Rhoen’s business got a lot of interest last year because of the takeover bid by Fresenius AG (FMS), a major German healthcare group. In April 2012, Fresenius offered to buy Rhoen at €22.5 shares each. The offer was contingent on Fresenius being able to buy 90% plus 1 shares of Rhoen, as required by the bylaws of Rhoen. To block the deal, some competitors (Asklepios, Braun) bought 5% stake each in Rhoen. M&A and arbitrage specialist John Paulson also threw his hat in the ring by buying a stake — hoping for a higher bid. Around the beginning of September, Fresenius announced that it has decided against renewing the bid.
“We decided that our responsibilities and reputations as good stewards and guardians of your capital were more important than the sheer desire to ram this through and teach some of our adversaries a lesson,” said Ulf Schneider, CEO, Fresenius.
The stock price dropped 21% to €14.98, which is near the price where it was trading before the offer (see [Bloomberg]).
The business of running hospitals is very stable and non-cyclical in nature. Patients are generally unaffected by economic turmoil and given that the company operates in the private hospitals — the patients are well to do and the risk of a bill not being paid is small.
Being a small company with €2.8 billion in revenue, Rhoen has (not surprisingly) clocked in an enviable growth rate of 11.3%.
The company is also well managed. It has had very predictable margins, even with the high growth rates mentioned above.
The rise in the share outstanding is due to capital increases to fund acquisition.
The following is the relevant data from the annual report of 2012. We can quickly deduce that the company has no problems in paying its interests.
|Item (€ mn)||2012||2011|
The debt is also too onerous. Nearly €267 million of debt is due this year. This can be covered given that the company has €237 million in cash and it generates €150 million in EBIT. Most probably though, the company will need some cash to run its business and to pay dividend. In this case, the company will look to get money from the capital markets.
Historically, RHK has been able to get money at good terms.
It has already arranged a revolving syndicated credit line in the amount of €350 million with a term running until 2017 replacing the credit line of 2010. This is going to help significantly in terms of paying the debt. The interest rate for the drawn sum is 1.36% p.a. and the interest rate on the undrawn amount is 0.4375% p.a. This is a very good deal for RHK.
From the balance sheet and debt perspective RHK seems comfortable.
The founding family (Münch) owns 12.5% of the shares outstanding. Eugen Münch is the chairman of the board of directors and has significant say in the supervision of the company still.
The return on invested capital has averaged around 8%.
That being said, the company does seem to be using more money than it is generating. The FCF has been negative in the past three years. The positive FCF in 2012 of €37.4 million seems more like a byproduct of not being able to use the excess cash than any realization on the management part to use cash responsibly. On a positive side, the money seems to be being used for acquiring new hospitals and improving revenue. Given that the revenue growth has averaged 11.3% for the last 10 years, I find the negative FCF not too worrying.
|Item (€ mn)||2009||2010||2011||2012|
The management seems to be quite shareholder friendly. They have been paying increasing dividend since 1989! In 2012 though there has been a drop in the graph which looks like an anomaly. See below.
The reduction in the dividend was due to the drop in the net income of the company €1.13 per share in 2011 to €0.65 per share in 2012. RHK’s dividend policy seems to be based on paying less than 40% of the net income on dividends — because they need a lot of cash to grow. The net income declined by €69.1 million or 42.9% because
:The company opened new buildings and extensions (at Giessen and Marburg) during the year 2011 and 2012. This has increased the depreciation and amortization expense, which explains the drop in net income. It is to be noted that the new revenue from these extensions will probably start contributing to profits from this year, increasing the income.
... essentially due to effects at Giessen and Marburg University Hospitals as well as extraordinary effects affecting the result in connection with the voluntary public takeover offer by Fresenius and further consultancy fee.
Risk of litigation by patients.
Risk of changes in law and additional regulation. There has been higher collective wage deals in 2012 and this will not be offset completely by new financing basis for the hospital area. This has increased the operating costs of hospitals throughout Germany.
The revenue risk is limited by the fact that in Germany, state approved hospitals enjoy de facto state regulated protection in their respective areas. Revenue risks exist only when assessment of hospital’s quality by referring physicians or patients turn out to be significantly worse than expected.
There is no currency and transaction risk because the company operates exclusively in Germany.
The new credit facility of €350mn has secured Group’s money problems. As the company hedges its interest exposure, there is no significant interest rate risk in the short and medium term.
In the hospital business, hiring and retaining quality staff is of utmost importance. Historically, the personnel cost ratios run between 50-70% of the revenue.
This is going to difficult given that the company has no history of positive FCF and the dividend has been recently cut — putting a question mark on its reliability. Also, at current prices of €16 a share, the dividend yield is a measly 1.5% which is not much to speak of — after 26.375% German withholding tax.
|Shares outstanding/Price||138 mn/€16.25|
|Market Cap||€2.24 bn|
|Net Debt||€803 mn|
The company has an EV of €3 billion and is selling for 10 times OCF. Following is an attempt to value the company. We start with the current revenue of €2.8 billion and then try to value the company after five years depending on revenue growth, net margin and price multiple the market is willing to pay.
|Revenue (2017)||Revenue Growth||Net Margin||P/E||Price in 5 years||Price now at 10% discount|
|€3.57 bn||5%||5%||10||€1.78 bn||€1.11 bn|
|€4.50 bn||10%||6%||15||€3.375 bn||€2.1 bn|
So, even after putting on the rosy glasses — the company seems expensive to me.
My verdict: Too expensive. Buy after a 30% drop.
Additional disclosure: Data taken from morningstar.com and Rhoen's website. The graphs have been taken from Rhoen's annual reports or made by me using the google spreadsheet tool.