As­cendis Health

A thor­ough ex­am­i­na­tion

Financial Mail - Investors Monthly - - Front Page - Nigel Dunn

As­cendis Health fell 77% in 2018, one of the worst-per­form­ing shares on the JSE. Were there signs of im­pend­ing trou­ble? If so, what were they?

As­cendis Health is an SAbased in­ter­na­tional health and well­ness com­pany. Founded in 2008 and listed on the JSE in Novem­ber 2013, the group has sup­ple­mented its or­ganic growth by buy­ing com­ple­men­tary busi­nesses.

Since 2015 it has ac­quired four busi­nesses in Europe: Far­malider in Spain (phar­ma­ceu­ti­cals and over-the-counter medicine); Remed­ica in Cyprus (generic phar­ma­ceu­ti­cals); Scitec in Hun­gary (sports nu­tri­tion); and Sun Wave Pharma in Ro­ma­nia (nu­traceu­ti­cals).

The largest Euro­pean ac­qui­si­tions were Remed­ica and Scitec, cost­ing about €500m.

This anal­y­sis of As­cendis re­lies on re­turn on as­sets man­aged (Roam), the cap­i­tal struc­ture of the group and the re­turns gen­er­ated thereon.

Roam is de­rived from two ra­tios: Earn­ings be­fore in­ter­est and tax (Ebit) margin; and as­set turnover (ATO).

Roam has al­most halved, to 6% from 11% at its peak in 2015 (Fig­ure 1). Ebit margin has been con­stant around 12%-13%, 2016 be­ing the ex­cep­tion (Fig­ure 2). ATO has al­most halved from its 2015 peak. Given the limited com­pres­sion in margin, the con­clu­sion is that the in­crease in the bal­ance sheet has not been matched by an in­crease in earn­ings (Fig­ure 3).

Many in­vestors fix­ate on earn­ings and earn­ings growth (in­come state­ment), ig­nor­ing the health of the bal­ance sheet, in essence the en­gine of the busi­ness. Roam is a sim­ple ra­tio that ad­dresses that.

Re­turn on eq­uity (ROE) and re­turn on in­vested cap­i­tal (ROIC) paint a pic­ture of a busi­ness strug­gling to earn an ac­cept­able re­turn, be it on share­holder funds or the to­tal cap­i­tal in­vested in the busi­ness: 4% and 2% re­spec­tively (Fig­ure 4). This af­firms what the de­te­ri­o­rat­ing ATO shows: the group over­paid for ac­qui­si­tions. The falls in the two ra­tios also flag a group whose cap­i­tal struc­ture has de­te­ri­o­rated at both the debt and is­sued share cap­i­tal level.

The debt/eq­uity ra­tio, sharp in­crease in shares is­sued and poor re­turns con­firm a group with a de­te­ri­o­rat­ing cap­i­tal struc­ture, with a con­comi­tant in­crease in risk. The debt/eq­uity ra­tio is close to 100%, while the num­ber of shares in is­sue has in­creased by 150% since 2013. The group bor­rowed heav­ily to fund ac­qui­si­tions, par­tially sup­ple­mented by two rights is­sues: R1.2bn in 2016 at 2,200c per share, which was heav­ily over­sub­scribed; and R750m in 2017 at 2,000c per share, which was not fully sub­scribed for, some in­vestors hav­ing doubts then (Fig­ure 5).

As­cendis high­lights the dan­gers of fix­at­ing on Ebit, or the more com­monly used earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion. In­ter­est paid and de­pre­ci­a­tion/amor­ti­sa­tion are costs in­curred in op­er­at­ing a busi­ness. De­pre­ci­a­tion and amor­ti­sa­tion are not a cash charge, but need to be ac­counted for, so pro­vi­sion is made in the ac­counts to re­place as­sets at the end of their use­ful lives.

Com­par­ing Ebit with the earn­ings be­fore tax margin shows a dif­fer­ent pic­ture: the in­ter­est charge of R395m re­duces the re­turn to 7% (12%) (Fig­ure 6).

Fig­ure 7 high­lights the real prob­lem — de­spite a sig­nif­i­cant in­crease in the as­set base, rev­enue and earn­ings have failed to keep pace. The group has not ex­tracted the syn­er­gies hoped for, be they im­proved ef­fi­cien­cies and/or costs saved, and over­paid for as­sets.

A re­view of the fi­nan­cials

flagged enough is­sues: the de­te­ri­o­rat­ing trends in ATO, ROE and ROIC; the very low ROE and ROIC; a debt/eq­uity ra­tio close to 100%; a sharp in­crease in shares in is­sue via two rights is­sues; and the large in­crease in the as­set base not matched by a con­comi­tant in­crease in earn­ings. All th­ese were warn­ing signs that the group had over­stretched it­self in its ex­pan­sion strat­egy.

But there’s more. In­ter­est cover has more than halved in three years to be­low 2.5, good­will (R5.5bn) and in­tan­gi­bles (R4.3bn) now ex­ceed share­holder funds of R6.6bn, and ven­dor loans of R422m are payable this year at a time when cash and the abil­ity to raise fur­ther debt to make the pay­ment are con­strained, a fur­ther rights is­sue at the cur­rent rat­ing not be­ing an op­tion.

Remed­ica was bought for about €335m on af­ter-tax earn­ings of €16.5m for 2015, im­ply­ing the busi­ness was bought on a p:e of 20.3 times af­ter-tax earn­ings, or an earn­ings yield of 4.9% vs bor­row­ing costs of about 6%. Be­fore some purist ac­cuses me of com­par­ing pre- and post-tax rates, the tax rate for 2018 was only 12%; it will not make a mean­ing­ful dif­fer­ence. Con­sis­tently buy­ing as­sets on yields ap­prox­i­mat­ing your cost of cap­i­tal leaves lit­tle scope for er­ror.

Apart from the quan­ti­ta­tive warn­ings, there were qual­i­ta­tive ones as well — the group ap­pointed a new CEO and a ma­jor re­view of the busi­ness was un­der­taken.

The CEO who had over­seen the ex­pan­sion was re­placed a year ago. Was he solely re­spon­si­ble for the am­bi­tious global ex­pan­sion, or is there a more deep-rooted prob­lem? The ma­jor share­holder has acted as the group’s fi­nan­cial ad­viser. Given that over R8bn has been spent on ac­qui­si­tions since 2015, what fee in­come was gen­er­ated (if any)? If fee in­come was gen­er­ated, what was the ba­sis of cal­cu­la­tion and how much flowed to the ma­jor share­holder? What were the checks and bal­ances to re­solve po­ten­tial con­flicts of in­ter­est and en­sure other share­hold­ers were not prej­u­diced?

Com­pound­ing the prob­lem in re­cent months have been Sens an­nounce­ments stat­ing: “In­vol­un­tary sale, on mar­ket, as a re­sult of forced sales ac­tioned by fi­nan­cial in­sti­tu­tions due to the shares be­ing linked to eq­uity fi­nance trans­ac­tions re­sult­ing in margin calls.”

In plain speak, shares were pledged by the ma­jor share­holder to fi­nan­cial in­sti­tu­tions for funds to fol­low the last rights is­sue at 2,000c per share. The fall in the share price has re­quired margin to be topped up to avert the pledged shares be­ing sold; as margin was not forth­com­ing, the shares were sold to rem­edy the short­fall. Wise buy­ers have re­frained from pay­ing up, hence the fall in price — rolling head­line EPS are 78c, plac­ing the share on a p:e of 6.4.

The group has re­ceived an un­so­licited of­fer for Remed­ica — an as­set that is do­ing well. But it still re­quires a fur­ther pay­ment to the ven­dors of sev­eral hun­dred mil­lion rand this year. It has an­nounced the sale of its SA sports nu­tri­tion busi­ness for R54m and its di­rect sell­ing and net­work mar­ket­ing busi­ness for R40m; it has also con­cluded a sale agree­ment of its phar­ma­ceu­ti­cal man­u­fac­tur­ing fa­cil­ity in Isando for R130m. Fur­ther dis­pos­als may be needed to raise the funds nec­es­sary to keep the jewel.

At some point As­cendis may well be a buy. But given the un­cer­tainty around the group’s as­sets, those that are to be dis­posed of (and the price), the im­pact on prof­itabil­ity and cap­i­tal struc­ture, and the con­tin­ued dis­tressed sell­ing by the ma­jor share­holder, the pru­dent may elect to bide their time.

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