rs. 300 crore, by way of fresh issue of equity-cum-debt (equity infusion to the tune of Rs. 200 crore and debt Rs 100 crore, subsequently converted to equity), which leads to a weighted average / effective cost price of Rs. 190 per share for CDC. Considering a conversion price of Rs. 244 per share (at which only the debt portion got converted, excluding cost of Rs. 170 per share for the equity portion) is grossly misleading, as both the equity and debt investment were made at the same time (both in December 2014) by the same investor into the same company. Thus, investors must look at Rs. 190 per share as the last issue price.

While the company made a primary issue of equity shares at Rs. 190 per share a year ago, to facilitate part exit to PE investors, it is now undertaking a secondary sale, at 32% premium to the last issue price. Past 12 month financials have not been as supportive, with revenue growth of barely 15% and many hospitals yet to break-even. What is the justification to sell shares cheap when funds are coming into the company, but to offer them at a premium, when money is going into the pockets of investors/ promoters? Doesn’t bode well for company and its shareholders’ health!

Both the DRHP and even RHP (as recent as 8^th December 2015) to the issue mention consideration of retail discount, which has not been given, when price band was announced on 10^th Dec. This is similar to going back on the candy promised to a child!

At Rs. 250 per share, company will command a market cap of Rs. 5,100 crore and enterprise value of Rs. 5,400 crore. Annualising H1FY16 EBITDA of Rs. 92 crore, leads to EV/EBITDA multiple of 29 times, based on expected FY16 EBITDA.

There are 2 listed hospitals chains in India – Apollo Hospitals and Fortis Heathcare. Fortis, having exited its international business, holds 57% stake in the diagnostic chain SRL, which is its key margin driver, having EBITDA margin in mid-20s. Fortis’ hospital business reports EBITDA in the low single digits (H1FY16 hospital business EBITDA margin 3.2% on revenue of Rs. 1,722 crore and EBITDA of Rs. 55 crore), hence it is not a suitable comparative to Narayana Hrudayala.

Apollo Hospitals, with capacity of 8,985 beds and Rs. 6,000 annual topline, earns EBITDA margin of 13-14% (reduced on account of 3-4% EBITDA margins of standalone pharmacy business with annual topline of Rs. 1,750 crore), is ruling at EV/EBITDA multiple of 26 times, based on annualized H1FY16 earnings, with consistent net margins of 6-7% at the consolidated level. Return on capital employed (RoCE) for Apollo Hospitals’ healthcare services (excluding standalone pharmacy) business is also healthier, in mid-teens (14-15%), while that of Narayana barely manages to touch 10%, and was at 6.9% in FY15, with latter’s EBITDA margin also 300-400 basis points lower than Apollo.

Due to lower size, smaller topline and poor margins, one cannot justify higher multiple (EBITDA multiple of 29 vis-à-vis 26 for Apollo) for Narayana Hrudayalaya. If one is looking at the investment from the social purpose which Dr. Shetty and team are serving to make tertiary medical care affordable in the country, only with a big heart, can one put in money here. However, on pure financial rationale, Apollo Hospitals looks like a much stronger player, from investment point of view, with a more attractive price.

While their medical treatments may be affordable, sadly, one cannot say that for the issue pricing of Narayana Hrudayala. Hence, on pure fundamental grounds, the issue can be given a miss.

Disclosure: No interest.