Pieter van der Westhuizen
Group Chief Financial Officer
One of Life Healthcare’s strategic objectives is to accelerate the transition from a South African focused acute care group to an international, diversified healthcare provider. Life Healthcare’s growth strategy has been focused on expanding its complementary services within the South African market while increasing its international exposure.
In line with this strategy, Life Healthcare completed the acquisition of Alliance Medical in November 2016. The Group acquired Alliance Medical for an enterprise value of around GBP780 million (R13.9 billion). The acquisition was initially funded through ZAR and GBP debt bridge facilities, which have subsequently been partially repaid through the successful completion of the rights offer, and the balance is being refinanced via term debt.
The Group’s earnings have been impacted by the one-off items related to the Alliance Medical acquisition and the impairment of the investment in Poland with headline earnings per share down 56.8%.
|Net debt: normalised EBITDA (ratio), debt covenant is <3.5 (2016: 2.75)||4.221||8.24|
|Interest cover (ratio), debt covenant is >5.0||8.0||6.2|
|Capital expenditure as percentage of revenue (%)||4.1||2.2|
|Maintenance capital expenditure as percentage of revenue (%)||3.9||4.0|
|Growth capital expenditure as percentage of revenue (%)||93.9||169.42|
|Normalised EPS (cps)||120.6||179.02|
|Normalised EPS excluding amortisation (cps)||77.4||179.12|
|HEPS (cps)||3 591||3 637|
|EBIT||1 283||1 655|
|Free cash flow|
|Cash generated from operations as percentage of EBITDA, target is >95%||93.2||93.3|
|Normalised EBITDA margin (%)||24.0||26.3|
|1||Waiver consent letters were received from the relevant banks accepting the breach of covenants for a period of 13 months from the Alliance Medical acquisition date.|
|2||Prior year has been amended as a result of a change to the weighted average number of shares, which has been increased due to the rights offer and the related bonus element within the rights offer, in accordance with IFRS.|
Statement of comprehensive income
Summarised Group statement of comprehensive income
|Revenue||20 797||16 404||26.8|
|Normalised EBITDA3||5 001||4 314||15.9|
|EBITA||4 030||3 784||6.5|
|EBIT||3 620||3 660||(1.1)|
|Net finance costs||(1 137)||(500)||127.4|
|Share of associate’s net (loss)/profit after tax||(15)||8|
|Profit for the year||1 119||1 970||(43.2)|
|Profit attributable to ordinary equity holders||814||1 616||(49.6)|
|3||Life Healthcare defines normalised EBITDA as operating profit before depreciation on property, plant and equipment, amortisation of intangible assets, and non-trading related costs and income.|
Revenue and EBITDA
Group revenue increased by 26.8% to R20 797 million (2016: R16 404 million) consisting mainly of a 4.3% increase in southern African revenue to R15 890 million (2016: R15 230 million); R3 812 million new revenue from Alliance Medical and R1 095 million (2016: R1 174 million) revenue contribution from Poland.
Revenue from the southern African operations was driven by a higher revenue per paid patient day (PPD) of 6.3%, made up of a 6.1% tariff increase and a 0.2% positive case mix impact, partially offset by a 1.7% decrease in PPDs. The PPD volume decline of 1.0% reported in the first half of the year was impacted by Easter falling in the second half of the 2017 year, as opposed to the first half of 2016.
The decline of PPDs as at the end of February 2017 and April 2017 was 2.7% with the region impacted the most being KwaZulu-Natal. Post-Easter there has been an improvement in underlying activities, resulting in a full-year decline of 1.7%. Overall lower activity volumes have been due to limited or no growth in the private healthcare market, macroeconomic factors and intensified case management efforts by medical healthcare funders. Within this difficult trading environment, the Group is still experiencing good growth in its complementary services division with revenue growing by 18.5%. The overall weighted occupancy for the year decreased to 70.0% (2016: 72.5%). EBITDA margins for the period declined to 25.5% (2016: 27.5%), primarily as a result of the decrease in activities and changes in case mix.
Alliance Medical performed well against their previous 12 months with revenue increasing by 12.0% to R4 419 million and normalised EBITDA increasing by 11.3% to R1 168 million on a constant currency basis. In the UK, the business continues to benefit from the growth in PET-CT volumes but is experiencing increased competition on the mobile diagnostic business as more capacity is added to the market. The operations in Italy and Ireland performed according to expectations and northern Europe showed good growth on the back of the acquisition of the Life Radiopharma Group (previously Eckert & Ziegler) for R189 million (EUR13 million) in May 2017. This acquisition extends Alliance Medical’s molecular imaging presence in northern Europe and supplements its PET-CT scanning services.
Scanmed’s revenue for the year to 30 September 2017 was R1 095 million (2016: R1 174 million). Normalised EBITDA is significantly below last year with the EBITDA margin reducing to 4.0% (2016: 10.2%) The EBITDA margin excluding one-off items is 7.9%. This is primarily due to the impact of the reduction in cardiology tariffs as promulgated in Poland effective 1 July 2016 (-17%), further cardiology tariff reductions from 1 January 2017 (-11%) in a segment that makes up 45% of Scanmed’s NFZ revenue, and prior year debtor impairments to the value of R43 million. Several turnaround activities are taking place in the business, including major cost savings (such as administrative headcount and third parties’ cost reduction), integration and improvement in operational efficiency. Completion of the system integration with the Life Healthcare process is planned for mid 2018. Scanmed has successfully secured new four-year NFZ contracts, at better pricing, covering 85% of the business. We expect to complete contracts for the balance of the business in the first half of 2018.
Following the acquisition of Alliance Medial, the Group’s amortisation charge increased to R439 million (2016: R147 million) as a result of the R3.5 billion (GBP193 million) fair value uplift on intangible assets, resulting in earnings before interest and tax (EBIT) decreasing by 1.1%.
Max Healthcare reported revenue growth of 8.0% and EBITDA growth of 7.0% for the 12 months ended 30 September 2017. Max Healthcare was impacted by the demonetisation of the currency towards the end of 2016 and the introduction of a number of regulatory changes such as stent and knee implant price caps. To mitigate the regulatory impact, a number of cost efficiency initiatives have been identified totalling Rs93 Cr of which Rs34 Cr was realised in the last six months. The Group, with Max India, each acquired an equal share of the IFC stake at Rs105 per share equating to R428 million. The Group’s shareholding in Max Healthcare is now 49.7% and maintains the equal shareholding status with Max India, thus protecting our shareholder rights. The earnings of this business are impacted by the funding cost, costs of acquisition and development incurred in respect of the business acquisitions. While these operations continue to ramp up, the earnings will be low.
Earnings decreased by 49.6% to R814 million (2016: R1 616 million). The Group’s earnings have been impacted by the one-off items related to the Alliance Medical acquisition, which includes transaction costs of R267 million, and the further impairment of the investment in Poland of R167 million resulting from the further tariff reductions in January 2017.
The net finance costs include R778 million of funding costs for acquisitions, of which R427 million is non-recurring due to the settlement of a portion of the bridge funding via the rights offer. Finance costs from additional debt raised during the year amounts to approximately R190 million.
Southern Africa’s alternative reimbursement model
Life Healthcare receives approximately 65% of our acute hospitalisation through an alternative reimbursement model (ARM). This includes fixed fees and per diems.
Fixed fees: This is a flat rate charged for a course of treatment, usually charged for procedures where the expected course of treatment is highly predictable (e.g. removal of tonsils). In a fixed fee tariff, Life Healthcare bears the risk of cost overruns related to treatment, including the level of care, length of stay (LOS), quantity of pharmaceuticals and surgical supplies utilised, and the price of surgical supplies for the procedure. Life Healthcare is not exposed to price risks regarding the cost of pharmaceuticals as this is governed by the single exit price (SEP) regulations.
Per diems: This is a daily rate charged for facilities used. Life Healthcare is exposed to the risks of specific costs related to treatment, including the quantity of pharmaceuticals utilised, and the price and quantity of surgical supplies used. Life Healthcare has no risk on the LOS or the price of pharmaceuticals governed by the SEP regulations.
Effective analysis and reporting, coupled with 14 years of experience, ensures that all of our reimbursement contracts are managed appropriately throughout the business, and enable us to take advantage of opportunities offered by these arrangements. The ARM continues to aid effective pricing that enables us to share savings with medical healthcare funders.
Earnings per share (EPS)
Headline earnings per share (HEPS) decreased by 56.8% to 77.4 cps (2016: 179.1 cps). Earnings per share on a normalised basis, which excludes non-trading-related items, decreased by 44.6% to 93.9 cps (2016: 169.4 cps).
The earnings per share and headline earnings per share for the year ended 30 September 2016, have been amended as a result of a change to the weighted average number of shares, which has been increased due to the rights offer and the related bonus element within the rights offer, in accordance with IFRS.
Net debt to normalised EBITDA as at 30 September 2017 was 2.55 times (30 September 2016: 1.67 times). The banks covenants for net debt to EBITDA is 3.5 times (2016: 2.75 times). The increase in net debt is primarily due to the impact of the acquisition of Alliance Medical Group that was partially funded via debt.
Consolidated condensed statement of financial position
Capital expenditure and investments
During the current year, Life Healthcare invested R11 957 million (2016: R2 025 million), comprising mainly R9 568 million (net of cash acquired) for the acquisition of Alliance Medical, R428 million additional investment in Max Healthcare and R292 million (net of cash acquired) in new acquisitions by Alliance Medical. The Group invested in capital projects of R1 103 million in southern Africa and R553 million internationally. The Group approved R3.0 billion for our 2018 capital expenditure programme.
Acquisition of Alliance Medical
On 21 November 2016, the Group acquired 93.78% of the issued share capital of Alliance Medical, incorporated in the United Kingdom (UK). This is accounted for as a 100% subsidiary in terms of IFRS. The exchange rate as at 21 November 2016 and 30 September 2017 was GBP1:R17.88 and GBP1:R18.18 respectively. The acquisition has been accounted for in terms of IFRS 3 ‘Business combinations’.
The increase in intangible assets at 30 September 2017 mainly relates to the goodwill recognised of R9.6 billion and fair value uplift of intangible assets of R3.5 billion related to the Alliance Medical acquisition.
The purchase consideration was initially funded through ZAR and GBP debt bridging facilities with the bridge funding partially repaid through the successful completion of the rights offer. The rights offer consisted of 367 346 939 new Life Healthcare ordinary shares at a subscription price of R24.50 per rights offer share.
Adjustments to the management equity are accounted through profit or loss.
Life Healthcare views the entry into diagnostics as a natural part of the Group strategy of diversifying both internationally and into non-acute lines of business. Alliance Medical is one of western Europe’s leading providers of complex molecular and diagnostic imaging services, with strong market positions in the UK, Italy and Ireland, with existing participation in 10 European markets and a platform for expansion. Alliance Medical is unique in western Europe in terms of its vertically integrated model providing services across the molecular imaging value chain ranging from radiopharmaceutical production to scanning services provision and results reporting.
Benefits of the acquisition
The acquisition of Alliance Medical accelerates both Life Healthcare’s expansion of its complementary services business, adding diagnostics to mental health, acute rehabilitation, renal dialysis and oncology and geographic diversification, firmly positioning Life Healthcare in a strategically important high-growth business. Non-acute care revenue is now 27.6% of Group revenue (2016: 11.0%). International revenue as a percentage of Group revenue is now 23.6% (2016: 7.2%) and international normalised EBITDA as a percentage of Group normalised EBITDA is 19.0% (2016: 2.8%). Alliance Medical has a strong and highly complementary management team with broad healthcare experience to help support Life Healthcare’s international growth.
This increase in net debt is primarily due to the R14.6 billion raised in respect of the Alliance Medical acquisition, of which R8.8 billion was repaid with the net proceeds received from the rights offer.
The decrease in the weighted average cost of debt is largely attributable to the debt raised and brought on as a result of the Alliance Medical acquisition. The interest rates in the UK are lower than those in South Africa; as the Group grows internationally the debt raised will be aligned to where the earnings are generated and this will bring down the Group’s weighted average cost of debt.
The Group produced good cash flows from operations, and continues to anticipate positive free cash flow. The overall net cash inflow position of the Group is positive as a result of the related bridge loan funding raised for the acquisition of Alliance Medical and due to the rights offer proceeds that occurred in April 2017.
The Group’s dividend policy is to pay a progressive dividend that takes into account the underlying earnings and available funding of the Group both in southern Africa and internationally, while retaining sufficient capital to fund ongoing operations and growth projects as well as manage gearing to acceptable levels.
In considering the dividend, the board has considered the impact of the rights offer, the one-off acquisition costs and the higher debt levels.
The board has declared a final distribution for the year of 45 cps (2016: 92 cps). It takes the form of fully paid Life Healthcare Group Holdings Limited ordinary shares or through a cash alternative. The scrip distribution, with the elective to receive the cash dividend, allows the Group to use the cash saved through the programme to support growth plans.
This gives our shareholders the opportunity to increase their shareholding in the Group and provides flexibility for those who would prefer to receive a cash dividend. The scrip distribution will be at a discount of 2.5% of the 15-day volume weighted average share price ending on 20 December 2017.
Pieter van der Westhuizen
Group Chief Financial Officer