Commentary

Overview

Life Healthcare’s strategic objective is to establish a sizeable international business and to accelerate the transition from a South African-focused acute care group to an international, diversified healthcare provider. Life Healthcare’s international expansion strategy has been focused on selected attractive markets that display supportive characteristics for the longer-term growth of the private healthcare market.

In line with this strategy, Life Healthcare completed the acquisition of Alliance Medical in November 2016. The Group acquired Alliance Medical for an enterprise value of around GBP800 million (R14.3 billion) including a maximum contingent consideration of GBP40 million (R715 million). The acquisition was initially funded through ZAR and GBP debt bridge facilities, which have subsequently been partially repaid through the successful completion of the rights offer.

The Group results for the six months ended 31 March 2017 have been impacted by the acquisition of Alliance Medical with revenue up 22.6%, normalised EBITDA up 15.2% and headline earnings per share down 71.3%. The Group’s earnings have also been impacted by the once-off items related to the Alliance Medical acquisition and a further impairment of the investment in Poland.

Acquisition of Alliance Medical Group

Rationale
Life Healthcare’s vision is to be a market-leading, international, diversified healthcare provider offering high-quality, cost-effective care in its chosen markets. Over the past few years, Life Healthcare has expanded into mental health, acute rehabilitation, renal dialysis and oncology. Life Healthcare views the entry into diagnostics as a natural part of this growth and diversification strategy. Alliance Medical is one of Western Europe’s leading providers of complex molecular and diagnostic imaging services, with strong market positions in the United Kingdom (UK), Italy and Ireland, and a platform for expansion more broadly with existing participation in 10 European markets. Alliance Medical is unique in Western Europe in terms of its vertically integrated model providing services across the molecular imaging value chain, ranging from radiopharmaceutical production to scanning services provision and results reporting. Alliance Medical is well-positioned in attractive growth markets underpinned by favourable structural drivers, including ageing populations, growing disease burden, capacity constraints in public health systems, and the demand for improved access to diagnostics.

Benefits of the acquisition
The acquisition of Alliance Medical exposes Life Healthcare to a faster growing diagnostics market with a company which generates good cash flows, good margins and with excellent growth prospects. It further continues Life Healthcare’s expansion of its complementary services business, adding diagnostics to mental health, acute rehabilitation, renal dialysis and oncology, firmly positioning Life Healthcare in a strategically important, high-growth business. Alliance Medical has a strong and highly complementary management team with broad healthcare experience to help support Life Healthcare’s international, diagnostic and oncology growth.

Operational review

Southern Africa
Revenue from the southern African operations increased by 4.7% to R7.6 billion (2016: R7.3 billion). Revenue was negatively impacted by the decline in activity with paid patient days (PPDs) declining by 1% (2016: increased by 2.7%) and the impact in the Healthcare services division of the non-renewal of the mental health contract by the Gauteng Department of Health as of 30 June 2016. Overall, lower activity volumes have been due to limited or no growth in the private healthcare market, a greater than expected slowdown in the South African economy and an increase in active case management by medical aids. The overall weighted occupancy for the period decreased to 68.4% (2016: 69.9%). EBITDA margins for the period declined to 26.0% (2016: 27.7%) due to the impact of the lower activities and the resultant lower occupancies, an increase in discounts for volume and cost pressures.

An additional 82 beds (2016: 91) and 11 renal dialysis stations have been added to the business. The increase in beds in operation was primarily driven by the opening of the 60-bed mental health unit, Life Carstenview, in February 2017. Despite the lower trading in the southern Africa hospital division, the complementary services division continues to show good growth with revenue increasing by 22.7%.

The Group continued to provide high-quality clinical care with an improvement in overall patient experience.

Alliance Medical
The business has performed well against the comparative period, with normalised EBITDA for the six months ended 31 March 2017 up 7.5% on a constant currency basis. On a regional basis, there were strong performances from the UK, on the back of increased PET-CT volumes, and Northern Europe. Ireland performed in line with expectations and revenue in Italy was relatively flat. This was due to the negative impact of the Appropriateness decree on MRI demand, but the business is starting to benefit from the Albaro acquisition.

Poland
The Scanmed Group (Scanmed) now consists of 624 beds, 12 inpatient cardiology centres and 40 medical centres. Scanmed operations performed to expectations, with revenue of R530 million (2016: R572 million). Normalised EBITDA is significantly below last year, with the EBITDA margin reducing to 5.1%
(2016: 13.5%). This is primarily due to the impact of the reduction in cardiology tariffs as promulgated in Poland effective 1 July 2016 (-17%) and further cardiology tariff reductions from 1 January 2017 (-11%). Cardiology initially represented 45% of the Scanmed business. An adjustment of R23 million related to prior year over-quota underprovision, excluding this adjustment the normalised EBITDA margin is 9.2%.

The further tariff reductions in January 2017 have resulted in an additional impairment of R142 million of the Polish investment.

India
Max Healthcare reported strong growth, with revenue growing by 9.1% and EBITDA by 20.5%. The growth in revenue was primarily driven by the good growth in the phase 2 and 3 hospitals, which grew revenue by 25%. The EBITDA margin improved to 11.7% (2016: 10.6%) on the back of improved management of costs and a focus on driving efficiencies. Max Healthcare was impacted by the demonetisation of the currency and the introduction of regulatory changes including reduced pricing of stents, introducing a minimum wage and improved maternity benefits. The earnings of this business were impacted by both the funding cost, costs of acquisition and development incurred in respect of the business acquisitions. As these operations continue to ramp up, the earnings will be low.

Financial performance

Group revenue increased by 22.6% to R9.6 billion (2016: R7.9 billion), consisting mainly of a 4.7% increase in southern African revenue to R7.6 billion
(2016: R7.3 billion), R1.5 billion new revenue from Alliance Medical and R530 million (2016: R572 million) revenue contribution from Poland. The southern Africa hospital and complementary services division revenue increased by 5.6% to R7.2 billion (2016: R6.8 billion) driven by a higher revenue per PPD of 6.3%, made up of a 6.1% tariff increase and a 0.2% positive case mix impact, partially offset by a 1.0% decrease in PPDs. Healthcare services revenue decreased by 10.5% to
R399 million (2016: 446 million) due to the impact of the non-renewal of the mental health contract by the Gauteng Department of Health.

Normalised EBITDA¹ increased by 15.2% to R2.4 billion (2016: R2.1 billion), with R410 million new EBITDA from Alliance Medical.

¹ Life Healthcare defines normalised EBITDA as operating profit before depreciation on property, plant and equipment and amortisation of intangible assets and non-trading-related costs and income.

R'm  6 months
31 March
2017
 
   %
Change 
6 months
31 March
2016 
  
Normalised EBITDA                
   Operating profit  1 790        1 779    
   Depreciation on property, plant and equipment  441        270    
   Amortisation of intangible asset  187        65    
   Other  –        (15)   
Normalised EBITDA  2 418     15.2  2 099    
   Southern Africa  1 981     (2.0) 2 022    
   Alliance Medical  410        –    
   Poland  27        77    

Cash flow

The Group produced good cash flows from operations and continues to anticipate positive free cash flow. The overall net cash inflow position of the Group is positive as a result of the investment in Alliance Medical, and the related bridge loan funding raised for the acquisition and related costs.

Financial position

Net debt to normalised EBITDA as at 31 March 2017 was 3.99 times (30 September 2016: 1.67 times). The increase in net debt is primarily due to the R14.6 billion raised in respect of the acquisition of Alliance Medical. The bank covenant for net debt to EBITDA is 2.75 and 3.0 times. The net debt ratio has decreased following the repayment of a portion of the debt raised with the net proceeds received from the rights offer, following which the net debt:EBITDA has reduced to approximately 2.35 times.

Capital expenditure

During the current financial period, Life Healthcare invested R10.9 billion (2016: R1.3 billion), comprising mainly capital projects of R603 million
(2016: R345 million), and R9.9 billion (net of cash acquired) for the acquisition of Alliance Medical. The Group has approved R1.2 billion of its 2017 capital expenditure programme to date.

Headline earnings per share (HEPS) and normalised earnings per share (EPS)

Headline earnings per share decreased by 71.3% to 26.7 cps (2016: 93.0 cps). Earnings per share on a normalised basis, which excludes non-trading-related items listed below, decreased by 35.7% to 56.0 cps (2016: 87.1 cps).

R'm  31 March
2017
 
   %
Change 
31 March
2016 
  
Normalised earnings                
Profit attributable to ordinary equity holders  144        965    
   Transaction costs  254        11    
   Contingent consideration released  –        (66)   
   Fair value adjustment of contingent consideration  18        –    
   Reorganisation and contract mobilisation costs  18        –    
   Impairment of investment  142        –    
   Other  14        (6)   
Normalised earnings  590     (34.7) 904    
Normalised EPS (cents) 56.0     (35.7) 87.1    
Southern Africa operations (cents) 96.7        97.3    
Poland and India operations (cents) (2.9)       1.3    
Alliance Medical operations (cents) 10.8        –    
Funding costs (international acquisitions) (cents) (48.6)       (11.5)   

Changes to board of directors

LM Mojela resigned from the board with effect from 25 January 2017. MEK Nkeli was appointed chairman of the social, ethics and transformation committee and PJ Golesworthy as a member of the social, ethics and transformation committee with effect from 25 January 2017.

Distribution consideration

In considering the dividend, the board has considered the impact of the rights offer, the once-off acquisition costs and the higher debt levels.

The Group's dividend policy is to pay a dividend that takes into account the underlying earnings and future growth needs of the Group, both in southern Africa and internationally, while retaining sufficient capital to fund ongoing operations and to manage gearing to acceptable levels.

Scrip Distribution and Cash Dividend alternative

1. Introduction
The board has declared an interim distribution for the period ended 31 March 2017, by way of the issue of fully paid Life Healthcare Group Holdings Limited ordinary shares of 0.0001 cent each (the Scrip Distribution) payable to ordinary shareholders (Shareholders) recorded in the register of the Company at the close of business on the Record Date, being Friday, 30 June 2017.

Shareholders will be entitled, in respect of all or part of their shareholding, to elect to receive a gross cash dividend of 35 cents per ordinary share in lieu of the Scrip Distribution, which will be paid only to those Shareholders who elect to receive the cash dividend, in respect of all or part of their shareholding, on or before 12:00 on Friday, 30 June 2017 (the Cash Dividend). The Cash Dividend has been declared from income reserves. A dividend withholding tax of 20% (2016: 15%) will be applicable to all shareholders not exempt therefrom after deduction of which the net Cash Dividend is 28.0 cents per share.

The new ordinary shares will, pursuant to the Scrip Distribution, be settled by way of capitalisation of the Company’s distributable retained profits.

The Company’s total number of issued ordinary shares is 1 440 939 874 as at 11 May 2017. The Company’s Income Tax reference number is 9387/307/15/1.

2. Terms of the Scrip Distribution
The Scrip Distribution will be done at a 2.5% discount to the 15-day volume weighted average price (VWAP). The number of Scrip Distribution shares to which each of the Shareholders will become entitled pursuant to the Scrip Distribution (to the extent that such Shareholders have not elected to receive the Cash Dividend) will be determined by reference to such Shareholder’s ordinary shareholding in Life Healthcare Group Holdings Limited (at the close of business on the Record Date, being Friday, 30 June 2017) in relation to the ratio that 35 cents multiplied by 1.025 bears to the VWAP of an ordinary Life Healthcare Group Holdings Limited share traded on the JSE during the 15-day trading period ending on Monday, 19 June 2017. Where the application of this ratio gives rise to a fraction of an ordinary share, such fraction will be rounded down to the nearest whole number, resulting in allocations of whole ordinary shares and a cash payment for the fraction.

The applicable cash payment will be determined with reference to the VWAP of an ordinary Life Healthcare Group Holdings Limited share traded on the JSE on Wednesday, 28 June 2017, (being the day on which an ordinary Life Healthcare Group Holdings Limited share begins trading ‘ex’ the entitlement to receive the Scrip Distribution or the Cash Dividend alternative), discounted by 10%.

The applicable cash payment will be announced on Stock Exchange News Service (SENS) on Thursday, 29 June 2017.

Details of the ratio will be announced on the SENS of the JSE in accordance with the timetable that follows.

3. Circular and salient dates
A circular providing shareholders with full information on the Scrip Distribution and the Cash Dividend alternative, including a Form of Election to elect to receive the Cash Dividend alternative will be posted to Shareholders on or about Friday, 2 June 2017. The salient dates of events thereafter are as follows:

Announcement released on SENS in respect of the ratio applicable to the Scrip Distribution, based on the 15-day VWAP ending on Monday,19 June 2017, discounted by 2.5%, by 11h00 on Tuesday, 20 June 2017
Announcement published in the press of the ratio applicable to the Scrip Distribution, based on the 15-day VWAP ending on Monday,19 June 2017, discounted by 2.5%, on Wednesday, 21 June 2017
Last day to trade in order to be eligible for the Scrip Distribution and the Cash Dividend alternative Tuesday, 27 June 2017
Ordinary shares trade “ex” the Scrip Distribution and the Cash Dividend alternative on Wednesday, 28 June 2017
Listing and trading of maximum possible number of ordinary shares on the JSE in terms of the Scrip Distribution from the commencement of business on Wednesday, 28 June 2017
Announcement released on SENS in respect of the cash payment for fractional entitlements, based on the VWAP traded on the JSE on Wednesday, 28 June 2017, discounted by 10% on Thursday, 29 June 2017
Last day to elect to receive the Cash Dividend alternative instead of the Scrip Distribution, Forms of Election to reach the Transfer Secretaries by 12h00 on Friday, 30 June 2017
Record Date in respect of the Scrip Distribution and the Cash Dividend alternative Friday, 30 June 2017
Scrip Distribution certificates posted and Cash Dividend payments made, CSDP/broker accounts credited/updated, as applicable, on Monday, 3 July 2017
Announcement relating to the results of the Scrip Distribution and the Cash Dividend alternative released on SENS on Monday, 3 July 2017
Announcement relating to the results of the Scrip Distribution and the Cash Dividend alternative published in the press on Tuesday, 4 July 2017
JSE listing of ordinary shares in respect of the Scrip Distribution adjusted to reflect the actual number of ordinary shares issued in terms of the Scrip Distribution at the commencement of business on or about Wednesday, 5 July 2017

All times provided are South African local times. The above dates and times are subject to change. Any change will be announced on SENS.

Share certificates may not be dematerialised or rematerialised between Wednesday, 28 June 2017 and Friday, 30 June 2017, both days inclusive.

Competition Commission Market Inquiry

A revised timetable for the Health Market Inquiry was released in December 2016, with a provisional report due in September 2017 and the final report due in December 2017. Life Healthcare remains committed to participating in the Healthcare Market Inquiry and continues to make detailed submissions on the subject matter.

Outlook

General market conditions in southern Africa are not expected to improve substantially in the foreseeable future and we expect continued pressure on acute hospital volumes. The Group is well-positioned to continue driving its complementary services business through expansion in southern Africa and through Alliance Medical. The successful completion of the rights issue will result in the Group’s net debt to EBITDA decreasing to approximately 2.35 times.

In southern Africa, the Group aims to add over 112 acute hospital brownfield beds in the next six months. The complementary services business will grow through the addition of 22 mental health beds, 10 renal stations and one oncology unit. Further growth will come from the mental health beds added in H1 and at the end of 2016. Pressure on costs and occupancies will continue, and the Group has implemented measures to mitigate the impact of these pressures and will continue to focus on driving efficiency programmes.

Alliance Medical will continue to execute on its growth strategies in both its existing territories as well as new potential markets. The roll-out of the PET-CT programme will continue in the UK and the business will start rolling out the CDCs with an initial focus on six sites. In Germany, the business has acquired Eckert & Zieglers cyclotron division for EUR13 million effective May 2017. This extends Alliance Medical’s molecular imaging presence in Northern Europe and supplements PET-CT scanning services across the region as well as the radiopharmacy facilities in the UK and Italy. It creates the largest European integrated radiotracer supply and imaging organisation.

In Poland, Scanmed will continue to focus on improving efficiencies and cutting costs. In addition, Scanmed will focus the business to benefit from the new NFZ contracts and tenders which are due out in the second half of the year, as well as increasing the percentage of business from non-government work.

The Max Healthcare business will continue to focus on driving revenue through increasing the number of operational beds, improving occupancies and its channel mix. Max Healthcare will continue to focus on improving operational efficiencies despite the introduction of regulatory pricing on stents, the introduction of a minimum wage and extended maternity benefits. The International Finance Corporation (IFC) is currently in the process of disposing of its 7.5% shareholding in Max Healthcare. Both Life Healthcare and Max India will take up an equal share from the IFC at Rs105 per share. This will allow Life Healthcare to retain an equal shareholding in Max Healthcare, protect its existing shareholding rights as well as continuing the partnership with Max Healthcare. Life Healthcare remains excited by the good growth prospects of the Indian healthcare market on the back of strong economic growth, a growing middle class, an ageing population and an increasing disease burden.

Trading statement for the 12 months ending 30 September 2017

Life Healthcare’s results for the full financial year ended 30 September 2017 are expected to show a decline of more than 20% in EPS (minimum decline of
31.0 cps) and HEPS (minimum decline of 38.5 cps) from those reported for the financial year ended 30 September 2016 (EPS: 154.9 cps and HEPS: 192.5 cps). This is primarily due to the impact of the transaction costs as well as the increased funding costs related to the Alliance Medical acquisition and the impairment of Poland.

A detailed trading statement will be released in early October 2017. The forecast financial information on which this trading statement is based has not been reviewed and reported on by the Group’s external auditors.

Shareholders are advised that the investors presentation for the six months ended 31 March 2017 and the rights offer circular issued in April 2017 are published on Life Healthcare’s website (www.lifehealthcare.co.za).

Thanks

The contributions of the doctors, nurses and employees of Life Healthcare have greatly enhanced the quality of our performance. We thank them for their contributions.

Approved by the board of directors on 11 May 2017 and signed on its behalf:

Mustaq Brey
Chairman
André Meyer
Group Chief Executive Officer