Narayana Hrudayalaya IPO: Too high “scarcity premium”

Bengaluru-based Narayana Hrudayalaya Limited, which specializes in the treatment of heart diseases, is coming with its initial public offering (IPO) on 17 December. In its red herring prospectus (RHP) filed with SEBI, the company said the IPO will involve sale of 24.52 million shares. Price band of the offer is set between INR245-250. Narayana Hrudayalaya IPO received the regulatory approval to bring the public offer early this month.

Read also: SEBI approves Narayan Hrudayalaya IPO

According to the prospectus, Narayana Hrudayalaya IPO will only comprise of offer for sale (OFS) and thus, the company will not receive any proceeds from the public issue.

The Devi Shetty-promoted company has a strong track record in providing quality medical treatment at affordable rates and this history has won it a number of impressive investors. These include JP Morgan, CDC Group, and Kiran Mazumdar Shaw.

Issue Details

OFS issue, no fresh shares

We are not fans of OFS issues as the parent company gets nothing but surprisingly, all major healthcare issues this year have been offers from existing shareholders. This also includes Biocon’s Syngene International which rewarded investors with excellent returns. Similarly, recently-concluded Alkem Laboratories and Dr Lal Path Labs were both OFS issues but scored well with investors.

JP Morgan Yes, CDC No

Some of the existing investors in Narayan Hrudayalaya including JP Morgan, Ambadevi Mauritius, Ashoka Holdings, Dr. Devi Prasad Shetty, and Shakuntala Shetty will be selling their shares. The biggest chunk of shares will be offloaded by JP Morgan which plans to sell 12.26 million shares. JP Morgan currently holds 10.67% stake which is expected to come down to 4.67% following the offer. Ashoka Holdings plans to sell 6.28 million shares while 2.04 million shares will be offered by Dr. Devi Prasad Shetty and Shakuntala Shetty each. Nearly 1.88 million shares will be offered by Ambadevi Mauritius Holding.

Following an investment in December 2014, CDC Group is another private equity investor in the company with 5.76% stake while Kiran Mazumdar Shaw also holds 2.3% equity stake. Separately, CDC India Opportunities Limited (CDC IOL) also holds 2.13% stake in the company which has acquisition price of INR244.67 per share. Neither CDC Group nor Kiran Mazumdar Shaw will be participating in the Narayana Hrudayalaya IPO. CDC IOL’s shares are not available for sale until 30 November 2016 but no such restrictions apply on holdings of CDC Group and Kiran Mazumdar Shaw. It is interesting to note that CDC Group’s cost of acquisition is INR170 per share which indicates a notional return of 44.1% on its year old investment. We like that CDC Group and Kiran Mazumdar Shaw are not diluting their positions.

Business background

Narayan Hrudayalaya operates India’s third-largest hospital chain under Narayana Health brand. As on November 2015, the company had a network of 23 hospitals, 8 heart centres and 24 primary care facilities with 5,442 operational beds, The network is spread across a total of 31 cities, towns and villages in India. While it has been traditionally strong in Karnataka and Eastern India, the network is growing in western and central India as well now. Over the next 12 -24 months, the company aims to start operations at new facilities in Vaishno Devi, Mumbai, and Lucknow.

Financial Performance

While there are absolutely no questions about the strength of the Narayan Hrudayalaya brand, it needs to be seen how it stacks up in terms of financial performances. Narayan Hrudayalaya doesn’t disappoint with top line growth and has almost trebled its revenues in the last five years. This is not surprising as several new centers came up during the timeframe.

As a result, the company’s operating performance takes centerstage in the review. Except the loss in the latest year, the general trend has been that of increasing profits. However, that is attributable to a rising top-line which makes the analysis a little complicated. Apart from being on the lower side, the company’s net margin has been inconsistent and dipped in the red in FY2015, as higher professional fees to doctors and loss-making operations in Cayman Islands took toll on the overall performance.

Thankfully, Narayana Hrudayalaya has performed better in the six months ended September 2015 with profits of INR124.8 million, resulting in a margin of 1.6%.

Low margins – a deal breaker?

Not really! While these margin levels are hardly encouraging, let’s not forget that healthcare is a cash rich business and Narayan Hrudayalaya has an impeccable record with cash flows. While we are not exactly enthusiazed by the financial performance but this observation comes with the obvious understanding that it is a long term story.

Narayana Hrudayalaya IPO also makes sense for investors considering the limited investment options available in this space. This demand-supply mismatch was one of the factors behind the massive subscription of public offers by Alkem Laboratories and Dr Lal Path Labs. A positive in OFS issues is that earnings are not diluted following the offer. With Narayan Hrudayalaya, we are glad to see that controlling shareholders – Devi Shetty and Shakuntala Shetty – will continue to hold more than 62% equity stake. High promoter shareholding ensures that promoters have skin in the game and their objectives are aligned with that of retail investors.

In terms of valuation figures, investing in Narayana Hrudayalaya IPO is not advisable. Since the company posted a loss in the latest year, six month performance is a better fit for the valuation exercise. At the higher end of the price band, the company is asking for a valuation of 201 times its expected earnings for FY2016. This is too high considering 59 times for Apollo Hospitals which is much bigger a player than Narayan Hrudayalaya. Apollo Hospitals also beats Narayan Hrudayalaya on the “return on net worth” front with 10.7% compared to -1.4%  for the latter.

However, an apple to apple comparison isn’t possible since Narayan Hrudayalaya is very much a “work in progress” while Apollo Hospitals is a bigger franchise with capacity to absorb lot of pain. It is also worth highlighting that Fortis Healthcare – another industry peer – is trading close to its 52-week high levels despite being in losses.

While it is difficult to get comfortable with valuations, an investment decision in Narayana Hrudayalaya IPO has to be necessarily a call on Devi Shetty.