Temasek-MHE deal hinges on the company’s market position and operational scale to yield potential returns. The sustainability of growth and P/E multiples in the public markets will be essential to realise deal returns. While rich, the valuation of this deal is based on the high-quality business that MHE has and the attractive public market valuations enjoyed by its peers.
The recent Temasek deal valuing Manipal Hospitals at US$5 billion has brought the focus firmly back on India’s hospital sector as a prime space for FDI and investor capital. With major tailwinds such as increasing urbanisation, healthcare spending, chronic disease prevalence, and life expectancy, the potential for generating market-beating returns through roll-up platform investments in Indian hospitals is immense.
How Does The Deal Valuation Look Like?
Temasek has purchased the majority of shares at an enterprise value of approximately US$4.9 billion in Manipal Health Enterprises. This significant investment follows Temasek’s previous stake purchase of 18 percent in Manipal Hospitals.
The deal valuation is closely linked to Apollo Hospitals Enterprise Limited’s public market valuation. With a price to earnings multiple of around 79, Apollo Hospitals Enterprise is the benchmark for evaluating the Temasek-Manipal deal.
MHE reported an EBITDA of US$71.7 million (INR 588 Crores) with an EBITDA margin of 26 percent for the year ending March 2022, resulting in a deal valuation multiple of 66.5 for the equity component. However, this multiple represents a 20 percent discount from the earnings multiple of its public market peer, thereby providing Manipal and Temasek with the opportunity to grow into the public market valuation equivalent by further improving the business.
Further analysis from a free cash flow (FCF) perspective reveals that Manipal generates approximately US$137.5 million per year in free cash flow owing to its attractive working capital cycle and business dynamics. This translates to a free cash flow yield of 2.88 percent, indicating the percentage of free cash flow the equity investor can expect to receive relative to the amount paid for the acquisition.
While rich, the valuation of this deal hinges on the high-quality business that MHE is and the attractive public market valuations enjoyed by its peers.
How Will Returns Be Generated?
The Temasek-Manipal deal hinges on the company’s market position and operational scale to yield potential returns. Additionally, careful financial engineering has the potential to generate value significantly.
Sustainability of growth and P/E multiples in the public markets will be essential to realise deal returns. High-quality hospital assets with operational scale are still relatively rare in India and hold much potential that lends some protection to the rich P/E multiple on this deal. The public market multiples holding sway will be necessary for the deal valuation to hold up.
Projected earnings and FCF growth will be the other primary driver of long-term value creation. Manipal has 2 essential tools to boost earnings, including consequently FCF- increase revenues at attractive margins and cut costs.
From a revenue perspective, Manipal can increase prices or increase volumes at attractive margins. Manipal, being in the premium segment, faces a challenging task in boosting its revenues through price increases. As such, the company’s firm focus will be on increasing volumes. This can be achieved through both organic and inorganic strategies.
To achieve organic growth, Manipal must execute projects that can be FCF yield accretive. This entails setting a threshold FCF yield that greenfield projects must generate on the CAPEX for future growth. A minimum threshold FCF yield of 10-12 percent is recommended, based on the current 5-year IGB yield of approximately 7 percent adjusted for a risk premium. A careful assessment of potential projects with respect to their FCF generating capacity as a function of cash flow and CAPEX will be essential.
On the other hand, inorganic growth through strategic acquisitions of smaller hospitals will be crucial. Manipal has been quite acquisitive in the past; however, now is the time to put the foot on the accelerator. The MHE platform must look to acquire more hospitals at significant multiple discounts on the earnings than what the platform enjoys. Essentially, look to add to its earnings via acquisitions that trade at multiples at more than a 50 percent discount to its own P/E multiple. More importantly, it must look to use its common stock for such acquisitions with a minimum cash usage. Doing so will create significant value for its shareholders.
From a cost perspective, Manipal is a well-oiled business with an EBITDA Margin of 26 percent, at par with the best in the industry. The key for MHE will be acquiring smaller hospitals at lower multiples and improving their EBITDA margins to the 26 percent enjoyed by the Manipal platform.
Value creation for this deal will depend on managing high-quality growth. Both operational improvements and financial engineering will be crucial.
What Does The Hospital Industry Hold For Investors In The Future?
The KKR-Max Hospital deal is the highest return deal by a PE firm in India validating the Hospital Roll-Up Playbook. Now the Temasek-Manipal deal sets the scene for hospital roll-up platforms in India. India’s private markets in healthcare provide attractive roll-up opportunities for funds of all sizes ranging from US$50 million to US$5 billion. The key will be creating value accretive platforms that can acquire and partner with smaller hospitals to create a larger platform.
Such a strategy will benefit from superior capital allocation, elevated cost synergies, an improved capital structure leading to reduced cost of capital, and a higher multiple on the platform’s high-quality earnings.
The Indian healthcare sector houses numerous smaller hospital assets with attractive growth prospects. Both hospital promoters and the investor community must recognise the exceptional investment opportunity that the Indian hospital space offers.
In conclusion, the healthcare private equity party has just started in India, and the next 15 years will see value creation of over $100 billion market cap in healthcare businesses.
—The authors, Poornima Vardhan and Taponeel Mukherjee, are the Founders and Principals at AltG. The views expressed are personal.
(Edited by : C H Unnikrishnan)
First Published: Apr 11, 2023 8:50 AM IST
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