Healthcare Sector - CIMB Research 2015-10-05: Do M&As make good investment sense?

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Healthcare Sector Q & M DENTAL GROUP (S) LIMITED QC7.SI  ISEC HEALTHCARE LTD. 40T.SI  SINGAPORE O&G LTD 41X.SI 

Healthcare - Overall Do M&As make good investment sense? 

• SGX CIMB Healthcare conference showcased six corporates: 1) First REIT, 2) PLife REIT, 3) Religare Health Trust, 4) Q&M, 5) ISEC, and 6) SOG. 
• Discussions centered around expansion strategies: 1) M&As (Q&M), 2) JVs (ISEC), and 3) recruiting new doctors into existing practices (SOG). 
• To the extent of companies not overpaying, M&A remains our preferred strategy. Maintain Add on Q&M. 

Three broad expansion strategies 

• In the small/mid-cap healthcare space, in addition to organic growth (i.e. ramping up of patient footfall in existing clinics), we see corporates expanding via three strategies: 1) M&A, 2) JV with other doctors, and 3) opening up new clinics by recruiting new doctors. We think that an acquisition-led strategy offers the greatest immediate impact to the bottomline. 

The M&A route: aka the Q&M route 

• Q&M has been growing in Singapore and China via an acquisition-led strategy. The positives of this strategy are: 
  1. no gestation period and start-up costs, 
  2. the inclusion of profit guarantees protects from downside risk, and 
  3. a ~50/50 cash/shares purchase consideration is immediately accretive (since the company uses its ~40x P/E stock to acquire targets at 10-15x). 
• The downsides are 
  1. the risk of overpaying, and 
  2. succession plans for the acquired clinics after the key doctor/dentist retires. 

The JV route: more risky with no guaranteed income 

• The next strategy is to expand via JVs. ISEC will be expanding into Sibu, Malaysia via a 55% JV with commencement expected in late-2015/early-2016. This involves incorporating a JV company with other doctors and profits are split according to ownership interest. This strategy requires: 
  1. an established brand name to drive patient flow, 
  2. partnering the right doctors, and 
  3. higher initial investment to equip a new clinic. 
• Positives include alignment of interest as doctors hold stakes in the JV. 

The traditional route: longer gestation periods for new doctors 

• Recruiting doctors into new clinics is another way to grow. We understand this is the route that SOG likely intends to undertake. The key difference between this and a JV is ownership. Challenges include 
  1. compensation (where wages are typically the biggest cost of opening a clinic at 30-60% of revenue), 
  2. long gestation periods, and 
  3. retention of ‘star doctors’. 
• ISEC witnessed this first hand, and closed their Mount E Novena clinic as the slow patient buildup made the high doctor wages untenable. 

M&A our preferred strategy 

• We think that M&A is akin to acquiring top doctors with existing profitable clinics. The other strategies typically involve recruiting younger and less established doctors which could involve longer gestation periods. While dilution risk is also the greatest with an M&A strategy, shareholders remain protected as long as they do not overpay. 

Jonathan SEOW CIMB Securities | Kenneth NG CFA CIMB Securities | http://research.itradecimb.com/ 2015-10-05

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