The SRL Listing Is All Squeezed Out

The run-up in the stock implies all the exuberance is in the price

Merger and demergers continue to make headlines on Dalal Street. The latest being hospital chain Fortis Healthcare’s decision to separately list its diagnostic business run under its subsidiary SRL. Under the pretext of unlocking value for shareholders, promoters often opt for a separate listing when a particular sector has caught the fancy of investors.

In the largely unorganized $6 billion diagnostic market, SRL is the largest player with 7,200 collection points and a network of 325 labs followed by Dr Lal PathLabs, which has 5,000 collection points and 172 labs. Since its IPO in December 2015, Dr Lal has zoomed from its IPO price of Rs.550 a share to Rs.930, valuing it at 26x its estimated FY18 Ebitda.

If the same multiple is applied, the value of Fortis Healthcare's 56.4% stake in SRL would be close to Rs.3,860 crore or Rs.75 per share, which is 42% of the current market price (Rs.181) of holding company Fortis Healthcare. However unlike Dr Lal, analysts prefer to value this business conservatively at about 18-20x Ebitda, which comes to Rs.52-58 a share.

The promoter’s reasoning is that a separate listing of SRL will not only unlock value but also simplify the holding structure. But does it really? The game seems to have already played out. According to the merger scheme SRL will be demerged from Fortis Healthcare and merged under another listed company Fortis Malar Hospitals. Fortis Malar has 1.69 crore shares outstanding against the 51.4 crore shares of Fortis Healthcare which also means there is going to be a huge dilution. Before the merger Fortis Malar will transfer its hospital business to Fortis Healthcare on a slump basis for a consideration of Rs.45 crore.

To compensate, Fortis Malar will issue 98 shares to Fortis shareholders for every 100 shares in the company. Since the market had already assumed that SRL is worth at least Rs.75 a share, buying interest moved to Fortis Malar, which was trading at Rs.50 a share before the announcement. Post that, the stock hit two 20% upper circuits and now trades at Rs.83 a share. At that price, SRL seems overvalued at about 28x its estimated FY18 Ebitda. "Fortis Malar is a thinly traded stock with very small equity. So it is difficult to gauge if there is a fair amount of price discovery. We have valued SRL at Rs.70-75 a share and to that extent it has already played out," says Tushar Manudhane, analyst, Anand Rathi.  

As opposed to Dr Lal, which has close to 70% of its labs in north India, SRL is well diversified (north accounts for 35%). SRL gets close to 20% of its revenue from hospitals and 33% from walk-ins. But compared to Dr Lal which has a operating margin of close to 30%, SRL has a 22% operating margin. But that hasn’t dimmed analyst expectation. “With a diversified geographical presence and significant operating leverage (40-45% current capacity utilisation), we expect SRL’s revenue to compound at a high-teens rate over the next three years with operating leverage pushing up Ebitda margins,” says analyst Abhishek Singhal, Macquarie Capital. The future may be red and rosy but the current run up has left very little on the table for investors wanting to capitalize on the demerger.