Description

Company specific issues, industry headwinds and mid/small cap carnage in the Indian equity markets have combined to make an investment in Max India at today’s price a compelling proposition. I believe now is the time to buy – the company is showing real signs of operational improvement which has perhaps gone unnoticed due to the lack of sell-side coverage, general market weakness and convoluted corporate structure. There has been potential insider buying at much higher levels, the management/promoters are clean and competent, the underlying businesses are good/growing and the current corporate structure effectively guarantees a set of corporate actions to unlock value in the coming years.

Uuh00 wrote up MAXI in February year, and I would recommend reading that post for background on the situation. There have been some significant developments since then (not least the price, which is now ~40% lower). I do not intend for this write-up to be a deep dive on the business model (Uuh00’s write up addresses the key characteristics of the business model, so does the annual report), but rather the reasons why I believe the stock is a compelling bargain today.

1/ Quick background:

MAXI is a spin-out from a conglomerate that held several businesses; the most valuable of which was a life insurance business (MAXF IN) which today has a market cap of INR 110bn vs MAXI market cap of INR 18bn. Note, there was also another tiny spinoff (MVIL IN) which is interesting in its own right.

MAXI owns and actively manages a 49.7% stake in Max Healthcare (“MHC”, the core hospitals business), a 51% stake in Max Bupa Health Insurance (currently loss making but potentially very valuable and growing fast) and a 100% stake in Antara Senior Living (insignificant in the larger scheme of things).

2/ The valuation today is a mathematical no brainer:

Kohlberg Kravis Roberts (KKR) announced the acquisition of a 49.7% in the hospitals subsidiary (MHC) of MAXI two months ago (September 2018). KKR’s price for MHC, at INR 80 per MHC share, implies an equity valuation of INR 43bn for MHC. MAXI owns 49.7% of MHC; which implies MAXI’s stake is worth INR 21.4bn vs. today’s market cap of 18bn. One could reasonably argue that KKR got a bargain given the seller (Life Healthcare of South Africa) wanted to exit the Indian market for strategic reasons and wanted to get a deal announced quickly (before their fiscal year-end in September). The previous minority stake sale in MHC was done in May 2017 at a price of INR 105 per share, implying a valuation of INR 56bn (i.e. MAXI stake value of INR 28bn). That transaction saw International Finance Corporation (IFC) sell 7.5% in MHC to MAXI and Life Healthcare (with both acquiring 3.75% stake each).  

 I am not sure how the valuation of INR 43bn for the latest transaction was derived, but it looks to me to be ~20x EV/EBITDA multiple on a depressed EBITDA of FY19 (March year-end). Most Indian (indeed Asian) hospitals trade at 16-25x EBITDA multiples, given the long and predictable run-way for growth and decent normalized return ratios. Recent hospital deals in India (Fortis being the most high profile case) have been done at similar multiples (18-25x).

 There is no debt at MAXI level (in fact it has ~INR 3bn in cash). Therefore, at today’s price, you are getting a chance to buy an asset at 15-20% discount to a potentially depressed price that KKR paid, and you get the insurance business, the senior living business and the HoldCo cash for free (all of which KKR doesn’t get). If I went to the owners today and asked to buy-out the company at INR 68 per share (today’s price), I would be laughed out of the room.             

3/ The insurance business is valuable today, and potentially very valuable over time:

 Max Bupa (JV with Bupa UK) is an excellent, fast growing, retail oriented health insurance firm. It is expected to be slightly loss making for the coming 2-3 years. The company is growing its Gross Written Premium (GWP) at ~30% run-rate, which should see GWP grow to INR 17-20bn by FY21/FY22 (vs. 8.5bn today). Health insurance is hugely underpenetrated in India and (in my opinion), it makes perfect sense for MAXI to aggressively grow this business at a slight loss for the coming 2-3 years. Max Bupa has recently signed up distribution agreements with some high pedigree retail banks (e.g. HDFC Bank, india’s premier private sector bank) – the fruits of these upfront investments will appear in the coming years.

 General insurance companies in India (e.g. ICICIGI IN) trade at 2.5-3.5x GWP. I would argue a fast growing, profitable, retail oriented health insurer should get a multiple in the higher end of that range but even if we take 2.5x GWP at 17bn GWP in FY21 – that would imply an ~INR 43bn equity value of Max Bupa. MAXI’s 51% stake would be worth ~INR 22bn, or INR 82 per MAXI share (i.e. this subsidiary is potentially worth more than the current market cap).

3/ MHC itself is potentially worth a lot more than what KKR paid – normalized EBITDA (FY22 or FY23) is 2.5-3.5x higher than FY18 EBITDA

 The company faced significant industry and company specific headwinds in FY18 and FY19 - most significant being (a) political interventions to cap the price of certain healthcare products and procedures, (b) a high profile, tragic case in one of their hospitals which caused public uproar (although unfortunately the case is far from unusual in Indian hospitals) which led to a temporary shutdown in one of their main hospitals, possibly as a political stunt by the local ruling party (the hospital, Shalimar Bagh, is now up and running again). Revenue growth fell from 20%+ run-rate to 9% in FY18 and FY19 is likely to be flattish (note no negative growth despite the headwinds). More importantly, margins fell from ~11% in FY17 to 8% in FY18 and below 5% in the Jun 2018 quarter. Management has proactively implemented several initiatives to improve margins and get growth back on track and have called FY18 and FY19 the years of transition. They are seeking to insulate the business from further regulatory interventions have taken some upfront margin dilutive actions in this regard, to get “in front” of the problems.

  The latest guidance is that the business should get to ~15% EBITDA margin levels by FY22 or so (this margin level has been achieved in mature hospitals already (East Delhi Complex) and is within industry range). Note that Sep Q EBITDA margins are already back to 9.6%, and October month is running at 11%+ (mgmt. comment in conf call). Assuming 12% revenue CAGR in FY20-FY22 and 14.5% margin implies INR 5.7bn EBITDA in FY22 vs FY18 EBITDA of INR 2.2bn. Applying an industry multiple of 18x to that implies: ~INR 100bn EV, INR 80bn equity value and MAXI stake value of ~INR 40bn (i.e. more than double the market cap today).

4/ Good quality promoter group and professional management and potential insider buying                 

 Max Group has been a significant value creator over the years, and tends to treat minority shareholders fairly. MAXI is professionally run, with top-quality management, reputed JV partners and an independent board. Promoters own ~41% and have an option of exercising warrants at INR 154 per share (vs. current price of 68) for a further 4%. The warrants were priced almost 18 months ago when the stock was much higher and the company needed some cash infusion to buy the 3.5% stake in MHC that IFC sold. A warrants issue in India requires 25% upfront payment. The promoter needs to decide whether to exercise the warrants in December 2018 (when they expire), which would take their stake to ~45% from 41%. Since the dilution is “only” 4% and perhaps will not happen given the current share price, I have not used a diluted share count in my calcs (I use 268m shares).

5/ Why does this opportunity exist?   

Some fundamental reasons, and some totally non fundamental reasons. Possible reasons:

A/ The market got spooked by the regulatory headwinds, the hospital closure and margins falling off a cliff.

B/ Some people also do not like the continuing tolerance of the insurance losses.

 C/ The corporate structure doesn’t help (the official quarterly reporting of the HoldCo is a joke, given the numbers are not consolidated in the reporting. The only way to get the proper quarterly numbers is through the company presentation and conf. call

 D/ No serious sell-side coverage (and usual spin-off lack of interest and shareholder base)

 E/ Indian market regulator (SEBI) introduced new guidelines for mutual fund ownership (e.g. large cap funds not allowed to own small caps etc.) which potentially caused further selling in MAXI (and other Indian small/midcaps). Furthermore, DSP Blackrock MF owned a decent chunk of this (~2%) and is now completely out. It may or may not have to do with the fact that their CIO left and MAXI was “his” pick. In any case, there has been a significant churning of the shareholder base in the past year or so (stock is down 60%+ from top).

 F/ The average Indian stock in the broader markets (top 1200 by market cap) is down ~40% from its 52 week high… and that is only in INR terms. The currency has also depreciated 15% this year. There has been real pain in the broader markets… so even cheap stocks have got cheaper.  

5/ Corporate action in the coming years is almost inevitable

I think the management understands that there can be significant value unlocking by simplifying the corporate structure. KKR has probably come on board at MHC with an “exit event” in mind in the coming years, which could be a spinoff or IPO of the business. Likewise, a spinoff of or sale Max Bupa once it becomes profitable is seemingly inevitable if they want to unlock the full value. Given the corporate action history of Max group – it is reasonable to believe that they know all this and will take actions to maximize shareholder value (they are the largest shareholders). In a best case scenario, Max India ceases to exist in 3-5 years, with MHC and Max Bupa listed separately and valued properly by the markets.

 6/ I believe the stock is worth INR 200-275 in 3-4 years’ time

The stock is clearly undervalued even by today’s depressed operating metrics. However, with reasonable growth assumptions and normalized profitability, the stock is severely underpriced if looked at from a 3-4 year perspective. My base case valuation (~FY22):

A/ MHC equity value to MAXI: INR 40bn (assumptions: 12% CAGR FY20-22, 14.5% EBITDA margin, 18x multiple, INR 22bn MHC level net debt vs 12bn today)

B/ Max Bupa value to MAXI: INR 22bn (assumptions: 30% GWP CAGR till FY21, 2.5x valuation multiple)

C/ Antara and HoldCo cash valued at zero: Antara book value is around INR 2bn. HoldCo cash will be used to finance MHC growth and fund Max Bupa losses.

 D/ With 268m shares outstanding, that gives me a 3-4 valuation of MAXI at INR 225-250 per share (3.5x vs today). I see significant margin of safety here, even if some of these assumptions end up being too bullish (clearly, as things stand, I think they are reasonable).

Catalyst

Corporate actions in the coming years to unlock value and/or simplify the structure (spinoffs or IPOs of subsidiaries)

Operational improvement 

Insiders exercising warrants