It might be worth getting a second opinion of stalwart investment company Remgro after the market cast a jaundiced eye across the interim numbers posted by Mediclinic International, its 44.6%-held private hospitals subsidiary.
Since the initial euphoria died down around Mediclinic securing a primary listing on the London Stock Exchange (LSE) — via a reverse takeover of hospital group Al Noor — sentiment for the shares of the enlarged private hospitals conglomerate has looked vulnerable. In three months Mediclinic lost more than 30% of its market value on the JSE. After the release of interim results last week, the share dropped almost 10% in one day.
Understandably, Remgro’s shares on the JSE have been dragged down by developments at Mediclinic. In the end-June financial results Mediclinic accounted for a chunky 44% of Remgro’s intrinsic value of R158bn.
While existing Remgro shareholders will probably be spooked by the market’s harsh prescription on Mediclinic, prospective Remgro investors might well take encouragement from developments.
At this point, however, watching and waiting at Remgro might be the most prudent remedy, with market watchers’ initial jittery reaction even giving way to paranoid speculation.
Remgro doesn’t get much wrong in terms of its big deal-making endeavours (though some may disagree about RCL Foods) and its portfolio pain has been limited to manageable messes such as Sage, Xiacom, Trans Hex and Nampak.
Most market watchers will also agree Remgro has a great track record of allocating capital — albeit generally with an air of caution.
Mediclinic, on paper, does appear to be different. Remgro has aggressively backed the company’s acquisition forays in recent years by underwriting rights issues.
It also took significant debt on board to back the reverse takeover of LSE-listed Al Noor group (which operates mainly across the Middle East).
Most readers probably won’t recall when last the usually cash-flush Remgro held significant debt on its balance sheet. At the end of June, Remgro’s debt-at-centre sat at almost R16.5bn. Now, that’s certainly not a frightening gearing level — not with Remgro’s investments strongly cash-flow generative and its earning more than R3.5bn in dividends.
But Remgro would not want to push up gearing significantly, as this would arguably limit deal-making endeavours that would move the needle in the investment portfolio.
That probably explains why Remgro — with a good chance of snagging SABMiller’s large stake in liquor subsidiary Distell — recently took the unusual step of raising R9.3bn of fresh capital in an attractively discounted rights issue.
Remgro’s commitment to new-look Mediclinic — which now spans operations in Switzerland, SA and the Middle East, and has a 29% stake in UK-based private hospitals group Spire — is not open to question. In March Remgro completed the placement of £350m in bonds, due in 2021, that are exchangeable into Mediclinic shares.
The bonds pay a coupon rate of 2.625%, but the initial exchange price for the bonds is £11.3086/share, which is nearly 33% higher than the ruling share price on the LSE.
Remgro has, literally, put its stock on the block to support Mediclinic in its global endeavours. But Mediclinic’s underwhelming interim showing prompts questions over whether Mediclinic has not done too much too soon.
If the interim results are unpacked, it’s clear that the Swiss operations are chugging along steadily, but the SA and the Middle East operations have had some hitches.
In SA, profits were hampered by local margins, and pressured by pharmacy inflation, salary increases and the creation of additional clinical positions.
The salary increases require some explanation in that personnel costs were put through three months earlier to align the SA operations with the other operating segments of the group. This is important to note in the context of a 5% drop in underlying earnings to R596m from the local private hospital network.
But there’s no disputing that the performance from the Middle East operations under the enlarged Al Noor group — albeit signalled in trading updates — has turned the stomachs of many investors.
A combination of operational and regulatory factors in the United Arab Emirates (UAE) hit profits from the Middle East operations. These included, specifically, the introduction in July of co-payments on health insurance for UAE nationals living in Abu Dhabi, a large number of doctor vacancies and, perhaps most worrying, a delay in opening the Al Jowhara Hospital.
Underlying earnings from the Middle East operations were down 39% to £76m, with inpatient and outpatient numbers down slightly.
The performance from the Middle East is so disappointing that some market watchers have questioned whether Remgro and Mediclinic were not overly hasty in chasing down Al Noor. Predictably, there were even suggestions that Remgro and Mediclinic may have missed certain key details in the due diligence because the deal was really focused on securing a primary listing on the LSE.
Remgro CEO Jannie Durand stresses that a key factor like the co-payments on health insurance was not in the frame when the due diligence was undertaken at Al Noor.
"No-one saw the surcharge issue. It was a bad trading period, but strategically the Al Noor deal was the right thing to do," he says.
Indeed, a simple matter such as a more robust oil price could make Al Noor’s longer-term prospects look a lot rosier.
Mediclinic CEO Danie Meintjes also argues that the Al Noor integration process is progressing well and remains on track to deliver annualised cost synergies of 75m dirham (R274m) from the combined Middle East platform.
However, the bottom line is that, from a Remgro perspective, a lot has changed in the portfolio balance since the release of the results for the year to end-June.
The Mediclinic stake was worth almost R70bn at the end of June, but now carries a value of closer to R45bn. This has implications for the composition of the portfolio, with Mediclinic now representing less than 30% of the intrinsic value.
Punters may prefer this balance, which means there’s more value flavour to Remgro’s other large investments like RMB/FirstRand, RMI, Distell, RCL Foods and Unilever.
What’s more critical for investors is that, by the Financial Mail’s calculations, the discount to an updated intrinsic value is shifting closer to 20%.
That’s an attractive level for prospective investors, as Remgro has been inclined to trade at a much narrower discount in the past 18 months.
The billion rand question is whether the Mediclinic share price has already priced in lingering pain at Al Noor, or whether there might be some more remedial action needed before sentiment heals properly.
There might well be a propensity for market overreaction now that Mediclinic has a primary listing on the UK. Deviating ever so slightly from earnings guidance — which major offshore investors tend to hold dearly — can result in sentiment evaporating quickly. Local investors might be more stoic, knowing Remgro’s reputation to invest for the longer term and not be panicked by setbacks. This is a situation to keep close tabs on during the weeks ahead.