Indian Hospitals Health is Wealth! Nitin Agarwal ● Ritesh Shah November 2010 Fortis Apollo MAX cardiac care orthopedics hub & spoke medical tourism multi specialty franchisee asset light, india shining opportunity US$125bn ter t i a ry care long gestation capital intensive exponential economic boom healthcare spends private sector lifestyle ARPOB corporate hospitals Vaatsalya regulation medicities, t rauma radiology, super-specialty GDP inorganic REITS in su ra n ce ALOS diseases Narayana telemedicine daycare sugery Hrudayalaya real manpower estate
Transcript
Indian HospitalsHealth is Wealth!
Nitin Agarwal ● Ritesh ShahNovember 2010
Fortis
Apollo
MAX
cardiac care
orthopedics
hub & spoke
medical tourism multi specialty
franchisee
asset light, india shining
opportunity
US$125bn
tertiary care long gestationcapital intensive exponential economic boomhealthcare spends
private sector
lifestyle
ARPOB corporate hospitals
Vaatsalyaregulation
medicities, t
rauma radiology,super-specialty
GDP
inorganic
REITSinsurancece
ALOS
diseases
Narayana
telemedicine
daycare sugeryHrudayalaya
real
manpower
estate
Indian healthcare industry is poised to double to US$125bn by 2015E, driven by a combination of ageing population, growing lifestyle diseases, increasing ability to afford quality healthcare and growing medical insurance penetration. With public spend likely to be limited to ~20% of the annual healthcare spend, organized private hospital players will be the primary beneficiaries of this expected boom. However, high upfront investments and long gestation periods, as also burgeoning real estate costs and growing manpower shortages, will compel the hitherto tertiary-/ metro-focused private sector to innovate with business models. While the competitive landscape in this relatively nascent sector is still evolving, we believe entry barriers are rising – which strongly favours the leading incumbents. Being the only two listed players in the healthcare space, Apollo and Fortis (cumulative market cap of <$5bn) are the best proxies on the rapidly growing Indian healthcare opportunity. We believe the stocks deserve to trade at a premium not just to the broader market but also to global peers as they are in the high growth phase of their life cycle.
Indian healthcare – organized private hospitals join the party: At ~5.5% of GDP (according to OESC), Indian private healthcare spend is among the highest globally and accounts for ~80% of the total US$62bn spend in 2009. Hospitals account for ~50% of the healthcare spend in India. Organized hospital chains (>100 beds), ~10% of private sector capacity currently, are steadily increasing their presence as public spending would remain limited. Thus, we see interesting times ahead for private sector healthcare players.
Attractive business but the road ahead is not easy: While successful tertiary hospitals can potentially generate 25%+ EBITDA margins with return ratios > 30% from the seventh year of operations, private sector hospital chains need deep pockets to grow given the significant upfront capex requirement (~Rs2bn for a 200-bed tertiary hospital) and long gestation periods. Shooting real estate costs, growing shortage of skilled medical personnel leading to wage inflation, and emergence of pockets of overcapacity add to the challenges. This should spur innovation in business models. The stress on innovation is already visible in Apollo’s launch of newer formats like Apollo Reach as also Fortis’s increased use of an asset-light strategy involving leasing of land/ building.
Advantage Incumbents: As the going gets difficult, we believe the leading incumbents are favorably placed with their sizeable assets, significant geographical footprint and strong brand identities. As new entrants would find it increasingly difficult to scale up unless they innovate significantly, the two listed leaders – Apollo and Fortis (19% and 41% revenue CAGR respectively over FY10-13E) – will continue to dominate the market and command significant premium for being the only relevant proxies to the Indian healthcare market.
Investment Argument.................................................................................................... 3 Indian healthcare: In a sweet spot ............................................................................. 4 Healthcare models: Expect increased innovation ................................................... 7
Indian healthcare: A snapshot.................................................................................... 10 Private healthcare providers gaining relevance .................................................... 14
The Best is Ahead ......................................................................................................... 19 Indian healthcare: In a sweet spot ........................................................................... 19 Drivers for Indian healthcare................................................................................... 21
Tertiary Hospitals: Attractive, but… ................................................................................. 28 Brace for long gestation; the wait is worth it... ...................................................... 29 Operating indicators for a successful tertiary hospital........................................... 32 Real estate costs: Key to commercial viability ....................................................... 33 Medical equipment: High obsolescence costs ....................................................... 36 Right People: A challenging proposition ............................................................... 38 An evolving regulatory scenario… ......................................................................... 43
Companies ..................................................................................................................... 66 Apollo Hospitals........................................................................................................ 67 Fortis Healthcare........................................................................................................ 93 Other companies...............................................................................................119-122
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INVESTMENT ARGUMENT Low levels of spend and structural inefficiencies in public healthcare system
leading to woeful healthcare standards; driving Indians to private sector
Unorganized sector dominates private healthcare space, but organized hospitals, with ~10% of capacity currently, expected to capitalize on the boom in healthcare spend (estimated to double to US$125bn by 2015)
However, conventional models increasingly inhibiting players’ ability to fully tap into the opportunity; innovation in business models, hitherto focused on tertiary care / metros, underway
With increasing entry barriers, e.g. growing capex intensity and resource crunch, we favour incumbents with critical mass to pursue accelerated growth
We believe Indian players should command growth premium over global peer valuations; initiating coverage with Outperformer on Apollo Hospitals and Fortis Healthcare (28% upside in each)
Indian healthcare – private hospital players coming to the fore With national healthcare spending at 5.5% of GDP in 2009 (as per OESC), healthcare is one of the largest industries in India with hospitals contributing ~50% of the pie. While globally healthcare is typically provided through a largely government-funded public system, the Indian healthcare industry is dominated by the private sector (government spending at only ~1% of GDP, as compared to 3.5% for Brazil and 1.9% for China). Interestingly, almost 80% of India’s overall spending on healthcare is accounted for by the private sector, which is among the highest globally.
With the government’s healthcare spends not keeping pace, private players have been steadily increasing their dominance in tertiary as well as secondary care.
Exhibit 1: Public health – lowest on the government’s focus list
Source: Industry, NSSO, IDFC Securities Research
Unorganized sector dominates but organized sector inching up In India, the healthcare sector is highly fragmented with the unorganized component accounting for ~90% of the private market. To put this into perspective, of ~1.05m beds in the country (Crisil estimates), Apollo Hospitals (Apollo) – the largest organized healthcare player in India – has only ~8000 beds under management including owned (by itself and associates) and managed beds.
In India, government spending on healthcare at
only ~1% of GDP
Organized healthcare gradually gaining relevance
in India
Health expd. (as % of GDP)
0 4 8 12 16
India
Brazil
China
Russia
UK
USA
Global
0.0
2.0
4.0
6.0
8.0
(% of GDP)
Public sectro spend Private sector spend
India Low income
Lower middle income Upper middle income
High income
Per capita spend on health (US$) (2007)
40 27 80
488
4405
India Low income Lowermiddleincome
Uppermiddleincome
High income
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Exhibit 2: Private players enjoy a dominant position
Source: Mckinsey-2007, IDFC Securities Research
However, in realization of the huge demand-supply gap in tertiary care segment, organized healthcare (corporate hospitals) has been slowly gaining relevance with the emergence of corporate healthcare hospitals like Apollo, Fortis Healthcare (Fortis), Manipal Hospitals, Max Healthcare, Wockhardt, etc; and we expect the trend to accelerate.
Indian healthcare: In a sweet spot
A confluence of multiple positive drivers will drive high growth in the US$62bn Indian healthcare industry over the next several years. Hospitals, the largest component of healthcare spend in India, will be the key beneficiary of the trend.
Exhibit 3: Key enablers to growing Indian healthcare
Source: IDFC Securities Research
> 100 beds30-100 beds<30 bedsVariable; based on type
Major corporate hospital chains and specialty hospitals
Corporate hospitals with in-house staff and consulting physicians
Primarily nursing homes and recovery rooms with adequate infrastructure
Healthcare centres, district hospitals and general hospitals
Top-tierMid-tierNursing Homes
PrivateGovernment
> 100 beds30-100 beds<30 bedsVariable; based on type
Major corporate hospital chains and specialty hospitals
Corporate hospitals with in-house staff and consulting physicians
Primarily nursing homes and recovery rooms with adequate infrastructure
Healthcare centres, district hospitals and general hospitals
Top-tierMid-tierNursing Homes
PrivateGovernment
0 25 50 75 100
2005
2015
Govt. Hospitals Mid-tier Top-tier Nursing homes
Private sector
Indian Healthcare
Growing affordability
Growing affordability
Increasing awarenessIncreasing awareness
Growing populationGrowing
population
Rising Health Insurance
penetration
Rising Health Insurance
penetration
Rise of medical tourism
Rise of medical tourism
Increasing life expectancy &
ageing population
Increasing life expectancy &
ageing population
Indian Healthcare
Growing affordability
Growing affordability
Increasing awarenessIncreasing awareness
Growing populationGrowing
population
Rising Health Insurance
penetration
Rising Health Insurance
penetration
Rise of medical tourism
Rise of medical tourism
Increasing life expectancy &
ageing population
Increasing life expectancy &
ageing population
A confluence of drivers will drive high growth in Indian
healthcare
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Indian healthcare – likely to be a $125bn opportunity in five years Indian healthcare sector is currently valued at $62bn and is estimated to be growing at 13% per annum. We expect the healthcare opportunity to double to $125bn in the next five years. We estimate population to grow at 2% annually and factor in a 10% annual increase in healthcare spend on the back of changing demographics and rising income levels.
Exhibit 4: Indian healthcare – a US$125bn opportunity by 2015E
Private healthcare segment to be the biggest beneficiary Crisil estimates that India requires 632,000 additional beds over the next 10 years, ~60% higher than the current base of 1.05m beds. Of these, ~20% will be required for complex medical procedures in cardiac and oncology segments. In our view, hospitals is a high gestation business entailing significant upfront investments but long payback periods. Construction of a new hospital bed costs Rs2.5m-3m on an average with a high-end tertiary hospital bed costing Rs5m-5.5m. This implies an overall capital expenditure of ~$40bn over the next 10 years for setting up the incremental 632,000 beds required. As the government is hardly in a position to fund this growth, it presents an attractive opportunity for private sector players.
Attractive but not an easy business; brace for long gestations While the tertiary corporate hospital segment presents a lucrative opportunity for private players, it is a relatively complex business due to high upfront costs and challenges embedded in the day to day running of hospitals. The initial capital cost of setting up a tertiary hospital bed is Rs7m-10m in larger cities with real estate and medical equipment accounting for 60-65% of the total project cost. This leads to long gestation periods – besides 2-3 years for project conceptualization to commissioning, achieving cash breakeven for a healthcare facility could take up to another 2.5-3 years assuming steady patient inflow and no mishandled cases.
However, the rewards are attractive enough for the successful hospitals. We estimate tertiary hospital can potentially generate > 25% operating margins from 5th year of operation with margins stabilizing at 30-35% in a matured state. As hospitals stabilize operations and utilize free cash to repay debt, return ratios steadily expand from the fifth year of operations. Based on our estimates, a well run tertiary hospital can begin to generate return ratios > 25% from 6th -7th year of operation.
Limited public sector funding and high costs put
private healthcare players at an advantage
Sector expected to grow at 13% per annum
Though a tertiary hospital can make operating margins
of 25-30%, it takes ~5 years to hit these levels
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Exhibit 5: Sweet returns post stabilization Capital Cost
Source: IDFC Securities Research
Rising real estate costs to spur innovation in business models Real estate cost is a key factor that determines the viability of a hospital project. Land and building together account for 37-40% of the total project cost and are among the key measures to gauge its financial viability. Based on our analysis, we find for a hospital operating at 15% margins in the fifth year of operations, an increase/decrease in land and building costs by 20% results to contraction/expansion in return ratios by nearly 40-50bps. The impact of land & building costs is relatively lower for well-run hospitals. i.e. return ratios for a hospital enjoying 30% margins would be impacted only to the extent of 20bps on 20% increase/decline in land & bldg. costs.
Exhibit 6: RoCE sensitivity to real estate costs (in the fifth year of operations)
We expect newer operating models to evolve as the private sector seeks ways to tackle high real estate costs and aggressively expand footprint. We expect players to increasingly pursue asset light strategies e.g. Build, Lease and Transfer, transferring assets to REIT structures, etc.
Medical equipment – high obsolescence costs Industry estimates indicate that medical equipment accounts for the largest chunk of capital costs (up to 30-40%) towards setting up a tertiary care unit. The healthcare industry is characterized by frequent product innovations and evolving technology. That leads to redundancy of expensive medical equipment every 5-7 years, compared with a depreciable life of up to 14 years (based on accounting periods). The problem is compounded by the fact that there is practically very limited indigenous medical device manufacturing industry in India, which necessitates purchase of significantly expensive imported equipment.
Hospitals, to recover the cost of expensive imported medical equipment over its short life cycles, resort to higher treatment pricing. That often leads to a vicious cycle of lower utilization rate, which dents profitability due to negative operating leverage.
Equipment account for a major chunk of capital
costs, especially due to high import component
Capital Costs breakup
Land8%
Construction 19%
Machinery 38%
Pre operative expenses
12%
IDC 8%
Others15%
Cash flows
-2,000
-1,500
-1,000
-500
0
500(Rs m)
YR1 YR2 YR3 YR4 YR5 YR6 YR7
Operating cashflow Free Cash Flow
-8
1
10
19
28
YR1 YR2 YR3 YR4 YR5 YR6 YR7-8
2
12
22
32RoCE (% - LHS) Operating margins (% - RHS)
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Right people – an increasingly challenging proposition Managing people issues – i.e. finding the right people and at the right cost, we believe, will be a critical scale-up challenge for hospital operators in India. Doctors, nurses and paramedics are the key enablers of the success of any hospital, and retention of key personnel is an imperative – especially for tertiary care hospitals.
In our view, while there are clear indications of shortage in the overall pool of doctors required going forward, these shortages will be particularly acute in the case of specialized and experienced doctors required for manning the newer tertiary care set-ups. This will logically lead to aggressive wage inflation which will further stress the economics of successfully running tertiary care hospitals.
Exhibit 7: Healthcare infrastructure shortfall from 13-41%
As per 2001 consensus Required Shortfall % shortfall Sub -Centres 158,792 20,903 13 PHCs 26,022 4,803 18 CHCs 6,491 2,653 41 Source: NSSO
Healthcare models: Expect increased innovation
Till recently, organized private sector healthcare business models in India were largely one-dimensional with focus on providing multi-specialty tertiary care in larger metros, supplemented with some element of secondary and primary care set-ups. Given the escalating competitive intensity in metros as well as an increasingly tough operating environment, we see a strong case for exploring new and innovative business models to tap into less-penetrated geographies as well as patient segments. We are encouraged by the unconventional models being tried out by some of the new entrants as also increased willingness of existing players to experiment with new healthcare delivery formats.
A broad scan of the operating environment indicates the presence/ emergence of multiple newer models. Below we list some of the more interesting ones:
• Existing tertiary healthcare providers experimenting with setting up secondary/ primary tertiary care hospitals in Tier II/ III towns – Apollo with Apollo Reach
• Single specialty tertiary care hospitals, e.g. Healthcare Global
• Day care surgery centers, e.g. Nova Day Care Centre
• Hospital chains solely focused on primary/ secondary care in Tier II/ III towns, e.g. Vaatsalya
• Healthcare cities, e.g. Dr Trehan’s Medicity
• O&M contracts, e.g. Fortis’ contract with SL Raheja in Mumbai
• JV Structures e.g. Apollo’s proposed Thane hospital in JV with Yash Birla Group
Shortage of doctors is especially acute in
specialized fields
Hospitals increasingly experimenting with new
delivery formats
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Competitive landscape – still evolving The corporate hospitals industry in India is relatively nascent as most of the corporate groups, barring Apollo, having entered the business in the last few years, are still in relatively early phases of growth. Currently, there are three major listed players in the space: Apollo Hospital Group, Fortis Healthcare and Max Healthcare (subsidiary of Max India – a listed entity). Additionally, there are other large unlisted players like Manipal Health (strong presence in South India), Narayan Hrudayalaya (another predominantly South-India based entity), HealthCare Global (oncology-focused tertiary care hospital chain, etc).
Given that the corporate hospital industry is in an early growth phase, we believe it will take some time before the implications of their diverse strategies get crystallized and start becoming evident to investors.
Increasing entry barriers…advantage Incumbents Shooting real estate prices, especially in metros, and increasing shortages in recruiting highly qualified super specialists (required for running high-end tertiary hospitals) as well as the lower skilled paramedics are making it increasingly difficult to run a commercially successful private healthcare business. Thus, it is becoming increasingly difficult to run a commercially successful private healthcare business. These issues are further accentuated by the fact that existing players have already entrenched themselves in most of the high-potential geographies across India.
This means significant advantages for established incumbent players like Apollo, Fortis, Manipal, etc. These players have had the early mover advantage to accumulate sizeable hospital assets on land acquired at historical prices and create solid brand equity which enables them to acquire talent from India as well as abroad. These existing players have built up significant franchise in the key metros, the key markets for high-end tertiary care, which makes it relatively difficult for new players to make inroads in these markets. Additionally, their operations are now reaching a stage where internal cash flows can take care of further expansions to a large extent.
A $125bn industry by 2015E, but less than $5bn market cap We are positive on the near- and medium-term outlook for the Indian healthcare sector. We believe that private sector hospitals are the best proxy to play the healthcare opportunity in India, which is poised to grow rapidly over the next several years and decades.
Interestingly, while the healthcare market in India is poised to double to US$125bn by 2015, the two largest and most relevant healthcare stocks in the country have a combined market capitalization of <$5bn. This clearly underlines the inherent growth potential in these companies.
Initiating coverage on Apollo and Fortis with Outperformer In the private sector hospitals space, we are particularly bullish on two of the leading incumbents – Apollo Hospitals and Fortis Healthcare – as they are well-entrenched in the industry with strong national brand equity as well as a difficult to replicate geographical footprint and capacity. Given that these two are the only relevant listed entities in the Indian healthcare space and the ones that are likely to dominate the market (with a secular growth story) for the next several years, we believe these
Indian corporate hospitals industry is relatively
nascent
Incumbents have well-entrenched franchises in the
metros, a major roadblock for new entrants
Private players offer the best proxy to the Indian healthcare opportunity
Given their brand identity and geographic spread, we
see little competition for Apollo and Fortis
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stocks deserve to command a significant premium with respect to the broader market.
Apollo Hospitals – Apollo Hospitals is the largest and probably most well-known hospital networks in India with ~8,000 beds under operations currently. With the relatively conservative management now willing to step on the gas and pursue more aggressive expansion, we expect growth to accelerate in the coming years. This is reflected in Apollo’s plans to add ~2,700 beds over the next three years. This will drive 19% and 25% CAGR in revenues and EBITDA respectively over the FY10-13. Further, with the growing proportion of mature beds in the network, RoCE is also expected to touch 12.6% by FY13 and expand thereon. Initiating coverage on the stock with a price target of Rs651/share. Apollo is our top pick in the space.
Fortis Healthcare – With support from its well-funded promoters, Fortis has grown to be India’s the second largest hospitals player with 3,250 beds under management, largely aided by two large ticket acquisitions of Wockhardt Hospitals and Escorts Delhi. With as many as 8 hospitals likely to be commissioned over the next two years, Fortis will likely expand its operational beds by ~2,000 over FY10-13. We expect Fortis to create value for stakeholders through unconventional strategies. On the flip side, Fortis has a limited execution track record and the robustness of its business model will be borne out over the next 3-4 years as its newer Greenfield hospitals go on stream and the recent acquisitions stabilize. Initiating coverage on the stock with a price target of Rs206/share.
INDIAN HEALTHCARE: A SNAPSHOT With 5.5% of GDP spend, healthcare is one of the largest industries in India
with hospitals accounting for ~50% of this spend
Unlike most other countries where public spend dominates, private sector accounts for 80% of India’s healthcare spend; leads to woeful standards of healthcare against global norms
Private hospital providers have moved in to fill the gap over the years and now dominate the tertiary/ quaternary care segments
Hitherto, private hospital space was dominated by the unorganized sector but organized players gaining ground with the emergence of corporate hospital chains like Apollo, Fortis, Manipal, Max, etc
Frenetic VC/ PE activity underlines growing investor interest, and thereby the attractiveness of the organized private healthcare space
Healthcare – one of the largest industries in India With national healthcare spending at 5.5% of GDP in 2009 (as per OESC), healthcare is one of the largest industries in India. The sector is also one of the largest employers in the country with around 4m employees across the sector.
The constituents: The sector is broadly classified into hospitals, pharmaceuticals, diagnostic centers and others (medical equipment, insurance, etc). Hospitals and pharmaceuticals account for 75% of the total healthcare spend.
Exhibit 9: India healthcare spend – Hospitals and Pharma account for 75% of the pie Healthcare spend - 2010
Hospitals50%
Pharma25%
Diagonistics10%
Insurance & Medical Equipment
15%
Source: MAX, IDFC Securities Research
Unlike most countries, public healthcare spend lags private spend Globally, healthcare provision is typically provided by a largely government-funded public healthcare system. In contrast, the Indian healthcare industry is dominated by the private sector with government spending at only ~1% of GDP, as compared to 3.5% of GDP (as on 2007, source: WHO) for Brazil and 1.9% for China. Interestingly, almost 75% of India’s overall spending on healthcare is accounted for by the private sector, which is among the highest globally.
Private players rule the roost in India, unlike
government predominance in developed nations
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Exhibit 10: Public health – lowest on the government’s focus list
Notably, India has the lowest ratio of public to private health expenditure (~0.36x) among the countries listed above. This includes some of world’s poorest nations.
With its history of under-spending, India’s public healthcare infrastructure is ‘woefully inadequate’ – and it leaves majority of the population devoid of basic healthcare amenities. Public health facilities, which are not only under-staffed but also ill-equipped in terms of obsolete or poorly managed medical equipment, offer only basic services.
370 493 863 43.940.459.69.7Global
3,968 3,317 7,285 22.654.545.515.7United States of America
546 2,446 2,992 62.718.381.78.4United Kingdom
1,107 536 1,643 93.967.432.63.1Singapore
83
92
58.8
89.9
Out-of-pocket exp. as % of pvt. exp. on
health
35.8
55.3
58.4
73.8
Pvt. exp. as % of total
healthcare spend
64.2
44.7
41.6
26.2
Public exp. as % of total
healthcare spend
285 512 797 5.4Russian Federation
129 104 233 4.3China
489 348 837 8.4Brazil
80 29 109 4.1India
"Per capita Pvt. sector
exp. on healthcare(PP
P in $)"
"Per capita govt. exp. on healthcare
(PPP int. $)"
"Per capita total
expenditure on healthc
(PPP int. $)"
Total expenditure
on health as % of gross
domestic product
Particulars* (2007)
370 493 863 43.940.459.69.7Global
3,968 3,317 7,285 22.654.545.515.7United States of America
546 2,446 2,992 62.718.381.78.4United Kingdom
1,107 536 1,643 93.967.432.63.1Singapore
83
92
58.8
89.9
Out-of-pocket exp. as % of pvt. exp. on
health
35.8
55.3
58.4
73.8
Pvt. exp. as % of total
healthcare spend
64.2
44.7
41.6
26.2
Public exp. as % of total
healthcare spend
285 512 797 5.4Russian Federation
129 104 233 4.3China
489 348 837 8.4Brazil
80 29 109 4.1India
"Per capita Pvt. sector
exp. on healthcare(PP
P in $)"
"Per capita govt. exp. on healthcare
(PPP int. $)"
"Per capita total
expenditure on healthc
(PPP int. $)"
Total expenditure
on health as % of gross
domestic product
Particulars* (2007)
Health expd. (as % of GDP)
0 4 8 12 16
India
Brazil
China
Russia
UK
USA
Global
0.0
2.0
4.0
6.0
8.0
(% of GDP)
Public sectro spend Private sector spend
India Low income
Lower middle income Upper middle income
High income
Per capita spend on health (US$) (2007)
40 27 80
488
4405
India Low income Lowermiddleincome
Uppermiddleincome
High income
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Public healthcare also weighed down by structural inefficiencies • Planning of Indian public healthcare programmes has always been centralized,
creating broad verticals for prevention and control that grossly ignore local/ regional issues. Again, provision for infrastructure is based on population size rather than epidemiology profiles, which results in poor accessibility, acceptability and utilization.
• The human resource gap at various levels and long waiting periods compound the problems. We believe the Indian healthcare system lacks efficient monitoring, evaluation and feedback systems. Besides this, there are no incentives for working well. The absence of quality measurement standards has led to a dysfunctional health infrastructure.
• Healthcare financing is equally dysfunctional. Funds are released in five-year terms, and divided under several complex budget heads — revenue, capital, etc – with little flexibility to respond to health emergencies.
• Lack of incentives to attract skilled resources (doctors/ nurses) and inadequate funding for technology upgradation in public sector healthcare has resulted not only in a drastic change in the perception of patients, but also resident doctors. The bias against public healthcare is clearly evident from the fact that specialist doctors lean towards private hospitals and that private hospitals have higher occupancy levels vis-à-vis public hospitals (see exhibit below). About 72% of the specialist doctors in India are based in Tier I cities, in which private hospitals are concentrated.
Exhibit 12: Public healthcare facilities continue to face a steady decline in occupancy rates
21
19
22
24
20
19
17
19
21
23
25
1986-87 (42nd) 1995-96 (52nd) 2004 (60th)
(%)Rural Urban
Source: NSSO 60th Round (2004)
Public healthcare lacks efficient monitoring and
feedback systems
Lack of incentives to retain talent has seen doctors veering towards private
hospitals in tier I metros
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Is it lack of funds or structural bottlenecks restricting progress? Our interaction with healthcare personnel at the village level indicates that it is not the shortage of funds but lack of efficient and flexible mechanisms to utilize the funds that has been impeding improvement in healthcare delivery. So, one cannot argue that the government is not deploying enough funds as a significant amount of allocated funds remains unutilized each year.
The problem lies in the way the departmental budgets are structured for a 5-year tenure with the primary divisions being revenue and capital, and plan and non-plan. This leads to fragmentation of the health budget into more than 400 sub-heads, with funds under each head non-transferable and surrendered to the state’s general pool if unutilized at end of the fiscal.
We believe such budgeting fares perfectly well from an accounting perspective, with expenditure control as the central objective. This also ensures prevention of misuse or diversion of funds. However, this archaic system of budgeting is not based on any meaningful programme audits and is also not subject to any evaluation or review on physical targets. Our interaction at the village level indicates that cumulative energy of departmental workers remains focused on obtaining utilization certificates to release funds to district societies rather than health outcomes. However, annual budget utilization helps protect future allocations under the scheme.
In summary, we believe there is an urgent need to restructure the budgeting system to make it more functional and flexible.
Exhibit 13: Extent of under-utilization of the health budget
7.265.25
12.4
-3.28
-30.77
7.61
-6.55
2.37 3.81
-5.47
-35
-25
-15
-5
5
15
(%)
Kerala Tamil Nadu Orissa Rajasthan Uttar Pradesh
1990-95 1995-01
Source: RBI
End result – woeful standards of healthcare against global norms The woefully low as well as inefficient public healthcare spend effectively ensures that quality healthcare is accessible to only to those who can afford to pay for it. Thus, India continues to significantly lag on key healthcare indicators like life expectancy, infant mortality, etc. Life expectancy in India is 66 years compared to 78 years in developed countries while infant mortality rate stands at 70 deaths per 1,000 births as compared to six deaths in developed countries. Further, India has only 0.9beds per 1,000 people as compared to 3.9beds in high middle income countries. Similarly, the ratio of registered doctors per person is also fairly short of the global benchmark.
This is clearly reflected in India’s dismal ranking at 134 among 182 countries listed on United Nation’s Human Development Index (HDI).
Life expectancy, infant mortality and beds per
person much lower In India vs comparable economies
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Government’s baby steps not enough In the FY11 Union Budget, the government increased healthcare allocation by Rs27bn to Rs223bn. However, the healthcare budgetary allocation is just 2% of the total budgeted outlay i.e., way short of the government’s target of 3% of GDP. More importantly, most of the planned outlay remains concentrated on revenue expenditure (96%), implying that only 4% of the planned expenditure is available for the much-required infrastructure creation. Interestingly, despite 46% of the planned allocation for the entire fiscal budget being directed towards infrastructure development, we find healthcare infrastructure attracting only 0.23% of the budgeted corpus.
Exhibit 14: Capital expenditure has averaged 4% over last 5years Helathcare budgetary allocation remains miniscule
Source: RBI, IDFC Securities, Bloomberg
Private healthcare providers gaining relevance
Private players enjoy a lion’s share With the government’s healthcare spends not keeping pace with the requirement and the focus limited largely to primary and preventive infrastructure in India, private players have been steadily increasing their dominance in tertiary as well as secondary care. In particular, they have established a dominating presence in tertiary/ quaternary care, operating an estimated 93% of all hospitals and owning 64% of beds nationwide.
The private healthcare provider space has both for-profit and non-profit healthcare providers. In terms of practice, the scale varies from small solo clinics and nursing homes (in-patient facilities with usually <30 beds) to large corporate hospital chains which typically run high-end tertiary care hospitals with >100 beds.
Unorganized sector rules the roost In India, the private healthcare sector is highly fragmented with the unorganized component accounting for ~90% of the private healthcare sector. To put this into perspective, of ~1.05m beds in the country (CRISIL estimates), Apollo (the largest organized healthcare player in India) has only ~8000 beds under management including owned (by itself and associates) as well as managed beds. According to McKinsey, while private sector accounted for ~75% of beds in 2005, hospitals with more than 100 beds (organized players) accounted for ~10% of the overall beds. Hospitals with less than 100 beds accounted for a whopping ~65% of beds.
0
60
120
180
240
FY06 FY07 FY08 FY09 FY10 FY110
2
4
6
8Total (Rs bn - LHS) Capital Exp. (% of Budgeted Exp. - RHS)
4.00
4.25
4.50
4.75
5.00
5.25
FY06 FY07 FY08 FY09 FY10 FY110.28
0.30
0.33
0.35
0.38
0.40as % of total planned allocation as % of GDP
Organized healthcare gradually gaining relevance
in India
NOVEMBER 2010 15
IDFC Securities
Exhibit 15: Private players enjoy a dominant position
Source: Mckinsey-2007, IDFC Securities Research
Share of organized sector set to increase However, in realization of the huge demand supply gap in the tertiary care offering segment, organized healthcare (corporate hospitals) segment has been slowly gaining relevance over the last few years with the emergence of corporate healthcare hospitals like Apollo, Fortis, Max, Wockhardt, etc and we expect this trend to accelerate.
Importantly, the government, whose focus has been primary/ preventive care, has acknowledged that the capital intensive nature of the sector would need private players to step in. Several government policies (tax sops for up to five years for setting up hospitals (>200beds) in tier II/ III cities, lowering of tariff rates, etc.) are a clear evidence of the same.
This is amply reflected in the fact that over FY06-09, bed additions at Apollo and Fortis Healthcare have grown ~2x the pace of government hospitals. Though this could be partly on account of a low base, we also see a broader trend of growing appetite of Indian corporates to invest in healthcare, and thereby the increasing dominance of organized private players in the Indian healthcare market.
Exhibit 16: OverFY06-09, Apollo & Fortis have grown at 2x the pace of government beds
(no of beds)
500
1,000
1,500
2,000
2,500
FY06 FY07 FY08 FY09450,000
475,000
500,000
525,000
550,000
Fortis Healthcare AHEL Standalone
Total Govt. hospital beds
Source: IDFC Securities Research, Companies, NSSO
> 100 beds30-100 beds<30 bedsVariable; based on type
Major corporate hospital chains and specialty hospitals
Corporate hospitals with in-house staff and consulting physicians
Primarily nursing homes and recovery rooms with adequate infrastructure
Healthcare centres, district hospitals and general hospitals
Top-tierMid-tierNursing Homes
PrivateGovernment
> 100 beds30-100 beds<30 bedsVariable; based on type
Major corporate hospital chains and specialty hospitals
Corporate hospitals with in-house staff and consulting physicians
Primarily nursing homes and recovery rooms with adequate infrastructure
Healthcare centres, district hospitals and general hospitals
Top-tierMid-tierNursing Homes
PrivateGovernment
0 25 50 75 100
2005
2015
Govt. Hospitals Mid-tier Top-tier Nursing homes
Private sector
Govt. has acknowledged the greater role of private
players, evident in the tax sops and lower tariffs
NOVEMBER 2010 16
IDFC Securities
Multiple large corporate chains on the scene now Unlike the situation a few years ago, when Apollo was probably the only relevant corporate hospital group in the Indian market, multiple new players have emerged on the scene in yet another demonstration of the attractiveness of this high-end tertiary care healthcare opportunity for corporates. The major players include Apollo Group, CARE Hospitals, Manipal Group, Fortis Healthcare and MAX Healthcare. The exhibit below summarizes operations of three of the leading private sector players in India.
Exhibit 17: Key players in the organized healthcare sector
Particulars Apollo Hospitals Fortis Max India Manipal Group No. of beds 8064 3250 1100 7575 Owned 5476 2885 NA. NA Managed 2588 366 NA NA Planned expansion (No. of beds) 2668* 2075* 1350^ NA Geographical presence Pan India Pan India NCR Region South India No. of hospitals 47 39 8 18 Hospital mix Primary/Secondary/ Tertiary Secondary/Tertiary Primary/Secondary/Tertiary Secondary/Tertiary Other businesses Pharmacies, Healthcare BPO, Pharmacies, Insurance, Speciality Consulting, Insurance, Diagnostic labs, etc. products Education Source: IDFC Securities Research, Company* by FY14, ^by FY16
Frenetic PE, VC activity reinforces the attractiveness of the space That the sector is indeed attractive has been widely acknowledged by financial investors (both domestic and global), clearly visible in the slew of equity infusions over the past couple of years. Domestic and global private equity/ venture capital firms have invested across the Indian healthcare delivery chain. The exhibit below lists investments from standalone tertiary care hospitals in metros/ tier II cities, chains of hospitals, diagnostic labs, etc.
Further, based on investor appetite, a number of investments have been made in the following areas: (a) holding company level/ chain of hospitals (e.g., Warburg Pincus and IFC in MAX healthcare); (b) individual tertiary units in expansion mode (e.g., Actis in Sterling Hospitals); and (c) building a portfolio of beds by pooling; e.g., ICICI Ventures. The following exhibit details a few recent equity infusions in the sector.
PE activity mainly seen at holding company level and
in tertiary care units
NOVEMBER 2010 17
IDFC Securities
Exhibit 18: Recent equity participation in the healthcare delivery sector
Buyer Target Company Deal value (USDm) % stake IFC Rockland Hospitals (RH) 12 na JP Morgan Asset Management Seven Hills Hospital 72 na India Venture Advisors Kavery Medical Centre 20 30 Fortis Healthcare Apollo RM Hospital na 56 Sequoia Capital Vasan Eye Care 18 na Milestone Religare HealthCare Global 7 na IDFC HealthCare Global 10 na Premji Invest HealthCare Global 18 na Evolvence HealthCare Global 6 na Milestone Religare Krishna Institute of Medical Sciences 13 21 Kavery Medical Centre & Hospital Sea Horse Hospital 5 34 AIG & J P Morgan Narayana Hrudayalaya 89 25 Fortis Healthcare Oscal Investments Malar Hospitals 8 62 Aavishkaar India Micro Venture Capital Fund, Vaatsalya Healthcare 4 32 Oasis Capital, Seedfund I-Ven Medicare India Pvt Ltd Vikram Hospital, Delhi 24 na I-Ven Medicare India Pvt Ltd RG Stone Hospital, Delhi 10 na I-Ven Medicare India Pvt Ltd Medica Synergie, Calcultta 15 I-Ven Medicare India Pvt Ltd Sahaydri Hospital, Pune 36 India Venture Advisors KG Hospital 12 na Global Hospitals Shankar Hospital 57 100 Fortis Healthcare Hiranandani Healthcare, Navi Mumbai 6 100 IDFC Manipal Hospitals 70 na APAX Partners Apollo Hospitals Enterprise 104 13.6 Warburg Pincus MAX Healthcare 30 30 IFC MAX Healthcare 60 3.9 Actis Sterling Hospitals 15 41 Indivision Global Hospitals 25 25 Aavishkaar India Micro Venture Capital Fund Swas Healthcare Global Technology Investment Group Nova Medical Centers BCCL Wockhardt 10 1.5 CitiGroup Wockhardt 20 3.2 Ashmore funds CARE Hospitals 90 19 Oyester & Pearl Sabre Healthcare 14 n.a. Sequoia Capital Dr Lal's path labs na 26 Source: IDFC Securities Research, news flow, ISI
However, FDI interest remains low Despite government incentives to attract FDI investments (including 100% FDI in all health-related services), FDI inflows in the hospital sector have been surprisingly lukewarm given the attractiveness of the space. A scan of the landscape indicates the presence of limited 100% foreign-owned healthcare players in the Indian market.
Following are some of the activities undertaken by the foreign players in the Indian healthcare space
• Singapore's Pacific Healthcare made its first foray into the Indian market, opening an international medical centre, which is a joint venture with India's Vitae Healthcare, in the Indian city of Hyderabad.
• The Singapore-based Parkway Group Healthcare PTE Ltd penetrated into the Indian healthcare market in 2003 through a joint venture with the Apollo group to
Given the attractiveness of the space, FDI has been
relatively low so far…
NOVEMBER 2010 18
IDFC Securities
build the Apollo Gleneagles hospital, a 325-bed multi-speciality hospital at a cost of US $29m.
• Columbia Asia Group, a Seattle-based hospital services company, a worldwide developer and operator of community hospitals, started its first American-style medical centre in Hebbal, Bangalore.
• The Parkway group had also entered into a JV with a Mumbai-based Asian Heart Institute and Research Centre to set up specialized centres of medical excellence in Mumbai.
• Max Healthcare and Singapore General Hospital (SGH) have a collaboration for medical practice, research, training and education in healthcare services.
• India’s first geriatric hospital, the Heritage Hospital of Hyderabad has formed a joint venture with US-based United Church Homes to recruit, train and provide placement to registered Indian nurses in USA.
However, we do anticipate increased activity on this front going forward as the attractiveness of the Indian healthcare market opportunity compels more players to explore options in India.
…but we see the situation changing as the India story
grows more compelling
NOVEMBER 2010 19
IDFC Securities
THE BEST IS AHEAD A confluence of multiple positive factors, e.g. growing affordability, an
expanding base of elderly population and growing incidence of lifestyle diseases, will driven sustainable high growth
We estimate Indian healthcare market to double over the next five years to be a $125bn opportunity by 2015
Along with favorable demographics, increasing penetration of medical insurance along with medical tourism will be key catalysts for growth
Organized private healthcare providers, particularly in the tertiary care segment, will be the biggest beneficiary of this growth opportunity
Indian healthcare: In a sweet spot
A confluence of multiple positive drivers including rapidly growing affordability, a steadily growing population which is adding elderly people at a much faster pace, growing incidience of lifestyle diseases combined with growth of medical insurance as well as the potential of medical tourism will drive sustainable high growth in the $62bn Indian healthcare industry over the next several years / decades. Hospitals , the largest component of the healthcare spend in India, will be the biggest beneficiary of this macro trend.
Exhibit 19: Key enablers to growing Indian healthcare
Source: IDFC Securities Research
Indian Healthcare
Growing affordability
Growing affordability
Increasing awarenessIncreasing awareness
Growing populationGrowing
population
Rising Health Insurance
penetration
Rising Health Insurance
penetration
Rise of medical tourism
Rise of medical tourism
Increasing life expectancy &
ageing population
Increasing life expectancy &
ageing population
Indian Healthcare
Growing affordability
Growing affordability
Increasing awarenessIncreasing awareness
Growing populationGrowing
population
Rising Health Insurance
penetration
Rising Health Insurance
penetration
Rise of medical tourism
Rise of medical tourism
Increasing life expectancy &
ageing population
Increasing life expectancy &
ageing population
NOVEMBER 2010 20
IDFC Securities
Indian healthcare – likely to be a $125bn opportunity in five years Indian healthcare sector is currently valued at $62bn and is estimated to be growing at 13% per annum; this implies that the sector garners per capita expenditure of ~US$53, according to our calculations. We expect the healthcare opportunity to double to US$125bn in the next five years as we estimate population to grow at 2% annually and factor in a 10% annual increase in healthcare spend on the back of changing demographics and rising income levels.
Exhibit 20: Indian healthcare – a US$125bn opportunity by 2015E
Particulars 2009 2010 2011 2012 2013 2014 2015 Population (in m) 1166 1189 1213 1237 1262 1287 1313 Assumed Growth (%) 2 2 2 2 2 2 Per capita health expd. (US$/pp) 53 58 64 71 78 86 95 Assumed Growth (%) 10 10 10 10 10 10 Health Expenditure (US$bn) 62 70 78 88 98 111 125 Source: IDFC Securities Research
Private healthcare segment to be the biggest beneficiary Crisil estimates that India requires 632,000 additional beds over the next 10 years, ~60% higher than the current base of 1.05m beds. Of these, ~20% will be required for complex medical procedures in cardiac and oncology segments. In our view, hospitals are a high gestation business entailing significant upfront investments but long payback periods. Construction of a new hospital bed costs Rs2.5m-3m on an average with a high-end tertiary hospital bed costing Rs5m-5.5m. This implies an overall capital expenditure of ~$40bn over the next 10 years for setting up the incremental 632,000 beds required. As the government is hardly in a position to fund this growth, it presents an attractive opportunity for private sector players.
Going forward, we believe the already established and well-funded corporate hospitals like Apollo, Fortis, Max and Wockhardt will garner a substantially higher market share. Other than their much stronger financial capabilities, these organized players provide for complex procedures as also superior service levels, which significantly enhance their competitiveness.
Given the huge demand of incremental hospital beds in the private sector and the currently negligible share of corporate hospitals, we believe the growth trajectory of corporate hospital players in India is limited only by their ambitions and ability to manage growth.
With limited public sector funding and high costs
involved, private players poised to benefit
NOVEMBER 2010 21
IDFC Securities
Drivers for Indian healthcare
A booming ecomony; increasing per capita healthcare spend With Indian economy expected to register 8-9% CAGR over the next several years, per capita income and standard of living are expected to improve significantly going forward. This should lead to a jump in the pool of patients who can afford to pay for quality tertiary healthcare as provided by the private sector. Higher dispsoable incomes, coupled with increasing health awareness, should provide further impetus for higher per capita healthare spend over the next several years. We estimate per capita healthcare spends to witness a CAGR of 10% over the next five yers to US$95, translating into a market opportunity of $125bn by 2015. We expect private sector hospitals to be the key beneficiary of this trend.
Exhibit 21: Evolving favorable demographics to boost healthcare spend
Source: Industry, IDFC Securities Research
Increasing life expectancy and ageing population India’s population is now more than 1.3bn and growing at an annual rate of ~2% over the past five years. At this rate, India will overtake China by 2030 to become world’s most populous nation. More importantly, a combination of population growth, higher average life expectancy and declining mortality rates will result in sharp growth in the pool of ageing population. It is estimated that India’s population > 45years will increase from 20% in 2007 to 24% by 2017. Increasing life expectancy and growing pool of elderly people will necessitate higher healthcare spends in future years, providing a strong growth thrust to healthcare industry.
Exhibit 22: Rising life expectancy and declining mortality rates to see a steady increase in ageing population
Rising lifestyle diseases imply higher revenue per bed India’s urban population has increased 4.5x over 1951-2001, while its total population has registered a 3x increase over the same period. According to census data, the share of urban population currently stands at ~28%. The segment is expected to grow at 4% per annum and account for more than 32% of the total population by 2014.
With increasing urbanization and the problems associated with modern-day living in urban settings, we expect disease profiles to shift from infectious to lifestyle-related. While this is bound to steadily result in higher treatment costs, we expect a steady increase in revenue/ bed (ARPOB). Notably, most of the new corporate hospitals are coming up in tier I and II cities and cater to the growing urban population and targeting lifestyle-related diseases like cardiac, digestive and genitor-urinary ailments.
According to an IBEF survey conducted in 2001, the average treatment cost for lifestyle-related diseases was ~7x that of infectious diseases. Based on demographic trends and an expected shift in disease profile (towards chronic segments), we expect India’s disease profile to follow the pattern of developed economies. Based on this, we expect a swift increase in in-patient revenues.
Exhibit 23: Evolving demographics to drive inpatient volumes & ARPOB
Source: IBEF, E&Y, Mckinsey, IDFC Securities Research
Increasing insurance penetration – icing on the cake The widespread lack of health insurance is one of the primary causes for the limited access to quality healthcare in the country for majority of the population – as reflected in India’s low ranking in the human development index (HDI). Currently, <12% of the population is covered under health insurance in some form or the other, which suggests enough scope for penetration levels to rise. In FY05, only 1% of the population was covered by private health insurance. Group insurance accounted for 35% of the total health insurance business during that period. This has led to a situation wherein out-of-pocket payments for medical care account for 69% of the total healthcare expenditure by Indian households (according to FY02 census data). Given this high out-of-pocket expense, affordability emerges as a key issue in the way to seek healthcare in high-end tertiary hospitals. While there is a burgeoning middle-upper class which can afford to pay for the fees in high-end corporate
3 38 10 10
164 7 1
5 84
59 7
19 1319
4
516
14 18
18
2
3
2
3 4
9
22
2419
1618
17
16
15 10
1312
2
4434 37
20 17 15
0
25
50
75
100
(%)
India-2001 India-2012 Thailand-2001
Brazil*-2001 Singapore-2001
US-2001
Infectious and respiratory diseases
Developing world diseases Developed world diseases
Accident/injuries
Maternity/gynae
Musculoskeletal
Digestive & Genito urinary
Circulatory (cardio…)
Cancer
Other dieases
31 39 61 26 127 113
2,100 3,600 5,800 6,900 25,000 22,000
No. of hospitalisation ('000)
GDP per capita PPP $(1998)
0.0
1.0
2.0
3.0
4.0
5.0
Coronary heartdisease
Diabetes Asthma Obesity Cancer
No. of patients( )
2005 2015E(% of population)
36 62 31 46 27 34 14 34 2.0 2.5
Urban residents will account for more than 32% of India’s
population by 2014…
…leading to a rise in lifestyle-related diseases
…which in turn implies higher treatment costs and,
therefore, increased ARPOB for hospitals
Poor insurance penetration is the key reason for
people’s lack of access to quality healthcare
NOVEMBER 2010 23
IDFC Securities
hospitals, we believe growing awareness and penetration of health insurance will significantly enhance the target patient pool for this segment of hospitals.
Health insurance has registered a CAGR of 41% over the past four years. Despite the elevated growth rates, high premiums, inadequate and inefficient back-end infrastructure have kept health insurance out of reach for a large part of the population. With increased interest from private insurance players that are targeting this potentially huge opportunity, health insurance growth is expected to accelerate. Swiss Re estimates India’s health insurance premium market to grow to US $7.7bn by 2015.
In our view, better availability of health insurance would help drive demand for services and provide additional revenues while improving the quality of healthcare. Also, increasing penetration of health insurance would be a key catalyst in the growth of corporate hospitals in India.
Exhibit 24: Health insurance has grown at 41% CAGR over past four years!
0
10
20
30
40(Rs bn)
FY05 FY06 FY07 FY08 FY09
Non life - Public Non life - Private Standalone Health Insureers
Source: IRDA AR, IDFC Securities Research
Insurance schemes find favor with state/central governments too • The central government’s ambitious RSBY (Rashtriya Swasthya Bima Yojna)
scheme to provide insurance cover to BPL (below poverty line) households is one such step. In our view, successful implementation of this scheme will increase healthcare affordability for several million households.
• Several micro-insurance schemes running on partnership bases between the governments of Andhra Pradesh and Tamil Nadu and private healthcare service providers have been hugely successful.
In the coming years, we see improved affordability owing to a wider insurance penetration driving in-patient volumes for private healthcare providers.
An expanding upper middle class and rising healthcare
insurance penetration to benefit tertiary care sector…
Govt schemes will increase affordability and, therefore, enhance in-patient volumes
…and will catalyze the growth of corporate
hospitals
NOVEMBER 2010 24
IDFC Securities
Accreditations and growing insurance spread – advantage corporate providers • Unregulated growth of private healthcare over decades has led to inefficiencies
(lack of clinical protocols, duplication of work, inventory mismanagement, etc) and huge cost overheads. These have, in turn, impacted availability of quality medical care and driven up the cost of quality treatment. We believe greater insurance penetration could enhance the availability of quality medical care.
• Recent trends suggest growing preference of payors/ insurers towards hospitals that have acquired quality accreditations (e.g. NABH/ QCI/ JCI). There are reports of several government and state owned enterprises insisting that the Third Party Administrators (TPA) and insurers put accredited hospitals on the preferred provider list. We expect this trend to gain further momentum going forward.
• Given the growing importance of heath insurance in driving future growth, we believe hospitals will be forced to get national/ international accreditations like NABH/ JCI, etc. This will also help improve the spread of quality medical care.
• Interestingly, a positive fallout of this trend will be that several nursing homes may not be in a position to implement the norms in line with NABH regulations, etc – which will impede their capability to get accredited and thereby participate in the health insurance market. This state of affairs will favour the organized private players. Therefore, given the expected increase in insurance penetration and growing awareness of quality accreditations, we find the organized private healthcare sector in a sweet spot.
"Insured patients account for 10% of our inpatient volumes with corporates accounting for 70% of volumes. Insured patient volumes are increasing with 10-15% volume growth each year”
-A leading South Delhi Hospital
"Increase in insurance penetration is encouraging for healthcare service providers. Success of Govt. insurance programs in Andhra Pradesh and Karnataka has been encouraging. Insured patients account for 18% of our revenues; we target to increase this to 45% over next few years"
-Vaatsalya
Large hospital chains have also entered the healthcare insurance segment – e.g. Apollo Hospitals and MAX Healthcare have formed JVs with international partners like Munich Re and BUPA respectively to set up insurance companies. Apart from the economic benefits realizable by tapping into an opportunity presented by a significantly under-insured population, this business also provides hospitals an opportunity to cross-sell their products.
Exhibit 25: Large organized players have tied up with insurance companies
Source: Industry
Entry into insurance segment will help large
hospitals cross-sell services
Historical lack of regulation responsible for rising cost
of treatment and low quality
An increasing number of hospitals are seeking
accreditations – a positive trend
High standards required to qualify for accreditations
will favor organized players
NOVEMBER 2010 25
IDFC Securities
In another trend, hospitals – looking to provide affordable treatment – have tied up with state governments to provide micro insurance for the underprivileged. Narayana Hrudayalaya, for instance, successfully runs an insurance scheme called Yeshasivini launched in 2002.
Exhibit 26: Organizational structure of Yeshasvini Cooperative Farmers’ health scheme
Source: Industry
Rise of medical tourism – another potential catalyst “Medical tourism”, a phrase commonly used for overseas patients seeking treatment in India, has been gaining momentum over the past few years. The trend is developing not just because of the cost arbitrage but also because of India’s emergence as a high-quality healthcare destination. Also, long waiting periods for patients in the developed world and increasing attraction to innovative/ alternate therapies contribute to the rise in medical tourism. In a bid to seize this opportunity, Indian corporate hospitals have been striving to achieve international accreditations. According to IBEF, the medical tourism market was an estimated US$333m in terms of revenues in 2006 and is expected to grow to US$2bn by 2012.
Exhibit 27: Indian medical tourism expected to grow 6x over FY06-12 (US $ bn)
0.0
0.6
1.2
1.8
2.4
FY06 FY08 FY12 Source: Industry, IDFC Securities Research
Family Health Plan Ltd
YeshasviniFarmers Health
Trust
Department of Co-operation, Gov Karnataka
Federation(s) of Unions
District Coordinator
Network Hospitals
Member of Cooperative
Society
(2) District Coordination Committee(s)
Deputy Registrar of Cooperative
Societies
Union(s) of Cooperative
Socities
Cooperative Society
TPA TRUST
GOVERNMENT’S COOPERATIVE STRUCTURE
COOPERATIVE SECTOR
SUBSCRIPTIONUTILIZATION
CLAIM SETTLEMENT
Tow
n/Vi
llage
Lev
elD
istr
ict
Leve
lSt
ate
Leve
l
Family Health Plan Ltd
YeshasviniFarmers Health
Trust
Department of Co-operation, Gov Karnataka
Federation(s) of Unions
District Coordinator
Network Hospitals
Member of Cooperative
Society
(2) District Coordination Committee(s)
Deputy Registrar of Cooperative
Societies
Union(s) of Cooperative
Socities
Cooperative Society
TPA TRUST
GOVERNMENT’S COOPERATIVE STRUCTURE
COOPERATIVE SECTOR
SUBSCRIPTIONUTILIZATION
CLAIM SETTLEMENT
Family Health Plan Ltd
YeshasviniFarmers Health
Trust
Department of Co-operation, Gov Karnataka
Federation(s) of Unions
District Coordinator
Network Hospitals
Member of Cooperative
Society
(2) District Coordination Committee(s)
Deputy Registrar of Cooperative
Societies
Union(s) of Cooperative
Socities
Cooperative Society
TPA TRUST
GOVERNMENT’S COOPERATIVE STRUCTURE
COOPERATIVE SECTOR
SUBSCRIPTIONUTILIZATION
CLAIM SETTLEMENT
Tow
n/Vi
llage
Lev
elD
istr
ict
Leve
lSt
ate
Leve
l
Indian medical tourism driven by the promise of
global quality, not just cost arbitrage
NOVEMBER 2010 26
IDFC Securities
India’s USP…high quality delivered at significantly lower costs… The value proposition for patients from developed countries is lower cost, high levels of quality and service in Indian tertiary hospitals and availability of superior medical facilities for patients from the developing countries in Asia and Africa. In particular, it is an exciting proposition for patients from developed countries like USA and Europe – e.g., there are ~50m uninsured people in USA who are potential targets for this opportunity. Undergoing a complex medical procedure in India costs as less as one-tenth of the cost in those countries, accompanied with very high quality standards as a topping. India’s cost competitiveness is further established by the wide cost difference for various procedures between India and Thailand, the erstwhile “Medical Tourism Hub” in Asia.
Exhibit 28: Treatment in India costs nearly a tenth of that in developed countries
Treatment cost (US$) India Thailand USA Bone marrow transplant 30,000 62500 400,000 Liver transplant 40,000 75000 500,000 Open heart surgery 4,400 14250 50,000 Hip replacement 4,500 6900 na Knee surgery 4,500 7000 16,000 Gall bladder removal 555 1755 na Neuro surgery 8,000 na 290,000 Source: IBEF, Industry
…and almost no waiting period Patients in several developed economies, including the US, UK, Canada, etc, face long waiting periods that often run into months due to over-burdened healthcare systems. Indian healthcare service providers have seen a sharp jump in occupancy rates at their preventive medicine and wellness centers during holiday seasons, clearly indicating the emergence of the medical tourism segment. Further, India’s huge expat population, we believe, is also a target segment. The above factors have led to a visible jump in medical tourism in the country. The Indian government has lent support via expediting the visa-process to eliminate procedural delays. Leading private sector hospitals have seen near doubling of revenues garnered from medical tourists on a yoy basis and remain upbeat on the opportunity.
Exhibit 29: Long waiting periods a result of overburdened healthcare systems in Canada and UK
Source: NHS, IDFC Securities Research
0.0 6.0 12.0 18.0 24.0 30.0BCABSK
MBONQCNBNSPENL
Can
Wait from GP to specialist (Elective) Wait from specialist to treatment In-patient waiting list in UK
0
22,500
45,000
67,500
90,000
0 <
01 w
eeks
02 <
03 w
eeks
04 <
05 w
eeks
06 <
07 w
eeks
08 <
09 w
eeks
10 <
11 w
eeks
12 <
13 w
eeks
14 <
15 w
eeks
16 <
17 w
eeks
18 <
19 w
eeks
20 <
21 w
eeks
22 <
23 w
eeks
24 <
25 w
eeks
26 <
27 w
eeks
28 <
29 w
eeks
30+
wee
ks
IBEF estimates medical tourism to be a $2.2bn opportunity for Indian
corporate hospitals by 2012
Overburdened medicare systems in the West and
holistic treatments & alternative therapies in India
attracting patients
NOVEMBER 2010 27
IDFC Securities
Indian private hospitals – gearing up to tap expected medical tourism inflow Tapping into the medical tourism opportunity is a stated strategic objective for almost all organized Indian private healthcare providers. In line with the strategy, several Indian private healthcare facilities have already acquired international quality accreditations like JCI (Joint Commission International) an JCAHO (Joint Commission of Accreditation of Hospital Organizations). We expect these numbers to swell going forward. The exhibit below lists the accreditations secured by leading Indian private sector players.
Exhibit 30: JCI accredited organizations steadily on rise
Hospital Location First Accredition on Re-accredited on Ahalia Foundation Eye Hospital Palakkad/Kerala, India First Accredited: 24 December 2009 Apollo Hospitals, Bangalore Bangalore, India First Accredited: 18 July 2008 Apollo Hospitals, Chennai Chennai, India First Accredited: 29 January 2006 Re-accredited: 31 January 2009 Apollo Hospitals, Hyderabad Hyderabad , India First Accredited: 28 April 2006 Re-accredited: 17 April 2009 Apollo Gleneagles Hospital, Kolkata Kolkata, India First Accredited: 24 January 2009 Fortis Hospital Mohali , India First Accredited: 15 June 2007 Re-accredited: 24 July 2010 Fortis Escorts Heart Institute New Delhi, India First Accredited: 20 February 2010 Fortis Hospitals - Bangalore Bangalore , India First Accredited: 9 February 2008 (formerly Wockhardt) Fortis Hospitals - Mulund Mumbai, India First Accredited: 26 August 2005 Re-accredited: 20 November (formerly Wockhardt) 2008 Grewal Eye Institute Chandigarh , India First Accredited: 26 May 2007 Re-accredited: 30 July 2010 Indraprastha Apollo Hospital New Delhi , India First Accredited: 18 June 2005 Re-accredited: 12 July 2008 Moolchand Hospital New Delhi, India First Accredited: 5 December 2009 Satguru Partap Singh Apollo Hospital Punjab , India First Accredited: 3 February 2007 Re-accredited: 6 February 2010 Shroff Eye Hospital Mumbai , India First Accredited: 18 February 2006 Sri Ramachandra Medical Centre Chennai, Tamil Nadu, First Accredited: 7 February 2009 India Source: JCAHO, IDFC Securities Research
Partnerships with global insurance players Many Indian private hospitals catering to overseas medical patients have entered into tie-ups with foreign insurance players. For example, large Indian private healthcare service providers have tied up with insurers like BUPA (UK), Van Breda (Belgium) and Môn dial (France) to direct patients to India. We also understand that several large hospital chains are in active talks with overseas governments and insurance companies to offer best-in-class medical services at attractive prices on contractual basis.
“Overseas medical tourists account for 10% of our in-patient volumes. We expect 10-15% volume growth in this segment in FY11. We see steady inflow of patients from Middle East, Africa and neighboring countries.”
-A leading South Delhi Hospital
NOVEMBER 2010 28
IDFC Securities
TERTIARY HOSPITALS: ATTRACTIVE, BUT… With potential 25-30% EBITDA margins in steady state, along with 25-30%
ROCE, tertiary care is a highly attractive business – if executed well
However, operators need deep pockets and nerves of steel to succeed in this business given the long gestation periods and stiff challenges related to procuring land, right people as also an evolving regulatory framework
We estimate that a tertiary hospital will take at least three years to turn EBITDA-positive and generate 25-30% EBITDA typically from the fifth year onwards.
Land and building account for 30-35% of the cost of setting up a bed; hospital economics highly sensitive to these increasingly expensive items
Given the shortage of skilled personnel required for tertiary care units, recruiting and retaining people at manageable costs is a challenge
Attractive but definitely not an easy business While the tertiary corporate hospital segment presents a lucrative opportunity for private players, it is a relatively complex business. Multiple challenges exist on account of spiraling land procurement costs, high upfront equipment and building capex requirements, ensuring high occupancy, managing people issues and regulatory issues governing the sector as well as softer issues like the sensitivity associated with patient care. A widening shortage of reasonably priced land parcels at desired locations and restricted availability of qualified medical personnel have been adding to the complexity of this business.
On the financial front, we believe that while a tertiary hospital can make 25-30% operating margins on a steady basis, it will typically take 5-6 years for a successful hospital to reach that milestone. We assume successful tertiary hospital players will be efficient at procuring well-located land at attractive prices, have a strong referral network, can effectively manage people issues to attract and retain high quality medical personnel while being capable of establishing high quality standards on a sustained basis to attract patients.
Despite several years of existence of private sector tertiary hospitals, we do believe that the jury is still out on the most appropriate business model that can tackle long gestation, ensure viability and deliver profitability.
A tertiary hospital can achieve operating margins
of 25-30%, but could take 5-6 years to hit those levels
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Brace for long gestation; the wait is worth it...
Tertiary healthcare, in our view, is among the most capital-, people- and technology-intensive businesses. It is characterized by long gestation periods – besides 2-3 years for project conceptualization to commissioning, achieving cash breakeven for a healthcare facility could take up to three years assuming steady patient inflow and no mishandled cases.
Cost & Complexity: The initial capital cost of setting up a tertiary hospital bed is Rs7m-10m in larger cities with real estate and medical equipment accounting for 65-70% of the total project cost. The industry is characterized by frequent product innovations and evolving technology (e.g., high-cost imported equipment may become outdated earlier than anticipated). The quality of doctors and nurses is critical to the success of any hospital and, hence, retention of key medical personnel is imperative. Real estate, medical equipment costs along with employee retention are the key factors that determine the success or failure of a healthcare delivery model.
Rewards: Importantly, post stabilization i.e. typically after fifth year of operations, hospital operators can potentially enjoy >20% EBITDA margins with attractive return ratios. Further, based on management’s abilities to derive cost efficiencies, hospitals could enjoy margins in range of 30-35% by 6th - 7th year of operations and generate 25-30% RoCE. Apollo Chennai for instance operates at 30%+ EBITDA margins. After achieving EBITDA break-even, we expect well-run hospitals to clock steady annuity like cash flows.
Exhibit 31: Capital cost distribution Sweet returns post stabilization of beds
Source: IDFC Securities Research
The operating matrix of a hospital depends on a host of variables, including location, target markets, price sensitivity, specialization, level of technology, etc.
An efficient tertiary care unit would take two to three
years to break even, assuming steady patient
inflow
Real estate and equipment costs and retaining qualified
staff are key challenges for any delivery model
Capital Costs breakup
Land8%
Construction 19%
Machinery 38%
Pre operative expenses
12%
IDC 8%
Others15%
Cash flows
-2,000
-1,500
-1,000
-500
0
500(Rs m)
YR1 YR2 YR3 YR4 YR5 YR6 YR7
Operating cashflow Free Cash Flow
-8
1
10
19
28
YR1 YR2 YR3 YR4 YR5 YR6 YR7-8
2
12
22
32RoCE (% - LHS) Operating margins (% - RHS)
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The exhibit below cites detailed revenue and cost break-ups for a tertiary care hospital. However, to understand the economics of a multi-specialty tertiary care hospital and for the sake of simplicity, we limit the number of input variables.
Exhibit 32: Revenue and cost mix for a tertiary care hospital
Source: FICCI, E&Y, Industry
How do financials of a well-run hospital look like?
Exhibit below is a representation of the scale-up of a typical well run multi-specialty tertiary care hospital in a large metro.
Exhibit 33: Key operational assumptions for a 200-bed tertiary care hospital
• Per bed capital cost at Rs10m; implies total investment of Rs2bn for 200-bed tertiary care hospital in a metropolis.
• ARPOB of Rs20000 in first year of operations with 5% increase assumed in second year followed by 10% annual increase thereon. We see 10% increase as conservative after considering an improving case-mix and as well as the inflationary impact.
• Occupancy rates at 30%, 45%, 65%, 75% in year 1,2,3,4 of operation. Year 5 onwards we expect operations to stabilize with 85% occupancy levels.
Revenue Streams
Bed17%
OT Rent17%
Pharmacy17%
Doctor's fees16%
Radiology4%
Pathology5%
Consumables19%
OPD5%
Cost heads
Personnel cost22%
Marketing & PR2%
Maintenance7%
Pharmaceuticals13%
Consumables11%
Utilities6%
Admin. Expenses5%
Doctors share16%
EBITDA18%
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• Consumables and employee costs account for 30-40% and 35-40% of the sales in initial years of operation. Operational costs include power & fuel, repairs & maintenance, laundry, and other miscellaneous costs, and account for 10-15% of sales.
• We factor in steady margin expansion as hospital beds mature and the hospital steadily realizes the benefits of scale with higher purchasing power.
Well-run hospitals focus on top line in initial years • Hospital operators, in the first year of operations, focus energies on achieving
targeted footfalls to ensure revenue growth. Hospitals usually have an 80:20 footfall ratio, with 80% of footfalls contributing only 20% of the revenues generated. The remaining ~20% of in-patients typically contribute 80% of the revenues generated.
• Once requisite sustained footfalls are observed in year one, the hospital administration shifts focus to revenue growth and thereafter to operating profits (in years two and three respectively).
• In the aforesaid scenario, new hospitals typically incur operating losses in the initial two years of operations and turn EBITDA-positive only by the third year of operations.
Key observations • Losses incurred in the initial years not only erode net worth but may also force
companies to borrow short-term funds for working capital. Across scenarios, we observe a ‘camel hump’ gearing profile, with gearing as high as 3x in the third year of operation.
• Hospital beds, in our view, are a perishable commodity. Medical equipment accounts for a third of the total capital costs. Assuming a depreciable life of five years on critical equipment (say 30% of the equipment cost) would imply that 25% of the cumulative EBITDA of the first five years would need to be provisioned for equipment upgrades by the fifth year of operations.
• Given capital intensiveness of the sector, hospitals have a payback period stretching over 7-10 years. Return ratios, initially negative, turn positive by the third or fourth year of operations in most cases.
Medium- to long-term – tertiary healthcare is an attractive business • Importantly, hospital operators of well-administered facilities enjoy healthy
operating margins upwards of 20% typically the 5th year of operation.
• Higher inpatient volumes and consequently improved capital efficiency results to hospitals churn attractive return ratios. We expect well-run hospitals to clock on average 15-20% RoCE from the fifth year of operations.
• Further, based on improved case-mix and management’s abilities to realize cost gains, hospitals could witness EBITDA margins as high as 35%. Apollo Chennai for instance operates at EBITDA margins in excess of 30%.
• For a hospital operating in steady state (say 7th year of operation), we expect every 100bps expansion in EBITDA margins to lead to 75-80bps expansion in return ratios. We estimate a hospital operating at 35% EBITDA margins to clock return ratios in the region of 25-30%.
Optimizing case mix and management ability to
derive cost gains key to higher margins
The 80:20 principle – 80% of footfalls generate 20% of
revenue, and vice versa
25% of total EBITDA for the first five years may need to
be provisioned for equipment upgrades
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• After initial years of negative cash flows, hospitals on stabilization witness steady increase in positive free cash flows reflecting improvement in operational metrics. As per our estimates, cumulative free cash flows over a five year period post breakeven (in Yr 3) covers nearly ~65% of the initial setup cost.
Operating indicators for a successful tertiary hospital
While land acquisition at a strategic location and reasonable costs goes a long way towards laying the foundation of a successful tertiary hospital, we believe some of the following operating parameters help to present a complete picture.
Exhibit 35: Indicators for a healthy tertiary hospital
Source: IDFC Securities Research
Achieving an optimal case mix, which combines higher average revenue per occupied bed (ARPOB) with lower average length of stay (ALOS), along with higher occupancy is the operating Holy Grail of tertiary corporate hospitals. While it is relatively easy to achieve higher occupancy if the location and service quality of the hospital are in order, a hospital’s commercial savvy lies in its ability to achieve these occupancies with a superior case mix.
Low “Average Length of Stay” (ALOS) Occupancy rates
Average daily revenue per occupied bed
Strong OPD (Outpatient
Department) patient flow /revenues
Diagnostic and dispensing related
revenues
• Inpatient revenues are dependent upon the Average Length of Stay (ALOS)
• ALOS indicates average time for which patient occupies a hospital bed.
• As maximum inpatient revenues are generated within first 48-72 hours of admission, reduction in ALOS to closer to 2-3 days will lead to higher profitability for a tertiary hospital
• Given high fixed costs associated with tertiary hospitals, ensuring high occupancy rates is critical.
• Typically a tertiary hospital starts breaking even at 60-65% occupancy
• An important indicator for the financial health of a tertiary hospital
• Indicative of the complexity of average procedures undertaken in the hospital
• While the Outpatient revenues contribute a relatively smaller component of overall revenues for a tertiary hospital (20-25%), it is a critical revenue stream
• Outpatient revenues act as a strong pull for Inpatient revenues and creates a solid base for a hospital
• Also, operating margins in outpatient revenues are significantly higher due to very low operating costs
• Hospitals with a higher component of the high margin diagnostic services related and drug dispensing related revenues are able to achieve superior operating margins
Low “Average Length of Stay” (ALOS) Occupancy rates
Average daily revenue per occupied bed
Strong OPD (Outpatient
Department) patient flow /revenues
Diagnostic and dispensing related
revenues
• Inpatient revenues are dependent upon the Average Length of Stay (ALOS)
• ALOS indicates average time for which patient occupies a hospital bed.
• As maximum inpatient revenues are generated within first 48-72 hours of admission, reduction in ALOS to closer to 2-3 days will lead to higher profitability for a tertiary hospital
• Given high fixed costs associated with tertiary hospitals, ensuring high occupancy rates is critical.
• Typically a tertiary hospital starts breaking even at 60-65% occupancy
• An important indicator for the financial health of a tertiary hospital
• Indicative of the complexity of average procedures undertaken in the hospital
• While the Outpatient revenues contribute a relatively smaller component of overall revenues for a tertiary hospital (20-25%), it is a critical revenue stream
• Outpatient revenues act as a strong pull for Inpatient revenues and creates a solid base for a hospital
• Also, operating margins in outpatient revenues are significantly higher due to very low operating costs
• Hospitals with a higher component of the high margin diagnostic services related and drug dispensing related revenues are able to achieve superior operating margins
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Exhibit 36: Holy Grail to tertiary care hospitals
Source: IDFC Securities Research
Strong brand recognition The long-term success of a hospital clearly rests on the brand image it enjoys in the addressable market. To be a success, a hospital requires significant time and investments which many players find difficult to afford. People value hospitals by their consistent quality service. Even as we acknowledge the huge supply shortage in the healthcare service delivery space, we believe it is imperative for hospitals to develop strong brand equity to succeed in the long term. With the organized private healthcare service sector now focusing on quality of delivery and also, importantly, on clinical outcomes, patients are increasingly preferring hospitals over solo practitioners.
Hub & spoke – unconventional models emerging The private sector in India has traditionally opted for the multi-specialty format and has focused on tertiary care hospitals. Unregulated growth and polarization of beds have forced hospitals to compete for patients and grapple with rising cost pressures. To tackle the aforesaid scenario, besides setting up external feeder networks (family physicians, etc), many tertiary care hospitals have set up spokes (secondary hospitals) to ensure steady in-patient volumes at the hub (tertiary care unit). This model not only improves profitability of the hubs but also ensures a steady stream of in-patient volumes with a favourable case-mix, thereby enhancing occupancy rates and ARPOB. The hub also realizes lower ALOS as patients are located at the secondary care facilities (spokes) before and after surgery cases.
Real estate costs: Key to commercial viability
Real estate cost is probably the most important factor that determines the viability of a hospital project. Land and building together account for 30-35% of the total project cost and are among the key measures to gauge a hospital’s financial viability. On the revenue side, location of a tertiary care unit defines the catchment area and, correspondingly, the ability of the hospital to attract a relevant patient pool with the desired economic profile. Treatment pricing is often dependent on economic profile of the local populace and, therefore, impacts a hospital’s revenues.
A 200-bed hospital demands two acres of land Based on expansion plans of upcoming tertiary care units in 2010, we have estimated that one bed would correspond to ~750 sq ft of space; so a 200-bed tertiary hospital would broadly need 1,45,000 sq ft of constructed space to accommodate all the facilities.
Higher profitability
Lower ALOS
Desired case - mix
Higher ARPOB+
Improving clinical outcomes at private hospitals are
drawing patients away from solo practitioners
Tertiary care hospitals are setting up feeder networks
to compete for patients and drive down costs
Land and building account for ~35% of project cost
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Exhibit 37: Average space required for a tertiary care hospital
Hospital No. of beds Total area (000’ sq. ft) Area/bed (sq. ft/) Apollo Hospital, Bhubaneswar 300 200 667 Fortis Hospital, Delhi 550 383 696 Global Hospital, Mumbai 425 366 862 Fortis Hospital, Kolkata 450 300 667 Vikram Hospital, Bangaluru 200 150 750 Average 728 Source: IDFC Securities Research, news-flow
Assuming an FSI of ~2.5x, a hospital would require 1.4 acres to set up its facility. We assume an additional 40% would be required for open spaces and landscaping. Setting up a 200-bed hospital would, therefore, require 1.8-2.0 acres of land. We assume Rs80m per acre as land acquisition cost and Rs4,000/ sq. ft as construction cost . Extrapolating this for a 200-bed facility (145,000 sq. ft of constructed space and 1.9 acres of total land), we arrive at a total cost of ~Rs732m for land acquisition and construction – 37% of the total capital cost for setting up a 200-bed hospital.
Exhibit 38: Land procurement and construction costs Area required for a 200-bed hospital (sq. ft) 145,649 Assumed FSI limit (x) 2.50 Required land area (sq. ft) 58,259 Construction cost (per sq. ft) 4,000 Total construction costs (A) 583 Area required for a 200-bed hospital (acres) 1.34 Area allotted for landscaping/ gardens (acres) 0.53 Total area required (acres) 1.87 Assumed land cost per acre (Rs m) 80 Total land cost (B) 150 Total costing (A+B) (Rs m) 732 Source: IDFC Securities Research
Impact of real estate cost on return ratios Real estate cost is a key factor that determines the viability of a hospital project. Land and building together account for 37-40% of the total project cost and are among the key measures to gauge its financial viability. Based on our analysis, we find for a hospital operating at 15% margins in the fifth year of operations, an increase/decrease in land and building costs by 20% results to contraction/expansion in return ratios by nearly 40-50bps. The impact of land & building costs is relatively lower for well-run hospitals. i.e. return ratios for a hospital enjoying 30% margins would be impacted only to the extent of 20bps on 20% increase/decline in land & bldg. costs.
Exhibit 39: RoCE sensitivity to real estate costs (in the fifth year of operations)
A 200-bed hospital would require ~Rs732m for real estate and construction
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Due to high land and building costs, some private healthcare service providers have opted for the lease model. For example, land for six of Fortis’s 10 planned Greenfield projects (underway) has been taken on lease.
Exhibit 40: 60% of Fortis’s planned hospital expansion are under lease contracts
Having said so, we believe high real estate lease costs weigh heavily on a hospital’s operating cash flows. Our base case scenario for a 200-bed hospital operating in a Tier I city and servicing Rs600/ sq. ft/ annum of lease rental would shave off as much as 60% of the cumulative EBITDA generated over the first three years of operations. A case in point is Fortis wherein lease rentals accounted for 2% of the net sales respectively in FY10.
In an environment of high lease rentals and land and construction costs, we believe increased regulatory intervention is imperative to make healthcare delivery affordable. We expect newer operating models to evolve as the private sector seeks ways to tackle high real estate costs and aggressively expand footprint. We list a few emerging trends:
• Innovative models: We expect hospitals to follow an asset-light strategy and adopt various innovative models:
o REITs: These operate on the principle of a mutual fund. Like mutual funds collect money from investors and deploy it into equities and bonds, REITs deploy investors’ money in real estate assets. These trusts invest mainly in commercial property and pay the rent collected from these properties to the shareholders as dividend.
SEBI, the market regulator had issued a draft guideline on REITs a couple of years ago, but nothing has happened since then. We believe the government’s renewed focus on affordable healthcare could speed up progress on this front. We understand that several healthcare companies are evaluating the possibility of listing such REIT entities in overseas markets (like Singapore) where there is an appetite for these asset classes.
o BOT and BLT (build-operate-transfer or build-lease-transfer). Under these models, a private player builds and operates the hospital on land owned either by a private entity or the government for a fixed period of time.
Some have adopted the leased model to circumvent
high real estate costs
Regulation may help curtail rising land costs somewhat,
but private players are evolving innovative models
Several healthcare providers are looking at REITs to avoid costs of
owning properties
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"To overcome high land and real estate costs, we operate either on leased land or set up our hospitals on acquired nursing homes. This significantly reduces our cost base."
-Vaatsalya
"We work on quick payback models with a focus on minimizing initial outlay of investments. Of our 11 premises, only one is owned with the remaining on leased land"
-A leading hospital chain in South India
• Regulatory intervention: We expect the government to take the following regulatory measures soon to make healthcare affordable.
o Increase in FSI limit for hospitals in metros.
o Land subsidy for hospitals with reserved beds for people below the poverty line.
o Tax rebates for setting up hospitals in select geographies and catchment areas.
Medical equipment: High obsolescence costs
Industry estimates indicate that medical equipment accounts for the largest chunk of capital costs (up to 30-40%) towards setting up a tertiary care unit. The healthcare industry is characterized by frequent product innovations and evolving technology. That leads to redundancy of expensive medical equipment every 5-7 years, compared with a depreciable life of up to 14 years (based on accounting periods). The problem is compounded by the fact that there is practically very limited indigenous medical device manufacturing industry in India which necessitates purchase of significantly expensive imported equipment.
Hospitals, to recover the cost of expensive imported medical equipment over its short life cycles, resort to higher treatment pricing. That often leads to a vicious cycle of lower utilization rate, which dents profitability due to negative operating leverage.
Exhibit 41: Industry faces high depreciation costs The vicious loop of higher pricing Depreciation
Hiking FSI limits, subsidies and tax rebates are key
policy measures that can make medicare affordable
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Solutions for equipment obsolescence Most large Indian private healthcare service providers have adopted the strategy of having ‘state-of-art’ technology, partly to target lucrative medical tourists and also to provide the best available treatment to domestic patients. A side effect of this has been that as hospital administrators strive to achieve their target return ratios and with overseas medical tourists still a small fraction of overall patient base, the domestic patient base bears the brunt of high treatment charges. This tends to result in a portion of in-patient volumes shopping for more affordable alternatives.
Many tertiary care units also often embrace high-end technology to retain the best of doctors and to showcase their “leading edge” treatment. We note that these “latest technologies” may not be the most appropriate ones for the recommended treatment. This results in a higher fixed cost base and loss of in-patient volumes.
“We got out of the arms race a few years ago… Fortis now promises only that its scanners are world class, not the newest”
-Fortis
However, we expect private healthcare service providers to formulate operating models that rationalize the cost of imported medical equipment. Help from the government can also be expected in the form of regulations that incentivize R&D further and encourage domestic manufacturing/sourcing.
"To rationalize high medical equipment costs, we operate on a variety of models like “pay per use”, “percentage of revenue share”, “cost plus basis” as well as outsourcing model depending on the location and facility offerings"
- Fortis
"Vaatsalya, as a policy, has restricted medical equipment purchases to bare essentials like ultrasound machines, ventilators, X-ray machines, etc. This helps us reduce pay-back periods."
- Vaatsalya
Measures we expect from the government • The government should stress on the use of ‘appropriate technology’ over ‘latest
• Medical equipment imports have seen a large 18% CAGR over 2000-07. The government needs to encourage domestic manufacturing and sourcing, which could considerably reduce end-product prices.
• Incentivizing R&D further: Most domestic medical device markets continue to be flooded by low-cost Chinese equipment or serviced by majors like GE and Siemens. None of the domestic manufacturers, barring a few likes L&T, are involved in R&D. We believe the government needs to further incentivize R&D.
Initiatives from the private sector • Equipment leasing: High medical equipment costs and risks related to earlier-
than-expected redundancy of costly imported equipment should force this trend. Global majors like GE and Siemens have already taken the first steps in this direction to provide equipment lifecycle management as well as manage technology obsolescence through planned equipment renewals.
Hospitals tend to buy costly hi-tech equipment to attract doctors, resulting in higher
fixed costs
Govt could encourage domestic manufacture of
equipment by providing sops for R&D
The equipment market is dominated by foreign majors and low-cost
Chinese brands
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• Alternate financing models: Several global medical equipment manufacturers (e.g., GE and Siemens) have come up with alternate financing mechanisms for larger hospitals chains. Deferred payment on equipment purchases, part upfront payment with profit sharing, fixed rate reagent volume supplies contract, etc are a few innovative methods that have come to the fore. We expect more such solutions to emerge.
• Others: To cope with technological advances and enhance the life of medical equipment, larger hospitals operating on the hub & spoke model often pass on equipment from hubs (in large cities) to spokes (facilities in Tier II/ III cities), or sell them in the secondary, unorganized market. We believe there is a huge second-hand medical equipment market in India.
Right People: A challenging proposition
Along with the well-known challenges like high upfront capex requirements and long gestation periods, we believe managing people issues – i.e. finding the right people and at the right cost – will be a critical scale-up challenge for tertiary care hospital operators in India. Doctors, nurses and paramedics are the key enablers of the success of any hospital, and retention of key personnel is an imperative – especially for tertiary care hospitals.
In our view, while there are clear indications of shortage in the overall pool of doctors required going forward, these shortages will be particularly acute in the case of specialized and experienced doctors required for manning the newer tertiary care set-ups. This will logically lead to aggressive wage inflation which will further stress the economics of successfully running tertiary care hospitals.
General availability of medical resources – not enough Prima facie, India has a rich pool of medical practitioners. But when considered from a resource density perspective, they trail even some poorer developing nations.
Medical infrastructure in India includes 757,377 physicians, an equal number of AYUSH doctors, 93,332 dental surgeons, 1,652,561 nurses and 655,801 pharmacists (as on 31 Dec’08). India’s medical infrastructure currently includes more than 750,000 physicians, 15,533 hospitals, and >700,000 hospital beds.
Exhibit 42: Healthcare infrastructure – bad or worse
Nurses
13
10
14
40
81
India
Low income
Low middleincome countries
High middleincome countries
High income
Physicians
6.0
4.0
10.0
24.0
28.0
India
Low income
Low middleincome countries
High middleincome countries
High income
Beds
9
15
18
39
58
India
Low income
World Avearage 27
Low middleincome countries
High middleincome countries
High income
14 28 Source: WHO, IDFC Securities Research
Per 10,000 Per 10,000 Per 10,000
Deferred payment, part upfront payment, etc, for purchases are some new
trends in the private sector
‘Right people at the right cost’ is crucial for the
success of any hospital…
…and critical for tertiary care, as it demands
specialized doctors and other personnel
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We believe lack of adequate infrastructure, qualified teaching staff and high entry barriers to medical education have contributed to the poor growth in medical staff. The number of allopathic doctors (registered with the Medical Council of India) has grown at a dismal 3.5% CAGR over the past four years. There are more than 250 medical colleges in the modern system of medicine and >400 in the Indian system of medicine and homeopathy (ISM&H). The country produces ~35,000 doctors annually in the modern system of medicine and a similar number of ISM&H practitioners, nurses and para-professionals.
Exhibit 43: Supply increasing steadily; but not fast enough No. of students enrolled to MBBS Course
24,000
27,000
30,000
33,000
36,000
FY06 FY07 FY08 FY09 FY10 Source: Medical Council of India, IDFC Securities Research
According to a survey by FICCI, India would need to add 0.7m doctors by 2025. At the current rate of doctor addition each year, we see significant shortage of skilled resources in the times ahead.
Exhibit 44: Healthcare infrastructure shortfall from 13-41%
As per 2001 consensus (nos.) Required Shortfall % shortfall Sub -centres 158,792 20,903 13 PHCs 26,022 4,803 18 CHCs 6,491 2,653 41 Source: NSSO
Compensation models in tertiary care hospitals After consumables, employee expenses form the biggest cost component that influences a hospital’s operating margins (see exhibit below). Doctors are the most important factor of a tertiary care set-up, as most often it is the doctor’s reputation that is the key deciding factor for where a patient goes for treatment. Having reputed doctors is fairly critical for a new hospital set-up to gain traction, which effectively means paying significant payouts to these doctors to switch over. This leads to fairly high upfront costs and thereby strains the financials of a newly commissioned hospital.
Educational capacity highly inadequate to meet the
burgeoning needs of the Indian healthcare industry
India would need an incremental 0.7m doctors
by 2025
Hospitals need to balance between high salaries and their need to have the best
doctors
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Exhibit 45: Margin profile for a hospital – base-case scenario Margin profile - for base case scenario
0
30
60
90
120
YR1 YR2 YR3 YR4 YR5 YR6
Consumables Personnel Other Costs OPM
Source: IDFC Securities Research
Our interaction with industry experts indicates that employee cost structure for hospitals follow pareto charts, with 20% of the employees (mostly doctors) responsible for ~80% of the total employee costs. Given the challenges on key employee availability and constantly escalating costs, hospitals have been forced to come up with innovative performance structures.
"Over the past three years, salaries have increased ~2x with overall compensation increasing 3x. This has been on the back of increased competition in Delhi/NCR”
-A leading South Delhi Hospital
We believe ‘one size fits all’ doesn’t work in the hospital sector and it is imperative for hospital managements to maintain a judicious mix of compensation structures for doctors (full time/ part time) and cost structures (fixed pay/ fee for service/ revenue sharing, ESOPs etc) to rationalize the employee costs.
"To manage employee costs, we have 50% of the doctors on full time basis and balance as visiting consultants. Full time doctors contribute 65-70% of our revenues"
-A leading South Delhi Hospital
"Doctor engagement for us is very location-specific. For example, Bangalore's COE has majority of full time doctors, while Vashi facility has more of visiting consultants. We operate on a combination of fixed fee and fee for service model to retain and incentivize doctors. Our attrition rates are definitely below industry benchmarks"
-Fortis
"Unlike industry which follows fee-for-service model, we have full time exclusive consultants at Vaatsalya. There is enough supply of doctors in secondary care unlike for tertiary care specialties. However, to retain the talent is always a challenge"
-Vaatsalya
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Exhibit 46: Various performance models for medical staff • Model I: The entire staff is on the rolls of the institution and has a
largely fixed salary structure – similar to the practice in the public sector.
• Model II: The consultant medical staff is on the rolls on a retainer basis and is paid a fixed retainership along with either an incentive plan or sharing of revenues over and above the fixed component (retainership). The non-consultants are treated as employees (as in Model I).
• Empanelled model: Primarily used for consultant medical staff who are paid on the basis of 'fee for service' with a deduction of service charges depending on the policy of the individual hospital. For example, the hospital may deploy the entire medical staff in clinical disciplines on this model and keep the consultant medical staff in diagnostics and anesthesiology on a staff model (model 1) (salary basis with or without an incentive plan).
• Mixed model: A mix of staff and empanelled models for consultant medical personnel. This is used to offset the fixed high cost of senior medical staff with a bigger variable component linked to the volume of work.
Source: Express healthcare Magazine, IDFC Securities Research
A 200-bed hospital would need 700 employees to start with: According to our analysis based on industry benchmarks, a tertiary care bed would require 3.5 employees and 3.5 shifts operating all the time at 70% occupancy. Of the 3.5 employees, 20% would be doctors, 35% nurses and paramedics, and the remaining technicians and those involved in accounts, housekeeping, etc. Therefore, a 200-bed tertiary care unit would need 700 employees to start with.
Exhibit 47: Employee cost distribution
Source: CRISIL, Industry, IDFC Securities Research
Employee distribution per bed (%)
Doctors20%
Nurses45%
Others (technicians,pantry, housekeeping,
accounts, etc)35%
No. of employees for a 200-bed tertiary care unit
0
70
140
210
280
350
Doctors Nurses Others (technicians,pantry,
housekeeping,accounts, etc)
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Addressing the human resource availability gap Until recently, only state governments, universities, government-promoted autonomous bodies, registered societies and public religious and charitable trusts were permitted to set up medical colleges. Also, a minimum of 25 acres land was mandatory for a hospital to set up a medical college. To address the huge resource demand-supply gap, the government has recently allowed private hospitals to set up medical colleges and as also lowered the land requirement to 10 acres for metros and 20 acres for smaller cities.
What to expect:
• Greenfield medical colleges: Based on recent changes in regulation, we expect leading healthcare service providers like Fortis, Apollo and MAX to set up captive medical colleges in the years to come.
• Reverse brain drain: Hospital chains like Apollo, Fortis and Manipal Hospital have been witnessing increased enquiries from doctors of Indian origin who are looking to come back to India. We expect this trend to pick up as the larger hospitals not only offer attractive salaries but also the latest medical technology, which was not the case a few years ago. This trend catching up pace, we believe, could help assuage the supply shortage.
Exhibit 48: Indian-origin doctors are are the backbone of healthcare in UK and the USA
Indian IMG's (2005) Rank No. of IMG's % of workforce In US 1 40,838 4.9 In UK 1 15,093 10.9 In Canada 3 1,449 2.1 In Australia 2 4,664 4.0 Total 62,044 Source: The new england journal of medicine, IDFC Securities Research
The number of Indian medical college graduates practicing (as of 2005) in the US, UK, Canada and Australia stood at 62044, equivalent to ~9% of the number of physicians registered by the Medical Council of India in 2005.
"The reverse brain drain trend is picking up. We see several applications from overseas doctors. This should, to some extent, address the supply gap."
-A leading hospital chain in South India
“…over the last six months, we have recruited 17 doctors from overseas – many of them coming from the United States, from the United Kingdom, the Middle East as well. Indian doctors are returning home and these doctors are adding a tremendous amount in terms of value to the organization from a best practices, clinical outcomes and results”
-Fortis
Govt has allowed private hospitals to set up colleges
and has also eased land requirement policy
With corporate chains offering higher salaries,
expat doctors are looking to return to India
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An evolving regulatory scenario…
The growth of Indian healthcare sector has been unplanned and unregulated, and lacks accountability. Surprisingly, the Centre as well as states have provided tax incentives and concessions to hospitals and nursing homes to promote healthcare delivery, but have completely failed to regulate the sector and ensure a minimum level of patient care quality. According to a Business World Survey [Who Cares... 2008], only 13 states in India [as indicated in the map below] register nursing homes/ hospitals under the Nursing Home Act, whereas the remaining states register nursing homes/ hospitals either under the Shops and Establishments Act or even the Societies Act. In the absence of consistent and relevant regulations in most of the states, a patient with a grievance would have to approach a consumer court, which in effect is putting a patient on par with a person complaining about, say, adulterated washing powder.
Exhibit 49: Only 13 states mandate registration of hospitals / nursing homes under the Nursing Home Act
Source: BW Survey, 2008
Consequences: Decades of unregulated growth in the private healthcare market has made the incumbent medical fraternity quite powerful and vociferous. On the premise of professional independence, incumbents declare the profession accountable only to themselves (specifically nursing home practitioners). This has manifested in serious problems like opaque pricing, overcharging and inefficiencies in the system. We believe secondary/ tertiary care treatment costs have risen sharply in the recent years not only due to higher investment costs but also due to the unregulated nature of the industry.
State Applicable regulation Andhra Pradesh Private Medical Care Establishment Act, 2002
Tamil Nadu Private Clinical Establishment Act, April 1997
West Bengal Clinical Establishment Act, 1950
Patients bear the brunt of high costs driven by lack of
regulation in private healthcare
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The government’s role on the aforesaid issues Regulating private healthcare delivery systems: The central government passed the Clinical Establishments Bill, 2010. The bill makes it mandatory for all clinical establishments to register under the Clinical Establishment Act (see details in Annexure 1 of the Appendix section). However, this would be applicable only to four states – Arunachal Pradesh, Mizoram, Himachal Pradesh and Sikkim – and Union Territories for now.
"We do not want to impose a licence raj on the health sector... we need to go slowly and not take harsh measures which may be problematic."
Health Minister Ghulam Nabi Azad, 3August 2010, reacting to Opposition charges that the legislation would be toothless.
Ensuring minimum quality standardards: The Ministry of Health and Family Welfare (MoHFW) and the Indian healthcare industry have established a National Accreditation Board for Hospitals and Healthcare Providers (NABH). NABH accreditation of facilities confirms quality assurance and its standards focus on patient safety and quality of patient care. NABH standards are based on a comparative analysis of various aspects of healthcare, including those in Australia, Thailand, the United Kingdom and the United States, and have been adapted to meet Indian requirements. NABH standards include 49 applicable licenses and statutory obligations under Indian law.
Regulating medical devices: The Department of Health and Family Welfare currently has nominal jurisdiction over medical devices with detailed regulation under consideration and sale of medical devices yet to be fully regulated. The limited regulation that has been introduced till date covers sterile medical devices under the Drugs and Cosmetics Act 1940. The Drug Controller General of India (DCGI) has formulated guidelines for the import and manufacture of medical devices with effect from July 2006. These guidelines were amended in 2007 in terms of; (a) required regulatory clearances for the imported equipment, and (b) addition of 10 categories of sterile devices under the Drugs and Costmetics Act.
"Mushrooming nursing homes (unorganized sector) has definitely impacted the corporate hospitals. Increased competition would see a steady increase in pressure on standalone nursing homes and thereby drive consolidation in the unorganized sector"
–A leading hospital chain in South India
What to watch for:
• Nationwide implementation of Clinical Establishment Act, 2010 (CEA, 2010): CEA, 2010 would be implemented only in four states and all Union Territories. Assuming the act is eventually implemented nationwide and strictly enforced, there may be a spate of closure of nursing homes.
• Nursing homes have been proliferating in the unorganized private healthcare delivery space. Enforcement of strict regulations/ guidelines pertaining to minimum area/ beds, minimum number of qualified doctors/ nurses per bed, maintenance of records, checks on medical equipment, accreditation
Clinical Establishment Bill is a step in the right direction,
but now applies only to a few states in India
NABH is an attempt to bring global quality checks to the
Indian landscape
Better regulation will weed out unscrupulous players
and drive in-patient volumes to the organized sector
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IDFC Securities
requirements, etc could mount cost pressures on nursing homes – thereby forcing many to close. This bodes well for organized healthcare service providers, as that would not only drive higher in-patient volumes, but also improve the supply of medical fraternity.
"Indian healthcare delivery is going through a transformation seen in retail akin to the coming of Big Bazaar and its impact on kirana shops. The end result would be good for patients"
-A leading hospital chain in South India
• Only 54 hospitals in the county have got NABH accreditation of the 450 that have applied for it so far. We believe the recent surge in applications is both a reflection of rising awareness among consumers and minimum requirements set by the government for participation in its healthcare schemes. According to a recent health ministry directive, NABH accreditation is now mandatory for hospitals seeking empanelment in the Central Government Health Scheme (CGHS).
NABH is now mandatory for empanelment in the Central
Govt Health Scheme
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BUSINESS MODELS: INNOVATION AHEAD Till recently, organized private sector healthcare models in India were largely
one-dimensional with focus on multi-specialty tertiary care in metros, supplemented with a few secondary and primary care set-ups.
Escalating competitive intensity in metros as also an increasingly tough operating environment due to inflation in real estate and personnel cost in these areas forcing a rethink
Strong case for exploring innovative business models to tap into less-penetrated geographies as well as newer patient segments.
We are encouraged by unconventional models being tried out by some of recent entrants as well as increased willingness of incumbents to experiment with new healthcare delivery formats
Some of the innovative formats include single specialty tertiary hospitals, day care centers, secondary care focused models etc.
Healthcare models: Expect increased innovation
Currently, bed distribution is lopsided Most of the existing beds are largely located in metros/ A class cities. Our channel checks indicate pockets of temporary oversupply in tertiary care building up in places like Hyderabad and NCR (especially Gurgaon), where significant capacity addition in specific therapies has happened over the last few quarters.
Exhibit 50: Bed distribution skewed towads the urban/ affluent class
0.0
1.0
2.0
3.0
4.0(Hospital beds/10,000 population)
All-India Mumbai - Lowincome segment
Mumbai - Middleincome segment
Mumbai - Highincome segment
WHO recommended
Source: Industry, IDFC Securities Research
While the larger incumbents remain fairly convinced that this is a temporary situation and demand will soon begin to outpace supply, their plans to start looking beyond the conventional “multi specialty tertiary care focused on metros” model has certainly helped.
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Innovation is in the air A broad scan of the operating environment indicates presence/ emergence of multiple new models. We have listed the more interesting ones:
• Existing tertiary healthcare providers experimenting with setting up secondary/ primary tertiary care hospitals in Tier II/ III towns – Apollo with Apollo Reach
• Single specialty tertiary care hospitals, e.g. Healthcare Global
• Day care surgery centers, e.g. Nova Day Care Centre
• Hospital chains solely focused on primary/ secondary care in Tier II/ III towns, e.g. Vaatsalya
• Healthcare cities, e.g. Dr Trehan’s Medicity
• O&M contracts, e.g. Fortis’ contract with SL Raheja in Mumbai
• JV Structures – Apollo’s proposed Thane hospital in JV with Yash Birla Group
Existing players expanding into Tier II / III towns…
Exhibit 51: Larger private hospitals spreading their wings
Source: IDFC Securities Research, Industry news flow
Hospital name
Apollo Hospitals
Fortis Healthcare
MAX Healthcare
Global Hospitals
Manipal Group
Tier II and Tier III plans
Apollo plans to set-up upto 200bed hospitals in Karimnagar, Chittoor (Andhra Pradesh), Karur, Karaikudi(Tamil Nadu) and Andaman& Nicobar Islands. Apollo has huge plans to set-up 250 Apollo Reach hospitals across non-urban India
Plans to start a new model of healthcare delivery for tier II and III cities. It intends to set-up small hospitals with capacity up to 200 beds and by reducing the investment costs to half per bed in these areas in order to provide treatment at nearly 50% less cost than present facilities in tier I cities. It has presence in Mohali, Raipur, Amritsar and Srinagar. Besides with Wockhardt acquisition, Fortis got access to hospitals in Rajkot, Surat, Nagpur (2). Erstwhile Wockhardt had plans to set up facilities in Goa, Nashik and Ludhiana.
Max Healthcare plans for a three-phase expansion plan to t ier II and III cities. It started green field projects in Mohali, Bhatinda and Dehradun with bed strength of 150-250. It also plans to expand to Muradabad or Rohtak
It plans to expand to tier II and III cities through acquisitions and tie-ups. The pan is to build 100-150 bed hospitals The list of cities include Nagpur, Ahmedabad, Trivandrum, Chandigarh, Bhubaneswar, Coimbatore, Ludhiana, Sholapur and Pune
The Group invested Rs4 bn in tier II projects in places like Goa, Vizag, Salem, Tumkur, Mysore, Vijayawada and Jaipur. Salem and Vijayawada have brown field projects while all others are green field projects
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Single specialty tertiary hospital chains Single-specialty tertiary hospital chains have evolved from hospitals looking to leverage the credibility generated by offering “best in class” treatment in certain defined therapy areas and positioning those hospitals as center of excellence in those therapies. This enables them to attract the best of the specialists in those segments and clearly helps these hospitals drive in-patient volumes overriding geographical constraints. However, single super-specialty chains face the disadvantage of being inherently ill-equipped to tackle case complexities which require several types of surgeons. Additionally, single-specialty hospitals may not be able to optimally utilize the diagnostic infrastructure, etc which can be utilized/ shared by other therapies in a conventional multiple-specialty hospital set-up.
So, in our view, single super-specialty model may be effective only for select therapy segments like ophthalmology and oncology. Some of the hospital chains adopting this model include HCG (Healthcare Global) focused on oncology and Shankar Netralaya and Arvind Eye Hospital focused on ophthalmology.
Models focusing on secondary/ primary care in Tier II/ III cities A largely unregulated industry and skewed bed addtions biased towards the metros have resulted in 80% healthcare facilites servicing less than 30% of the country’s population. Eying the huge opportunity, private players like Vaatsalya are working on innovative models to tap the unmet healthcare needs of the majority of the population by setting up the secondary care hospitals in Tier II/ III cities. These models offer standardized secondary care with limited specialities including gynaecologists, obstretricians and dermatologists, operate on leased facilites and with limited capital investments. Given the relatively less complex nature of facilities provided, these set-ups do not require highly specilaized doctors, and thereby have a relatively large pool of doctors to tap into.
Exhibit 52: Setting up a secondary care facility costs 40-70% less than a tertiary care facility
Particulars Secondary Low cost secondary Tertiary care Care care facility in metro Floor space/bed (sq. ft) 800-900 700-800 950-1050 Building cost (US$/sq. ft) 70 45 89 Equipment cost (US$/bed) 50,000 30,000 77,778 Total Cost (US$) 109,500 63,750 162,222 Total cost per bed (Rs m) 4.9 2.9 7.3 Source: IDFC Securities Research
"Pressure due to oversupply in certain mature markets is visible with a few larger hospitals and new entrants already suffocating. We won’t be surprised to see consolidation in single doctor practice (nursing homes) in times to come and newer operational models come to fore"
-Vaatsalya
Daycare surgery centres This involves setting up of healthcare units which essentially focus on conducting procedures where the patient is discharged on the same day and does not need to be hospitalized. While the number of procedures that such a set-up can execute are
Traditional bias towards metros has exposed a huge
opportunity in tier II/ III cities
Super specialty hospitals are not equipped to tackle
case complications…
… but could be a viable model for a few segments
like oncology and ophthalmology
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IDFC Securities
relatively limited compared to a full-fledged tertiary care centre, the roster of possible procedures is significant enough to keep such centers reasonably occupied. Larger tertiary care chains like Apollo are particularly focused on setting up these centers as it enables them to free up capacity in their core tertiary care hospitals and increase the ARPOBs while retaining the patients in the network. Also, the returns are attractive as the capex required is significantly limited in such set-ups. Additionally, we believe such daycare centers will bring in more efficiency in the execution of several procedures which currently involve multiple days of hospitalization but can be conducted more efficiently.
“We expect the Indian healthcare delivery landscape to change substantially going forward, e.g., knee surgery in India takes 4-5 days unlike in the West where it is a daycare surgery."
-A leading hospital chain in Delhi/NCR region
Healthcare cities – still on the drawing board “Medicities” are one-stop shops. They offer all healthcare services, including wellness centers, preventive medicine facilities, clinical research centers, research & development centers, educational & training institutes, retail & hospitality, commercial & residential complexes, etc.
We believe a step towards setting up healthcare cities has already been taken in India, though not completely aligned to the western concept of medicities. Until recently, the government of India did not even allow private hospitals to set up medical colleges. However, with recent changes in regulation, we believe the entire concept is ready to be truly replicated in India.
Exhibit 53: Several planned health cities
Health Cities Beds Area (acres) Investment (USD m) Dr. Naresh Tehran's Medi City, Gurgaon 1,600 93 293 Fortis Medi City, Gurgaon 600-800 na 293 Fortis Medi City, Lucknow 800 52 122-195 Apollo Health City, Hyderabad 700 33 246 Nagpur Health City, Nagpur 2,000 100 na Chennai Health City, Chennai 1,000 46 245 Bengal Health City, Durgapur 50,000 800 487 Narayana Health City, Bangalore 5,000 100 488 Narayana Hrudayalaya Health City 1,000 5 22 Source: news flow, IDFC Securities Research
More importantly, the success of a health city would depend on its location and the ability of the hospital administrator to drive in-patient volumes. Due to large land requirements, health cities are often situated on the outskirts of a city and, hence, attracting patients could be a challenge.
O&M contracts We expect private healthcare service providers to increasingly use PPP models and O&M contracts. Healthcare service providers seeking entry into Tier I markets, but wanting to avoid the high real estate costs, have been veering towards these models. These models are also used by healthcare providers, seeking to widen their presence in India, to gain an initial understanding of new territories before making large investments.
Many corporates have drawn up plans to set up
medicities…
O&M and PPP models allow hospitals to gauge new
territories before infusing large funds
…with regulatory changes that allow private players
to replicate Western models in India
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Hospitals which have a presence in this segment include corporate chains like Apollo and Fortis. Recently, Fortis entered into an O&M contract with S L Rajeha Hospital in Mumbai. Apollo, Fortis, etc have typically been undertaking the management responsibility of such hospitals and overlooking several functions like marketing, operations, finance and administration. These administrators get a fixed annual management fee and enter into revenue/ EBITDA-sharing arrangements.
Exhibit 54: A typical O&M model
Source: IDFC Securities Research
JV structures Larger hospital chains looking to establish presence in Tier I cities and overcome high real estate costs have opted for the JV route by collaborating with trust hospitals. Traditionally, trust hospitals have been allocated prime tracts of lands at nominal lease rentals. However, given operating model limitations and lack of professional management, several trust hospitals have failed to keep pace with the private hospital sector in terms of technology and occupancy. Of late, some trust hospitals have formed JVs with leading corporate hospital chains like Apollo and Fortis.
Under a JV agreement, a trust hospital leases out the entire building and medical equipment to the newly-formed SPV or company. The corporate hospital chain (new administrator), which has a certain equity stake in the SPV, infuses capital and undertakes management responsibility of marketing, finance, administration, operations, etc. In return, the corporate hospital receives a share of profits.
Exhibit 55: JV structure between a corporate hospital (new administrator) and target hospital
Source: IDFC Securities Research
Corporate hospital
(like Fortis, Apollo)Target hospital
Manages mrktg. financeoperations & other functions
Fixed mgmt. fee or revenue / EBITDA sharing arrangement
SPV
Corporate / trust hospital
Corporate hospital(Operator)
Lease rental + share of profits
Lease bldg & medical equipments
Manages marketing operations, finance & other functions
Infuses cash
Medical trusts have huge land assets in tier I cities but lack expertise, a gap
corporates can efficiently fill
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Aravind Eye Hospital Aravind Eye Hospital (AEH) derives its success from scale of operation, innovation, technology, focus on operational efficiencies, cross-subsidization of costs and, most importantly, philanthropy.
Motivation: Cataract is the most common cause of preventable blindness. India has 6m cataract blind people with an estimated 2m cases being added every year. Though the condition is curable, many remain blind due to the huge demand-supply gap. Dr. Govindappa Venkataswamy started Aravind Hospital in 1976 with 11 beds to address this gap. Aravind now has more than 4000 beds.
“ If Coca-Cola can sell billons of sodas and McDonald’s can sell billions of burgers, why can’t Aravind sell millions of sight resotring operations and eventually belief in human perfection?"
– Dr Govindappa Venkataswamy
AEH’s eye care system
Source: Company
Method:
• Leveraging efficiencies: AEH has an assembly-line approach. Its surgeons perform 2000 surgeries annually, 10x the national average, made possible by efficient division of labour and innovative use of equipment.
• Equipment: Each surgeon works on two tables, one for the patient undergoing surgery and the other for the patient being prepped. AEH’s surgeons use state-of-the-art equipment like operating microscopes that can swivel between patients.
• Manpower: Trained manpower and optimization of tasks are key to Aravind’s success story. For example, each operation theatre has a team of qualified opthalmic assistants and intermediate-level specialists who prepare the patient for surgery. This takes care of ~70% of the activities in a normal operaton and the surgeon, the most scarce resource, only has to focus on the most crucial activity in the operation theatre.
• Global quality: Contrary to the perception that scale compromises quality, Aravind’s single-speciality focus has led to sharpening of surgeons’ skill sets. As a result, Aravind boasts of quality comparable to the best in the world.
Mission:To eliminate needless blindness by providing compassionate & high
quality eye care to all, rich and poor
Education & Training
Telemedicines
Community Outreach
Programmes
Aravind Medical Research
Foundation
Lions AravindInstitute of Community
Ophthalmology (LAICO)
Aurolab
Aravind Eye Hospitals
Rotary AravindInternational
Eye Bank
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Aravind Eye enjoys high success rates across treatments
Adverse events during surgery (%) Aravind, Coimbatore (N=22932) UK National survey (N-18472) Capsule rupture & vitreous loss 2 4.4 Incomplete cortical clean-up 0.75 1 Iris trauma 0.3 0.7 Persistent iris prolapse 0.01 0.07 Anterior chamber collapse 0.3 0.5 Loss of nuclear fragment into vitreous 0.2 0.3 Choroidal hemorrhage na 0.07 Loss of intra-ocular lens into vitreous 0.01 0.16 Source: Aravind Eye
Technology-driven inclusion to drive scale: AEH faces two distinct problems: 1) it needs a continuous flow of patients to feed the efficiencies and scale it has created, and 2) despite offering free treatment to two-thirds of its patients getting people to hospital has been a challenge. The hospital has been using technology and health camps in partnership with local groups to reach out to patients. It also transports needy patients seeking surgery from villages to its Madurai center.
Eye camps and technology to ensure steady demand
Lowering treatment costs: AEH mainly performs two types of cataract surgeries, ICCE and ECCE. ICCE is the more common type wherein patients are advised spectacles post diagonisis. ECCE requires replacing natural lens with intraocular lens (IOL). AEH, in its early days, found it difficult to provide free ECCE tratment even to the most needy due to the high cost of imported IOL. In 1992 AEH set up the AURO lab which manufactured quality IOL at a cost of US$5 per lens, vs US$200 for imported lens. Not only does AEH now offer free ECCE treatment but AURO now exports IOL lenses to more than 85 countries.
Free treatment for ~75% patients: Innovative strategies and benefits of scale have helped AEH develop an economically viable model. The hospital now offers 75% of its patients free treatment via cross-susbsidization of costs.
Innovation through cross-subsidization Consulting fee Poor patients Free Paying patients Rs50 (valid for 3months) Cataract Surgery with IOL Poor patients Rs0 (70% of all surgeries): Subsidized rate Rs750 53% of surgeries Regular rate Rs3500-6000 22% of surgeries Phaco surgery Rs6500-12000 25% of surgeries Source: Aravind Eye, IDFC Securities Research
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Aravind performs 59% of NHS surgeries AEH leverages its strong resource pool
0
15,000
30,000
45,000
60,000
No. of eye surgeries
NHS*-UK Aravind
59%
0.0
17.5
35.0
52.5
70.0
Ophthalmologists graduating annually
NHS*-UK Aravind
71%
Source: NHS, Aravind Eye, IDFC Securities Research
Narayana Hrudayalaya Narayana Hrudayalaya (NH) started in 2000 with the sole motive of providing affordable and quality tertiary care to people irrespective of financial status. It built a formidable brand equity by process innovation and best-in-class treatment at affordable rates helped by cross-subsidization and high capacity utilization.
“Japanese companies reinvented the process of making cars. That's what we're doing in healthcare. What healthcare needs is process innovation, not product innovation”.
- Dr. Devi Shetty, chairman, Narayana Hrudayalaya
Reducing costs and driving scale: Most tertiary care providers are in wont to buy costly medical equipment. NH leases them at a monthly rental, which saves it huge upfront capital investment. It also has an arrangement to source reagents from the lessor on a continious basis, which makes the proposition attractive for both parties. The management has indicated that bulk purchases have helped it get 30-35% discount on consumables, which account for the largest cost component for a hospital (upto 35% of sales).
NH has also continously replaced costly imported medical equipment with indigineous technology. It sources part of its medical equipment from domestic players (eg, Centennial Equipment) which offer best-in-class quality at nearly half the price offered by MNCs like GE or Siemens.
Best-in-class treatment: NH has an uncompromising view on best-in-class treatment. It sources high-end imported technology from MNCs if substitutes of similar quality are unavailable domestically. This has helpd NH retain even its elite customer base.
Creating scale: The benefits of efficient capacity utilization makes NH’s operating model financially viable. Surgeons at NH peform an average 19 open heart surgeries and 25 catherization procedures a day, 8x the national average. Employee costs are ~22% of sales, compared with 30-35% for comparable private sector hospitals. NH says its surgeons are paid on par with market rates, but employee costs (as a percentage of sales) look lower due to surgeons operating longer hours. Surgeons at NH perform an average 200 surgeries an year, nearly twice that of surgeons in the US.
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Price comparisons for coronary bypass surgery
0 10,500 21,000 31,500 42,000 ($)
US Medicare
Indian private hospitals
Narayana Hrudayalaya
20,000 to 42,000
5,000
2,000
Source: WSJ, IDFC Securites Research
NH clearly leveraging benefits of scale
Particulars Cleveland Clinic Mass General Hospital NH No. of CABG surgeries a year 1151 1000 3570 Average surgeries a day 3 3 10 Number of cardiac surgeons 11 9 18 Average surgeries per surgeon 105 111 198 Source: HBS Case Study, IDFC Securities Research
Inclusivenss through technology, insurance and parterships
NH has smartly leveraged technology, embraced local partnerships and initiated micro-insurance schemes to reach the rural and needy populace. It operates one of the largest telemedicine networks in the world in partnership with ISRO. To enhance its rural reach, NH initially launched nine cardiac care units (CCUs) which were connected to it via teledensity networks. Given the success of teledensity-CCUs, the Karnataka government sponsored 29 CCUs for Narayana. In partnership with the Karnataka government, NH launched a micro-finance scheme, Yeshasvini, to deepen its reach. The scheme provides each member (or cardholder) access to free treatment at 150 hospitals spread across 29 districts at just Rs5 a month.
The way forward: Providing affordable treatment through higher capacity utilization of assets has been behind NH’s success. Dr. Shetty says there is a limit to reducing costs and leveraging benefits of scale for a particular speciality. NH has now forayed into other specialities like neurosurgery, orthopaedics, bone marrow transplants, etc. And it has sucessfuly reduced costs and provided affordable health care in each of these tertiary care segments too. Dr. Shetty also plans to set up a ‘health city’ to provide tertiary care at affordable prices.
Vaatsalya Hospital Vaatsalya Hospitals aims to address the healthcare needs of millions by adopting a no-frills operational model with a focus on standardization of procedures and lower capital costs. Ironically, 80% of India’s healthcare facilities are located in urban areas or metros while ~70% of the Indian population lives in semi-urban and rural areas. Vaatsalya is India's first hospital network focused on Tier II and III towns providing primary and secondary care services with an emphasis on disease prevention.
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Vaatsalya’s footprints across tier II cities
Source: Company
Afforable treatment in spite of lower scale: Vaatsalya’s focus is to provide primary and secondary care treatment to the masses. However, Vaatsalya does not have the advantage of scale that Aravind or Narayana do. So how does Vaatsalya provide affordable treatment and retain doctors in rural/ sem-urban areas?
• Standardization of operations: Vaatsalya has classified operations into four segments – gynaecology, pediatrics, general medicine and general surgery. Standardization of operations has helped Vaatsalya’s centralized procurement team to achieve significant cost savings.
• Restricting investments: Vaatsalya has opted for a no-frills model with standardized 50-bed hospitals, each equipped with a pharmacy, diagonistic lab and ICU. To control upfront investments, Vaatsalya leases hospital facilities, substantially lowering payback periods. Also, it has restricted medical equipment purchases to essentials like ultrasound machines, ventilators, x-ray machines, etc.
• Empowering doctors: Vaatsalya’s biggest challenge, in our view, is to retain doctors. Vaatsalya pays its doctors up to 20-25% higher than what they would have got in larger cities. Vaatsalya also offers doctors higher responsibilities and autonomy, a key variable which has helped it retain doctors.
The way forward: We believe steady expansion would make Vaatsalya’s operating model more economically viable as it would be able to leverage the benefits of scale while sourcing consumables and medical equipment. Having said so, the key risk lies in retaining star doctors and enhancing mass outreach.
Healthcare Global (HCG) HealthCare Global Enterprises Ltd, headquartered in Bangalore, is South Asia's largest cancer care network. HCG has more than 600 beds across 18 centers. HCG has diversified into CRO to enhance its oncology offerings.
Motivation: HCG’s vision is to transform cancer care by bringing core clinical services to one place and offering comprehensive care.
Model: HCG operates on a hub & spoke model with super specialty hospitals supported by daycare centers. HCG has JVs with local partners to set up and run spokes with the JV partners bearing the land, building and equipment costs. HCG has been able to expand geographically using this model. It has eight spokes supporting three hubs in Bangalore, Ahmedabad and Delhi.
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ADVANTAGE INCUMBENTS We are positive on the near- and medium-term outlook for Indian healthcare
sector and believe that private sector hospitals are the best proxy to play the opportunity
Corporate hospital space in India is still nascent as most players have entered only recently. However, entry barriers (land, people, etc) are clearly going up, making it increasingly difficult for new entrants
This state of affairs is positive for the larger incumbents that have already created formidable footprints and have the critical mass to grow
We are positive on two of the leading incumbents, Apollo (top pick in the space) and Fortis as they have acquired a strong national brand equity and have difficult-to-replicate geographical footprint and capacity
The fact that two of the largest and most relevant healthcare stocks in the country have a combined market capitalization of <$5bn underlines the inherent growth potential in these companies
Competitive landscape still evolving
The corporate hospitals industry in India is relatively nascent as most of the corporate groups, barring Apollo, having entered the business in the last few years, are still in relatively early phases of growth. Currently, there are three major listed players in the space:
• Apollo Hospital Group
• Fortis
• Max Healthcare (a subsidiary of Max India – a listed entity)
While all the players – Apollo, Fortis and Max – have a hub-and-spoke model based around tertiary hospitals, we notice variations in their strategy.
• Apollo is the largest and the oldest corporate hospital player in India with ~8000 operational beds after two decades of inception. Apollo has chosen a strategy of establishing multi-specialty tertiary hospitals across locations and to scale-up gradually.
• Fortis commenced operations in 2000 with a hospital in Mohali, Punjab. Fortis has acquired an almost national footprint in a short period of time, primarily through aggressive inorganic growth with a series of acquisitions including Wockhardt Hospitals, Escorts Delhi, Malar hospital, etc. While Fortis currently operates 3250 beds, it aims to operate 5000+ beds with pan-India presence by 2013.
• Max Healthcare started operations in 2000. Max Healthcare’s strategy focuses on leveraging its two single-specialty tertiary hospitals and consolidating the existing hospital network in the NCR before seeking to expand nationally. According to expansion plans, Max is likely to have 2450 hospital beds in NCR by 2016 – up from 1100 beds currently.
Indian corporate hospitals industry relatively nascent
Corporate hospital chains have adopted diverse
strategies
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Also, there are other large unlisted players like Manipal Health (strong presence in South India), Narayan Hrudayalaya (another predominantly South India based entity), and HealthCare Global (oncology focused tertiary care hospital chain).
Given that the corporate hospital industry is in an early growth phase, we believe it will take some time before the implications of their diverse strategies get crystallized and start becoming evident to investors.
Rising entry barriers…advantage incumbents
We strongly believe that running private sector hospitals in India is difficult given the myriad challenges involving land procurement, staff recruitment as well as an evolving regulatory scenario. Given that existing players have already firmly entrenched themselves in most of the high potential pockets and shooting land/ people costs, it is increasingly tougher for new entrants. Further, the incumbents are poised to grow from strength to strength as their operations start increasingly self-sustaining in this capital hungry business.
Private sector hospitals – An increasingly tougher business The private sector hospitals business is arguably quite a challenge to run in India. Such projects entail fairly complicated project management issues (in terms of obtaining the right land parcels at right prices, doing an efficient job of executing the hospital construction and then ensuring that the right mix of doctors comes on board) and complex people management issues (growing shortage of trained medical personnel) on an ongoing basis. Shooting real estate prices, especially in metros, and increasing shortages in recruiting both highly qualified super specialists (required for running high-end tertiary hospitals) as well as the lower skilled para medics add to the challenge. Thus, it is becoming increasingly difficult to run a commercially successful private healthcare business. These issues are further accentuated by the fact that existing players have already entrenched themselves in most of the high potential geographies across the country.
The people angle adds to the complexities While these challenges sound similar to the ones in the hospitality business, we believe the situation is more complicated by the big role played by doctors in the healthcare business. It is relatively easy to institutionalize the hospitality business and thereby decrease the reliance on individuals, but the same is not possible in healthcare, as processes cannot effectively substitute personal credibility and stature of individual doctors.
In our view, the fact that most of the larger Indian corporates have chosen to stay away from healthcare, despite the inherent potential in this business, is yet another indicator of the challenges/ entry barriers in this business. We expect these entry barriers to only increase going forward – making it incrementally difficult for new entrants to build up a successful healthcare business, particularly in tertiary care.
Advantage Incumbents In our view, this state of affairs essentially means significant advantages for established incumbent players like Apollo, Fortis, Manipal, etc. These players have
Newer players face high entry barriers and
formidable competition from well-financed incumbents
Processes cannot effectively substitute
personal credibility and stature of individual doctors
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had the early mover advantage to accumulate sizeable hospital assets on land acquired at historical prices and create solid brand equity which enables them to acquire talent from India as well as abroad. These existing players have built up significant franchise in the key metros, the key markets for high-end tertiary care, which makes it relatively difficult for new players to make inroads in these markets. Additionally, their operations are now reaching a stage where internal cash flows can take care of further expansions to a large extent.
Apollo and Fortis: Leaders today…and of future
We believe it is difficult, if not impossible, for a new entrant to break into the top league. In our view, there are innumerable hurdles to scalability and economic viability in the hospitals business. Even among the incumbents, we believe two of the largest players in the industry today – i.e. Apollo Hospitals and Fortis Healthcare with ~10000 and ~5000 beds respectively under operation by 2013 – are significantly ahead of the pack. These companies offer scale (in terms of their bed capacities) and a pan-India footprint that they have built up over the years. While Apollo has gradually built up its network over the last few decades through the organic route, Fortis has leapfrogged in the last few years on the back of its aggressive inorganic growth strategy.
For a new entrant, replicating the achievements (scale and scope) of Apollo and Fortis looks increasingly difficult. There are limitations to the pace of scale-up achievable through the organic route given the challenges involved in operationalizing a Greenfield hospital. Also, we see limited inorganic growth opportunities (of relevant size) on the horizon unless one of the larger players intends to sell out.
We believe Apollo and Fortis will continue to dominate the Indian private healthcare landscape for the next several years followed by players like Manipal and Max.
Initiating coverage on Apollo and Fortis with Outperformer We are positive on the near- and medium-term outlook for the Indian healthcare sector. We believe that private sector hospitals are the best proxy to play the healthcare opportunity in India which is poised to grow by leaps and bounds over the next several years and decades.
In the private sector hospitals space, we are particularly bullish on two of the leading incumbents – Apollo Hospitals and Fortis Healthcare – as they are well-entrenched in the industry with strong national brand equity as well as a difficult to replicate geographical footprint and capacity. Given that these two are the only relevant listed entities in the Indian healthcare space and the ones that are likely to dominate the market (with a secular growth story) for the next several years, we believe these stocks deserve to command a significant premium with respect to the broader market.
Interestingly, while the healthcare market in India is poised to double to US$125bn by 2015, the two largest and most relevant healthcare stocks in the country have a combined market capitalization of <$5bn. This clearly underlines the inherent growth potential in these companies.
The large players have built unassailable positions, both
in terms of beds and geographical spread…
Organic growth faces operational challenges while
inorganic opportunities of relevant size are limited…
…justifying our valuation premiums for
Apollo and Fortis
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APPENDIX
Annexure 1: Regulatory landscape
Extract from Clinical Establishment Act, 2010 1) For registration and continuation, every clinical establishment shall fulfill the following conditions, namely:
(i) the minimum standards of facilities and services as may be prescribed; (ii) the minimum requirement of personnel as may be prescribed; (iii) provisions for maintenance of records and reporting as may be prescribed; (iv) such other conditions as may be prescribed.
2) The clinical establishment shall undertake to provide within the staff and facilities available, such medical examination and treatment as may be required to stabilize the emergency medical condition of any individual who comes or is brought to such clinical establishment.
Source: Loksabha documents
Doctors protest against Clinical Establishment Bill; Patiala, 15 July
…Doctors were opposing the Clinical Establishment Bill. They demanded the restoration of the Medical Council of India (MCI) without any delay. According to the IMA leaders, the implementation of the Bill on private clinics will cost a huge monetary burden to them, which will ultimately pass on to the patients making the health services beyond the reach of a common man….
Malerkotla, July 15
Members of the local unit of Indian Medical Association (IMA) today closed their clinics to protest implementation of the Clinical Establishment Bill. General Secretary of the association said, “The government should have asked the medical fraternity before introducing the Bill, as there were apprehensions that it will only cater to the needs of the people, but it should meet the needs and concerns of both, the doctors and the patients.”
The members said the expenses for meeting the provisions of the bill would significantly increase treatment fees.
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Annexure 2: Key takeaways from FY09-10 budget
We believe the government needs to focus on; 1) encouraging public-private partnership for the creation/ upgradation of health infrastructure, 2) capacity building in manpower, 3) health insurance penetration, and d) setting minimum quality standards for healthcare delivery and implementation/ enforcement of regulations.
Key positive steps We list some key positive steps taken by the government:
• The government has increased the weighted average deduction for scientific research. According to industry estimates, India’s medical device exports grew at 18% CAGR over FY00-07. We see higher deduction for research as a step that could significantly boost domestic R&D.
• The government has extended the exemption under Section 80D from contributions to health insurance schemes to contributions under the Central Government Health Scheme (CGHS). This will likely to increase the disposable income of families covered by CGHS.
• The finance ministry rationalized import duty at 5% for all items from only 37 items earlier. This should help the industry reduce import costs, helping reduce the cost of healthcare delivery. Exemption of service tax for healthcare services to individual patients will also help contain the cost of medical check-ups.
• The finance minister’s Budget speech cites a plan to conduct an annual health survey and prepare district-wise health profiles of the rural populace. We believe using the compiled data efficiently for budgetary allocation would be a step in the right direction.
A negative surprise Even as budgetary allocation for healthcare saw a 22% yoy increase for 2010-11 to Rs223bn, the government reduced allocation for premier institutions like AIIMS, PGIMER, Dr Ram Manohar Lohia Hospital and Safdarjung Hospital by 5-11% yoy. We believe this is worth monitoring going forward.
Healthcare budget allocation – a snapshot
Source: Union Budget documents
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Annexure 3: NABH-accredited hospitals
Source: NABH
G. Kuppuswamy Naidu Memorial Hospital, Coimbatore
Kailash Hospital & Heart Institute, Noida, U.P.
Chacha Nehru Bal Chikitsalaya, New Delhi
Dharamshila Hospital & Research Centre, Delhi
Sevenhills Hospitals Ltd., Visakhapatnam
Advanced Medicare And Research Institute (AMRI), Kolkata
Medwin Hospitals, Hyderabad
Fortis Hospital, Mohali
Kasturba Hospital, Manipal
Fortis Flt. Lt. Rajan Dhall Hospital, New Delhi
Godrej Memorial Hospital, Mumbai
N.M. Virani Wockhardt Hospital, Rajkot, Gujarat
P.D. Hinduja National Hospital & Research Centre, Mumbai
Wockhardt Hospitals Ltd, Nagpur, Maharashtra
Paras Hospitals Pvt Ltd., Gurgaon, Haryana
Apollo Speciality Hospitals, Madurai
Amrita Institute Of Medical Sciences, Kochi
Sterling Hospitals, Ahmedabad, Gujarat
G. Kuppuswamy Naidu Memorial Hospital, Coimbatore
Kailash Hospital & Heart Institute, Noida, U.P.
Chacha Nehru Bal Chikitsalaya, New Delhi
Dharamshila Hospital & Research Centre, Delhi
Sevenhills Hospitals Ltd., Visakhapatnam
Advanced Medicare And Research Institute (AMRI), Kolkata
Medwin Hospitals, Hyderabad
Fortis Hospital, Mohali
Shalby Hospitals, Ahmedabad, GujaratDr. L. H. Hiranandani Hospital, Mumbai
Apollo Speciality Hospital, Chennai, Tamil NaduNarayana Hrudayalaya, Bangalore
Sparsh Hospital for Accidents, Orthopaedic, Plastic & Maxillo Facial Surgery, Bangalore, KarnatakaMoolchand Hospital, New Delhi
Artemis Health Institute, Gurgaon, HaryanaMax Super Speciality Hospital, New Delhi
Sterling Hospitals, Vadodara, GujaratKerala Institute of Medical Science, Thiruvananthapuram
Ruby Hall Clinic, Pune, MaharashtraMIMS Hospital (MIMS Ltd.), Calicut
Escorts Hospital and Research Centre Ltd., Faridabad, HaryanaB.M. Birla Heart Research Centre, Kolkata
General Hospital, Gandhinagar, GujaratNABH accredited Hospitals
B.L. Kapur Memorial Hospital, New DelhiFortis Escorts Hospital, Jaipur
Frontier Lifeline Hospital, Chennai, Tamil NaduSir Ganga Ram Hospital, New Delhi
PSG Hospitals, Coimbatore, Tamil NaduEscorts Heart Institute And Research Centre, New Delhi
Batra Hospital & Medical Research Centre, New DelhiBaby Memorial Hospital, Calicut
Holy Spirit Hospital, Mumbai, MaharashtraLakeshore Hospital & Research Centre Ltd., Kochi
K.G. Hospital, Coimbatore, Tamil Nadu Nethradhama Superspeciality Eye Hospital, Bangalore
Rockland Hospital, New DelhiManipal Hospital, Bangalore
Wockhardt Hospitals Ltd , NashikColumbia Asia Medical Centre – Hebbal, Bangalore
Shalby Hospitals, Ahmedabad, GujaratDr. L. H. Hiranandani Hospital, Mumbai
Apollo Speciality Hospital, Chennai, Tamil NaduNarayana Hrudayalaya, Bangalore
Sparsh Hospital for Accidents, Orthopaedic, Plastic & Maxillo Facial Surgery, Bangalore, KarnatakaMoolchand Hospital, New Delhi
Artemis Health Institute, Gurgaon, HaryanaMax Super Speciality Hospital, New Delhi
Sterling Hospitals, Vadodara, GujaratKerala Institute of Medical Science, Thiruvananthapuram
Ruby Hall Clinic, Pune, MaharashtraMIMS Hospital (MIMS Ltd.), Calicut
Escorts Hospital and Research Centre Ltd., Faridabad, HaryanaB.M. Birla Heart Research Centre, Kolkata
General Hospital, Gandhinagar, GujaratNABH accredited Hospitals
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Annexure 4: Comparaitve healthcare spend – India and global
Source: WHO -2007, Reserve Bank of India, IDFC Securities Research
Annexure 5: Corporate hospitals – strategies to target primary markets
The business models of the larger hospital chains in India have steadily evolved from tertiary care to serving the entire healthcare delivery network. They are clearly positioned to grab a larger pie of the market opportunity by diversifying revenue streams to de-risk the business while pursuing an asset-light strategy.
New strategies We list some measures adopted by incumbents to enhance their presence in the healthcare delivery chain. Private players seeking to maximize returns on capital employed have turned to asset-light strategies – hospital management (O&M contracts) and consultancy services. Meanwhile, larger players have set up captive diagnostic labs and pharmacy centers to tap high margins in diagnostics, radiology and pharmacy.
Incumbents stepping up presence across the healthcare delivery chain
Source: IDFC Securities Research
Composition of World health expenditure
Private Insurance, 18%
Others, 4%
Social Insurance, 25%General Govt. Expd., 35%
Out of pocket spend, 18%
Composition of Healthcare spend in India
Households, 69%
Public firms, 2%
Private firms, 3%
External funds, 2%
Banks, 0%
NGOs, 0%
Central Govt., 7%
State Govt., 14% Local Govt., 2%
Hospital management
Healthcare insurance
Consultancy
Pharmacies
Secondary care
Tertiary care
Primary care
Diagnostic labs
Diversified offering
Hospital management
Healthcare insurance
Consultancy
Pharmacies
Secondary care
Tertiary care
Primary care
Diagnostic labs
Diversified offering
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Next-door clinics: 50% of healthcare expenditure occurs outside hospitals. Therefore, larger hospital chains have begun targeting primary healthcare markets by setting up ’next-door clinics‘. Apollo, for instance, has adopted a franchising model and has set up a chain of Apollo Clinics all over the country. We believe the motive goes beyond enhancing its reach to the urban masses – it is also looking to enhance the feeder network for its secondary care hospitals (in tier II cities) and specialty hospitals (in metro cities).
The Apollo Clinic: The ‘next door’ franchise partner bears all the investment-related costs of setting up the clinic and makes a one-time franchisee payment to Apollo (for a specified tenure). In exchange for this fee and a 5% royalty on sales, Apollo offers comprehensive support services like selection and training of all medical and support staff including physicians, procurement of necessary medical equipment and IT systems and also designing of the clinic. Apollo advises on setting the prices for medical services offered at the clinic and helps evolve marketing strategy.
Apollo clinic – reception, consulting room and lab
Source: The Apollo Clinic
Diagnostic labs: India boasts of ~45,000 diagnostic laboratories, which conduct over 2m tests daily. However, this industry is highly fragmented and we see a huge opportunity for organized private providers. As per industry estimates, pathology tests account for up to 5-6% of hospital revenues and enjoy attractive margins. Larger hospital chains and also several standalone players have already entered this space by offering captive services and setting up standalone pathology labs and radiology centers. We highlight a couple of models: The Apollo Clinic, part of Apollo Health and Lifestyle Limited, an initiative of Apollo Hospitals, offers several diagnostic services including clinical pathology, radiology, imaging and cardiology. A few Apollo clinics are also equipped with facilities like CT scan, MRI and endoscopy. Apollo operates these clinics on a franchisee model.
Super Religare Laboratories Limited (formerly SRL Ranbaxy Ltd.) claims to be the largest pathology laboratory network in India covering nearly 4,000 hospitals and more than 50,000 doctors. SRL has said that owning these laboratories has helped it ensure uniformity in standards and practices.
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SRL’s pathology network – steady expansion
Source: SRL
SRL operates a hub & spoke model – its clinical reference lab and 50 satellite labs are supported by more than 1000 collection centers spread across 450 cities in India and abroad. Recently, SRL acquired Piramal Healthcare’s 107 diagnostic lab network for a consideration of Rs6bn valuing the transaction at 2.9x EV/sales and 15.8x EV/EBITDA.
Pharmacy chains: India’s retail pharmacy sales for CY07 were estimated at Rs488bn, with organized retail garnering 3.2% of total sales. The highly fragmented nature of the industry has thrown up an attractive opportunity for retailers. According to industry estimates, pharmacy chains enjoy gross margins (ex-corporate costs) as high as 30%+ at standalone levels. Large hospitals chains like Apollo and Fortis have opted for different models to grab a pie of this attractive opportunity. Besides Apollo and Fortis, several pharmacy chains like Aushadhi, CRS Health, Dial for Health, Dr. Morepen, Global Healthline, Guardian Pharmacy, Health and Glow, Lifeken, Medicine Shoppe, 98.4o, etc. have also come up. In a market flooded with spurious drugs, we believe organized pharmacy chains with strong repute would emerge winners.
Indian pharmacy market growing rapidly
(Rs bn)
320
365
410
455
500
2006
2.6
422
488
3.2
2007
2.0
2.4
2.7
3.1
3.4
Indian retail pharmaceutical market (LHS) Organized retail as % of total retail market (RHS)
Source: Industry, IDFC Securities Research
Several organized players have been providing value-added services like weight measurement, blood pressure, diabetes, etc. to consumers to enhance margins and lower payback periods. Apollo pharmacies, for instance, offer several value-added services (see exhibit below) to retain its customer base. Apollo intends to maintain a desired sales mix between Rx drugs and consumer products to enhance its margin profile.
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Value added services provided by Apollo pharmacies
Consulting operations The evolving healthcare landscape has led to a huge demand for healthcare consultants, both in India and globally. Domestic hospital chains with vast experience in building and maintaining facilities have set up consultancy divisions to tap this opportunity. Apollo, for instance, has a consultancy arm that undertakes projects primarily classified as ‘transition management’ and ‘operations management’. Transition management involves helping clients design and build facilities. Under operations management, the consultancy division runs facilities, often also recruiting and training staff. We expect several reputed hospitals to enter this segment, as it is an effective alternate revenue stream.
Hospital consultancies in India – the key players Hosmac, Mumbai H-PAMCO, New Delhi MedicontriversIndia PvtLtd Mumbai KSA Technopak, New Delhi Ace Vision Health Consultant PvtLtd, Jaipur NOUS Hospital Consultancy (P) Ltd, New Delhi Professional Health Planners, New Delhi Apollo Hospital Enterprise Ltd, Chennai Hospic, Mumbai Total Hospital Solutions, Jaipur Source: IBEF, IDFC Securities Research
International hospital management Private healthcare service providers with limited capital to invest and seeking to widen their geographic presence have entered into hospital management contracts. This has allowed hospitals to leverage successfully their operational expertise while remaining asset light. This model would also help private healthcare providers understand new markets. Apollo and Fortis, for instance, manage several hospitals across Asia and the Middle East.
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Companies
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Apollo Healthcare (Apollo) is Asia’s largest healthcare group with 8,000+ operational beds and 1,000+ retail pharmacies. With 47 owned hospitals and focus on clinical outcomes, Apollo is a formidable brand in the Indian healthcare space. However, its cautious approach has prevented Apollo from effectively leveraging its first mover advantage beyond Southern India till now. Bolstered by growing internal accruals (EBITDA of Rs5.9bn in FY13E) and increasing ability to raise resources, Apollo’s traditionally conservative management is now looking to step up pace through planned expansions beyond South India as well as newer delivery formats like Apollo Reach for entry in Tier II/ III markets. This, we believe, will drive accelerated growth for Apollo (19% CAGR in revenues as well as earnings) over FY10-13. Value unlocking in non-hospital businesses may provide further upside triggers. Initiating coverage with Outperformer and an 18-month SOTP-based price target of Rs651.
Leader of today and tomorrow: Apollo seeks to extend its leadership position in Indian healthcare market by adding ~1,000 beds a year over the next three years, taking its total bed count to over 10,000 by 2013. While further fortifying its presence in its traditional Chennai/ Hyderabad clusters, Apollo now seeks to make inroads in western India as well as enter Tier II / III towns through Apollo Reach format. With mature beds ARPOB growing 2% sequentially, we expect 19% revenue CAGR for Apollo over FY10-13.
Margins to expand: Despite steady new bed additions (which depresses profitability in initial years), we expect margins to expand by 227bp over FY10-13 as Apollo drives a consistent improvement in operating metrics for existing beds. Over FY06-10, Apollo’s ARPOB grew at CAGR of 10%+ as it worked on increasing occupancies and optimizing case mix across its network.
Good getting better; Outperformer: Its cautious approach to growth and a defined Southern Indian tilt notwithstanding, Apollo remains the most formidable healthcare play in the Indian market. With clear signs of management’s intent to step up investments/ growth, Apollo is set to enhance its dominance. With return ratios set to improve (400bp gain over FY10-13) as proportion of mature beds keeps growing, along with value unlocking in non-core businesses including Apollo Pharmacy, we see a strong case for re-rating of the stock. Apollo is our top pick in the space.
Key valuation metrics Year to 31 Mar FY09 FY10 FY11E FY12E FY13ENet sales (Rs m) 16,142 20,264 25,357 28,831 34,408Adj. net profit (Rs m) 1,065 1,377 1,868 2,068 2,724Shares in issue (m) 120 124 124 124 124Adj. EPS (Rs) 8.8 11.1 15.1 16.7 22.0 % growth 34.5 26.0 35.7 10.7 31.7 PER (x) 57.6 45.7 33.7 30.4 23.1 Price/Book (x) 4.1 3.8 3.5 3.2 2.9 EV/EBITDA (x) 29.8 23.0 17.0 15.3 12.5 RoE (%) 7.5 8.7 10.7 11.0 13.2 RoCE (%) 7.3 8.5 11.0 11.1 12.6
INVESTMENT ARGUMENT AHEL is Asia’s largest healthcare group with 8,000+ tertiary/ quaternary care
beds and 1,000+ pharmacy stores across India; plans to add ~2,700 beds by FY14
Apollo brand epitomizes superior quality and clinical outcomes in healthcare; management’s philosophy is to pursue clinical excellence
Generates decent return ratios despite the traditional approach of growing organically and owning assets even while using cutting-edge technology – evidence of a calibrated growth strategy and operational skills
We value Apollo’s healthcare business at 15x two-year forward earnings and pharmacy at 1x EV/sales to build in the growth premium as well as quality and scale of Apollo’s assets
No. 1 end-to-end healthcare service provider in Asia
Apollo is Asia’s largest healthcare group in terms of number of beds. From humble beginnings as a 150-bed hospital in Chennai in 1984, AHEL today has over 8,000 beds in 47 hospitals across India and services that span the healthcare delivery chain. Most of this growth has been largely organic and business has been practically built hospital by hospital, bed by bed. Promoted by Dr Parthap Reddy, one of most well-known doctors in India, Apollo has pioneered the concept of delivering high-end private healthcare in India. Over the years, the Apollo brand has become synonymous with tertiary healthcare which is reflective of the group’s success.
Exhibit 1: Apollo – organically increasing capacities
Source: Company, IDFC Securities Research
Today, Apollo services the entire healthcare delivery chain from primary care to tertiary/ quaternary care. Apollo reaches masses via a chain of Apollo Clinics. Additionally, hospitals under Apollo Reach initiative and multi-speciality/ super-speciality hospitals offer secondary and tertiary/ quaternary care.
Started with 150 beds 1983-88 1989-00 2000-04 2005-10
Apollo Chennai
Apollo Hyderabad
Apollo Vizag
Apollo Indraprastha
Apollo Madurai
Apollo Aragonda
Apollo Speciality
Apollo Ahmedabad
Apollo Samudra
Apollo First Med
Apollo Mysore
Apollo Kolkata
Apollo Bilaspur
Apollo Colombo
Apollo Bhubaneshwar
Apollo Lavasa
Apollo Children’s Hospital
Apollo Mauritius
Apollo Karur
Apollo KakinadaApollo Karim Nagar
Apollo Bangalore
Apollo Ludhiana
Apollo Dhaka
Started with 150 beds 1983-88 1989-00 2000-04 2005-10
Apollo Chennai
Apollo Hyderabad
Apollo Vizag
Apollo Indraprastha
Apollo Madurai
Apollo Aragonda
Apollo Speciality
Apollo Ahmedabad
Apollo Samudra
Apollo First Med
Apollo Mysore
Apollo Kolkata
Apollo Bilaspur
Apollo Colombo
Apollo Bhubaneshwar
Apollo Lavasa
Apollo Children’s Hospital
Apollo Mauritius
Apollo Karur
Apollo KakinadaApollo Karim Nagar
Apollo Bangalore
Apollo Ludhiana
Apollo Dhaka
Apollo pioneered high-end private healthcare in India
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Exhibit 2: Apollo offers services from primary to quaternary care
Source: IDFC Securities Research
Besides owning and operating tertiary and secondary hospitals (Apollo Reach Initiative), the group has established its footprint in several segments like primary healthcare services (Apollo Clinics), retail pharmacies (Apollo Pharmacy), medical BPO services (Apollo Health Street), health insurance & TPA (Apollo Munich RE), project consultancy and clinical research divisions working at the cutting edge of medical science.
Exhibit 3: Apollo – presence across the entire healthcare delivery chain
Source: IDFC Securities Research
Over a period of three decades, Apollo has created strong brand equity and is synonymous with quality healthcare and clinical outcomes. Apollo is a partner of choice of several domestic/ international companies as well as countries looking to set up or maintain high-end tertiary healthcare facilities (Parkway Hospitals, Yash Birla Group, etc). Importantly, Apollo is at the forefront of India’s growing stature on the global healthcare map backed by the management’s philosophy of pursuing clinical excellence. Apollo has been able to achieve world-class success rates (e.g., >49,000 cardiac surgeries with a 98.5% success rate) in complex tertiary/ quaternary care.
Apollo
Health Insurance and TPA
Owned & Managed Hospitals
Standalone Pharmacies
Global Projects Consultancy
Primary Care Clinics
Health Education & e-Learning
Clinical Research & Site Management
Technology Services & Solutions
Apollo
Health Insurance and TPA
Owned & Managed Hospitals
Standalone Pharmacies
Global Projects Consultancy
Primary Care Clinics
Health Education & e-Learning
Clinical Research & Site Management
Technology Services & Solutions
Primary Secondary Tertiary
Apollo ClinicsApollo reach
Hospital
Apollo MS / SS Hospitals
Apollo’s diversified offering
Primary Secondary Tertiary
Apollo ClinicsApollo reach
Hospital
Apollo MS / SS Hospitals
Apollo’s diversified offering
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Uncompromising focus on clinical outcomes and quality Over the years, Apollo’s strategy has been to expand organically with sharp focus on clinical outcomes. Brand Apollo is synonymous with quality healthcare delivery and clinical excellence. Apollo’s quality consciousness and patient-centric approach have resulted in steady improvement in operational and clinical efficiency over the years, benchmarking it with the best globally. That Apollo owns seven JCI-accredited hospitals across specialties is also clear evidence of its focus on clinical processes and outcomes.
Exhibit 4: Apollo owns 50% of JCI accredited hospitals in India
Source: Company, IDFC Securities Research
Focus on core specialties: Via its multi-specialty and super-specialty hospitals, Apollo continues to focus on CONCORT, i.e. Cardiology, Oncology, Neurology, Critical care & Trauma, Orthopedics, Radiology and Transplants. Cardiology, Oncology and Orthopedics together contribute 70-75% of Apollo’s revenues. In addition to CONCORT, Apollo has set up Apollo Children’s Hospital in Chennai – specifically offering pediatric care for children from birth to adolescence. Even as Apollo begins to venture into secondary care (via Apollo Reach), the management seeks to retain its focus on core treatment offerings – CONCORT + pediatrics.
Exhibit 5: Apollo derives 65% of revenues from Cardio, Ortho and Onco therapies
Cardiology30%
Orthopaedics20%
Oncology15%
Others35%
Source: Company, IDFC Securities research
Measurable approach to achieve clinical excellence: The group has implemented ACE@25, a balanced scorecard that analyzes patient experience in terms of care quality and environment safety. This approach has also helped the group strengthen functional efficiency and benchmark it against international standards. Importantly, all hospital heads under the Apollo network are accountable to the outcomes at the end of each month. Apollo also runs a pilot project “Apollo Way” with international consulting firms like McKinsey to ensure operational excellence (revenue management, lean operations, etc) and quality healthcare delivery.
Chennai Banaglore Hyderabad Delhi
Ludhiana DhakaKolkata
Operational and clinical efficiency benchmarks
Apollo with the best hospitals globally
Multi- and super-specialty hospitals continue to bring 75% revenues even as the
group ventures into secondary care
Initiatives like ACE@25 and Apollo Way measure
outcomes to ensure strict clinical standards are
maintained
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Exhibit 6: Roster representing Apollo’s focus on clinical outcomes
Source: Company
A new, more aggressive, Apollo emerging…
Hitherto, strongly focussed on Southern India About 85% of Apollo’s 3,330 owned beds are in the three southern states of Tamil Nadu, Andhra Pradesh and Karnataka. The Chennai and Hyderabad clusters (1,970 beds) account for 60% of Apollo’s total owned beds and 82% of its standalone revenues as of FY10. Apollo has adopted the hub & spoke model, under which its network of multi-specialty hospitals and day care centers (spokes) support its super-specialty hospitals (hubs), most of which are located in the larger metro cities in South India. Apollo has a strongly entrenched network in this part of the country and the regional focus has enabled Apollo to significantly enhance its profitability over the years as it has been able to garner the full benefit of the hub & spoke model.
• Apollo Hospitals, Ahmedabad, completed successful 20 stem cell transplants; also conducted the first successful "Autologous Stem Cell Transplant for Acute Leukemia" in Gujarat.
• Instituted a contemporary Neuro Rehabilitation Programme at the main hospital in Chennai, the first of its kind in India; to introduce robotics in neurorehab for the first time in India in association with Hocoma.
• Revolutionary Ceramic Coated Knee Replacement was performed for the first time in South India at Apollo Specialty Hospital, Chennai.
• Apollo Centre for Liver Disease and Transplantation completed 50 liver transplants, a key milestone for Chennai.
Jan-Mar10
• Apollo Bramwell Hospital in Mauritius, a JV with BAI, clocked numerous firsts within its first 100 days of operations, conducting innovative surgeries in urology, general surgery and orthopaedics.
• Apollo Group completed a record 268 organ transplants in the nine months ending Dec 2009.
• Apollo Knee Clinic’ was launched in all the major Apollo hospitals
Oct-Dec09
• Apollo Hospitals, Chennai, completed 10,000 coronary bypass operations using the beating heart technique.
• The Chennai orthopaedic team successfully performed an Arthroscopic Brachial Plexus Catheterization, a first in India.
• Apollo Hospitals, Chennai, crossed the milestone of having performed the largest number of cadaver Liver Transplants in a single year.
Jul-Sep09
• Apollo Hospitals, Chennai, conducted the first heart transplant on a US citizen in India.
• Apollo BSR Hospitals, Mysore, performed its 100th renal transplant.
• The Apollo Hospitals Group finalized a roadmap for NABH accreditation for five more hospitals.
• 27 six-sigma projects completed across various locations in India.
Apr-Jun09
Regional focus has helped the hospital chain to
significantly increase profitability
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Exhibit 7: Chennai and Hyderabad clusters account for 60% of Apollo’s owned beds
Operating since Name of hospital Type* Capacity % of total owned beds Chennai cluster 1983 Apollo Hospitals, Gerams Lane SS 619 1994 Apollo Specialty Hospitals, Nandanam SS 251 2000 Apollo Hospitals, Thondiarpet MS 61 2002 First Med Hospital MS 120 2003 Apollo Hospitals, Sowcarpet MS 17 2008 Apollo Children’s Hospital 81 Total beds 1,149 35 Hyderabad cluster 1988 Apollo Hospitals, Jubilee Hills SS 405 1996 Apollo Centre, Vikrampuri MS 50 1996 Apollo Emergency, Hyderguda MS 38 2000 Apollo Medical Emergency Centre, Malakpet DC 4 2000 Apollo Medical Emergency Centre, Medhipatnam DC 4 2000 Apollo Emergency Medical Centre, Kukatpally DC 20 2001 Apollo DRDO MS 150 2010 Apollo Hospital, Secundrabad MS 150 Total beds 821 25 Source: Company, IDFC Securities Research
Exhibit 8: AHEL's other owned beds in South India
Location Name of hospital Type Capacity Tamil Nadu Madurai Apollo Hospitals SS 185 Karur Apollo Loga reach Hospital MS 70 Andhra Pradesh Vizag Apollo Heart & Kidney Hospital SS 65 Aragonda Apollo Hospitals MS 54 Kakinada Apollo Hospitals MS 150 Karim Nagar Apollo Reach Hospital MS 120 Karnataka Mysore Apollo BGS Hospitals and Medical Centre SS 176 Total beds 820 25 AHEL's owned beds in other regions Chhattisgarh Bilaspur Apollo Hospitals SS 250 Orissa Bhubaneswar Apollo Hospitals SS 290
Total beds 540 16 Total owned beds 3,330 100 Source: Company, IDFC Securities Research * SS: super specialty; MS: multi specialty
Relatively limited presence in other parts of the country Over the last few years, Apollo has started to work on increasing its geographical reach beyond the southern region. However, unlike its strategy in southern India where it owns most of its hospitals, most of the hospitals (total 12 hospitals currently) in northern, western and eastern regions are run either on a contractual basis (O&M contracts) or as part of JV structures with partners. For example, to establish its
JVs and O&M contracts characterize Apollo’s low-
risk approach in regions outside South India
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presence in the East, Apollo set up Apollo Gleneagles, a JV with Parkway Hospitals, in Kolkata in 2002. Its foray into western India was marked by a 50:50 JV with Cadila Pharma to set up a 300-bed super-specialty hospital in Ahmedabad, Gujarat. This clearly reflects the low-risk approach adopted by Apollo over the years as it seeks to go to newer geographies.
Overall, in terms of beds under operation across various categories, i.e. owned, franchise, JVs, etc, Apollo has created a formidable geographical footprint and remains an eminent private healthcare provider in India.
Exhibit 9: AHEL in rest of India – subsidiaries/ JVs/ associate partnerships
Location Name of hospital Ownership (%) Type Since Capacity Owned beds Bilaspur Apollo Hospitals 100 SS 2001 250 Bhubaneswar Apollo Hospitals 100 SS 2009 290 JVs/Associates Delhi Apollo Hospitals (IMCL) 20 SS 1996 632 Kolkata Apollo Gleneagles Hospitals 50 SS 2002 470 Ahmedabad Apollo Hospitals (AHIL) 50 SS 2003 300 Noida Apollo Hospitals (IMCL) 28 MS 2005 100 Bangalore Apollo Hospitals 50 SS 2007 250 Lavasa Apollo Hospitals 7 MS 2010 67 Source: IDFC Securities Research, Company
Exhibit 10: AHEL in the rest of India - managed and franchise beds
Location Name of hospital Type Since Capacity Managed beds Ranchi ARAM Hospital SS 1996 137 Pune Jehangir Hospital SS 1998 331 Bacheli NMDC Hospital SS 1998 100 Raichur Rajeev Gandhi SS Hospital SS 2002 350 Ranipet Apollo KH Hospital MS 2003 100 Ludhiana Apollo SS Hospital SS 2005 350 Dhaka Apollo Hospitals, Dhaka SS 2005 330 Agra Apollo Pankaj Hospitals SS 2006 150 Bhilai Apollo BSR Hospitals SS 2007 150 Total beds 1,998 Franchisee Hospital Beds Margao Apollo Victor Hospitals SS 2003 150 Indore Convenient Apollo Hospitals SS 2001 140 Total beds 290 Source: Company, IDFC Securities Research
Overcautious approach = opportunity missed? Apollo’s keen focus on the home market (South India) reflects the management’s cautious approach to building the business – e.g., with the exception of Indraprastha Apollo, Delhi (set up in 1996), Apollo does not have owned beds in North, West and East India. In our view, it implies that Apollo has not been able to effectively leverage its first mover advantage as well as strong brand equity to create a strong footprint of hospitals in other part of the country. The opportunity arising due to Apollo’s relatively limited presence outside of South India has been lapped by new entrants like Fortis and Max that have created strong footholds in the lucrative NCR region and are beginning to make in other parts of the country too.
Limited presence outside South India points to lost
opportunity in leveraging its brand advantage
nationwide…
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Having said that, we also believe that management’s decision-making would have been influenced by restricted access to capital in the past as limited internal accruals would not have been sufficient to meet the high capex involved in setting up owned facilities.
Turning a new leaf In a break from its past characterized by slow and steady growth, we believe Apollo is set on shifting the growth gears up by several notches. This is reflected in its plan to add as many as 2668 owned beds over the next three years on top of the ~750 beds and six new hospitals (Chennai, Karur, Bhubaneswar, Secunderabad, Hyderabad and Madurai) added over the last six quarters. Considering that in the last 25 years of existence, Apollo has set up a cumulative 5,376 owned beds (overall 8,000+ beds including O&M, etc), growth plans are quite aggressive and may well mark a dramatic shift in Apollo’s future growth trajectory.
Further, there are clear signs of Apollo management now willing to experiment with newer delivery formats like Apollo Reach hospitals, day care centers, dialysis centers, etc. With this, the company seeks to build on its leadership position in the Indian healthcare market and experiment with innovative formats to increase effectiveness of the network. We are particularly excited on the possibilities offered by Apollo Reach initiative, Apollo’s vehicle for entering into Tier II / III town, as it can add a new dimension to the future growth trajectory. We like this newfound aggression in the management and believe it bodes well for Apollo’s future growth outlook.
Apollo Reach Hospital Initiative Apollo Reach Hospitals (ARH) are positioned as a no-frills model providing quality healthcare and extending Apollo’s presence to Tier II / Tier III towns where it is not economically feasible to set up the conventional high-end tertiary care hospitals. The ‘Reach’ hospitals would be in the higher secondary and acute care categories and capable of developing into tertiary care centers. Apollo plans to add >500 beds under this initiative over the next three years. Successful execution of the same will enable Apollo to further strengthen its footprint pan-India and fortify the Apollo brand.
These hospitals will cost Rs5m-6m per bed compared to Rs8m-12m for conventional tertiary care hospital in a metro. The hospitals are expected to start breaking even by the second year and generate attractive 20-22% EBITDA margins in steady state, leading to strong return ratios. ‘Reach’ hospitals would also ensure a steady stream of screened inpatient flow to Apollo’s multi-specialty/ super-specialty hospitals – leading to higher ARPOB and lower ALOS in those higher-end hospitals.
Targeting 10,000+ beds by 2013 From its present base of 8,000+ beds, Apollo has embarked on an ambitious plan to set up 2,668 beds (including ~825 beds under Apollo Reach) over the next three years with most of the additions to be owned beds. This would take total operational beds under the Apollo brand to 10,000+ by 2013. The planned bed addition, while cementing its position on the home turf (Chennai and Hyderabad), would also expand Apollo’s national footprint.
Interestingly, unlike peers that are increasingly adopting the unconventional models like leasing land & building as also machinery so as to reduce the capital intensity of
…but is also indicative of restricted access to capital
and limited cash flows
Large bed-addition target and entry into new formats
point to new-found aggression, which we see as
positive
‘Reach’ is a no-frills initiative aimed at expanding Apollo’s
presence in Tier I/ II towns
Planned additions targeted at cementing leadership on
the home turf and nationally
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the business, Apollo continues to prefer the traditional approach of growing by owning hospitals and equipment.
While fortifying presence in Southern India…
Apollo plans to add 850 beds in the Chennai and Hyderabad, taking the total number of beds in the clusters to 2,820 over the next three years. Of the planned 1,000-bed addition in South India over the next three years, 50% would be under the Apollo Reach initiative.
…a major thrust on Mumbai is on the cards
Apollo plans to set up ~1,000 beds to augment its presence in western India. About 90% of the new beds would be in Mumbai, where it currently does not have a meaningful capacity. The management recently indicated that it would set up two wholly-owned facilities in Mumbai with a total 650 bed capacity. In addition, Apollo is currently setting up a 250-bed super specialty facility in Thane in a joint venture with the Yash Birla group. Apollo also plans to expand its capacities in Delhi and Chhattisgarh by 150 beds each by FY12.
These plans would, in our view, help Apollo maintain its numero uno position on the domestic landscape.
Exhibit 11: Ambitious expansion plans to help Apollo maintain its numero uno position
Location Ownership Type By Bed capacity Hyderabad cluster Hyderabad - international Owned Expansion Mar-11 100 Secundrabad Owned SS Apr-10 150 Hyderguda Owned SS Jun-11 175 Chennai Cluster Chennai – MAIN Owned Expansion Sep-12 30 Ayanambakkam Owned ARH Jun-12 200 Karaikudi Owned ARH Sep-10 100 Others Bangalore JVs - 50% Expansion Oct-10 52 Nellore Owned ARH Oct-12 200 Vizag Owned ARH Jun-13 300 Trichy Owned ARH Mar-13 200 North India New Delhi JVs - 50% Expansion Oct-10 136 West India Nashik Owned ARH Mar-12 125 Mumbai* Owned SS Jun-13 650 Thane JV – Yash Birla SS Sep-12 250 Central India Bilaspur-Oncology Owned Expansion Sep-11 NA Total 2,668 Source: IDFC Securities Research, Company, *two different hospitals
Some more new delivery formats Given the growing challenges of managing real estate and personnel costs, development of newer delivery formats is the need of the hour for Indian private sector healthcare providers, and we expect Apollo to be on the forefront of this trend. Along with Apollo Reach format, Apollo is also adopting three more formats.
About 90% of the planned 1000 beds in western
India would be in Mumbai
Apollo is at the forefront ofevolving new delivery
formats…
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Day care surgery centers: Day care surgery centers involve carrying out procedures where the patient can be discharged in a day and which do not require overnight stay. Apollo plans to open these day care centers close to its high-end super-specialty and multi-specialty tertiary care hospitals. This would enable Apollo to shift the relatively less complex procedures to these centers and free up capacity in the tertiary hospitals, which can then target more valuable and complex procedures. Currently, Apollo operates one day care surgery center in Kolkata offering non-invasive treatment. The pilot projects seem to be doing well and are witnessing high occupancy rates improving the ARPOB for the overall network. The management plans to have alteast 1 day care surgery centre in Metros and category A cities in near future.
Dedicated pediatric hospitals – Apollo has recently established a dedicated 81-bed pediatric hospital in Chennai. The hospital has been extremely successful – evident in the fact that it became EBITDA positive in the first year of operations. While the format was initially set up with the intent to reduce the load at tertiary care hospitals in Chennai, Apollo may experiment with this format on its own merit across different cities.
Dialysis clinics: Apollo has also initiated Apollo Dialysis Clinics – India’s first out-of-hospital dialysis clinic. The format provides high-end dialysis facilities designed to address specific issues in this segment of medical care in India.
Apollo Pharmacies: India’s largest organized chain
India’s combined Rx and OTC medicine sales were estimated at US$22bn in 2010. BMI estimates pharmaceutical sales to reach US$39bn and US$66bn in 2014 and 2019 respectively. Industry estimates indicate that India has >700,000 pharmacies, indicating that the pharmacy retailing industry is largely unorganized. These are represented by regional associations or unions. The organized pharmacy segment is dominated by 10-12 big players, but they form a miniscule proportion of this industry (see exhibit below).
Exhibit 12: Apollo – India’s largest retail pharmacy chain Indian pharmacy market growing rapidly
Source: CRISIL – 2008 report, Industry
0
175
350
525
700(Nos)
Apollo Medplus GuardianLifecare
MedicineShoppe
GlobalHealthline
FortisHealthworld
(Rs bn) (%)
320
365
410
455
500
2006
2.6
422
488
3.2
20072.0
2.4
2.7
3.1
3.4
Indian retail pharmaceutical market (LHS)
Organized retail as % of total retail market (RHS)
Pharmacies – adding value to the business Apollo Pharmacy (SAP) is by far the largest organized pharmacy chain in the India with 1,066 stores across 21 states. The management strongly believes the segment can add value to the business while capitalizing on the Apollo brand. It plans to expand its reach to 1,700+ stores by FY13. Apollo Pharmacy offers a wide range of medicines, surgical & hospital consumables and healthcare products. Additionally, it provides several value-added services to customers, including free delivery, appointment with doctors at hospitals, etc. Most of Apollo’s pharmacies also have nursing stations to provide basic medical services like measuring blood pressure, dressing, etc. Many of Apollo’s standalone pharmacies operate on a 24-hour basis.
Exhibit 13: Value-added services provided by Apollo Pharmacy
Apollo Pharmacy’s total store count stood at 1,110 as of 30 September 2010. It reports financials in two batches – matured pharmacies, i.e. stores set up before 2007 and stores set up after 2007. Apollo Pharmacy achieved EBITDA breakeven in Q4FY10 and we expect the business to be EBITDA-positive in FY12. We expect overall EBITDA margins to improve to 5% by FY13. We expect steady improvement in operating metrics on the back of: (i) progressive improvement in the ratio of matured stores to new stores; (ii) introduction of generic and self-branded products which command higher margins (management plans to increase share of private label brands to 20% from 8% now); and (iii) higher bulk distribution of medical supplies and disposable equipment to healthcare service providers including hospitals.
AHEL believes pharmacies will add value to the
business; plans to add ~600-700 stores to its existing
1110 by FY13
Increase in mature stores, high-margin products and
bulk distribution to drive profitability
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Exhibit 14: SAP to grow to 1,700+ by FY13E EBITDA margins steadily improving
Source: IDFC Securities Research, Company
Exhibit 15: Apollo Pharmacy – state-wise distribution (as of 2009)
Apollo management has been contemplating value unlocking in the SAP business for some time now. The SAP business has acquired critical size, and we believe value unlocking is now imminent through either induction of strategic investors or an IPO. While reflecting the value of SAP, the largest organized pharmacy in one of the largest pharma markets globally, this event will also generate cash for the parent.
No. of stores
0
450
900
1350
1800
FY07 FY08 FY09 FY10 FY11E FY12E FY13E-15
-10
-5
0
5
10
(%)
Q1FY10 Q2FY10 Q3FY10 Q4FY10 FY10 Q1FY11 Q2FY11
Stores upto 2007 Stores after 2007
South India accounts for abulk of pharmacy stores
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Other Ventures
Apollo Munich Re Insurance According to industry estimates, health insurance is the fastest growing and second largest non-life insurance segment in the country. IRDA estimates 25% CAGR in health insurance premiums over FY09-14, with insurance premium collections for FY10 at US$1.3bn. Apollo entered the thinly-populated health insurance space through a JV with Munich Health to tap the significant opportunity. Munich Health is a subsidiary of Munich Re, a world leader in health insurance with >5,000 employees catering to clients in more than 40 countries. Apollo holds a 19.72% stake in the JV and will not be investing any further equity in the JV, which implies that its stake in the venture will keep coming down progressively.
Apollo Munich Re doubled its gross written premium to Rs1.1bn in FY10 from Rs481m in FY09.
Apollo Health Street – a ‘medical BPO’ Apollo Health Street (revenues and EBITDA of Rs4.5bn and Rs511m respectively in FY10) is a medical BPO offering a range of outsourcing services and IT solutions to hospitals and physicians. AHS’s service offerings include medical coding, billing, medical transcription, claims generation and patient follow-ups. Apollo has a 39.38% stake in Apollo Health Street operations. The management is positive on the prospects of this business as it continues to add clients and expand service offerings. We expect the business to be eventually divested as it is not core to Apollo’s healthcare offerings.
Exhibit 17: AHS – key financials
(Rs m) FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 FY10 Q1FY11 Q2FY11 Revenues 4,994 1,205 1,137 1,125 1,110 4,577 1,076 1,333 Other income 94 3 1 5 49 58 18 4 Total income 5,088 1,208 1,138 1,130 1,159 4,635 1,094 1,337 EBITDA 849 185 154 164 8 511 151 166 PBT 134 -30 53 30 53 106 41 13 PAT 147 -39 42 23 57 83 33 7 Source: Company
JV with global leader Munich Health to tap the fastest
growing non-life business
We expect Apollo to divest its stake in the business as
it is non-core
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Projects and consulting Apollo Global Projects is among the most renowned hospital consultants. It is the planning, implementation and operations management arm of the Apollo Hospitals Group. The venture provides project management and operations consulting services to other hospitals. It deploys staff and shares hospital management expertise with its clients, and derives revenues either as a flat fee or as percentage of the value of the project. Apollo Global Projects generated revenues of Rs205m in FY10.
Exhibit 18: Apollo Global Projects – consultancy revenues have been largely flat
Consultancy revenues
0
75
150
225
300
FY08 FY09 FY10
(Rs m)
Source: Company
Apollo Global Projects is among the most renowned
hospital consultancies; it contributed Rs205m in
revenues
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FINANCIAL ANALYSIS We expect 19% sales CAGR for Apollo over FY10-13 driven by strong
growth in heathcare services and Apollo Pharmacy
EBITDA margins to expand by 227bps over FY10-13 as we expect steady roll-out of new bed beds and declining losses at Apollo Pharmacy
Aided by margin expansion, we expect Apollo’s consolidated net profits to grow at a CAGR of 25% over FY10-13
Strong internal accruals (Rs10bn of cash profits over FY11-13) to support addition of 2,500 beds over the next three years, equivalent to 90% of Apollo’s existing net block position; net gearing to reduce to 0.48x by FY13E
A profitable business model With its prudent approach towards managing growth over the years, Apollo has put in place a sustainable operating model in the capital-intensive hospital industry. Despite its significant expansion over the years and adherence to the strategy of owning hospital beds and medical equipment while also using the latest technology, Apollo has been clocking core return ratios of ~12-13% over the past three years.
While the headlines return ratios do look subdued due to the significant investments undertaken which are yet to mature, an analysis of Apollo’s key operating metrics over the last five years clearly underlines the quality of the business model and is a validation of its calibrated growth strategy.
Exhibit 19: Key operational metrics at the group level
Particulars FY06 FY07 FY08 FY09 FY10 No. of beds (owned - Apollo standalone) 1959 2135 2237 2502 2717 Occupancy (%) 0.72 0.77 0.77 0.76 0.76 ALOS (Days) 5.7 5.5 5.18 5.13 5.25 Net ARPOB per day (Exc. HBP revenues) 7245 7563 8767 9666 10,750 Net ARPOB per day (incl. HBP revenues) - - - 16310 17940 Source: Company, IDFC Securities Research
Even while owned beds under operations have gone up by ~50% over FY06-10, Apollo’s overall occupancy is up to 76% from 72%. With occupancy rates comfortably above 75% over the last four years, Apollo has had the leeway to consistently increase its treatment prices over the past several years. This has reflected in a steep growth in ARPOB over this period which has grown at 10%+ CAGR over FY06-10. These data points are even more encouraging when viewed for Chennai and Hyderabad clusters, Apollo’s traditional strongholds.
Considering that Apollo’s ARPOB is net of the fees paid to doctors (22-23% of ARPOB), this is among the highest in the industry despite having a diverse mix of beds under operation. This is again testimony to Apollo’s operating model. The improvement in ALOS is impacted by the commissioning on several new beds.
Higher ARPOB via the hub & spoke model: Apollo follows a classic hub & spoke model – its super-specialty beds (at COE) are supported by multi-specialty hospitals and day care centers. Of the total 1,970 beds in the Chennai and Hyderabad clusters, 65% are super-specialty (at COE) and the remaining are multi-specialty and day care
Healthy core return ratio of ~15% despite owning assets
in a capital-intensive industry
Occupancy has increased and AHEL’s ARPOB growth rates are among the best in
India...
... bolstered by the classic hub & spoke model
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surgery beds. As a result of the strong bed network and careful screening of patients, Apollo has been able to ensure a desired case mix at its capital intensive COE (Chennai Main and Jubilee Hills). This has resulted in higher ARPOB and occupancy rates as also lower ALOS at the mature clusters.
Exhibit 20: key operating metrics for mature clusters
Expect 19% consolidated revenue CAGR over FY10-13 We expect 19% consolidated revenue CAGR for Apollo to Rs34.4bn over FY10-13 driven by strong growth in both heathcare services and Apollo Pharmacy. We expect the two businesses to contribute 61% and 35% respectively to standalone sales in FY13, from 72% and 26% in FY10. Apollo has been seperately reporting HBP revenues for standalone clusters as well as those derived from subsidiaries/ JVs from Q1FY11; our forward estimates have factored in the new available data points. We expect standalone revenues of Rs31bn in FY13, including Rs10.8bn from SAP. Of the remaining Rs18.9bn, we expect hospital revenues of Rs15.9bn and pharmacy (HBP at subsidiaries and JVs) revenues of Rs3.1bn.
Exhibit 21: Hospital & SAP to contribute 61% and 35% to standalone revenues by FY13
Source: IDFC Securiteis Research
By FY13, we expect hospital revenues (Rs19bn) to contribute 65% of standalone revenues. Of this, we expect the Chennai and Hyderabad clusters to contribute Rs8.9bn and Rs4.3bn respectively. We epxect Rs2.9bn contribution from relatively newer hospitals at Madurai, Mysore, Vizag, Pune, Karur, Karimanager, Bilaspur and Bhubaneshwar.
Consolidated Revenues
0
7,000
14,000
21,000
28,000
35,000
FY08 FY09 FY10 FY11E FY12E FY13E
Rs m) Standalone Revenues (FY13E)
Hospital Revenues
(includes HBP)51%SAP
35%
Revenues from
HBP from
sub's/Jvs10%
ARH4%
We expect revenues of Rs31bn in FY13, including
Rs10.8bn from the SAP business
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From a quarterly run rate of Rs1.5bn and Rs492m of hospital revenues (ex-HBP revenues) from Chennai and Hyderabad (Q1FY11), we expect Apollo’s exit rate to increase to Rs1.8bn and Rs877m by Q4FY13. We believe our exit rate estimate is conservative as we factor in a 2% qoq increase in ARPOB in each of the clusters and a steady increase in opeational beds. We expect tertiary operational beds at the Chennai and Hyderabad clusters to increase by 30 and 350 respectively from existing levels. We factor in bed additions under Apollo Reach as a separate head. We expect ARH to contribute 4% to standalone revenues by FY13.
We expect HBP revenues from Apollo’s standalone hospitals at Rs3.8bn in FY13 from a quarterly run rate of Rs768m in Q1FY11. We expect HPB revenues derived from subsidiaries/ JVs to increase to Rs2.9bn in FY13 from Rs643m in Q1FY11.
We expect revenue contribution from SAP to increase from Rs4.8bn in FY10 to Rs10.8bn in FY13 owing to an increase in the number of stores and potential higher revenues from each store. We expect 5% CAGR in per store revenue contribution over FY10-13.
We estimate revenue contribution of Rs3.8bn from subsidiaries/ JVs in FY13.
Margins to steadily expand over FY10-13E We expect Apollo’s consolidated EBITDA margins to expand by 227bps over FY10-13 with EBITDA registering 25% CAGR over the period to Rs5.9bn in FY13. We expect Apollo’s EBITDA margin to steadily expand on back of steady increase in operationalized beds and declining losses at Apollo Pharmacy.
We expect Apollo’s Chennai and Hyderabad clusters to report conservative EBITDA margins of 34% and 20% respectively in FY13. We expect other facilites (in Madurai, Mysore, Pune, Vizag, Karur, Karimanagar, Bilaspur and Bhubaneshwar) to operate at 30% margin by FY13. Factoring in bed additions in FY12, we expect Apollo Reach margins to be lower in FY12 and then rising to 22.5% in FY13.
Reflecting strong topline growth, we expect Apollo’s EBITDA to grow 1.95x over the next three years to Rs5.9bn in FY13.
Exhibit 22: AHEL’s EBITDA margins to remain flat in FY11 and FY12
Consol. OPM
13.5
14.5
15.5
16.5
17.5
(%)
FY08 FY09 FY10 FY11E FY12E FY13E Source: IDFC Securities Research
Steady increase in operationalized bed,
declining losses at Apollo Pharmacy to aid margin
expansion
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Working capital – stays lean While there are significant upfront costs, private sector hospital players have a lean working capital cycle due to the low levels of debtors and inventories. Apollo’s working capital cycle has improved significantly over FY09-10 with redcution in net working capital cycle from 17 days in FY09 to five days in FY10. The sharp decline in working capital cycle is primarily on the back of a propotionate increase in payable days over the duration with inventory and recievable days largely constant. This further strengthens Apollo’s ability to undertake expansions.
PAT to almost double by FY13E We expect Apollo’s consolidated profit to post 25% CAGR in FY10-13. With a meagre 60bp expansion in EBITDA margin over the period, we expect profitability to largely track topline growth. Our estimates do not factor in tax benefits for setting up hosptials in tier-II and tier-III cites. Apollo plans to add 825 beds under Apollo Reach. We factor in an effective tax rate of 33.4% over FY10-13. Overall, we expect Apollo’s consoldiated PAT to increase 2x over FY10-13 to Rs2.7bn by FY13.
Exhibit 23: Apollo’s consolidated PAT to grow 2x over FY10-13
Consol PAT
700
1,200
1,700
2,200
2,700
FY08 FY09 FY10 FY11E FY12E FY13E
(Rs m)
Source: IDFC Securities Research
Return ratios to expand by 400bp Over FY10-13, we expect AHEL’s consolidated RoE and RoCE to expand by 450bps and 407 bps to 13.2% and 12.6% respectively. Expansion in RoE would primarily be driven by a higher asset turnover and steady expansion in margins over the next two years. With turnover at Apollo Pharmacy expected to increase 2.2x times over FY10-13, we expect improved capital efficiency to support RoE expansion. We expect AHEL’s asset turnover to increase from 1.77x in FY10 to 2x by FY13.
Healthy growth in turnover and thereby improved
capital efficiency to support RoE
Strong rise in working capital cycle will support AHEL’s expansion plans
Planned capex for FY11-14E at 90% of existing net block Apollo has ambitious plans to add 2,668 beds over the next three years. The cost of the planned expansion would be Rs13.5bn, with Apollo likely to incur a capex of Rs11.6bn (its proportionate share). The planned capex of Rs11.6bn over FY11-14 translates into ~90% of its existing net block position as of end-FY10.
Exhibit 25: Apollo’s ambitious expansion plans
(Rs m) Own projects Project Total J V AHEL AHEL Estd. Description Cost Debt Share invstd. Completion Hyderabad Cluster Hyderabad - international Expansion 1225 0 1225 1029 Mar-11 Secundarabad SS 370 0 370 370 Apr-10 Hyderguda SS 443 0 443 40 Jun-11 Chennai Cluster Chennai - MAIN Expansion 100 0 100 0 Sep-12 Ayanambakkam ARH 700 0 700 66 Jun-12 Karaikudi ARH 260 0 260 238 Sep-10 Others Bangalore Expansion 60 0 60 0 Nov-10 Nellore ARH 667 0 667 85 Oct-12 Trichy ARH 655 655 136 Mar-13 Vizag SS 1150 1150 80 Jun-13 North India New Delhi Expansion 400 250 0 0 Nov-10 West India Nasik ARH 520 0 520 34 Jun-12 Belapur SS 3500 0 3500 700 Jun-13 Masina SS 1400 0 1400 0 Jun-13 Thane SS 2000 1000 500 0 Mar-13 Central India Bilaspur-Oncology Expansion 80 0 80 0 Sep-11 Total 13530 1250 11630 2778 Source: Company, IDFC Securities Research
Apollo’s strong operational cash flows would allow it to comfortably fund its massive capex rollout. We expect Apollo to generate operating cash flow of Rs7.2bn over FY11-13 as against our capex estimate of Rs10bn. To maintain its targeted financial leverage, Apollo continues to fund its expansions by raising incremental debt (US$15m recently raised from IFC via issuance of FCCBs at a conversion price of
Operational cash flow of Rs7.2bn over FY11-13 will contribute significantly to
capex needs
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Rs303 per share). However, strong internal accruals, along with cash flows expected from issuance of promoters’ warrants, should limit debt requirement. Overall, we expect Apollo’s balance sheet position to grow stronger hereon, with consolidated net gearing at 0.48x by FY13 (0.36x as of FY10).
Exhibit 26: Gross OCF estimated at Rs7bn vs estimated capex of Rs10bn (FY11-13)
Cash flows
-4,500
-2,500
-500
1,500
3,500
(Rs m)
FY08 FY09 FY10 FY11E FY12E FY13E
OCF Capex FCF
Source: IDFC Securities Research
Timely divestitures to enhance shareholder value Apollo management has reiterated its intention of timely divestiture/ value unlocking of its non-core business (Apollo Pharmacies and Apollo Health Street) to enhance shareholder value. Apollo attempted to list its BPO operations in 2008, but decided to back out due to the unfavorable market conditions. With Apollo Pharmacy having already achieved EBITDA breakeven, a strategic stake sale or IPO launch of the retail pharmacy business should not come as a surprise. We expect proceeds from the planned transactions to be utilized to retire debt or fund incremental expansions.
Key risks
Venturing into new geographies While we are positive on Apollo’s strategy to venture into newer and challenging geographies like Mumbai as it seeks to reduce the dominance of its Southern India footprint in the business mix, we believe it will likely test Apollo’s project execution / operational management capabilities. Apollo’s ability to successfully manage this geographical expansion will be a key metric to track.
Innovating with newer formats Further, Apollo is also seeking to aggressively invest in newer delivery formats including Apollo Reach as well day care centers etc. Given that the sustainability of these newer models is yet to conclusively proven, Apollo’s ability to successfully execute the same remains a key risk to monitor.
Risk of spreading resources too thin Over the past few years, Apollo has sought to accelerate the pace of capacity addition while managing to ensure quality delivery standards. However, with aggressive expansion plans in place, Apollo could be spreading its resources too thin across
We believe Apollo Pharmacy is a prime candidate for a
stake sale or an IPO, which will boost expansion plans
Apollo’s ability to successfully execute
projects in new geographies like Mumbai will be a key
metric to track
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newer facilities and which may impact quality. Even as we believe in the management’s ability to deliver on scale and superior execution skills, we would continue to monitor the situation.
Resource availability poses operational and financial risk India produces 35,000 MBBS doctors on an average each year, but the number of MDs (super-specialists) is far lower. Apollo’s hospital network includes several multi-speciality and super-speciality centers, which require highly skilled human resources (MBBS and MD doctors). A strong brand equity has enabled Apollo to attract good doctors. However, getting super specialist doctors for the newer super-speciality units would be a challenge given the scarcity of this highly qualified talent. Given the nature of Apollo’s service offerings, we see that as a key operational and financial risk (higher employee costs) for the company.
Getting specialists for super-specialty hospitals
continues to be a challenge
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VALUATIONS & VIEW Apollo Hospitals is India’s largest and probably the best known healthcare
provider with a proven business model
Internal accruals attaining critical mass, which would be used to fund the ambitious expansion plans of the hitherto conservative management
Potential strategic stake sale/ IPO in Pharmacy business as well as divestiture of non-core assets further triggers for value unlocking
Indian hospitals, particularly leaders like Apollo and Fortis offering immense growth potential, deserve to trade at premium to global peers
We initiate coverage on Apollo with an 18-month price target of Rs651share
Apollo – stepping on the gas With 47 owned hospitals and ~8,000 beds under operation in prime spots across key cities, along with its phenomenal brand equity for quality healthcare, Apollo has created an enviable and difficult to match footprint in India. With increasing real estate costs as well as manpower shortages, Apollo’s competitive edge vis-à-vis the new entrants is bound to increase further. Apollo’s strong balance sheet and healthy EBITDA margins add to the edge.
While Apollo’s relatively conservative approach to growth in the past, involving focus on its Southern India strongholds, may have provided an opportunity for some other new players to create strong foothold in North India, we sense a change in the air. Having built a strong base (operating profits likely to cross ~Rs4.75bn by FY12), we believe the company is now willing to step on the accelerator so as to encash on its first mover advantage. This is reflected in its decision to commence operations on a large scale in western India as well as a willingness to experiment with innovative business models like Apollo Reach, Day Care Centers, etc. Overall, Apollo is looking to add ~2,700 beds over the next three years against ~8,000 beds opertionalized so far.
With opportunities aplenty in the Indian healthcare space, we believe Apollo management’s aggression in pursuing the same bodes well for the stakeholders.
Indian players deserve growth premium Given the capital-intensive nature of the business and long gestation periods (steady margins attained only by fourth or fifth year of operations), we prefer to value Indian private hospital operators on EV/EBITDA rather than based on DCF and PE multiples. Further, most of these players are in an aggressive growth phase – leading to regular upscaling of medium-term growth plans, which have the potential to dramatically alter the business profile in the later years.
Hospital operators in developed economies (USA and EU) trade 8-9x one-year forward EV/ EBITDA, reflecting an average 8% EBITDA CAGR over the next two years. In contrast, we expect EBITDA for leading Indian players like Apollo and Fortis to register a significantly higher CAGR of 26% an 34% respectively over FY10-12. As Indian players are in their early growth phase in a market offering tremendous potential available as compared to the relatively limited growth opportunities for players in developed markets, we believe Indian hospital players should trade at a significant premium (14-15x one-year forward EBITDA) to global peers
Strong balance sheet and healthy margins give an
edge to Apollo’s scale and geographical spread
We value Apollo using EV/ EBITDA given hospitals’
capital intensiveness and long gestation periods
Hospitals is a play on Indian healthcare, which offers
better growth potential for than developed markets
Valuing retail phamacy: Like the hospital business, retail pharmacies also have long gestation periods due to high upfront real estate and other costs. Therefore, retail chains achieve EBITDA and PAT breakeven after suffering losses for a few years. In this context, we prefer to value the pharmacy business on EV/ sales basis. Given the leadership position of Apollo Pharmacy in the one of the fastest growing pharma markets globally and factoring in 31% revenue CAGR over FY10-13E, we value Apollo Pharmacy at a premium to global peers.
Initiating coverage with an 18-month price target of Rs651/share Leading private healthcare service providers like Fortis and Apollo, we believe, deserve to command significant valuation premium to peers as well as the broader Indian market as they are the only relevant proxies to the rapidly growing and highly attractive domestic healthcare industry (US$125bn by 2015E). Further, we strongly believe that with ~10,000+ beds operational by 2013E, Apollo will continue to be among the leading players in the domestic market for years (and even potentially decades) as the entry barriers keep on going up. The economic benefits of this enviable leadership position will be visible in the years to come.
We value Apollo’s consolidated business using SOTP of its hospital and retail pharmacy businesses. Given the quality and scale of assets, along with its strong brand equity and 25% earnings CAGR over FY10-13E, we value Apollo’s healthcare business (including HBP) at 15x FY13 EV/ EBITDA, which is in line with its historical two-year forward multiples.
Apollo Pharmacy is a leader in one of the fastest growing pharma markets in the world
Apollo deserves command a significant premium to peers
We assign a valuation of 15 FY13 EV/ EBITDA to Apollo’s
healthcare business
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Exhibit 28: Historical EV/EBITDA and PE (x) band charts
Source: IDFC Securities Research
Initiating coverage on Apollo with Outperformer and an 18-month SOTP-based price target of Rs651/share (valuing the hospital business at 15x FY13E EV/EBITDA, in line with our target multiple for leading Indian healthcare providers; and valuing the Apollo Pharmacy business at 1x EV/ sales (FY13E) – implying an upside of 21% from the current levels. Ability to accelerate margin improvement in existing hospitals, a faster-than-expected pick-up in newer hospitals and value unlocking in non-core assets will lead to upsides on the target price.
Exhibit 29: AHEL’s SOTP valuation
Deriving price on FY13 Hospital business Target EV/EBITDA (x) 15 EBITDA (non-SAP operations) 5,339 Enterprise value (A) 80,080 Retail pharmacy Revenues 10,786 Target EV/sales (x) 1 Enterprise Value (B) 10,786 Total Enterprise Value (A+B) 90,865 Debt 10,867 Cash 460 Derived Market cap 80,459 FDE (no. of shares) 124 Fair value 651 Upside 28% Source: IDFC Securities Research
Our target multiple of 15 FY13E EV/ EBITDA is in line with those of leading Indian
Fortis Healthcare (Fortis) is India’s second largest healthcare player with 49 hospitals, ~3,250 beds and a pan-India footprint built over just ~10 years – aided by aggressive inorganic growth. Fortis is on track to achieve a 6,000+ installed bed capacity by FY13 as 8 new hospitals go on stream. This should drive 41% CAGR in Fortis’s revenues and 75% CAGR in earnings over FY10-13. While the backing of well-funded promoters (erstwhile Ranbaxy owners) and a strong balance sheet have enabled Fortis to make bold moves like bidding for Parkway, the group’s innovative streak is also reflected in its willingness to adopt novel models to reduce resource-intensity in its future expansion. However, subdued return ratios, limited track record of executing Greenfield hospitals and pending integration of Wockhardt hospitals are key risks to monitor. Initiating coverage with Outperformer and 18-month price target of Rs206.
Second largest and growing: In addition to organic growth, Fortis has aggressively pursued inorganic growth (Escorts, Wockhardt, Malar, etc) as also O&M contracts to build ~3,250 bed network (~46% in Greenfield facilities). With a national footprint in place, Fortis is looking to consolidate presence across different regions by adding ~2,000 new beds over FY10-13. Growth in mature beds and new additions should drive 41% revenue CAGR for Fortis over FY10-13. The recent decision to pursue international growth through promoter entities is a positive as it leaves Fortis free to focus on tapping the opportunities in the domestic market.
Margins to be impacted by new bed additions: With the planned addition of ~2,000 Greenfield beds, which typically take 6-8 quarters to breakeven, we expect Fortis’ margins to decline by 160bp over FY10-13 but improve sharply thereon as the new beds begin to mature. We expect 37% CAGR in EBITDA over FY10-13 to Rs4.95bn in FY13, creating a solid platform for funding future growth.
An exciting growth story despite the execution risks: A 75% earnings CAGR over FY10-13, strong balance sheet, an aggressive promoter/ management with demonstrated ability to innovate in its bid to create value and a still nascent market that offers multiple growth opportunities, Fortis is a company to watch for. While caution is warranted given Fortis’s limited execution history, we rate the stock as Outperformer with an 18-month price target of Rs206 per share.
Key valuation metrics Year to 31 Mar FY09 FY10 FY11E FY12E FY13ENet sales (Rs m) 6,589 9,872 14,914 21,156 27,961Adj. net profit (Rs m) 145 695 1,721 2,520 3,809Shares in issue (m) 406 406 406 406 407Adj. EPS (Rs) 0.4 1.7 4.2 6.2 9.4 % growth (126.1) 379.0 147.6 46.5 50.8 PER (x) 451.8 94.3 38.1 26.0 17.3 Price/Book (x) 6.0 3.5 1.9 1.7 1.6 EV/EBITDA (x) 61.3 56.4 24.7 16.3 10.7 RoE (%) 1.3 4.7 6.6 7.0 9.5 RoCE (%) 4.1 2.9 2.7 5.4 8.3
INVESTMENT ARGUMENT India’s second largest (listed) healthcare player in the secondary/ tertiary
segment is on track to take total installed capacity to >6,000 beds by FY13
Through aggressive inorganic growth, FHL has doubled its operational bed capacity in two years; a track record of successfully integrating acquired assets (Escorts Delhi, Fortis Malar, etc)
FHL has embraced innovative strategies to reduce resource intensity (land, employees, equipment, etc) and freed up capital to fund expansion plans
Growth set to accelerate backed by a strong balance sheet and well-funded promoters (erstwhile Ranbaxy owners); however, we perceive risks of spreading resources too thin and operational integration challenges
Our 18-month price target of Rs206 on the stock corresponds to 15x FY13E EV/EBITDA, in line with peers’ average historical 2-year forward multiples
India’s second largest healthcare service provider
Fortis Healthcare (FHL), promoted by the erstwhile owners of Ranbaxy Labs, is India’s second largest healthcare service provider (listed) and a key player in the secondary and tertiary care segment. Since setting up Fortis Hospital at Mohali (Punjab) in 2001, the group’s first flagship venture, FHL has attained an all-India footprint in a relatively short period of time. In the process, it has significantly altered the traditionally-staid Indian healthcare landscape. Within 10 years of starting operations, the group has a network of 49 hospitals and >4,053 installed beds (of which 2,973 beds are operational) across the country. Fortis’s network hospitals include multi-specialty and super-specialty centers providing comprehensive tertiary and quaternary healthcare covering cardiac care, orthopedics, neurosciences, oncology, renal care, gastroenterology and mother & child care among many others.
Mr Unconventional… FHL, we believe, has been among the most innovative of the leading private healthcare service providers, willing to experiment with non-conventional strategies to build capacity and adopt new paradigms of doing business. This is reflected in the company’s willingness to pursue aggressive inorganic growth in an industry where gradual organic growth was the established norm. FHL’s willingness to push the envelope is also evident in its bid for Parkway Assets, a fairly unthinkable proposition for an India-based healthcare operator. Further, by bringing senior managers from non-healthcare backgrounds to run the business, we believe FHL has upped the “management quotient” in the Indian private healthcare industry – a domain of medical professionals so far. While some of these unconventional moves have proved effective, their sustainability over the long run needs to be monitored.
Achieved pan-India presence rapidly and
transformed Indian healthcare in the process…
… by adopting new paradigms in the largely conservative healthcare
business
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Exhibit 1: FHL – India’s second largest private healthcare service provider
Source: IDFC Securities Research, Company, Industry
Exhibit 2: FHL’s bed additions – historical timeline
Bed count has doubled in the past two years… FHL’s network beds have doubled in the past two years, from 1,483 in 2008 to 2,973 in 2010. Unlike Indian hospital operators’ approach of largely focusing on organic growth, FHL has aggressively pursued inorganic growth to complement its organic growth trajectory. This has enabled FHL to acquire a national footprint within a short period of time and strengthen its brand franchise.
Exhibit 3: Recent acquisitions
Date Acquired Consideration paid (Rs m) No. of beds 2005 Escorts Hospitals 5850 1000 2008 Fortis Malar 560 180 2009 Wockhardt Hospitals 9090 1902 Source: IDFC Securities Research
0
2250
4500
6750
9000
(Nos)
Apollo Fortis CARE Manipal Max
Speciality Mix (FY10)
Cardiac, 42%
MSH, 16%
Others, 21%
Renal 4%
Gastro 2%
Onco 2%
Ortho8%
Neuro6%
OPD, 9%
Pulmo, 2%
Gynae, 3%
Others, 4%
Bed capacity increased from 1483 in 2008 to 2973 in 2010, driven mainly by
inorganic means
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Notably, bed acquisitions have mainly been in tertiary space in metro areas. With long timelines associated with setting up of these acute care facilities and growing challenges in procuring real estate at appropriate locations, these acquisitions have jumpstarted FHL’s progress as a leading hospital player in India. While there could be issues around the valuation paid for these assets, the acquisitions are indeed a sound strategic asset.
…greenfield beds <50% of overall beds Only 46% of FHL’s overall operational beds (as of end-FY10) are greenfield with the remaining either acquired or operated by JVs/ associates or under O&M contracts. This is in sharp contrast to peers like Apollo and Manipal, whose network primarily consists of beds built up through the Greenfield route. Over the next few years, as FHL’s own Greenfield beds come on stream, it will need to demonstrate the ability to manage growth by building hospitals from scratch.
Exhibit 4: Only 46% of FHL’s operational beds are Greenfield
Bed distribution (FY10)
HCC2%
Brownfield30%
Greenfield46%
Associate10%
O&M12%
Source: IDFC Securities Research, Company
FHL‘s installed capacity – over 6,000 beds by 2013E FHL has come a long way from 150 beds in 2001 to ~3,000 in 2010 including 2,311 owned beds. The company plans to add 2,075 owned beds over the next two years, taking the total owned bed count to 4,386 by 2013. FHL’s installed capacity will increase to 6,000 beds (of which 5,000 would be operational beds) by FY13. As most of this incremental capacity addition will be through Greenfield hospitals, it will be interesting to watch FHL’s ability to successfully manage this sharp growth over the next few years.
Managing Greenfield facilities is a key challenge
going forward…
…as planned capacity additions will be
mainly organic
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Exhibit 5: Fortis seeks to expand operational beds to 5000 by FY13 Fortis planned owned bed expansion over FY11-13
Improving operating metrics; imparts confidence on execution FHL has not only created excellent physical assets over the past few years but has also managed to grow and integrate assets within the wider Fortis network. FHL has doubled its bed count and network revenues have almost doubled from Rs6.5bn in FY08 to Rs12.4bn in FY10. Besides scaling up its Greenfield facilities, FHL has seamlessly integrated its acquired facilities (Fortis Malar and Escorts Delhi). This, in our view, underlines the group’s excellent project execution capabilities.
Tertiary care hospitals typically break even by the fourth year of operations. FHL has demonstrated the ability to break even by the second year in several cases. Its Jaipur hospital achieved EBITDA breakeven in the 14-16th month of operation. This proves FHL’s capability to ramp up scale and achieve superior operating margins much earlier than the conventional norms. While these are early days yet, the data points enhance our comfort on FHL’s execution capabiilties.
To ensure standardized services across its network and derive gains from economies of scale, FHL has implemented Fortis Operating System (FOS) and Purchase Supply Management (PSM) programmes. This has helped FHL demonstrate steady improvement in margins across the network including Greenfield and acquired facilities. For example, Escorts Delhi’s (EHIRCL) revenues recorded 28% CAGR over the past two years and the hospital now contributes 23% to FHL’s consolidated revenues. EHIRCL’s operational margins too improved by 1690bps to 21% in FY10.
Initiatives to standardize services across its facilities
have helped improve margins
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Exhibit 6: Revenues have tracked bed count
Source: IDFC Securities Research, Company
A well-crafted strategy to support scale
Supported by well-funded promoters (erstwhile Ranbaxy owners) and a strong balance sheet position (net cash of Rs6.6bn, end-FY11E), FHL seeks to grow aggressively via all means
Promoters remain keen on expanding global reach by acquiring assets at a right price. Management recently indicated that FHL (listed) would focus on expanding scale at home, while promoters’ ambition of gaining a global footprint would be routed through their own holding company
Withdrawal from the Parkway deal due to expensive valuations enhances comfort in the management’s ability to manage inorganic growth
FHL has embraced an innovative asset-light strategy to garner resources (land, employees, equipment, etc.). This should free up capital, leaving ample bandwidth for future growth
Aiming to build scale; capital not a constraint FHL has been aspiring to firmly establish itself on both the domestic and global healthcare map. The group believes that there is a huge untapped market for quality tertiary healthcare services in India and remains upbeat on its ability to grab these opportunities through organic and inorganic growth strategies. In this pursuit to build scale and establish a leadership position, FHL has employed a fairly broad-based approach for network expansion via building new hospitals, acquiring existing ones, and entering into O&M contracts for both existing and new hospitals.
Analysis of FHL’s bed mix over the years clearly reflects its multi-pronged growth strategy with simultaneous increase in beds across multiple categories.
Exhibit 7: FHL’s network has grown across multiple dimensions
0
800
1600
2400
3200(Nos)
FY06 FY07 FY08 FY09 FY10
Greenfield O&M Associate Brownfield HCC
Source: IDFC Securities Research, Company
Supported by well-funded promoters and a strong balance sheet (net cash of Rs6.6bn as of end-FY11E), we believe capital constraints would be the least of FHL’ concerns.
Inorganic route remains a key growth imperative Despite consummating a series of high-ticket deals, FHL continues to see significant consolidation and expansion opportunities in the domestic market. FHL has a dedicated team which continously scouts for and evaluates potential acquisition and O&M opportunities with a pre-defined assessment matrix (exhibit below).
Exhibit 8: What FHL looks for while acquiring a new facility Cost Specialties at existing facility Quality of infrastructure Location population base Work culture Availability of leading doctors Source: IDFC Securities Research, Company
“As we move forward, yes the focus on growth in India will continue through organic and inorganic opportunities.. “
–Mr. Malvinder Singh, Fortis Healthcare
FHL aims to tap the wide variety of opportunities in Indian healthcare using a mix of growth strategies
A dedicated team scouts for and assesses acquisition
and O&M opportunities
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Synopsis of key recent inorganic growth transactions FHL’s recent acquisitions of Escorts Hospitals and Wockhardt Hosptials has significantly enhanced its profile and accelerated its journey towards becoming a leading hospital player in India.
Exhibit 9: FHL’s significant acquisitions over the past few years
Target Consideration (Rs m) Rationale Sep-05 Escorts Heart Institute & Research Centre Ltd. (EHIRCL) 5850 Bed capacity (operational) No. of beds EHIRC – Delhi 331 Fortis Escorts Hospital, Jaipur 150 Fortis Escorts Hospital, Faridabad 250 Fortis Escorts Hospital, Amritsar (under Escorts Delhi) 166 Escorts Hospital, Raipur 50
Target Consideration (Rs m) Rationale Dec-09 Wockhardt 9,090 Bed capacities (under construction) No. of beds Yeshwantpur, Bengaluru 120 Anandpur, Kolkata 414 Total Beds 534 Bed capacities (operational) No. of beds Mulund, Mumbai 567 Kalyan, Mumbai 60 BG Road, Bengaluru 451 Cunnigham Road, Bengaluru 128 Chord Road, Bengaluru 40 Nagar Bhavi, Bengaluru 55 Rashbehari Avenue, Kolkata 67 Sarat Bose Road, Kolkata 0 Total existing bed capacity (856 operational) 1,368 Total bed capacity 1,902 Source: IDFC Securities Research, Company
Exhibit 10: Valuation of major acquisitions
Wockhardt acquisition valuations (2009) Rs m Total amount paid 9090 Total no. of beds 1368 EV/BED (Rs m) 6.64 Consideration towards Operational Beds 7190 No. of operational beds 856 EV/BED (Rs m) 8.40 Consideration towards ongoing projects 1900 Non-operational beds 534 EV/BED 3.71
Escort acquisition valuations (2005) Rs m Enterprise value (Rs m) 6500 Acquired 90% at 5850 No. of beds acquired 1000 EV/bed (Rs m) 6.50 Source: IDFC Securiteis Research
2nd largest private health care provider in the country Largest player in cardiac care in terms of depth of coverage
COE in the cardiac, neurology and orthopedic segments Three specialties account for 54-58% of revenues Largest cardiac care and joint replacement centre in India Improved purchase and supply management Integrated marketing and customer acquisition Supports depth of coverage given long-term plans
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FHL’s global plans; the ‘Parkway saga’ Besides creating a formidable position in the domestic market, FHL has aspired to establish a global footprint. In 2008, FHL marked its first major international foray by joining hands with a diversified Mauritiuan group to jointly acquire a controlling stake in Mauritius’ largest private hospital – Clinique Darné. Clinique Darné is one of the most modern medical centres in Mauritius with hi-tech facilities and offering a wide range of specialized medical services.
On 19 March 2010 FHL acquired a strategic stake (23.8%) in Parkway Holdings (PHL), Singapore, for US$685.3m from TPG Capital.
Incorporated in 1974, Parkway Holdings is a leading healthcare provider with presence in Singapore (1,022 beds), Malaysia (1,900 beds), India (425 beds), UAE (260 beds), Brunei (20 beds) and China (14 beds). It also has a GP clinic network (Parkway Shenton) and provides radiology (Medi-Rad Associates) and lab services (Parkway Laboratory Services). Besides, it owns a 35.4% stake in Parkway Life REIT, which invests in healthcare and related real estate assets.
Sucessful closure of the deal could have seen FHL emerge as a leading player in Asia with a network of 62 hospitals and 10,000+ beds.
… Khazanah counterbid.. After Fortis acquired a strategic stake in Parkway Holdings at SGD3.56 per share in March 2010, M/s Khazanah, a Malaysian sovereign fund and the second largest shareholder of Parkway, came up with a Voluntary Partial Conditional Open Offer (VPO) on 27 May to increase its stake to 51.5%. The offer was earlier priced at SGD3.78 and later increased to SGD3.95 in response to FHL’s raised offer.
Khazanah’s offer of SGD3.95 per share valued Parkway at SGD3.3bn, translating into 31x CY09 EV/EBITDA. At this price, a rough analysis indicates that Parkway would be valued at EV of Rs29m per bed comapred to Rs8.4m per bed and Rs6.5m per bed paid by FHL for Wockhardt and Escorts acquisitions respectively.
Exhibit 11: FHL – Parkway deal
Details of Parkway foray (2009) (in SGD m) Value attributed to Parkway based on Khazanah’s bid 3,307 Valuing Parkways investment in Parkway Life REIT 228 Valuation attributable to hospital beds and others 3,079 No. of beds to be acquired (nos.) 3,643 EV/ Bed (Rs m) 28.8 Source: IDFC Securities Research
With Khazanah seemingly determined to seize the asset as part of its broader pan-Asia healthcare strategy, the bidding war threatened to go out of hand.
…FHL’s withdrawal… At that stage, in realization that valuations were getting expensive, FHL decided to pull out of the price war and exited Parkway by selling its 25.4% stake to Khazanah at USD840m (our estimates) as against a purchase price of USD760m (our estimates). Post transaction costs, Fortis made net gains of Rs180m on the parkway exit.
Parkway acquisition is a clear indication of FHL’s
global ambitions…
… would have led to its emergence as a leading
player in Asia
The Khazanah offer priced Parkway much higher than
Fortis’ other comparable acquisitions
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…a positive move We take a lot of comfort from FHL mangement’s decision to withdraw from the Parkway deal as it undelines its adherence to financial discipline even while pursuing an aggressive inorganic growth strategy. It allays fears of managerial hubris prevailing over business economics and aggressive aspirations
Focus reorienting towards the domestic market The management recently indicated that FHL would focus only on the domestic market while the promoters’ plans to expand globally would be executed via their own private companies. In our view, this delineation of growth strategies will help sharpen the growth focus in FHL and also reduce the complexities associated with the limited disclosures, etc available on foreign acquisitions.
Recently, Fortis Healthcare Global (a promoter company) recently bought a Hong Kong based primary clinics chain Healthcare Asia Limited (QHA) for US$193m. QHA is the largest private integrated healthcare service platform in Hong Kong, providing medical services and allied health services. The acquired businesses comprise a network of over 60 wholly-owned medical centers, over 500 affiliated clinics, over 40 dental and physiotherapy centers, and a private nursing agency with a database of over 3,000 nurses. For the financial year ending 2009, QHA recorded consolidated revenues and EBITDA of US$131m and US$13.1m respectively.
“Fortis Global Healthcare will be our vehicle of growth for international healthcare businesses outside India, allowing Fortis Healthcare in India to continue to focus on the tremendous growth in the Indian hospital business.”
– Mr. Malvinder Singh, Fortis Healthcare
However, we do not rule out the possibility of FHL and healthcare business acquired through promoter entities exploring some sort of synergies at a later stage in time.
Hub & spoke – the mainstay of expansion strategy FHL is using the hub & spoke model to reinforce its presence in existing regions as well as enter new geographies. As part of the strategy, FHL seeks to establish super speciality “centre of excellence (COE)” facilities in key cities in a region (“hub for the region”) and then build a series of feeder hospitals across the region to feed these high-end hospitals. Having established its presence in parts barring East and Central India, we believe incremental growth strategy will involve creating COEs in Eastern and Central regions while further strengthening the feeder hospital network across other regioss to strengthen the hub & spoke.
As part of this strategy to expand its reach and strengthen the feeder network, FHL plans to set up low-cost secondary/ tertiary care facilities in Tier-2 cities. It has already set up pilot projects in several cites to guage the market and build active feeder networks for its super-speciality “COE” facilities at the hubs (metros). The exhibit below shows FHL’s targeted bed capacity and pan-india presence by FY13.
Exit from Parkway underscores the company’s
uncompromising focus on financial discipline
FHL will continue to hone core strengths; global forays
will be executed at promoter level
East and central India to be brought within the ambit of
Fortis’ growth plans
Plan to build low-cost tertiary care units in tier I/ II
metros
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Exhibit 12: Expected pan-India presence by FY13
Particulars No. of Hospitals Operational Beds Capacity / Total Beds North India 20 1,241 3,739 Western India 9 777 1,801 Central India 6 68 273 South India 7 710 1,144 Eastern India 3 67 481 Total - India 45 2,863 7,438 Overseas 2 110 120 Source: IDFC Securities Research, Company
Northern India: FHL has reinforced its brand equity, enhanced delivery capabilities and driven up in-patient volumes in the region through successful execution of its hub & spoke model and using a mix of organic and inorganic route. FHL established a network of super-speciality ’centers of excellence‘ and multi-speciality hospitals by acquiring EHIRCL as well as through its own greenfield hospitals like Mohali. More than 50% of EHIRCL’s in-patient volumes are from geographies beyond NCR and Delhi. This, in our view, vindicates the credibiltiy of FHL’s hub & spoke model.
Exhibit 13: Dominating presence in North India
Hospital Territory Care Total capacity Focus area Fortis Hospital, Mohali Punjab Quaternary 300 Cardiac Fortis Hospital, Noida NCR Quaternary 350 Orthopedics, Neurosciences, Oncology EHIRC - Delhi* NCR Quaternary 331 Cardiac Fortis Escorts Hospital, Faridabad* NCR Secondary 250 Multi-speciality hospital Fortis Escorts Hospital, Amritsar * Punjab Secondary / Tertiary 166 Multi-speciality hospital Fortis La Femme, GK - II, New Delhi NCR Quaternary 45 Healthcare needs of women Fortis Flt. Lt. Rajan Dhall Hospital, NCR Quaternary 200 Cardiac, renal care, joint replacement, Vasant Kunj, New Delhi pulmono-thoracic surgery and diabetec care Fortis Jessa Ram Hospital, New Delhi NCR Secondary 150 Oncology Shalimar Bagh, New Delhi^ NCR 550 Cardiac sciences, orthopedics, neuro- sciences, renal care, mother & child care and gastroenterology Gurgaon, Haryana^ - FIIBMS NCR 1,000 Oncology, trauma, pediatrics, mother & child care, cosmetology, gastroenterology, neuro-sciences and renal care Ludhiana 1, Punjab^ Punjab Tertiary 200 Ludhiana 2, Punjab^ Punjab Quaternary 75 Escorts Kalyani Hospital, Gurgaon* NCR Secondary 18 Yashoda Hospital, Ghaziabad* UP Secondary 5 GNRC, Guwahati* NCR Secondary 4 Total 3,644 Source: IDFC Securities Research, * satellite centre, ^under progress
Success of EHIRCL vindicates the efficacy of the
hub & spoke model
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South India: FHL established its presence in South India by acquiring a stake in Malar Hospital, Chennai in 2008. FHL then acquired a majority stake in RM Hospital, a multi-specialty hospital located in central Bengaluru. This was followed by the acquisition of Wockhardt in 2009, which cemented FHL’s position in South India. FHL now has six hospitals and 532 operational beds in Bengaluru. FHL is also setting up a 120-bed tertiary care facility in Yeshwantpur, Bengaluru.
Exhibit 14: Steadily gaining ground in South India
Western India: FHL has four hospitals in Mumbai. Two of these were part of the Wockhardt transaction. The group plans to have a total installed capacity of 1,055 beds in Mumbai by FY13. Its has two hospitals in Rajasthan, Fortis Modi Hospital in Kota and Fortis Hospital in Jaipur. The Kota hospital’s strategic location enables it to attract patients from Madhya Pradesh and Gujarat as well. FHL is also setting up a 200-bed tertiary care hospital in Ahmedabad, which will be its first unit in Gujarat.
Exhibit 15: Increasing foothold in the western region
Hospital Territory Care Total capacity Fortis Modi Hospital, Kota Rajasthan Secondary 200 S L Raheja Hospital Mumbai Tertiary 280 Kalyan, Mumbai Mumbai Tertiary 60 Mulund, Mumbai Mumbai Quaternary 567 Ahmedabad Gujarat Tertiary 200 Goyal Heart Institute, Jodhpur* Rajasthan Secondary 11 Arneja Heart Institute, Nagpur* Maharashtra Secondary 15 Hiranandani Hospital, Vashi Mumbai Secondary / Tertiary 148 Source: IDFC Securities Research, Company, *Satellite Centers
Eastern and central India: This region has so far remained out of focus for Fortis. The company only has a 44-bed tertiary care facility at Rashbehari Road, Kolkata and has recently commisioned another 414-bed tertiary care facility in Anandpur. Through this new facility, FHL aims to attract patients from the eastern states as well as neighbouring countries like Banglandesh and Burma.
An asset-light strategy provides enough leeway for growth The hospital industry is inherently capital intensive. Acknowledging this, FHL has adopted a diffrentiated asset-light strategy built around the following:
Overcoming land/ building costs: Prohibitive land and building costs have driven FHL to embrace the lease model over the traditional practice of owning property. The following exhibit shows that 60% of FHL’s incremental hosptial properties (36% of beds) are leased.
Acquisition-led expansion in South India
Ambitious plans to expand installed capacity in Mumbai
will further strengthen western India presence
A 414-bed tertiary care facility to cater to patients
from the eastern states and also neighboring countries
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Exhibit 16: Fortis adopting asset light strategies to reduce land and building costs
This is quite a variation from the usual practice of owning assets – an essential element of strategy with peers like Apollo.
Technology – contemporary, yet cost efficient: FHL uses some of the most advanced technologies to provide best-in-class healthcare facilities, which also helps attract reputed doctors and medical tourists. Importantly, FHL has adopted innovative operating strucutres to ensure that it stays at updated on the technology front while sustaining its asset-light model. For example, several of its network hospitals have active tie-ups with Super Religare Laboratories (SRL) to manage diagonostic and radiology services. FHL is also reportedly in talks with several international medical equipment majors like GE and Siemens to implement ‘pay-per-use’ and ‘leasing’ models at its network hospitals. FHL is employing a combination of owned, leased and outsourced models to provide modern technology while retaining its asset-light model.
"…the MRI machine that is being used at our hospitals should be the most modern. We may not need cutting-edge or innovative technology; we don't need to be trail blazers, but we do need to be sufficiently modern and contemporary."
-- Mr. Daljit Singh, Fortis Healthcare
Resources: ‘Availabilty of renowned doctors’ is among the key criteria FHL looks at while assesing potential acquistions. FHL believes in bringing reputed doctors on board while starting new operations, which often implies hefty remunerations. To keep fixed costs low, FHL has adopted a ‘fee for service model’ for its key doctors, wherein a certain portion (55-60%) of the compensation is fixed and the remaining is variable and marked to performance. With innovative methods like these, FHL has sucessfuly managed to keep fixed costs low while linking variable compensation to topline growth.
By adopting the aforementioned asset-light strategies, FHL strives to minimize its upfront capex spend – especially on projects – going forward. This strategy should free up capital to support the group’s aggressive expansion plans.
Has ‘fee for service’ arrangement with reputed
doctors to rationalize costs while ensuring quality
Several facilities have partners to manage
diagnostic and radiology services
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Standardizing quality across the network Rapid scale-up at FHL over the past few years makes it a challenge for the company to efficiently manage this growth by putting in place the requisite systems and processes. The challenges were compounded by the fact that more than 50% of FHL’s current operational capacity has been acquired/ under O&M contracts with varying standards/ processes. The healthcare industry in India has, in general, been weak on institutionalizing processes, etc. In this backdrop, FHL’s ability to effectively standardize processes and quality will be the key to its success.
In realization, standardization of processes and quality has been a priority at FHL. The company has undertaken initiatives such as FOS (Fortis Opertating System), Project NEXT and JOSH to standardize processes across the network and drive operational efficiencies. With this focus, Fortis has not only steadily improved operating metrics of its standalone greenfield/ acquired facilites but also managed to seamlessly integrate the myriad facilites across the Fortis network.
“It's always a challenge if your aspirations are to grow very fast. We need to train people to be able to cater to the requirements of patients and to the standards of the hospital. We have a program called FIELDS (Fortis Institute of Enhanced Leadership Development), which provides internal training. We cannot get people with common standards readymade, so we are looking at creating this capability ourselves.”
– Mr.Daljit Singh, Fortis Healthcare
Project NEXT: Project NEXT, an initiative in collabration with HCL, is aimed at standardizing processes to facilitate consisent delivery of high quality services. The project also seeks to centralize shared services and provide analytical capabilities to identify and replicate best practices among the network hospitals. FHL expects to complete the project by Q2FY12.
Project JOSH: FHL has implemented project JOSH to simplify and standardize nursing to improve patient outcomes, quality of patient care and enhance efficiency.
Driving operational efficiencies and consistent quality across the network
are key to success
Initiatives like NEXT and JOSH ensure best practices
across hospitals and improve clinical outcomes
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FINANCIAL ANALYSIS We expect 41% CAGR in FHL’s consolidated revenues over FY10-13 with
50% of consolidated revenues from new beds by FY13
Aggressive bed additions to lead to margin compression; we estimate EBITDA margin to decline by 161bp to 17.7% by FY13
PAT expected to grow 5x to Rs3.8bn by FY13, led by strong topline growth and investment yields from accumulated cash accruals; interest income to account for ~56% of consolidated PBT over FY11-13E
We expect FHL’s RoE and RoCE to expand by 477bp and 540bp to 9.5% and 8.3% respectively on high margins and a rise in asset turnover ratio
Expect 41% revenue CAGR over FY10-13 FHL’s consolidated revenues recorded 23% CAGR over FY07-10, which we expect to accelerate to 41% CAGR over FY10-13 with 37% CAGR in network revenues. The robust consolidated growth would be driven by incremental contribution from new bed additions (FY11 onwards) and sustained topline growth at matured beds. We estimate 18% revenue CAGR from matured beds over FY10-13 on the back of a steady improvement in occupancy rates and 2-3% qoq increase in ARPOB. Overall, we expect matured and new beds to contribute 50% (Rs13.7bn) each to consolidated sales by FY13.
Exhibit 17: New beds to contribute 50% of consolidated revenues by FY13
Exhibit 18: Consolidated revenues expected to register 41% CAGR over FY10-13
0
7,500
15,000
22,500
30,000(Rs m)
2008 2009 2010 2011 2012 2013 Source: IDFC Securities Research
We consider Wockhardt beds (acquired in Q4FY10) and new beds added by Fortis from FY11 as total ‘new bed addtions’. We expect new beds to register 164% CAGR in revenues over FY10-13 on the back of a 70% increase in bed capacity (by 2,075 to 5,048) even as we factor in conservative occupancy rates and ARPOB on the incremental capacity. We estimate 16% CAGR in FHL’s O&M revenues with 16% contribution to consolidated revenues in FY13.
Exhibit 18: Strong revenue growth on back of contribution from new beds
Particulars (Rs m) FY10 FY11E FY12E FY13E Network revenues 12,410 17,914 24,793 32,259 Consolidated revenues 9,343 14,646 20,926 27,731 From matured cluster 9,343 9,766 11,817 13,681 From new beds 0 4,740 8,948 13,862 Contribution from O&M contracts - 3.482 4,028 4,717 Source: IDFC Securities Research, Company
Margins to slip in the interim FHL’ s consolidated EBITDA margin has expanded by 760bp over FY07-10 to 19.3% with absolute EBITDA growing 3x to Rs1.9bn in FY10. However, we expect EBITDA margin to decline by 161bp to 17.7% by FY13 due to the impact of aggressive bed additions over the next three years. Despite lower margins, we expect 37% CAGR in consolidated EBITDA over FY10-13 to Rs4.9bn led by strong topline growth.
Expect new beds to clock 164% revenue CAGR
over FY10-13
Aggressive bed additions to suppress EBITDA margins
until FY13E
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Exhibit 19: FHL’s OPM to contract by 161bp over FY10-13E
Conventional tertiary care facilities typically achieve EBITDA breakeven by the second or third year of operations. However, we have assumed that FHL’s newer hospitals would achieve EBITDA-neutral status by the seventh or eighth quarter of launching operations because of the asset-light business model. We factor in new tertiary/ quarternary hospitals to operate at negative 7.5-15% EBITDA margins in the first two quarters of operations and improve steadily thereon. Our estimates factor in FHL’s matured cluster to witness 50-100bp margin expansion every year driven by improved operational parameters and higher pricing.
Expect PAT to grow 5x over FY10-13E We expect FHL’s consolidated net profit to grow 5x to Rs3.8bn in FY13. We expect 37% CAGR in EBITDA owing to strong top-line growth, with the impact of contracting margins getting offset by investment yeilds from accumulated cash accruals. Over FY11-13, we estimate interest income to account for ~56% of FHL’s consolidated PBT. Overall, we expect FHL’s consolidated net profit to clock 75% CAGR over FY10-13 to Rs3.8bn.
Exhibit 20: Net profit to register 75% CAGR over FY10-13E
FHL’s new hospitals to achieve EBITDA breakeven in 7-8 quarters, vs 2-3 years for most tertiary care units
Investment gains should offset the impact of margin contraction, helping strong
earnings growth
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Return ratios to expand by > 450bp; low compared to peers We expect FHL’s RoE and RoCE to expand by 478bp and 540bp to 9.5% and 8.3% respectively, driven by sharp potential improvement in asset turnover ratio (FATR) and net profit margin. FHL’s persistent focus on sweating assets has resulted in FATR improving from 0.61x in FY08 to 0.76x in FY10. We expect FHL’s FATR ratio to increase to ~1.6x by FY13. Also, robust revenue growth and strong other income would lead to 660bp improvement in net profit margin over FY10-13 to 13.6%. However, overall return ratios will continue to be lower than for peers like Apollo in the near term due to the impact of FHL’s large ticket acquisitions as well as massive planned expansion over the next few years.
Exhibit 21: FHL has among the lowest return ratios in comparison to Asian peers
Source: Bloomberg, IDFC Securities Research
Exhibit 22: RoE to expand by 478bp over FY10-13E Du Pont analysis
Source: IDFC Securities Research, Company
Big-ticket acquisitions and massive expansion plans to
Improving balance sheet health Strong internal accruals, proceeds from the Parkway exit, and an efficient working capital cycle should strengthen FHL’s balance sheet. FHL has indicated that it would utilize the Parkway proceeds to repay debt, which will reduce gearing from 2.9x in FY10 to 0.28x in FY11E.
Assuming organic growth to be largely in line with ongoing plans and no major inorganic growth initiatives in the near term, we believe the confluence of growing scale and steady improvement in operating metrics should allow FHL to generate cumulative free cash flows of ~Rs5.5bn over FY11-13 (after factoring in a capex of Rs5.2bn over the same duration). Overall, we expect FHL’s consolidated gearing to drop to 0.1x with net cash of Rs13bn by FY13.
Exhibit 23: FHL’s balance sheet to grow stronger with Rs13bn of net cash by FY13
(20,000)
(10,000)
0
10,000
20,000
30,000
40,000
50,000
FY09 FY10 FY11E FY12E FY13E0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
Net debt (Rs m - LHS) Net gearing (x - RHS)
Source: IDFC Securities Research
Key risks
Limited track record of successfully running greenfield hospitals While FHL has shown commendable improvement in operating parameters over the last few quarters, we believe ability to sustain this performance over the next 6-8 quarters will be critical as ~2,000 greenfield beds become operational over the next three years. This will arguably be one of the most aggressive bed rollouts in the Indian hospital industry. Also, given that most of FHL’s recent growth has been through the inorganic route, there has been limited evidence on FHL’s ability to manage such elevated levels of organic growth. Therefore, FHL’s ability to successfully implement its mega organic bed rollout over the next three years will be a key monitorable and remains a key risk going forward.
Inorganic growth – operational integration challenges FHL’s growth trajectory has amply illustrated the management’s appetite for inorganic growth. Fortis has sucessfuly integrated assets it acquired in the past, as demonstrated by the seamless integration of Escorts Delhi and Fortis Malar. Having said so, Fortis has not quite delivered in line with expectations related to Wockhardt Hospitals – its largest acquisition till date. Prior to the acquisition, Wockhardt
Proceeds from the Parkway exit and strong internal cash
will help reduce gearing
Ability to execute and manage ambitious organic
capacity addition is the main concern
Margin decline at Wockhardt post acquisition is
a cause for concern
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Hospitals enjoyed an EBITDA margin of 18%. However, post the management change at Wockhardt, EBITDA margin dropped to 15% in Q1FY11 and 12% in Q2FY11. This was in contrast to FHL mangement’s guidance of an expansion in margins (18%+) from Q1FY11 even after factoring in planned capacity expansion at its hospital in Mulund, Mumbai. The management attributes the drop to a change in accounting policy which demanded higher provisioning for debt and allowances for deductions. Though we believe a part of the margin decline could be due to accounting changes, we will monitor FHL’s operational integration capabilities – specifically for acquired assets. We expect Wockhardt’s operating margin to steadily expand from 15% currently to 17.5% by FY13. Given the complex nature of heatlhcare business, we see integration of assets, processes and resources as a key operational risk.
Uncertain outcome of pending litigations and contingent liabilites FHL’s 89.9% subsidary, Escorts Heart Institute and Research Centre (EHIRCL), is beset by several litigations, some of them even questioning the validity of the acquisition. The litigations include: (i) EHIRCL’s right on leasehold on the land on which EHIRCL’s Delhi hospital is currently located, (ii) provisioning of free treatment to indigent patients at EHIRCL Delhi, and (iii) income tax exemptions claimed by EHIRCL’s predecessors. Proceedings of several of these litigations are at various stages and outcome is yet uncertain. FHL’s auditors have expressed their inability to comment on; (i) an ongoing litigation of EHIRCL with Delhi Development Authority (DDA) pertaining to a leasehold arrangement with the latter, and (ii) the IT department’s claims of Rs1.2bn. An adverse court judgement on EHIRCL, in our view, would significantly impact FHL’s financials and also lead to potential loss of the entire fixed asset investment at EHIRCL Delhi. FHL has indicated contingent liabilites of Rs982m pertaining to income tax litigations with EHIRCL, but has not provisioned for the same. FHL’s management remains confident of the litiagtion being resolved in its favour.
Risk of spreading resources too thin; standardization issues Over the past few years, FHL has expanded capacity at a rapid pace while managing to ensure quality delivery standards. However, with aggressive expansion plans in place, FHL could be spreading its resources too thin across newer facilities and which may impact quality. Inititives like FIELD, FOS, Project NEXT and Project JOSH provide comfort and even as we believe in the management’s ability to deliver on scale and superior execution skills, we would continue to monitor the situation.
Resource availability poses operational and financial risk India produces 35,000 MBBS doctors on an average each year, but the number of MDs (super-specialists) is far lower. FHL’s hospital network includes several multi-speciality and super-speciality centers, which require highly skilled human resources (MBBS and MD doctors). A strong brand equity has enabled FHL to attract good doctors. However, getting MDs for super-speciality units would be a challenge. Given the nature of FHL’s service offerings, we see that as a key operational and financial risk (higher employee costs) for the company.
Management remains confident that litigations will
be resolved favorably
Getting MDs for super-specialty hospitals
continues to be a challenge
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VALUATIONS & VIEW Despite being one of the youngest hospital chains in the industry, Fortis
has carved out a niche for itself and entered the top-3 club in the industry
With an aggressive management willing to explore uncharted areas in the industry, we expect Fortis to create significant value for stakeholders
Indian hospitals, particularly leaders like Apollo and Fortis, deserve to trade at a premium to global peers in view of their future growth potential
We value FHL at Rs206/share, implying 15x FY13 EV/EBITDA, in recognition of its growth possibilities as well as leadership position in the domestic healthcare space
Fortis Healthcare – youngest and among the brightest… Backed by well-funded promoters with the willingness and ability to unlock the hitherto untapped potential in the Indian healthcare space through unconventional models, Fortis is one of the companies to watch out for among private hospital care providers in India. Propelled by its big-ticket acquisitions of Escorts Delhi, Fortis has leapfrogged into the big league of Indian healthcare space within 10 years of existence. Over the last three years, FHL’s bed under operations and revenues and have grown ~2x (to 2,311beds) and 23% CAGR respectively while EBITDA has grown 3x over this period.
The management’s willingness to push the envelope on traditional strategic thinking, as demonstrated in its decision to hire a CEO from a non-healthcare background and intent to explore newer models of delivering healthcare as well as unlocking value for shareholders, is commendable. However, the company’s limited execution track record in setting up and scaling up Greenfield facilities remains a risk – especially given its aggressive bed rollout plans over the next few three years.
Indian players should command growth premium over global peers Given the capital-intensive nature of the business and long gestation periods (steady margins attained only by fourth or fifth year of operations), we prefer to value Indian private hospital operators on EV/EBITDA rather than based on DCF and PE multiples . Further, most of these players are in an aggressive growth phase – leading to regular upscaling of medium-term growth plans, which have the potential to dramatically alter the business profile in the later years.
Hospital operators in developed economies (USA, EU, etc) trade 8-9x one-year forward EV/EBITDA, reflecting an average 8% EBITDA CAGR over the next two years. In contrast, we expect EBITDA for leading Indian players like Apollo and Fortis to register a significantly higher CAGR of 26% an 34% respectively over FY10-12. As Indian players are in their early growth phase in a market offering tremendous potential available as compared to the relatively limited growth opportunities for players in developed markets, we believe Indian hospital players should trade at a significant premium (14-15x one-year forward EBITDA) to global peers.
FHL doubled capacity and trebled EBITDA in the last three years by constantly
pushing conventional norms
Leading Indian players including Fortis offer better
Initiating coverage with a 18-month price target of Rs206/share Leading private healthcare service providers like Fortis and Apollo, we believe, deserve to command significant valuation premium to peers as well as the broader Indian market as they are the only relevant proxies to the rapidly growing and highly attractive domestic healthcare industry (US$125bn by 2015E). Further, we strongly believe that with 5,000+ beds operational by 2013E, Fortis will continue to be among the top 2-3 players in the domestic market for years (and even potentially decades) as entry barriers keep rising. The economic benefits of this enviable leadership position will be visible in the years to come.
We initiate coverage on FHL with Outperformer and an 18-month price target of Rs206/share (valuing it at 15x FY13 EV/EBITDA; in line with our target multiple for leading Indian healthcare providers). Our target price implies an upside of 28% from current levels. Ability to accelerate margin improvement in existing hospitals as well as a faster than anticipated pick-up in newer hospitals are key upside triggers on the target price.
Exhibit 25: Valuing FHL at Rs206/share
Particulars (Rs m) on FY13 Assumed EV/EBITDA 15 EBITDA 4,949 Enterprise value 74,229 Debt 7,733 Cash 22,500 Market Cap 88,996 Fair value 206 % upside 28 Source: IDFC Securities Research
We value the stock at 15 FY13E EV/ EBITDA, which
implies 28% potential returns from current levels
Fortis will continue to dominate Indian healthcare
Care Hospitals is a multi-specialty hospital chain started by cardiologists Dr. B Soma Raju and Dr. N Krishna Reddy in 1997. Quality Care India Ltd (QCIL) is the holding company of Hyderabad-based CARE group. Financial investors like Matrix Group, Ashmore Investments and Rakesh Jhunjhunwala together own 55% stake in CARE. The balance 45% lies with doctors (20%) and other smaller corporates (25%).
Motivation: CARE philosophy is to provide quality healthcare services at affordable prices. CARE treats several patients under state insurance scheme at subsidized rates (upto 35%).
“If there is one thing that we have demonstrated over the last decade at CARE, it is that a ‘good conscience’ can actually translate into ‘good businesses.”
– Dr. B. Somaraju
Model: CARE has restricted capital cost per bed to Rs2.5m to keep costs low and provide affordable care. CARE’s hospitals are largely built on leased land and buildings to reduce upfront capital costs. CARE has 11 hospitals but it owns land and building of only one hospital in Nampally, Hyderabad.
Expansion plans: CARE has more than 1500 beds across 11 hospitals and plans to double bed count over next few years.
CARE hospitals enjoys a pan-India presence
CARE no. of beds Banjara, Hyderabad 430 Nampally, Hyderabad 200 Musheerabad, Hyderabad 100 Secundarabad, Hyderabad 33 Vizag 140 Vijaywada 100 Nagpur 105 Raipur Bhubaneswar 100 Surat 110 Pune 110 Total 1,428
Financials: According to media reports, QCIL’s revenues grew at a CAGR of 35% over FY06-09. The group reported a net profit and operational income of Rs98.4m and Rs 3.3bn respectively in FY09. CARE’s mature hospitals have operating margins of more than 20%.
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NOT LISTEDManipal Hospitals
Manipal Hospitals is a leading healthcare service provider in South India. It also has presence in other parts of India and Nepal and Malaysia. Manipal Hospitals operates across the healthcare value chain and offers primary, secondary and tertiary healthcare services. It has more than 8000 beds spread across 23 hospitals and several primary clinics.
Model: Manipal has a hub & spoke model comprising a mix of owned hospitals as also JV and managed units. The exhibit below lists its key operational facilities.
Manipal hospitals
Particulars No. of beds KMC Hospital, Attavar, Mangalore 580 Kasturba Hospital, Manipal 1,230 Shirdi Sai Baba Cancer Hospital, Manipal 250 KMC Hospital, Ambedkar Circle, Mangalore 165 Manipal Northside Hospital, Bangalore 120 Manipal Hospial, Bangalore 600 TMA Pai Hospital, Udipi 180 Manipal Hospital, Goa 40 Govt. Hospital, Ajjarkad, Udipi 240 Women and Child Hospital, Udipi 70 Manipal Hospital, Tumkur 25 TMA Rotary Hospital, Karkala 100 Central Referral Hospital, Sikkim 500 STNM Hospial, Sikkim 375 Uma Hospital, Kasargod 40 Manipal Teaching Hospital, Nepal 700 Western Regional Hospital, Nepal 350 Green Pastures Leprosy Hospital 75 Govt. Wenlock Hospital, Mangalore 515 Muar General Hospital 800 Tangkok Hospital 80 Melaka General Hospital, Malaysia 800 Govt. Lady Goschem Hospital 170 Total 8,005 Source: Company
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NOT LISTEDMAX Healthcare
Max Healthcare, promoted by Max India, is among the leading hospital chains in North India with over 1100 beds, including 324 ICU beds, in eight hospitals. Max Healthcare is a 75.6% subsidiary of listed entity Max India. Warburg Pincus and IFC Washington hold 16.4% and 3.1% respectively in Max Healthcare. Max has centers of excellence in a wide rage of specialties, including cardiac, minimal access, metabolic and bariatric care, orthopedics and joint replacement, neurosciences, pediatrics, obstetrics & gynecology, oncology and aesthetic & reconstructive surgery. It plans to add other specialties like organ transplant, cord blood banking and stem cell research.
Model: Max predominantly operates in North India. It has a conventional hub & spoke model, with tertiary healthcare facilities supported by secondary care hospitals and primary care clinics.
MAX operating model
TERTIARY
SECONDARY
PRIMARY• Specialist doctor constult• Basic diagnostics like
pathology collection
• Surgery and inpatient facilities• Mother and Child• Doctor consultation• Eye and Dental Care
• Heart and Vascular• Neuosciences• Joint Replacement and Orthopaedics• Aesthetics and Reconstructive surgery• Oncology
• Clinics / Implants - 9
• Max Hospitals – 4• Specialty Centers - 2
• Max Heart and Vascular Institute• Max Super Specialty Hospital
TERTIARY
SECONDARY
PRIMARY• Specialist doctor constult• Basic diagnostics like
pathology collection
• Surgery and inpatient facilities• Mother and Child• Doctor consultation• Eye and Dental Care
• Heart and Vascular• Neuosciences• Joint Replacement and Orthopaedics• Aesthetics and Reconstructive surgery• Oncology
• Clinics / Implants - 9
• Max Hospitals – 4• Specialty Centers - 2
• Max Heart and Vascular Institute• Max Super Specialty Hospital
Source: MAX
Expansion plans: MAX has lined up aggressive expansion plans to fortify its presence in North India. It plans to increase its bed count from 1100 to more than 2450 by FY16. The land required for the expansion plans is already in place, according to the management.
Max hospitals expansion plans
Source: MAX, IDFC Securities Research
Financials: Max Healthcare’s revenues have grown at a CAGR of 42% in the past three years to Rs5.6bn in FY10, mainly driven by an increase in operational beds and improvement in ARPOB. Max steadily increased its operational bed count from 346 in FY06 751 in FY10. Improved case mix and higher volumes translated into a CAGR of 8% in ARPOB over
Max Hospitals No. of beds Date of commencement Dehradun 150 Jun-11 Shalimar Bagh 300 Sep-11 Mohali 300 Sep-11 Bhatinda 300 Sep-11 Greater Noida 300 FY16
770
1,100
2,150
2,450
0
500
1,000
1,500
2,000
2,500
FY09 FY10 FY12E FY16E
(nos)
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FY06-10 to Rs20,431 now. Contribution margins have steadily improved over years on back of operational efficiencies and benefits of scale, expanding by 660bps over the past four years to 57.2% in FY10.
Revenues have grown at a CAGR of 42% over the past four years
0
1,500
3,000
4,500
6,000
FY06 FY07 FY08 FY09 FY1050
52
54
56
58Revenue (Rs m - LHS) contribution margin (% - RHS)
DisclaimerThis document has been prepared by IDFC Securities Ltd (IDFC SEC). IDFC SEC and its subsidiaries and associated companies are a full-service, integrated investment banking, investment management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities.
This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable. While we would endeavor to update the information herein on reasonable basis, IDFC SEC, its subsidiaries and associated companies, their directors and employees (“IDFC SEC and affiliates”) are under no obligation to update or keep the information current. Also, there may be regulatory, compliance, or other reasons that may prevent IDFC SEC and affiliates from doing so. We do not represent that information contained herein is accurate or complete and it should not be relied upon as such. This document is prepared for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved). The investment discussed or views expressed may not be suitable for all investors.
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Explanation of Ratings: 1. Outperformer: More than 5% to Index
2. Neutral: Within 0-5% to Index (upside or downside) 3. Underperformer: Less than 5% to Index
Disclosure of interest: 1. IDFC SEC and affiliates may have received compensation from the company covered herein in the past twelve months for issue management, capital structure, mergers & acquisitions,
buyback of shares and other corporate advisory services.
2. Affiliates of IDFC SEC may have received a mandate from the subject company.
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