Event update: Apollo Hospitals (Outperformer) - Initiates restructuring of Standalone Pharmacy business

Event

• Apollo Hospitals (AHEL) has initiated restructuring of its Standalone Pharmacy (SAP) business

Key highlights

• Apollo (AHEL) also initiated the process of value unlocking in the SAP business. The process is constrained due to the foreign holding norms governing the retail business. Therefore Apollo has sought to create a regulatorily compliant structure for its SAP business.
• The retail front-end portion of the business is transferred through a slump sale to an entity APL (Apollo Pharmacy Ltd). The consideration is fixed Rs5.27bn. APL is 100% owned by entity called APML.
• 74.5% of APML will be owned a group of 3 domestic institutions while the balance 25.5% will be held by AHEL
• AHEL will continue to run the back-end operations as it does currently and will be the sole supplier of goods to APL. ~85% of the combined revs will continued to be captured in AHEL
• The scheme is so designed that APL will make 1-1.2% EBITDA on SAP sales and the balance economic interest will reside with AHEL. So effectively, AHEL will continue to capture bulk of the incremental EBITDA margin improvement going forward
• AHEL has an option to buy out the stake from the investors at a later date. It can choose to the exercise this option when the FII / FDI norms in the retail business change.
• At current revenue run-rate, SAP FY19 sales are projected to be ~Rs40bn implying EBITDA of Rs400m; In terms of EV/EBITDA, the implied valuations for APL are ~13x EBITDA FY20e
• Mgt indicated that the share of cash flows in APL will be lower at ~10% of overall cash flows given that the entire front-end capex will be undertaken by APL. Therefore, on a cash flow basis, ~Rs5.27bn represents ~10% of the value of the overall SAP business effectively valuing SAP at a value of ~Rs53bn or so. This is in-line with our valuation for the SAP business – Pls refer our detailed note

Valuations and view

This restructuring exercise is just the commencement of value unlocking process in the SAP business. It will take sometime to play-out completely. It will not lead to any meaningful changes in the AHEL’s consolidated EBITDA profile so it is pretty neutral from an earnings perspective.  As a starting point, this exercise provides a benchmark for valuing the SAP business and enhance market’s focus on this segment of AHEL business. Subsequently, AHEL can explore comprehensive value unlocking options in SAP business, when the retail FDI / FII norms change. Maintain Outperform on AHEL with TP of 1483. Top healthcare services pick.