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Event update: Apollo Hospitals (Outperformer) - Receives regulatory approvals for insurance stake sale; paves way for pledge/debt reduction

Event

Apollo Hospitals has announced receipt of all regulatory approvals for stake sale in Apollo Munich Health Insurance business

Key highlights

• Apollo has announced receipt of approvals from CCI, RBI and IRDAI. Post these approvals, the deal is now expected to close next week with the fund  to promoters / company likely over 15 days
• This should enable promoters to meaningfully reduce pledges and for Apollo to also partially trim its debt during Jan’20 itself
• Mgt has guided that the promoter net fund proceeds (~Rs12bn) from the transaction will be almost entirely be used to reduce pledge; we estimate residual promoter debt of Rs4-5bn post this transaction with 20-25% (~67% currently) of shares being pledged thereafter
• Apollo Hospital should be able to reduce its net debt by ~Rs3bn or so. Current net debt levels is Rs34.2bn as of Sep19
• Overall, with the closure of the pharmacy front-end stake sale transaction over next couple of months, company net debt should reduce by ~Rs6bn during Q4FY20
• Overall, these events will remove a significant overhang on the stock and bring the focus entirely back on business issues. Business remains on a fairly strong footing across all segments with steady improvement across all business segments over the last 8 quarters or so.

Apollo Munich stake sale transaction – an overview

• HDFC Ltd is acquiring 51.2% stake in Apollo Munich (Health insurance JV). HDFC Ltd will pay ~Rs16.3bn to shareholders towards the stake buyout. This transaction happened at ~1.5x Gross written premium - ~50% premium to the recent Max-BUPA stake sale transaction.
• Apollo Group will entirely exit the JV as part of this transaction. Apollo promoters own 40.8% of the JV with Apollo hospital (AHEL) owning ~10%. Employees own the balance 0.4% of the stake that’s being transacted. Munich will continue to hold its 49.8% stake in the new entity.
• As part of this transaction, Munich Health Germany will also pay a further Rs2.94bn to AHEL and Apollo Energy Ltd to support the transaction
• Therefore the total proceeds from the transaction to AHEL and Apollo promoters are ~Rs19.3bn – AHEL will receive ~Rs3bn of these proceeds with the balance Rs16.3bn going to the Apollo promoter group.
• AHEL will utilize the cash towards lowering overall debt in the business; current net debt is ~Rs34.2bn as of Sept-19
• As indicated, Apollo promoter group will utilize a significant proportion of their proceeds (net of taxes) to reduce their pledged shares.

o   Apollo promoters have 34% shareholding in the firm with 20% being held by the family holding company.

o   Mgt / promoters indicated that the shares have been pledged to initially generate funds to buy Apollo hospital shares between the 2008 to 2012 time period and to make the initial promoter equity contribution in Apollo Munich – the Health insurance venture where promoters own ~40% stake. The investment in Apollo Munich has turned out to be a pretty good investment for the promoters as it has scaled up well in a fast growing health insurance industry.

• Currently, ~67% of the promoter shares are pledged against outstanding debt of ~Rs16-17bn. We expect the pledges to be at ~20-25% post the completion of the transaction with an outstanding debt of Rs5bn or so. This is in-line with management guidance on this issue

Closure of the transaction and likely pledge share reduction will significantly reduce investor concerns on this issue (a key investor concern in recent times) and keep the focus on business aspects

Valuations & view

With its leadership position, national footprint and a multi-pronged healthcare delivery model, Apollo is a strong EM healthcare model. Apollo’s recently concluded big ticket expansion has created a strong growth platform. Post a long weak earnings phase, earnings recovery is visible from last 8 qtrs now. Led by sharp improvement in Navi Mumbai unit, the new hospital cluster has begun to contribute positively and the existing hospital profitability has also started to inch up steadily. While the Standalone Pharmacy (SAP) business will sustain its 20%+ EBITDA growth, sharp turnaround in AHLL will further aid consolidated profitability growth. We estimate EBITDA growth to bounce back to 18% CAGR over FY19-21E. Mgt guidance indicates potential for upsides to our estimates. Maintain Outperformer with a SOTP price target of Rs1738. One of our top picks in healthcare services space.