Elevator Pitch

Max India owns 46% of Max Healthcare, which is an owner / operator of 14 hospitals (~2400 beds) in North India that should yield ~100% valuation upside given ~200% EBITDA increase over the next ~3yrs driven by:

a) 15-20% annual growth in revenues from organic growth in # of beds, price hikes, inorganic growth from acquisition of two hospitals, and operational improvements.

b) EBITDA margins improving to 16.6% from 10.2% today driven by continued fixed cost leverage & variable cost rationalization programs at existing hospitals, and turnaround of newly acquired hospitals (these were loss making when acquired).

Max India currently has no sell-side coverage and the healthcare business has been overlooked for many years given it was loss-making and until just a few months ago it was buried inside a conglomerate dominated by a large life insurance company (Max Life).

Background / Context

Max India (MAX) holds three businesses – Max Healthcare (hospitals), Max Bupa (health insurance), and Antara (retirement homes). Max Healthcare (MHC) is a joint venture that is 46% owned by MAX, Max Bupa (MBHI) is a JV that is 51% owned by MAX, Antara is 100% owned.

Max Healthcare (MHC) is the only business that has reached breakeven, and hence the majority of Max India’s valuation comes from this: >80% when adjusted for cash. MAX has a market capitalization of INR31B today, holds INR4B in cash, has invested INR4.6B in Max Bupa and INR1.5B in Antara – which effectively ascribes INR21B market capitalization to MAX’s 46% equity stake in MHC.

MHC owns / operates 14 hospitals, most of which are in Delhi / National Capital Region (NCR) and are high- end tertiary / quaternary care facilities. Of the 14 hospitals, 8 are categorized as “mature” since they began operations prior to 2010, 4 are categorized as “new”, and 2 were “acquired” in 2015.

MHC generated INR21B net revenues in FY16 with EBITDA margins of 10.2%. Mature hospitals generated INR13.6B, new hospitals INR5.5B, acquired hospitals INR1.9B. EBITDA margins were 14.0%, 3.5%, and 3.0% respectively. The hospitals located in Saket (prime location in wealthy part of South Delhi) and Patparganj (East Delhi) are the crown jewels for MHC accounting for 53% of overall revenues and 71% of overall EBITDA but just 40% of overall beds.

Max Healthcare (MHC) is fundamentally an attractive long-term business

Hospitals are long-gestation businesses requiring high upfront capex in land/infrastructure which takes many years to recover. But once successfully operational they are 50+ year operating assets with high free cash flows and returns long-term (>100% FCF / Net Income, ROCE > 25%).

MHC enjoys a strong reputation / brand name, is geographically concentrated in the wealthy, high-growth NCR region where demand exceeds supply and land for new hospitals is next to impossible to come by (creating an extremely high barrier to new competition), 60% of revenues are from cash-paying customers, and MHC’s capacity growth going forward is brownfield not greenfield so less execution risk given management’s execution track record in existing locations.

From an industry perspective, healthcare is a vastly underserved market in India (9 hospital beds per 10k people vs. 23 in Brazil and global average of 30) in which demand far outstrips supply creating a market that continues to grow rapidly (estimated 22% industry growth over next 5yrs). Barriers to entry are high (finding land, capex) particularly in the top 4 cities, customer bargaining power is low (since mostly cash-paying individuals), there are no substitutes, competitor rivalry is not intense given demand > supply (all operate >70% occupancy), regulation should not be a huge constraint as the gov’t recognizes the need for investments in healthcare (despite the commentary from politicians). Doctor’s have some bargaining power given they are in short supply, but this should ease somewhat as the # of medical college students has doubled over the past 8yrs in India (source: Medical Council of India).

MHC should grow revenues 15-20% p.a. until FY20, driven by:

•  ~4% p.a. organic expansion of bed capacity as MHC plans to add 424 beds at “new” and “acquired” hospitals.

•  4-5% p.a. direct price hikes at all hospitals in line with inflation.

•  4-5% from inorganic expansion: full year consolidation of revenues from the hospitals acquired in FY16 (Vaishali & Saket City), and turnaround of these hospitals (currently at only 60% of the revenues generated by the neighboring existing MHC hospitals on a like-for-like basis).

•  ~3% from operational improvements via mix shift towards more profitable international / walk-in customers, increased mix of super specialties, and improvements in occupancy.

MHC should improve EBITDA margins ~600bps by FY20 driven by:

•  ~430bps from fixed cost leverage in employee expense, indirect overheads and head office expense.

•  ~160bps from ongoing raw materials cost rationalization program (already reduced 150bps since FY12).

•  ~50bps from reduction in clinicians expense as MHC continue with clinician negotiations (already reduced 330bps since FY12).

Looking at margins by hospital, the above implies (1) mature hospitals improve from 14.0% today to 18.0% in FY20, (2) the new hospitals improve from 3.5% today to 13.6% in FY20, (3) the two acquired hospitals improve from ~3% to ~17% (both hospitals are located very close to existing mature hospitals which operate at ~16% today).

Valuation – base case yields ~100% upside from current share price:

MHC should grow EBITDA at 32% CAGR over next 3yrs. Assuming 25x EV/EBITDA in FY20 , and assuming Max Bupa and Antara are still valued at invested capital yields a target share price of INR280 vs. 140 today for MAX.

-25x multiple seems reasonable since MHC will continue 15-20% revenue growth for many years post FY20 (organic bed capacity additions alone will yield 10%, price hikes another 5-6%), and mgmt believe they can reach 18% EBITDA margins which implies even faster earnings growth. MAX currently trades at 27x, whilst peer companies are: Narayana Hrudayalaya is at 27x (21% revenue / 29% EBITDA CAGR for next 3yrs), Apollo Hospitals is at 24x (16% / 14%).

-Downside is limited in my view – since the price hikes, organic bed additions, and acquisitions give high certainty into at least ~13% revenue growth. Assuming 300bps margin expansion by FY20, and a reduction in multiple to 15x yields 10% downside. 300bps assumes turnaround of the two acquired hospitals (yields 165bps overall margin improvement), Bhatinda breaks even (40bps margin improvement – mgmt say this has already happened), and mgmt improve materials cost by 100bps (they achieved 100bps improvement in FY16 and believe an additional 200bps is still feasible).

-There is potentially ~30% additional upside from Max Bupa. This business is currently loss making and hence the street values this at 1x invested capital (INR4.6B based on MAX’s 51% ownership). Mgmt expect Max Bupa to become profitable in 2018 (FY19), post which they believe valuation could rise to 2-3x invested capital (INR12B – 18B), or 2x revenues (INR5B currently expected to grow to INR12B in 3-4yrs) which implies additional INR45 upside per share of Max India is possible.

Balance sheet: MHC will require additional debt in FY19/20 but interest coverage & ROCE are improving

Heavy capex in FY19 / FY20 as MHC (1) acquire the remaining 51% equity stake in Saket City Hospital for ~INR4.7B (the sale has been agreed – MHC delayed this purchase to avoid taking on excess leverage), (2) acquire the remaining 22% equity stake in Vaishali Hospital for INR1.4B, and (3) start construction of 900 beds in Saket City Hospital which will operationalize in FY21/22 (capex outflow begins 2-yrs prior).

Even though FCF (post maintenance capex) / Net Income is >100% from FY18E onwards, it is insufficient to fund future acquisitions and bed expansion. Hence, MHC will take on additional INR4.5B debt in FY19 and INR 2.8B in FY20 – giving a peak debt of INR18B (currently INR11B). EBITDA / Interest expense is currently 2.0 and will improve to 3.2 in FY20 despite the increased leverage level.

Mgmt have no intention of raising equity capital.

ROCE is currently 5.4% (mature hospitals currently 17%) should improve to 13.3% by FY20 driven by EBITDA margin improvement but offset by the increase in debt. In FY2020 the mature hospitals should achieve 25% ROCE (based on 4% improvement in EBIT margins from 9% to 13% and assuming constant Asset Turnover of 1.9x).

Mgmt team

High standards of corporate governance: professional management team (not promoter managed), highly reputed international business partners, independent directors on Board, diligently manage shareholders, promoter owns >40% and professional MD / Chairman own ~1% through stock options.

Promoter aims to build businesses that are sustainable for the long-term –is not looking for shortcuts or quick wins. This is key in hospitals.

Key Risks / what I am less excited about

-MHC will not generate FCF over the next 4yrs at least given drag from investment in new capacity expansion and acquisition of remaining equity stake in Vaishali and Saket City hospitals.

Why this opportunity exists?

Max India was until recently a conglomerate which held a very valuable life insurance business (Max Life) with a market cap ~4x the remaining businesses combined. Hence the remaining businesses were not given much attention (especially since MHC and other businesses were loss making).

The demerged Max India just listed a few months ago, and currently has no sell side coverage.