Indian Hospitals

Health is Wealth!
November 2010 Nitin Agarwal ● Ritesh Shah

cardiac care
hub &
spoke
MAX
orthopedics
franchisee
real Narayana daycare
estate Hrudayalaya sugery
multi
specialty medical tourism telemedicine
asset light, india shining
ALOS medicities, long
t gestation
lifestyle tertiary care
diseases
exponential capital intensive
economic boom
healthcare spends
private sectorFortisARPOB opportunity
corporate hospitals
REITS
Apollo rauma US$125bn
radiology,insurance ce
super-specialty
Vaatsalya
regulation
inorganic
manpower
GDP
 15 November 2010
BSE Sensex: 20157

Indian Hospitals
Healthcare Health is Wealth!

Reason for report: Initiating coverage

Indian healthcare industry is poised to double to US$125bn by 2015E, driven by a combination of ageing
population, growing lifestyle diseases, increasing ability to afford quality healthcare and growing medical
insurance penetration. With public spend likely to be limited to ~20% of the annual healthcare spend,
organized private hospital players will be the primary beneficiaries of this expected boom. However, high
upfront investments and long gestation periods, as also burgeoning real estate costs and growing
manpower shortages, will compel the hitherto tertiary-/ metro-focused private sector to innovate with
business models. While the competitive landscape in this relatively nascent sector is still evolving, we
believe entry barriers are rising – which strongly favours the leading incumbents. Being the only two listed
players in the healthcare space, Apollo and Fortis (cumulative market cap of <$5bn) are the best proxies on
the rapidly growing Indian healthcare opportunity. We believe the stocks deserve to trade at a premium not
just to the broader market but also to global peers as they are in the high growth phase of their life cycle.

Indian healthcare – organized private hospitals join the party: At ~5.5% of GDP (according to OESC), Indian
private healthcare spend is among the highest globally and accounts for ~80% of the total US$62bn spend in
2009. Hospitals account for ~50% of the healthcare spend in India. Organized hospital chains (>100 beds), ~10%
of private sector capacity currently, are steadily increasing their presence as public spending would remain
limited. Thus, we see interesting times ahead for private sector healthcare players.

Attractive business but the road ahead is not easy: While successful tertiary hospitals can potentially generate
25%+ EBITDA margins with return ratios > 30% from the seventh year of operations, private sector hospital
chains need deep pockets to grow given the significant upfront capex requirement (~Rs2bn for a 200-bed
tertiary hospital) and long gestation periods. Shooting real estate costs, growing shortage of skilled medical
personnel leading to wage inflation, and emergence of pockets of overcapacity add to the challenges. This
should spur innovation in business models. The stress on innovation is already visible in Apollo’s launch of
newer formats like Apollo Reach as also Fortis’s increased use of an asset-light strategy involving leasing of
land/ building.

Advantage Incumbents: As the going gets difficult, we believe the leading incumbents are favorably placed
with their sizeable assets, significant geographical footprint and strong brand identities. As new entrants
would find it increasingly difficult to scale up unless they innovate significantly, the two listed leaders –
Apollo and Fortis (19% and 41% revenue CAGR respectively over FY10-13E) – will continue to dominate the
market and command significant premium for being the only relevant proxies to the Indian healthcare market.

Key valuation metrics for FY13E

Companies . Price Mcap EPS Earnings growth* P/E EV/EBITDA P/BV RoE RoCE Target price
(Rs) (Rs) (Rs/share) (%) (x) (x) (x) (%) (%) (Rs)
Apollo Hospitals 509 63.1 22 25 23.1 12.5 2.9 13.2 12.6 651
Fortis Healthcare 161 69.7 9.4 75 17.3 10.7 1.6 9.5 8.3 206
* CAGR FY10-13E

Nitin Agarwal Ritesh Shah

nitin.agarwal@idfc.com
91-22-6622 2568 Contents ritesh.shah@idfc.com
91-22-6622 2571

IDFC Securities Ltd.

Naman Chambers, C-32, G- Block, Bandra-Kurla Complex, Bandra (East), Mumbai 400 051 Tel: 91-22-6622 2600 Fax: 91-22-6622 2501

“For Private Circulation only” “Important disclosures appear at the back of this report
 IDFC Securities

Content

Investment Argument.................................................................................................... 3
Indian healthcare: In a sweet spot............................................................................. 4
Healthcare models: Expect increased innovation ................................................... 7

Indian healthcare: A snapshot.................................................................................... 10

Private healthcare providers gaining relevance.................................................... 14

The Best is Ahead ......................................................................................................... 19

Indian healthcare: In a sweet spot........................................................................... 19
Drivers for Indian healthcare................................................................................... 21

Tertiary Hospitals: Attractive, but… ................................................................................. 28

Brace for long gestation; the wait is worth it... ...................................................... 29
Operating indicators for a successful tertiary hospital........................................... 32
Real estate costs: Key to commercial viability ....................................................... 33
Medical equipment: High obsolescence costs ....................................................... 36
Right People: A challenging proposition ............................................................... 38
An evolving regulatory scenario… ......................................................................... 43

Business Models: Innovation ahead ......................................................................... 46

Healthcare models: Expect increased innovation ................................................. 46

Advantage Incumbents................................................................................................ 56
Competitive landscape still evolving...................................................................... 56
Rising entry barriers…advantage incumbents...................................................... 57
Apollo and Fortis: Leaders today…and of future................................................. 58

APPENDIX..................................................................................................................... 59
Annexure 1: Regulatory landscape ......................................................................... 59
Annexure 2: Key takeaways from FY09-10 budget.............................................. 60
Annexure 3: NABH-accredited hospitals............................................................... 61
Annexure 4: Comparaitve healthcare spend – India and global......................... 62
Annexure 5: Corporate hospitals – strategies to target primary markets.......... 62

Companies ..................................................................................................................... 66
Apollo Hospitals........................................................................................................ 67
Fortis Healthcare........................................................................................................ 93
Other companies...............................................................................................119-122

NOVEMBER 2010 2
 IDFC Securities

INVESTMENT ARGUMENT
¾ Low levels of spend and structural inefficiencies in public healthcare system
leading to woeful healthcare standards; driving Indians to private sector
¾ Unorganized sector dominates private healthcare space, but organized
hospitals, with ~10% of capacity currently, expected to capitalize on the boom
in healthcare spend (estimated to double to US$125bn by 2015)
¾ However, conventional models increasingly inhibiting players’ ability to fully
tap into the opportunity; innovation in business models, hitherto focused on
tertiary care / metros, underway
¾ With increasing entry barriers, e.g. growing capex intensity and resource
crunch, we favour incumbents with critical mass to pursue accelerated growth
¾ We believe Indian players should command growth premium over global peer
valuations; initiating coverage with Outperformer on Apollo Hospitals and
Fortis Healthcare (28% upside in each)

‰ Indian healthcare – private hospital players coming to the fore

In India, government
spending on healthcare at
only ~1% of GDP
With national healthcare spending at 5.5% of GDP in 2009 (as per OESC), healthcare
is one of the largest industries in India with hospitals contributing ~50% of the pie.
While globally healthcare is typically provided through a largely government-funded
public system, the Indian healthcare industry is dominated by the private sector
(government spending at only ~1% of GDP, as compared to 3.5% for Brazil and 1.9%
for China). Interestingly, almost 80% of India’s overall spending on healthcare is
accounted for by the private sector, which is among the highest globally.

With the government’s healthcare spends not keeping pace, private players have
been steadily increasing their dominance in tertiary as well as secondary care.

Exhibit 1: Public health – lowest on the government’s focus list

Health expd. (as % of GDP) Per capita spend on health (US$) (2007)
India Low income
(% of GDP) Lower middle income Upper middle income 4405
Global

O
8.0 High income
488
USA

UK 6.0

Russia
4.0
China
80
Brazil 2.0 40 27
India
India Low income Lower Upper High income
0.0
Public sectro spend Private sector spend
middle middle
0 4 8 12 16 income income

Source: Industry, NSSO, IDFC Securities Research

‰ Unorganized sector dominates but organized sector inching up

Organized healthcare In India, the healthcare sector is highly fragmented with the unorganized component
gradually gaining relevance
accounting for ~90% of the private market. To put this into perspective, of ~1.05m
in India
beds in the country (Crisil estimates), Apollo Hospitals (Apollo) – the largest
organized healthcare player in India – has only ~8000 beds under management
including owned (by itself and associates) and managed beds.

NOVEMBER 2010 3
 IDFC Securities

Exhibit 2: Private players enjoy a dominant position

Govt. Hospitals Mid-tier Top-tier Nursing homes
Private
Government
Nursing
Mid-tier Top-tier 2015
Homes
Primarily nursing Corporate
Healthcare Major corporate Private sector
homes and hospitals with
centres, district hospital chains
recovery rooms in-house staff
hospitals and and specialty
with adequate and consulting
general hospitals hospitals 2005
infrastructure physicians

Variable; based
<30 beds 30-100 beds > 100 beds
on type
0 25 50 75 100

Source: Mckinsey-2007, IDFC Securities Research

However, in realization of the huge demand-supply gap in tertiary care segment,

organized healthcare (corporate hospitals) has been slowly gaining relevance with
the emergence of corporate healthcare hospitals like Apollo, Fortis Healthcare
(Fortis), Manipal Hospitals, Max Healthcare, Wockhardt, etc; and we expect the trend
to accelerate.

Indian healthcare: In a sweet spot

A confluence of multiple positive drivers will drive high growth in the US$62bn
Indian healthcare industry over the next several years. Hospitals, the largest
component of healthcare spend in India, will be the key beneficiary of the trend.

Exhibit 3: Key enablers to growing Indian healthcare

Increasing
Increasing life
life
expectancy
expectancy & &
ageing
ageing
population
population

Growing
Growing Increasing
Increasing
affordability
affordability awareness
awareness
A confluence of drivers will
drive high growth in Indian
healthcare
Indian Healthcare

Rise
Rise of
of medical
medical Growing
Growing
tourism
tourism population
population

Rising
Rising Health
Health
Insurance
Insurance
penetration
penetration

Source: IDFC Securities Research

NOVEMBER 2010 4
 IDFC Securities

‰ Indian healthcare – likely to be a $125bn opportunity in five years

Sector expected to grow at
13% per annum
Indian healthcare sector is currently valued at $62bn and is estimated to be growing
at 13% per annum. We expect the healthcare opportunity to double to $125bn in the
next five years. We estimate population to grow at 2% annually and factor in a 10%
annual increase in healthcare spend on the back of changing demographics and rising
income levels.

Exhibit 4: Indian healthcare – a US$125bn opportunity by 2015E

Particulars 2009 2010 2011 2012 2013 2014 2015
Population (m) 1166.1 1189 1213 1237 1262 1287 1313
Assumed Growth (%) 2 2 2 2 2 2
Per capita health expd. (US$/pp) 53 58 64 71 78 86 95
Assumed Growth (%) 10 10 10 10 10 10
Health Expenditure (US$bn) 62 70 78 88 98 111 125
Source: IDFC Securities Research

‰ Private healthcare segment to be the biggest beneficiary

Limited public sector
funding and high costs put
private healthcare players at
an advantage
Crisil estimates that India requires 632,000 additional beds over the next 10 years,
~60% higher than the current base of 1.05m beds. Of these, ~20% will be required for
complex medical procedures in cardiac and oncology segments. In our view,
hospitals is a high gestation business entailing significant upfront investments but
long payback periods. Construction of a new hospital bed costs Rs2.5m-3m on an
average with a high-end tertiary hospital bed costing Rs5m-5.5m. This implies an
overall capital expenditure of ~$40bn over the next 10 years for setting up the
incremental 632,000 beds required. As the government is hardly in a position to fund
this growth, it presents an attractive opportunity for private sector players.

‰ Attractive but not an easy business; brace for long gestations

Though a tertiary hospital
can make operating margins
of 25-30%, it takes ~5 years
to hit these levels
While the tertiary corporate hospital segment presents a lucrative opportunity for
private players, it is a relatively complex business due to high upfront costs and
challenges embedded in the day to day running of hospitals. The initial capital cost of
setting up a tertiary hospital bed is Rs7m-10m in larger cities with real estate and
medical equipment accounting for 60-65% of the total project cost. This leads to long
gestation periods – besides 2-3 years for project conceptualization to commissioning,
achieving cash breakeven for a healthcare facility could take up to another 2.5-3 years
assuming steady patient inflow and no mishandled cases.

However, the rewards are attractive enough for the successful hospitals. We estimate
tertiary hospital can potentially generate > 25% operating margins from 5th year of
operation with margins stabilizing at 30-35% in a matured state. As hospitals stabilize
operations and utilize free cash to repay debt, return ratios steadily expand from the
fifth year of operations. Based on our estimates, a well run tertiary hospital can begin
to generate return ratios > 25% from 6th -7th year of operation.

NOVEMBER 2010 5
 IDFC Securities

Exhibit 5: Sweet returns post stabilization Capital Cost

Capital Costs breakup
Cash flows
28 RoCE (% - LHS) Operating margins (% - RHS)
(Rs m) 32
Operating cashflow Free Cash Flow
500
Land
Others
8%
15%
0 19 22
Construction
IDC
19%
8% -500
10 12
Pre operative
-1,000
expenses
12% 1 2
-1,500

Machinery
38% -2,000 -8 -8
YR1 YR2 YR3 YR4 YR5 YR6 YR7 YR1 YR2 YR3 YR4 YR5 YR6 YR7

Source: IDFC Securities Research

‰ Rising real estate costs to spur innovation in business models

Real estate cost is a key factor that determines the viability of a hospital project. Land
and building together account for 37-40% of the total project cost and are among the
key measures to gauge its financial viability. Based on our analysis, we find for a
hospital operating at 15% margins in the fifth year of operations, an increase/decrease
in land and building costs by 20% results to contraction/expansion in return ratios by
nearly 40-50bps. The impact of land & building costs is relatively lower for well-run
hospitals. i.e. return ratios for a hospital enjoying 30% margins would be impacted
only to the extent of 20bps on 20% increase/decline in land & bldg. costs.

Exhibit 6: RoCE sensitivity to real estate costs (in the fifth year of operations)
Land & Bldg. costs assumptions EBITDA margins (%)
15.0 20.0 25.0 30.0
20% decline 10.0 14.5 18.6 22.5
Base 9.6 14.1 18.3 22.3
20% increase 9.2 13.8 18.1 22.1
Source: IDFC Securities Research

We expect newer operating models to evolve as the private sector seeks ways to
tackle high real estate costs and aggressively expand footprint. We expect players to
increasingly pursue asset light strategies e.g. Build, Lease and Transfer, transferring
assets to REIT structures, etc.

‰ Medical equipment – high obsolescence costs

Equipment account for a Industry estimates indicate that medical equipment accounts for the largest chunk of
major chunk of capital capital costs (up to 30-40%) towards setting up a tertiary care unit. The healthcare
costs, especially due to high
import component industry is characterized by frequent product innovations and evolving technology.
That leads to redundancy of expensive medical equipment every 5-7 years, compared
with a depreciable life of up to 14 years (based on accounting periods). The problem
is compounded by the fact that there is practically very limited indigenous medical
device manufacturing industry in India, which necessitates purchase of significantly
expensive imported equipment.

Hospitals, to recover the cost of expensive imported medical equipment over its short
life cycles, resort to higher treatment pricing. That often leads to a vicious cycle of
lower utilization rate, which dents profitability due to negative operating leverage.

NOVEMBER 2010 6
 IDFC Securities

‰ Right people – an increasingly challenging proposition

Managing people issues – i.e. finding the right people and at the right cost, we
believe, will be a critical scale-up challenge for hospital operators in India. Doctors,
nurses and paramedics are the key enablers of the success of any hospital, and
retention of key personnel is an imperative – especially for tertiary care hospitals.

Shortage of doctors is In our view, while there are clear indications of shortage in the overall pool of
especially acute in
doctors required going forward, these shortages will be particularly acute in the case
specialized fields
of specialized and experienced doctors required for manning the newer tertiary care
set-ups. This will logically lead to aggressive wage inflation which will further stress
the economics of successfully running tertiary care hospitals.

Exhibit 7: Healthcare infrastructure shortfall from 13-41%

As per 2001 consensus Required Shortfall % shortfall
Sub -Centres 158,792 20,903 13
PHCs 26,022 4,803 18
CHCs 6,491 2,653 41
Source: NSSO

Healthcare models: Expect increased innovation

Hospitals increasingly Till recently, organized private sector healthcare business models in India were
experimenting with new
largely one-dimensional with focus on providing multi-specialty tertiary care in
delivery formats
larger metros, supplemented with some element of secondary and primary care set-
ups. Given the escalating competitive intensity in metros as well as an increasingly
tough operating environment, we see a strong case for exploring new and innovative
business models to tap into less-penetrated geographies as well as patient segments.
We are encouraged by the unconventional models being tried out by some of the new
entrants as also increased willingness of existing players to experiment with new
healthcare delivery formats.

A broad scan of the operating environment indicates the presence/ emergence of

multiple newer models. Below we list some of the more interesting ones:

• Existing tertiary healthcare providers experimenting with setting up

secondary/ primary tertiary care hospitals in Tier II/ III towns – Apollo with
Apollo Reach
• Single specialty tertiary care hospitals, e.g. Healthcare Global
• Day care surgery centers, e.g. Nova Day Care Centre
• Hospital chains solely focused on primary/ secondary care in Tier II/ III
towns, e.g. Vaatsalya
• Healthcare cities, e.g. Dr Trehan’s Medicity
• O&M contracts, e.g. Fortis’ contract with SL Raheja in Mumbai
• JV Structures e.g. Apollo’s proposed Thane hospital in JV with Yash Birla
Group

NOVEMBER 2010 7
 IDFC Securities

‰ Competitive landscape – still evolving

Indian corporate hospitals The corporate hospitals industry in India is relatively nascent as most of the
industry is relatively corporate groups, barring Apollo, having entered the business in the last few years,
nascent are still in relatively early phases of growth. Currently, there are three major listed
players in the space: Apollo Hospital Group, Fortis Healthcare and Max Healthcare
(subsidiary of Max India – a listed entity). Additionally, there are other large unlisted
players like Manipal Health (strong presence in South India), Narayan Hrudayalaya
(another predominantly South-India based entity), HealthCare Global (oncology-
focused tertiary care hospital chain, etc).

Given that the corporate hospital industry is in an early growth phase, we believe it
will take some time before the implications of their diverse strategies get crystallized
and start becoming evident to investors.

‰ Increasing entry barriers…advantage Incumbents

Shooting real estate prices, especially in metros, and increasing shortages in
recruiting highly qualified super specialists (required for running high-end tertiary
hospitals) as well as the lower skilled paramedics are making it increasingly difficult
to run a commercially successful private healthcare business. Thus, it is becoming
increasingly difficult to run a commercially successful private healthcare business.
These issues are further accentuated by the fact that existing players have already
entrenched themselves in most of the high-potential geographies across India.

Incumbents have well-
entrenched franchises in the
metros, a major roadblock
for new entrants
This means significant advantages for established incumbent players like Apollo,
Fortis, Manipal, etc. These players have had the early mover advantage to
accumulate sizeable hospital assets on land acquired at historical prices and create
solid brand equity which enables them to acquire talent from India as well as abroad.
These existing players have built up significant franchise in the key metros, the key
markets for high-end tertiary care, which makes it relatively difficult for new players
to make inroads in these markets. Additionally, their operations are now reaching a
stage where internal cash flows can take care of further expansions to a large extent.

‰ A $125bn industry by 2015E, but less than $5bn market cap

Private players offer the We are positive on the near- and medium-term outlook for the Indian healthcare
best proxy to the Indian
sector. We believe that private sector hospitals are the best proxy to play the
healthcare opportunity
healthcare opportunity in India, which is poised to grow rapidly over the next
several years and decades.

Interestingly, while the healthcare market in India is poised to double to US$125bn

by 2015, the two largest and most relevant healthcare stocks in the country have a
combined market capitalization of <$5bn. This clearly underlines the inherent growth
potential in these companies.

‰ Initiating coverage on Apollo and Fortis with Outperformer

Given their brand identity
and geographic spread, we
see little competition for
Apollo and Fortis
In the private sector hospitals space, we are particularly bullish on two of the leading
incumbents – Apollo Hospitals and Fortis Healthcare – as they are well-entrenched in
the industry with strong national brand equity as well as a difficult to replicate
geographical footprint and capacity. Given that these two are the only relevant listed
entities in the Indian healthcare space and the ones that are likely to dominate the
market (with a secular growth story) for the next several years, we believe these

NOVEMBER 2010 8
 IDFC Securities

stocks deserve to command a significant premium with respect to the broader

market.

Apollo Hospitals – Apollo Hospitals is the largest and probably most well-known
hospital networks in India with ~8,000 beds under operations currently. With the
relatively conservative management now willing to step on the gas and pursue more
aggressive expansion, we expect growth to accelerate in the coming years. This is
reflected in Apollo’s plans to add ~2,700 beds over the next three years. This will
drive 19% and 25% CAGR in revenues and EBITDA respectively over the FY10-13.
Further, with the growing proportion of mature beds in the network, RoCE is also
expected to touch 12.6% by FY13 and expand thereon. Initiating coverage on the
stock with a price target of Rs651/share. Apollo is our top pick in the space.

Fortis Healthcare – With support from its well-funded promoters, Fortis has grown
to be India’s the second largest hospitals player with 3,250 beds under management,
largely aided by two large ticket acquisitions of Wockhardt Hospitals and Escorts
Delhi. With as many as 8 hospitals likely to be commissioned over the next two years,
Fortis will likely expand its operational beds by ~2,000 over FY10-13. We expect
Fortis to create value for stakeholders through unconventional strategies. On the flip
side, Fortis has a limited execution track record and the robustness of its business
model will be borne out over the next 3-4 years as its newer Greenfield hospitals go
on stream and the recent acquisitions stabilize. Initiating coverage on the stock with a
price target of Rs206/share.

Exhibit 8: Global peer valuation matrix

(US$ m) PE (x) EV/EBITDA (x) RoE (%) OPM (%)
Company CY09 CY10 CY11 CY09 CY10 CY11 CY09 CY10 CY11 CY09 CY10 CY11
US
Universal Health Services-B 15.8 16.5 13.5 7.0 7.1 5.6 15.8 13.3 13.9 13.9 13.2 14.1
Health Mgmt Associates Inc-A 15.5 13.5 12.0 7.2 6.7 6.2 36.1 34.5 27.8 14.9 14.3 14.2
Community Health Systems Inc 12.1 10.9 10.0 7.2 6.7 6.4 13.7 13.4 13.0 13.5 13.6 13.2
Lifepoint Hospitals Inc 13.0 11.6 10.7 6.3 6.4 6.0 7.7 8.3 8.2 16.6 15.5 15.3
Tenet Healthcare Corp 12.2 12.5 15.1 6.4 6.4 5.7 87.2 32.5 15.8 10.9 10.6 11.5
Thailand
Bangkok Dusit Med Service 32.1 22.9 19.3 13.4 9.9 8.8 13.0 14.3 15.4 22.4 24.1 24.8
Bumrungrad Hospital Pub Co 22.9 20.8 18.2 15.0 11.3 10.1 24.1 21.7 22.5 21.9 23.4 24.0
Bangkok Chain Hospital PCL 18.2 16.8 14.6 10.3 8.8 7.8 24.6 20.9 21.9 27.9 29.6 32.7
Australia
Ramsay Health Care 26.1 17.2 15.1 11.3 8.4 7.7 18.1 15.3 16.0 13.3 13.8 13.9
Primary Health Care 12.8 11.1 10.0 8.4 6.8 6.3 5.8 5.6 6.1 24.9 25.6 26.3
India
Fortis Healthcare * 94.3 38.1 26.0 56.4 24.7 16.3 4.7 6.6 7.0 19.3 16.1 16.2
Apollo Hospitals Enterprise * 45.7 33.7 30.4 23.0 17.0 15.3 8.7 10.7 11.0 14.8 16.5 16.5
Singapore
Raffles Medical Group 37.0 28.6 24.5 25.7 20.0 16.9 16.1 16.4 17.3 23.9 24.1 25.2
Thomson Medical Centre 45.9 33.2 29.6 33.4 22.3 20.4 11.6 13.1 12.7 24.9 27.5 26.9
Malaysia
Kpj Healthcare Berhad 20.5 15.6 14.1 14.5 11.0 10.3 18.3 17.3 17.5 12.4 12.7 12.0
Source: Bloomberg, IDFC Securities Research; Note: * for years FY10, FY11, FY12

NOVEMBER 2010 9
 IDFC Securities

INDIAN HEALTHCARE: A SNAPSHOT

¾ With 5.5% of GDP spend, healthcare is one of the largest industries in India
with hospitals accounting for ~50% of this spend
¾ Unlike most other countries where public spend dominates, private sector
accounts for 80% of India’s healthcare spend; leads to woeful standards of
healthcare against global norms
¾ Private hospital providers have moved in to fill the gap over the years and now
dominate the tertiary/ quaternary care segments
¾ Hitherto, private hospital space was dominated by the unorganized sector but
organized players gaining ground with the emergence of corporate hospital
chains like Apollo, Fortis, Manipal, Max, etc
¾ Frenetic VC/ PE activity underlines growing investor interest, and thereby the
attractiveness of the organized private healthcare space

‰ Healthcare – one of the largest industries in India

With national healthcare spending at 5.5% of GDP in 2009 (as per OESC), healthcare
is one of the largest industries in India. The sector is also one of the largest employers
in the country with around 4m employees across the sector.

The constituents: The sector is broadly classified into hospitals, pharmaceuticals,

diagnostic centers and others (medical equipment, insurance, etc). Hospitals and
pharmaceuticals account for 75% of the total healthcare spend.

Exhibit 9: India healthcare spend – Hospitals and Pharma account for 75% of the pie
Healthcare spend - 2010

Insurance & Medical

Equipment
15%

Diagonistics
10%

Hospitals
50%

Pharma
25%

Source: MAX, IDFC Securities Research

‰ Unlike most countries, public healthcare spend lags private spend

Private players rule the Globally, healthcare provision is typically provided by a largely government-funded
roost in India, unlike
government predominance
public healthcare system. In contrast, the Indian healthcare industry is dominated by
in developed nations the private sector with government spending at only ~1% of GDP, as compared to
3.5% of GDP (as on 2007, source: WHO) for Brazil and 1.9% for China. Interestingly,
almost 75% of India’s overall spending on healthcare is accounted for by the private
sector, which is among the highest globally.

NOVEMBER 2010 10
 IDFC Securities

Exhibit 10: Public health – lowest on the government’s focus list

Health expd. (as % of GDP)
India Low income Per capita spend on health (US$) (2007)
(% of GDP) Lower middle income Upper middle income 4405
Global

O
8.0 High income
488
USA

UK 6.0

Russia
4.0
China
80
Brazil 40 27
2.0
India
India Low income Lower Upper High income
0.0 middle middle
0 4 8 12 16 Public sectro spend Private sector spend income income

Source: WHO, IDFC Securities Research

Exhibit 11: Healthcare expenditure remains skewed globally

Particulars* (2007) Total Public exp. as Pvt. exp. as % Out-of-pocket "Per capita "Per capita "Per capita
expenditure % of total of total exp. as % of total govt. exp. on Pvt. sector
on health as % hea lthcare healthcare pvt. exp. on expenditure healthca re exp. on
of gross spend spend health on healthc (PPP int. $)" healthcare(PP
domestic (PPP int. $)" P in $)"
product
India 4.1 26.2 73.8 89.9 109 29 80

Brazil 8.4 41.6 58.4 58.8 837 348 489

China 4.3 44.7 55.3 92 233 104 129

Russian Federation 5.4 64.2 35.8 83 797 512 285

Singapore 3.1 32.6 67.4 93.9 1,643 536 1,107

United Kingdom 8.4 81.7 18.3 62.7 2,992 2,446 546

United States of
15.7 45.5 54.5 22.6 7,285 3,317 3,968
America

Globa l 9.7 59.6 40.4 43.9 863 493 370

Source: WHO, IDFC Securities Research

Notably, India has the lowest ratio of public to private health expenditure (~0.36x)
among the countries listed above. This includes some of world’s poorest nations.

With its history of under-spending, India’s public healthcare infrastructure is

‘woefully inadequate’ – and it leaves majority of the population devoid of basic
healthcare amenities. Public health facilities, which are not only under-staffed but
also ill-equipped in terms of obsolete or poorly managed medical equipment, offer
only basic services.

NOVEMBER 2010 11
 IDFC Securities

‰ Public healthcare also weighed down by structural inefficiencies

• Planning of Indian public healthcare programmes has always been centralized,
creating broad verticals for prevention and control that grossly ignore local/
regional issues. Again, provision for infrastructure is based on population size
rather than epidemiology profiles, which results in poor accessibility,
acceptability and utilization.
Public healthcare lacks • The human resource gap at various levels and long waiting periods compound
efficient monitoring and
the problems. We believe the Indian healthcare system lacks efficient monitoring,
feedback systems
evaluation and feedback systems. Besides this, there are no incentives for working
well. The absence of quality measurement standards has led to a dysfunctional
health infrastructure.
• Healthcare financing is equally dysfunctional. Funds are released in five-year
terms, and divided under several complex budget heads — revenue, capital, etc –
with little flexibility to respond to health emergencies.
Lack of incentives to retain • Lack of incentives to attract skilled resources (doctors/ nurses) and inadequate
talent has seen doctors funding for technology upgradation in public sector healthcare has resulted not
veering towards private
hospitals in tier I metros
only in a drastic change in the perception of patients, but also resident doctors.
The bias against public healthcare is clearly evident from the fact that specialist
doctors lean towards private hospitals and that private hospitals have higher
occupancy levels vis-à-vis public hospitals (see exhibit below). About 72% of the
specialist doctors in India are based in Tier I cities, in which private hospitals are
concentrated.

Exhibit 12: Public healthcare facilities continue to face a steady decline in occupancy rates
(%)
Rural Urban
25
24

23
22

21
21
20

19 19
19

17
1986-87 (42nd) 1995-96 (52nd) 2004 (60th)

Source: NSSO 60 Round (2004)

th

NOVEMBER 2010 12
 IDFC Securities

Is it lack of funds or structural bottlenecks restricting progress?

Our interaction with healthcare personnel at the village level indicates that it is not the shortage of funds but lack of
efficient and flexible mechanisms to utilize the funds that has been impeding improvement in healthcare delivery.
So, one cannot argue that the government is not deploying enough funds as a significant amount of allocated funds
remains unutilized each year.

The problem lies in the way the departmental budgets are structured for a 5-year tenure with the primary divisions
being revenue and capital, and plan and non-plan. This leads to fragmentation of the health budget into more than
400 sub-heads, with funds under each head non-transferable and surrendered to the state’s general pool if unutilized
at end of the fiscal.

We believe such budgeting fares perfectly well from an accounting perspective, with expenditure control as the
central objective. This also ensures prevention of misuse or diversion of funds. However, this archaic system of
budgeting is not based on any meaningful programme audits and is also not subject to any evaluation or review on
physical targets. Our interaction at the village level indicates that cumulative energy of departmental workers
remains focused on obtaining utilization certificates to release funds to district societies rather than health outcomes.
However, annual budget utilization helps protect future allocations under the scheme.

In summary, we believe there is an urgent need to restructure the budgeting system to make it more functional and
flexible.

Exhibit 13: Extent of under-utilization of the health budget

(%)
1990-95 1995-01
15
12.4
7.26 7.61
5 5.25 3.81
2.37

-5
-3.28
-6.55 -5.47

-15

-25

-35 -30.77
Kerala Tamil Nadu Orissa Rajasthan Uttar Pradesh

Source: RBI

‰ End result – woeful standards of healthcare against global norms

Life expectancy, infant
mortality and beds per
person much lower In India
vs comparable economies
The woefully low as well as inefficient public healthcare spend effectively ensures
that quality healthcare is accessible to only to those who can afford to pay for it.
Thus, India continues to significantly lag on key healthcare indicators like life
expectancy, infant mortality, etc. Life expectancy in India is 66 years compared to 78
years in developed countries while infant mortality rate stands at 70 deaths per 1,000
births as compared to six deaths in developed countries. Further, India has only
0.9beds per 1,000 people as compared to 3.9beds in high middle income countries.
Similarly, the ratio of registered doctors per person is also fairly short of the global
benchmark.

This is clearly reflected in India’s dismal ranking at 134 among 182 countries listed on
United Nation’s Human Development Index (HDI).

NOVEMBER 2010 13
 IDFC Securities

‰ Government’s baby steps not enough

In the FY11 Union Budget, the government increased healthcare allocation by Rs27bn
to Rs223bn. However, the healthcare budgetary allocation is just 2% of the total
budgeted outlay i.e., way short of the government’s target of 3% of GDP. More
importantly, most of the planned outlay remains concentrated on revenue expenditure
(96%), implying that only 4% of the planned expenditure is available for the much-
required infrastructure creation. Interestingly, despite 46% of the planned allocation
for the entire fiscal budget being directed towards infrastructure development, we
find healthcare infrastructure attracting only 0.23% of the budgeted corpus.

Exhibit 14: Capital expenditure has averaged 4% over last 5years Helathcare budgetary allocation remains miniscule

Total (Rs bn - LHS) Capital Exp. (% of Budgeted Exp. - RHS) as % of total planned allocation as % of GDP
240 8 5.25 0.40

5.00 0.38
180 6

4.75 0.35

120 4
4.50 0.33

60 2
4.25 0.30

4.00 0.28
0 0
FY06 FY07 FY08 FY09 FY10 FY11 FY06 FY07 FY08 FY09 FY10 FY11

Source: RBI, IDFC Securities, Bloomberg

Private healthcare providers gaining relevance

‰ Private players enjoy a lion’s share
With the government’s healthcare spends not keeping pace with the requirement and
the focus limited largely to primary and preventive infrastructure in India, private
players have been steadily increasing their dominance in tertiary as well as
secondary care. In particular, they have established a dominating presence in
tertiary/ quaternary care, operating an estimated 93% of all hospitals and owning
64% of beds nationwide.

The private healthcare provider space has both for-profit and non-profit healthcare
providers. In terms of practice, the scale varies from small solo clinics and nursing
homes (in-patient facilities with usually <30 beds) to large corporate hospital chains
which typically run high-end tertiary care hospitals with >100 beds.

‰ Unorganized sector rules the roost

Organized healthcare
gradually gaining relevance
in India
In India, the private healthcare sector is highly fragmented with the unorganized
component accounting for ~90% of the private healthcare sector. To put this into
perspective, of ~1.05m beds in the country (CRISIL estimates), Apollo (the largest
organized healthcare player in India) has only ~8000 beds under management
including owned (by itself and associates) as well as managed beds. According to
McKinsey, while private sector accounted for ~75% of beds in 2005, hospitals with
more than 100 beds (organized players) accounted for ~10% of the overall beds.
Hospitals with less than 100 beds accounted for a whopping ~65% of beds.

NOVEMBER 2010 14
 IDFC Securities

Exhibit 15: Private players enjoy a dominant position

Govt. Hospitals Mid-tier Top-tier Nursing homes
Private
Government
Nursing
Mid-tier Top-tier 2015
Homes
Primarily nursing Corporate
Healthcare Major corporate Private sector
homes and hospitals with
centres, district hospital chains
recovery rooms in-house staff
hospitals and and specialty
with adequate and consulting
general hospitals hospitals 2005
infrastructure physicians

Variable; based
<30 beds 30-100 beds > 100 beds
on type
0 25 50 75 100

Source: Mckinsey-2007, IDFC Securities Research

‰ Share of organized sector set to increase

However, in realization of the huge demand supply gap in the tertiary care offering
segment, organized healthcare (corporate hospitals) segment has been slowly gaining
relevance over the last few years with the emergence of corporate healthcare
hospitals like Apollo, Fortis, Max, Wockhardt, etc and we expect this trend to
accelerate.

Govt. has acknowledged the
greater role of private
players, evident in the tax
sops and lower tariffs
Importantly, the government, whose focus has been primary/ preventive care, has
acknowledged that the capital intensive nature of the sector would need private
players to step in. Several government policies (tax sops for up to five years for
setting up hospitals (>200beds) in tier II/ III cities, lowering of tariff rates, etc.) are a
clear evidence of the same.

This is amply reflected in the fact that over FY06-09, bed additions at Apollo and
Fortis Healthcare have grown ~2x the pace of government hospitals. Though this
could be partly on account of a low base, we also see a broader trend of growing
appetite of Indian corporates to invest in healthcare, and thereby the increasing
dominance of organized private players in the Indian healthcare market.

Exhibit 16: OverFY06-09, Apollo & Fortis have grown at 2x the pace of government beds
(no of beds) Fortis Healthcare AHEL Standalone
2,500 Total Govt. hospital beds 550,000

2,000 525,000

1,500 500,000

1,000 475,000

500 450,000
FY06 FY07 FY08 FY09
Source: IDFC Securities Research, Companies, NSSO

NOVEMBER 2010 15
 IDFC Securities

‰ Multiple large corporate chains on the scene now

Unlike the situation a few years ago, when Apollo was probably the only relevant
corporate hospital group in the Indian market, multiple new players have emerged
on the scene in yet another demonstration of the attractiveness of this high-end
tertiary care healthcare opportunity for corporates. The major players include Apollo
Group, CARE Hospitals, Manipal Group, Fortis Healthcare and MAX Healthcare.
The exhibit below summarizes operations of three of the leading private sector
players in India.

Exhibit 17: Key players in the organized healthcare sector

Particulars Apollo Hospitals Fortis Max India Manipal Group
No. of beds 8064 3250 1100 7575
Owned 5476 2885 NA. NA
Managed 2588 366 NA NA
Planned expansion (No. of beds) 2668* 2075* 1350^ NA
Geographical presence Pan India Pan India NCR Region South India
No. of hospitals 47 39 8 18
Hospital mix Primary/Secondary/ Tertiary Secondary/Tertiary Primary/Secondary/Tertiary
Secondary/Tertiary
Other businesses Pharmacies, Healthcare BPO, Pharmacies, Insurance, Speciality
Consulting, Insurance, Diagnostic labs, etc. products Education
Source: IDFC Securities Research, Company* by FY14, ^by FY16

‰ Frenetic PE, VC activity reinforces the attractiveness of the space

That the sector is indeed attractive has been widely acknowledged by financial
investors (both domestic and global), clearly visible in the slew of equity infusions
over the past couple of years. Domestic and global private equity/ venture capital
firms have invested across the Indian healthcare delivery chain. The exhibit below
lists investments from standalone tertiary care hospitals in metros/ tier II cities,
chains of hospitals, diagnostic labs, etc.

PE activity mainly seen at
holding company level and
in tertiary care units
Further, based on investor appetite, a number of investments have been made in the
following areas: (a) holding company level/ chain of hospitals (e.g., Warburg Pincus
and IFC in MAX healthcare); (b) individual tertiary units in expansion mode (e.g.,
Actis in Sterling Hospitals); and (c) building a portfolio of beds by pooling; e.g., ICICI
Ventures. The following exhibit details a few recent equity infusions in the sector.

NOVEMBER 2010 16
 IDFC Securities

Exhibit 18: Recent equity participation in the healthcare delivery sector

Buyer Target Company Deal value (USDm) % stake
IFC Rockland Hospitals (RH) 12 na
JP Morgan Asset Management Seven Hills Hospital 72 na
India Venture Advisors Kavery Medical Centre 20 30
Fortis Healthcare Apollo RM Hospital na 56
Sequoia Capital Vasan Eye Care 18 na
Milestone Religare HealthCare Global 7 na
IDFC HealthCare Global 10 na
Premji Invest HealthCare Global 18 na
Evolvence HealthCare Global 6 na
Milestone Religare Krishna Institute of Medical Sciences 13 21
Kavery Medical Centre & Hospital Sea Horse Hospital 5 34
AIG & J P Morgan Narayana Hrudayalaya 89 25
Fortis Healthcare Oscal Investments Malar Hospitals 8 62
Aavishkaar India Micro Venture Capital Fund, Vaatsalya Healthcare 4 32
Oasis Capital, Seedfund
I-Ven Medicare India Pvt Ltd Vikram Hospital, Delhi 24 na
I-Ven Medicare India Pvt Ltd RG Stone Hospital, Delhi 10 na
I-Ven Medicare India Pvt Ltd Medica Synergie, Calcultta 15
I-Ven Medicare India Pvt Ltd Sahaydri Hospital, Pune 36
India Venture Advisors KG Hospital 12 na
Global Hospitals Shankar Hospital 57 100
Fortis Healthcare Hiranandani Healthcare, Navi Mumbai 6 100
IDFC Manipal Hospitals 70 na
APAX Partners Apollo Hospitals Enterprise 104 13.6
Warburg Pincus MAX Healthcare 30 30
IFC MAX Healthcare 60 3.9
Actis Sterling Hospitals 15 41
Indivision Global Hospitals 25 25
Aavishkaar India Micro Venture Capital Fund Swas Healthcare
Global Technology Investment Group Nova Medical Centers
BCCL Wockhardt 10 1.5
CitiGroup Wockhardt 20 3.2
Ashmore funds CARE Hospitals 90 19
Oyester & Pearl Sabre Healthcare 14 n.a.
Sequoia Capital Dr Lal's path labs na 26
Source: IDFC Securities Research, news flow, ISI

‰ However, FDI interest remains low

Given the attractiveness of
the space, FDI has been
relatively low so far…
Despite government incentives to attract FDI investments (including 100% FDI in all
health-related services), FDI inflows in the hospital sector have been surprisingly
lukewarm given the attractiveness of the space. A scan of the landscape indicates the
presence of limited 100% foreign-owned healthcare players in the Indian market.

Following are some of the activities undertaken by the foreign players in the Indian
healthcare space
• Singapore's Pacific Healthcare made its first foray into the Indian market, opening
an international medical centre, which is a joint venture with India's Vitae
Healthcare, in the Indian city of Hyderabad.
• The Singapore-based Parkway Group Healthcare PTE Ltd penetrated into the
Indian healthcare market in 2003 through a joint venture with the Apollo group to

NOVEMBER 2010 17
 IDFC Securities

build the Apollo Gleneagles hospital, a 325-bed multi-speciality hospital at a cost

of US $29m.
• Columbia Asia Group, a Seattle-based hospital services company, a worldwide
developer and operator of community hospitals, started its first American-style
medical centre in Hebbal, Bangalore.
• The Parkway group had also entered into a JV with a Mumbai-based Asian Heart
Institute and Research Centre to set up specialized centres of medical excellence
in Mumbai.
• Max Healthcare and Singapore General Hospital (SGH) have a collaboration for
medical practice, research, training and education in healthcare services.
• India’s first geriatric hospital, the Heritage Hospital of Hyderabad has formed a
joint venture with US-based United Church Homes to recruit, train and provide
placement to registered Indian nurses in USA.

…but we see the situation However, we do anticipate increased activity on this front going forward as the
changing as the India story attractiveness of the Indian healthcare market opportunity compels more players to
grows more compelling
explore options in India.

NOVEMBER 2010 18
 IDFC Securities

THE BEST IS AHEAD

¾ A confluence of multiple positive factors, e.g. growing affordability, an
expanding base of elderly population and growing incidence of lifestyle
diseases, will driven sustainable high growth
¾ We estimate Indian healthcare market to double over the next five years to be a
$125bn opportunity by 2015
¾ Along with favorable demographics, increasing penetration of medical
insurance along with medical tourism will be key catalysts for growth
¾ Organized private healthcare providers, particularly in the tertiary care
segment, will be the biggest beneficiary of this growth opportunity

Indian healthcare: In a sweet spot

A confluence of multiple positive drivers including rapidly growing affordability, a
steadily growing population which is adding elderly people at a much faster pace,
growing incidience of lifestyle diseases combined with growth of medical insurance
as well as the potential of medical tourism will drive sustainable high growth in the
$62bn Indian healthcare industry over the next several years / decades. Hospitals ,
the largest component of the healthcare spend in India, will be the biggest beneficiary
of this macro trend.

Exhibit 19: Key enablers to growing Indian healthcare

Increasing
Increasing life
life
expectancy
expectancy & &
ageing
ageing
population
population

Growing
Growing Increasing
Increasing
affordability
affordability awareness
awareness

Indian Healthcare

Rise
Rise of
of medical
medical Growing
Growing
tourism
tourism population
population

Rising
Rising Health
Health
Insurance
Insurance
penetration
penetration

Source: IDFC Securities Research

NOVEMBER 2010 19
 IDFC Securities

‰ Indian healthcare – likely to be a $125bn opportunity in five years

Indian healthcare sector is currently valued at $62bn and is estimated to be growing
at 13% per annum; this implies that the sector garners per capita expenditure of
~US$53, according to our calculations. We expect the healthcare opportunity to
double to US$125bn in the next five years as we estimate population to grow at 2%
annually and factor in a 10% annual increase in healthcare spend on the back of
changing demographics and rising income levels.

Exhibit 20: Indian healthcare – a US$125bn opportunity by 2015E

Particulars 2009 2010 2011 2012 2013 2014 2015
Population (in m) 1166 1189 1213 1237 1262 1287 1313
Assumed Growth (%) 2 2 2 2 2 2
Per capita health expd. (US$/pp) 53 58 64 71 78 86 95
Assumed Growth (%) 10 10 10 10 10 10
Health Expenditure (US$bn) 62 70 78 88 98 111 125
Source: IDFC Securities Research

‰ Private healthcare segment to be the biggest beneficiary

With limited public sector Crisil estimates that India requires 632,000 additional beds over the next 10 years,
funding and high costs ~60% higher than the current base of 1.05m beds. Of these, ~20% will be required for
involved, private players
poised to benefit complex medical procedures in cardiac and oncology segments. In our view,
hospitals are a high gestation business entailing significant upfront investments but
long payback periods. Construction of a new hospital bed costs Rs2.5m-3m on an
average with a high-end tertiary hospital bed costing Rs5m-5.5m. This implies an
overall capital expenditure of ~$40bn over the next 10 years for setting up the
incremental 632,000 beds required. As the government is hardly in a position to fund
this growth, it presents an attractive opportunity for private sector players.

Going forward, we believe the already established and well-funded corporate

hospitals like Apollo, Fortis, Max and Wockhardt will garner a substantially higher
market share. Other than their much stronger financial capabilities, these organized
players provide for complex procedures as also superior service levels, which
significantly enhance their competitiveness.

Given the huge demand of incremental hospital beds in the private sector and the
currently negligible share of corporate hospitals, we believe the growth trajectory of
corporate hospital players in India is limited only by their ambitions and ability to
manage growth.

NOVEMBER 2010 20
 IDFC Securities

Drivers for Indian healthcare

‰ A booming ecomony; increasing per capita healthcare spend
With Indian economy expected to register 8-9% CAGR over the next several years,
per capita income and standard of living are expected to improve significantly going
forward. This should lead to a jump in the pool of patients who can afford to pay for
quality tertiary healthcare as provided by the private sector. Higher dispsoable
incomes, coupled with increasing health awareness, should provide further impetus
for higher per capita healthare spend over the next several years. We estimate per
capita healthcare spends to witness a CAGR of 10% over the next five yers to US$95,
translating into a market opportunity of $125bn by 2015. We expect private sector
hospitals to be the key beneficiary of this trend.

Exhibit 21: Evolving favorable demographics to boost healthcare spend

(per capita) (m households) (m)

Nominal Real Urban population
250 600

1.2 3.3 9.5

200 450

13.3 60.6 128.0

150 300

192.4 180.1 143.0

100
150

2005 2015 2025

50
FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 0
Rich (1000) Middle Class (200-1000) Poor (<200) 1991 2001 2008 2030
Source: Industry, IDFC Securities Research

‰ Increasing life expectancy and ageing population

India’s population is now more than 1.3bn and growing at an annual rate of ~2% over
the past five years. At this rate, India will overtake China by 2030 to become world’s
most populous nation. More importantly, a combination of population growth,
higher average life expectancy and declining mortality rates will result in sharp
growth in the pool of ageing population. It is estimated that India’s population >
45years will increase from 20% in 2007 to 24% by 2017. Increasing life expectancy and
growing pool of elderly people will necessitate higher healthcare spends in future
years, providing a strong growth thrust to healthcare industry.

Exhibit 22: Rising life expectancy and declining mortality rates to see a steady increase in ageing population
Infant mortality rates in India Average age (years)
(%) 66.0
Rural Urban
135
65.5

65.0
90

64.5

64.0
45

63.5

0 63.0
CY80 CY85 CY90 CY93 CY96 CY00 CY05 CY04 CY05 CY06 CY07 CY08 CY09

Source: NSSO, IDFC Securities Research

NOVEMBER 2010 21
 IDFC Securities

‰ Rising lifestyle diseases imply higher revenue per bed

Urban residents will account India’s urban population has increased 4.5x over 1951-2001, while its total population
for more than 32% of India’s
has registered a 3x increase over the same period. According to census data, the share
population by 2014…
of urban population currently stands at ~28%. The segment is expected to grow at 4%
per annum and account for more than 32% of the total population by 2014.

…leading to a rise in With increasing urbanization and the problems associated with modern-day living in
lifestyle-related diseases
urban settings, we expect disease profiles to shift from infectious to lifestyle-related.
While this is bound to steadily result in higher treatment costs, we expect a steady
increase in revenue/ bed (ARPOB). Notably, most of the new corporate hospitals are
coming up in tier I and II cities and cater to the growing urban population and
targeting lifestyle-related diseases like cardiac, digestive and genitor-urinary
ailments.

…which in turn implies According to an IBEF survey conducted in 2001, the average treatment cost for
higher treatment costs and, lifestyle-related diseases was ~7x that of infectious diseases. Based on demographic
therefore, increased ARPOB
for hospitals trends and an expected shift in disease profile (towards chronic segments), we expect
India’s disease profile to follow the pattern of developed economies. Based on this,
we expect a swift increase in in-patient revenues.

Exhibit 23: Evolving demographics to drive inpatient volumes & ARPOB

(%) (% of population)
Developing world diseases Developed world diseases
100 2005 2015E
5.0
17 15 Infectious and respiratory diseases
20
34 2 Accident/injuries
37
75 44 12 4.0
13 17
Maternity/gynae

18 9 Musculoskeletal
15 10 16 3.0
50 4
16 3 18
Digestive & Genito urinary
19
14 18
24 2.0
2 Circulatory (cardio…)
22 19
25 3 16 19 13
5 1.0
2 4 Cancer
4 9 8
7 5
5 1 16 Other dieases
4 7 10 10
8
0 3 3 0.0
India-2001 India-2012 Thailand- Brazil*-2001 Singapore- US-2001 Coronary heart Diabetes Asthma Obesity Cancer
2001 2001
No. of disease
hospitalisation ('000) 31 39 61 26 127 113
GDP per capita No. of patients 36 62 31 46 27 34 14 34 2.0 2.5
2,100 3,600 5,800 6,900 25,000 22,000
PPP $(1998) ( )
Source: IBEF, E&Y, Mckinsey, IDFC Securities Research

‰ Increasing insurance penetration – icing on the cake

Poor insurance penetration The widespread lack of health insurance is one of the primary causes for the limited
is the key reason for
access to quality healthcare in the country for majority of the population – as
people’s lack of access to
quality healthcare reflected in India’s low ranking in the human development index (HDI). Currently,
<12% of the population is covered under health insurance in some form or the other,
which suggests enough scope for penetration levels to rise. In FY05, only 1% of the
population was covered by private health insurance. Group insurance accounted for
35% of the total health insurance business during that period. This has led to a
situation wherein out-of-pocket payments for medical care account for 69% of the
total healthcare expenditure by Indian households (according to FY02 census data).
Given this high out-of-pocket expense, affordability emerges as a key issue in the
way to seek healthcare in high-end tertiary hospitals. While there is a burgeoning
middle-upper class which can afford to pay for the fees in high-end corporate

NOVEMBER 2010 22

An expanding upper middle
class and rising healthcare
insurance penetration to
benefit tertiary care sector…
…and will catalyze the
growth of corporate
hospitals
Govt schemes will increase
affordability and, therefore,
enhance in-patient volumes
NOVEMBER 2010
IDFC Securities
hospitals, we believe growing awareness and penetration of health insurance will
significantly enhance the target patient pool for this segment of hospitals.
Health insurance has registered a CAGR of 41% over the past four years. Despite the
elevated growth rates, high premiums, inadequate and inefficient back-end
infrastructure have kept health insurance out of reach for a large part of the
population. With increased interest from private insurance players that are targeting
this potentially huge opportunity, health insurance growth is expected to accelerate.
Swiss Re estimates India’s health insurance premium market to grow to US $7.7bn by
2015.
In our view, better availability of health insurance would help drive demand for
services and provide additional revenues while improving the quality of healthcare.
Also, increasing penetration of health insurance would be a key catalyst in the
growth of corporate hospitals in India.
Exhibit 24: Health insurance has grown at 41% CAGR over past four years!
(Rs bn)
Non life - Public Non life - Private Standalone Health Insureers
40
30
20
10
0
FY05 FY06 FY07 FY08 FY09
Source: IRDA AR, IDFC Securities Research
Insurance schemes find favor with state/central governments too
• The central government’s ambitious RSBY (Rashtriya Swasthya Bima Yojna)
scheme to provide insurance cover to BPL (below poverty line) households is one
such step. In our view, successful implementation of this scheme will increase
healthcare affordability for several million households.
• Several micro-insurance schemes running on partnership bases between the
governments of Andhra Pradesh and Tamil Nadu and private healthcare service
providers have been hugely successful.
In the coming years, we see improved affordability owing to a wider insurance
penetration driving in-patient volumes for private healthcare providers.
23

Historical lack of regulation
responsible for rising cost
of treatment and low quality
An increasing number of
hospitals are seeking
accreditations – a positive
trend
High standards required to
qualify for accreditations
will favor organized players
Entry into insurance
segment will help large
hospitals cross-sell services
NOVEMBER 2010
IDFC Securities
Accreditations and growing insurance spread – advantage corporate providers
• Unregulated growth of private healthcare over decades has led to inefficiencies
(lack of clinical protocols, duplication of work, inventory mismanagement, etc)
and huge cost overheads. These have, in turn, impacted availability of quality
medical care and driven up the cost of quality treatment. We believe greater
insurance penetration could enhance the availability of quality medical care.
• Recent trends suggest growing preference of payors/ insurers towards hospitals
that have acquired quality accreditations (e.g. NABH/ QCI/ JCI). There are reports
of several government and state owned enterprises insisting that the Third Party
Administrators (TPA) and insurers put accredited hospitals on the preferred
provider list. We expect this trend to gain further momentum going forward.
• Given the growing importance of heath insurance in driving future growth, we
believe hospitals will be forced to get national/ international accreditations like
NABH/ JCI, etc. This will also help improve the spread of quality medical care.
• Interestingly, a positive fallout of this trend will be that several nursing homes
may not be in a position to implement the norms in line with NABH regulations,
etc – which will impede their capability to get accredited and thereby participate
in the health insurance market. This state of affairs will favour the organized
private players. Therefore, given the expected increase in insurance penetration
and growing awareness of quality accreditations, we find the organized private
healthcare sector in a sweet spot.
"Insured patients account for 10% of our inpatient volumes with corporates accounting for
70% of volumes. Insured patient volumes are increasing with 10-15% volume growth each
year”
-A leading South Delhi Hospital
"Increase in insurance penetration is encouraging for healthcare service providers. Success
of Govt. insurance programs in Andhra Pradesh and Karnataka has been encouraging.
Insured patients account for 18% of our revenues; we target to increase this to 45% over
next few years"
-Vaatsalya
Large hospital chains have also entered the healthcare insurance segment – e.g.
Apollo Hospitals and MAX Healthcare have formed JVs with international partners
like Munich Re and BUPA respectively to set up insurance companies. Apart from
the economic benefits realizable by tapping into an opportunity presented by a
significantly under-insured population, this business also provides hospitals an
opportunity to cross-sell their products.
Exhibit 25: Large organized players have tied up with insurance companies
Source: Industry
24
 IDFC Securities

In another trend, hospitals – looking to provide affordable treatment – have tied up

with state governments to provide micro insurance for the underprivileged.
Narayana Hrudayalaya, for instance, successfully runs an insurance scheme called
Yeshasivini launched in 2002.

Exhibit 26: Organizational structure of Yeshasvini Cooperative Farmers’ health scheme

GOVERNMENT’S
COOPERATIVE COOPERATIVE
TPA TRUST STRUCTURE SECTOR
State Level

Yeshasvini Department of
Family Health Federation(s) of
Farmers Health Co-operation,
Plan Ltd Unions
Trust Gov Karnataka
District Level

(2) District Deputy Registrar Union(s) of

District
Coordination of Cooperative Cooperative
Coordinator
Committee(s) Societies Socities

CLAIM
Town/Village Level

SETTLEMENT Cooperative
Network Hospitals
Society
SUBSCRIPTION
UT
ILIZ
AT
ION
Member of
Cooperative
Society
Source: Industry

‰ Rise of medical tourism – another potential catalyst

Indian medical tourism
driven by the promise of
global quality, not just cost
arbitrage
“Medical tourism”, a phrase commonly used for overseas patients seeking treatment
in India, has been gaining momentum over the past few years. The trend is
developing not just because of the cost arbitrage but also because of India’s
emergence as a high-quality healthcare destination. Also, long waiting periods for
patients in the developed world and increasing attraction to innovative/ alternate
therapies contribute to the rise in medical tourism. In a bid to seize this opportunity,
Indian corporate hospitals have been striving to achieve international accreditations.
According to IBEF, the medical tourism market was an estimated US$333m in terms
of revenues in 2006 and is expected to grow to US$2bn by 2012.

Exhibit 27: Indian medical tourism expected to grow 6x over FY06-12

(US $ bn)
2.4

1.8

1.2

0.6

0.0
FY06 FY08 FY12

Source: Industry, IDFC Securities Research

NOVEMBER 2010 25
 IDFC Securities

India’s USP…high quality delivered at significantly lower costs…

IBEF estimates medical
tourism to be a $2.2bn
opportunity for Indian
corporate hospitals by 2012
The value proposition for patients from developed countries is lower cost, high levels
of quality and service in Indian tertiary hospitals and availability of superior medical
facilities for patients from the developing countries in Asia and Africa. In particular,
it is an exciting proposition for patients from developed countries like USA and
Europe – e.g., there are ~50m uninsured people in USA who are potential targets for
this opportunity. Undergoing a complex medical procedure in India costs as less as
one-tenth of the cost in those countries, accompanied with very high quality
standards as a topping. India’s cost competitiveness is further established by the
wide cost difference for various procedures between India and Thailand, the
erstwhile “Medical Tourism Hub” in Asia.

Exhibit 28: Treatment in India costs nearly a tenth of that in developed countries
Treatment cost (US$) India Thailand USA
Bone marrow transplant 30,000 62500 400,000
Liver transplant 40,000 75000 500,000
Open heart surgery 4,400 14250 50,000
Hip replacement 4,500 6900 na
Knee surgery 4,500 7000 16,000
Gall bladder removal 555 1755 na
Neuro surgery 8,000 na 290,000
Source: IBEF, Industry

…and almost no waiting period

Overburdened medicare
systems in the West and
holistic treatments &
alternative therapies in India
attracting patients
Patients in several developed economies, including the US, UK, Canada, etc, face
long waiting periods that often run into months due to over-burdened healthcare
systems. Indian healthcare service providers have seen a sharp jump in occupancy
rates at their preventive medicine and wellness centers during holiday seasons,
clearly indicating the emergence of the medical tourism segment. Further, India’s
huge expat population, we believe, is also a target segment. The above factors have
led to a visible jump in medical tourism in the country. The Indian government has
lent support via expediting the visa-process to eliminate procedural delays. Leading
private sector hospitals have seen near doubling of revenues garnered from medical
tourists on a yoy basis and remain upbeat on the opportunity.

Exhibit 29: Long waiting periods a result of overburdened healthcare systems in Canada and UK
Wait from GP to specialist (Elective) Wait from specialist to treatment 90,000 In-patient waiting list in UK

Can
67,500
NL
PE
45,000
NS
NB
22,500
QC
ON
0
MB
30+ weeks
0 <01 weeks

02 <03 weeks

04 <05 weeks

06 <07 weeks

08 <09 weeks

10 <11 weeks

12 <13 weeks

14 <15 weeks

16 <17 weeks

18 <19 weeks

20 <21 weeks

22 <23 weeks

24 <25 weeks

26 <27 weeks

28 <29 weeks

SK
AB
BC
0.0 6.0 12.0 18.0 24.0 30.0

Source: NHS, IDFC Securities Research

NOVEMBER 2010 26
 IDFC Securities

Indian private hospitals – gearing up to tap expected medical tourism inflow

Tapping into the medical tourism opportunity is a stated strategic objective for
almost all organized Indian private healthcare providers. In line with the strategy,
several Indian private healthcare facilities have already acquired international quality
accreditations like JCI (Joint Commission International) an JCAHO (Joint
Commission of Accreditation of Hospital Organizations). We expect these numbers
to swell going forward. The exhibit below lists the accreditations secured by leading
Indian private sector players.

Exhibit 30: JCI accredited organizations steadily on rise

Hospital
Ahalia Foundation Eye Hospital
Apollo Hospitals, Bangalore
Apollo Hospitals, Chennai
Apollo Hospitals, Hyderabad
Apollo Gleneagles Hospital, Kolkata
Fortis Hospital
Fortis Escorts Heart Institute
Fortis Hospitals - Bangalore
(formerly Wockhardt)
Fortis Hospitals - Mulund
(formerly Wockhardt)
Grewal Eye Institute
Indraprastha Apollo Hospital
Moolchand Hospital
Satguru Partap Singh Apollo Hospital
Shroff Eye Hospital
Sri Ramachandra Medical Centre
India
Source: JCAHO, IDFC Securities Research
Location First Accredition on Re-accredited on
Palakkad/Kerala, India First Accredited: 24 December 2009
Bangalore, India First Accredited: 18 July 2008
Chennai, India First Accredited: 29 January 2006 Re-accredited: 31 January 2009
Hyderabad , India First Accredited: 28 April 2006 Re-accredited: 17 April 2009
Kolkata, India First Accredited: 24 January 2009
Mohali , India First Accredited: 15 June 2007 Re-accredited: 24 July 2010
New Delhi, India First Accredited: 20 February 2010
Bangalore , India First Accredited: 9 February 2008
Mumbai, India First Accredited: 26 August 2005 Re-accredited: 20 November
2008
Chandigarh , India First Accredited: 26 May 2007 Re-accredited: 30 July 2010
New Delhi , India First Accredited: 18 June 2005 Re-accredited: 12 July 2008
New Delhi, India First Accredited: 5 December 2009
Punjab , India First Accredited: 3 February 2007 Re-accredited: 6 February 2010
Mumbai , India First Accredited: 18 February 2006
Chennai, Tamil Nadu, First Accredited: 7 February 2009

‰ Partnerships with global insurance players

Many Indian private hospitals catering to overseas medical patients have entered into
tie-ups with foreign insurance players. For example, large Indian private healthcare
service providers have tied up with insurers like BUPA (UK), Van Breda (Belgium)
and Môn dial (France) to direct patients to India. We also understand that several
large hospital chains are in active talks with overseas governments and insurance
companies to offer best-in-class medical services at attractive prices on contractual
basis.

“Overseas medical tourists account for 10% of our in-patient volumes. We expect 10-15%
volume growth in this segment in FY11. We see steady inflow of patients from Middle East,
Africa and neighboring countries.”
-A leading South Delhi Hospital

NOVEMBER 2010 27

A tertiary hospital can
achieve operating margins
of 25-30%, but could take
5-6 years to hit those levels
NOVEMBER 2010
IDFC Securities
TERTIARY HOSPITALS: ATTRACTIVE, BUT…
¾ With potential 25-30% EBITDA margins in steady state, along with 25-30%
ROCE, tertiary care is a highly attractive business – if executed well
¾ However, operators need deep pockets and nerves of steel to succeed in this
business given the long gestation periods and stiff challenges related to
procuring land, right people as also an evolving regulatory framework
¾ We estimate that a tertiary hospital will take at least three years to turn
EBITDA-positive and generate 25-30% EBITDA typically from the fifth year
onwards.
¾ Land and building account for 30-35% of the cost of setting up a bed; hospital
economics highly sensitive to these increasingly expensive items
¾ Given the shortage of skilled personnel required for tertiary care units,
recruiting and retaining people at manageable costs is a challenge
‰ Attractive but definitely not an easy business
While the tertiary corporate hospital segment presents a lucrative opportunity for
private players, it is a relatively complex business. Multiple challenges exist on
account of spiraling land procurement costs, high upfront equipment and building
capex requirements, ensuring high occupancy, managing people issues and
regulatory issues governing the sector as well as softer issues like the sensitivity
associated with patient care. A widening shortage of reasonably priced land parcels
at desired locations and restricted availability of qualified medical personnel have
been adding to the complexity of this business.
On the financial front, we believe that while a tertiary hospital can make 25-30%
operating margins on a steady basis, it will typically take 5-6 years for a successful
hospital to reach that milestone. We assume successful tertiary hospital players will
be efficient at procuring well-located land at attractive prices, have a strong referral
network, can effectively manage people issues to attract and retain high quality
medical personnel while being capable of establishing high quality standards on a
sustained basis to attract patients.
Despite several years of existence of private sector tertiary hospitals, we do believe
that the jury is still out on the most appropriate business model that can tackle long
gestation, ensure viability and deliver profitability.
28
 IDFC Securities

Brace for long gestation; the wait is worth it...

An efficient tertiary care unit Tertiary healthcare, in our view, is among the most capital-, people- and technology-
would take two to three
intensive businesses. It is characterized by long gestation periods – besides 2-3 years
years to break even,
assuming steady patient for project conceptualization to commissioning, achieving cash breakeven for a
inflow healthcare facility could take up to three years assuming steady patient inflow and no
mishandled cases.

Real estate and equipment Cost & Complexity: The initial capital cost of setting up a tertiary hospital bed is
costs and retaining qualified Rs7m-10m in larger cities with real estate and medical equipment accounting for 65-
staff are key challenges for
any delivery model 70% of the total project cost. The industry is characterized by frequent product
innovations and evolving technology (e.g., high-cost imported equipment may
become outdated earlier than anticipated). The quality of doctors and nurses is
critical to the success of any hospital and, hence, retention of key medical personnel is
imperative. Real estate, medical equipment costs along with employee retention are
the key factors that determine the success or failure of a healthcare delivery model.

Rewards: Importantly, post stabilization i.e. typically after fifth year of operations,
hospital operators can potentially enjoy >20% EBITDA margins with attractive return
ratios. Further, based on management’s abilities to derive cost efficiencies, hospitals
could enjoy margins in range of 30-35% by 6th - 7th year of operations and generate
25-30% RoCE. Apollo Chennai for instance operates at 30%+ EBITDA margins. After
achieving EBITDA break-even, we expect well-run hospitals to clock steady annuity
like cash flows.

Exhibit 31: Capital cost distribution Sweet returns post stabilization of beds
Capital Costs breakup
Cash flows
28 RoCE (% - LHS) Operating margins (% - RHS)
(Rs m) 32
Operating cashflow Free Cash Flow
500
Land
Others
8%
15%
0 19 22
Construction
IDC
19%
8% -500
10 12
Pre operative
-1,000
expenses
12% 1 2
-1,500

Machinery
38% -2,000 -8 -8
YR1 YR2 YR3 YR4 YR5 YR6 YR7 YR1 YR2 YR3 YR4 YR5 YR6 YR7

Source: IDFC Securities Research

The operating matrix of a hospital depends on a host of variables, including location,

target markets, price sensitivity, specialization, level of technology, etc.

NOVEMBER 2010 29
 IDFC Securities

The exhibit below cites detailed revenue and cost break-ups for a tertiary care
hospital. However, to understand the economics of a multi-specialty tertiary care
hospital and for the sake of simplicity, we limit the number of input variables.

Exhibit 32: Revenue and cost mix for a tertiary care hospital
Revenue Streams Cost heads

OPD
5% Bed EBITDA
Personnel cost
17% 18%
Consumables 22%
19%

Marketing & PR
OT Rent Doctors share 2%
Pathology Maintenance
17% 16%
5% 7%
Radiology
4%
Admin. Expenses Pharmaceuticals
Doctor's fees 5% 13%
Pharmacy Utilities
16% 17% 6% Consumables
11%

Source: FICCI, E&Y, Industry

How do financials of a well-run hospital look like?

Exhibit below is a representation of the scale-up of a typical well run multi-
specialty tertiary care hospital in a large metro.

Exhibit 33: Key operational assumptions for a 200-bed tertiary care hospital
Particulars (Rs m) YR1 YR2 YR3 YR4 YR5 YR6 YR7 YR8 YR9 YR10
No. of beds 200 200 200 200 200 200 200 200 200 200
Occupancy rate (%) 30 45 65 75 85 85 85 85 85 85
ARPOB (Rs m, annualized) 20,000 21,000 23,100 25,410 27,951 30,746 33,821 37,203 40,923 45,015
yoy increase (%) 0 5 10 10 10 10 10 10 10 10
Revenues 438 690 1,096 1,391 1,734 1,908 2,099 2,308 2,539 2,793
Revenues ramp-up (x) - 1.6 2.5 3.2 4.0 4.4 4.8 5.3 5.8 6.4
Expenses (as % of sales)
Consumables 30 30 25 25 25 25 25 25 25 25
Personnel 40 35 35 25 20 20 20 20 20 20
Other Costs 35 35 30 35 32.5 27.5 25 25 25 25
Operating margins (%) (5) 0 10 15 23 28 30 30 30 30
Net profit margins (%) (35.3) (20.4) (5.3) 2.0 8.9 13.1 15.5 16.1 16.6 17.1
Source: IDFC Securities Research

Key assumptions
• Per bed capital cost at Rs10m; implies total investment of Rs2bn for 200-bed
tertiary care hospital in a metropolis.
• ARPOB of Rs20000 in first year of operations with 5% increase assumed in second
year followed by 10% annual increase thereon. We see 10% increase as
conservative after considering an improving case-mix and as well as the
inflationary impact.
• Occupancy rates at 30%, 45%, 65%, 75% in year 1,2,3,4 of operation. Year 5
onwards we expect operations to stabilize with 85% occupancy levels.

NOVEMBER 2010 30
 IDFC Securities

• Consumables and employee costs account for 30-40% and 35-40% of the sales in
initial years of operation. Operational costs include power & fuel, repairs &
maintenance, laundry, and other miscellaneous costs, and account for 10-15% of
sales.
• We factor in steady margin expansion as hospital beds mature and the hospital
steadily realizes the benefits of scale with higher purchasing power.

Well-run hospitals focus on top line in initial years

The 80:20 principle – 80% of • Hospital operators, in the first year of operations, focus energies on achieving
footfalls generate 20% of targeted footfalls to ensure revenue growth. Hospitals usually have an 80:20
revenue, and vice versa
footfall ratio, with 80% of footfalls contributing only 20% of the revenues
generated. The remaining ~20% of in-patients typically contribute 80% of the
revenues generated.
• Once requisite sustained footfalls are observed in year one, the hospital
administration shifts focus to revenue growth and thereafter to operating profits
(in years two and three respectively).
• In the aforesaid scenario, new hospitals typically incur operating losses in the
initial two years of operations and turn EBITDA-positive only by the third year of
operations.

25% of total EBITDA for the
first five years may need to
be provisioned for
equipment upgrades
Key observations
• Losses incurred in the initial years not only erode net worth but may also force
companies to borrow short-term funds for working capital. Across scenarios, we
observe a ‘camel hump’ gearing profile, with gearing as high as 3x in the third
year of operation.
• Hospital beds, in our view, are a perishable commodity. Medical equipment
accounts for a third of the total capital costs. Assuming a depreciable life of five
years on critical equipment (say 30% of the equipment cost) would imply that 25%
of the cumulative EBITDA of the first five years would need to be provisioned for
equipment upgrades by the fifth year of operations.
• Given capital intensiveness of the sector, hospitals have a payback period
stretching over 7-10 years. Return ratios, initially negative, turn positive by the
third or fourth year of operations in most cases.

Medium- to long-term – tertiary healthcare is an attractive business

• Importantly, hospital operators of well-administered facilities enjoy healthy
operating margins upwards of 20% typically the 5th year of operation.
• Higher inpatient volumes and consequently improved capital efficiency results to
hospitals churn attractive return ratios. We expect well-run hospitals to clock on
average 15-20% RoCE from the fifth year of operations.
Optimizing case mix and • Further, based on improved case-mix and management’s abilities to realize cost
management ability to gains, hospitals could witness EBITDA margins as high as 35%. Apollo Chennai
derive cost gains key to
higher margins for instance operates at EBITDA margins in excess of 30%.
• For a hospital operating in steady state (say 7th year of operation), we expect
every 100bps expansion in EBITDA margins to lead to 75-80bps expansion in
return ratios. We estimate a hospital operating at 35% EBITDA margins to clock
return ratios in the region of 25-30%.

NOVEMBER 2010 31
 IDFC Securities

• After initial years of negative cash flows, hospitals on stabilization witness steady
increase in positive free cash flows reflecting improvement in operational metrics.
As per our estimates, cumulative free cash flows over a five year period post
breakeven (in Yr 3) covers nearly ~65% of the initial setup cost.

Exhibit 34: Key financial parameters

Exhibit YR1 YR2 YR3 YR4 YR5 YR6 YR7 YR8 YR9 YR10
RoCE (%) (5.4) (4.8) 1.1 6.6 16.3 22.5 25.8 26.7 27.1 27.4
RoE (%) (23.9) (27.9) (13.0) 5.8 24.4 28.5 27.0 23.6 21.1 19.3
Gearing (x) 1.6 2.2 3.1 2.8 1.9 1.1 0.7 0.4 0.2 0.0
Interest coverage ratio (x) (1.4) (1.2) 0.3 1.5 3.8 6.5 9.9 15.9 31.9 n.a.
Source: IDFC Securities Research, *Debt service ratio

Operating indicators for a successful tertiary hospital

While land acquisition at a strategic location and reasonable costs goes a long way
towards laying the foundation of a successful tertiary hospital, we believe some of
the following operating parameters help to present a complete picture.

Exhibit 35: Indicators for a healthy tertiary hospital

Low “Average Length
of Stay” (ALOS)
• Inpatient revenues are
dependent upon the
Average Length of
Stay (ALOS)
• ALOS indicates
average time for
which patient
occupies a hospital
bed.
• As maximum inpatient
revenues are
generated within first
48-72 hours of
admission, reduction
in ALOS to closer to 2-
3 days will lead to
higher profitability for
a tertiary hospital
Occupancy rates
• Given high fixed
costs associated with
tertiary hospitals,
ensuring high
occupancy rates is
critical.
• Typically a tertiary
hospital starts
breaking even at 60-
65% occupancy
Strong OPD
Average daily Diagnostic and
(Outpatient
revenue per dispensing related
Department) patient
occupied bed revenues
flow /revenues
• An important • While the Outpatient • Hospitals with a
indicator for the revenues contribute a higher component of
financial health of a relatively smaller the high margin
tertiary hospital component of overall diagnostic services
revenues for a tertiary related and drug
• Indicative of the
hospital (20-25%), it is dispensing related
complexity of
a critical revenue revenues are able to
average procedures
stream achieve superior
undertaken in the
operating margins
hospital • Outpatient revenues
act as a strong pull for
Inpatient revenues
and creates a solid
base for a hospital
• Also, operating
margins in outpatient
revenues are
significantly higher
due to very low
operating costs

Source: IDFC Securities Research

Achieving an optimal case mix, which combines higher average revenue per
occupied bed (ARPOB) with lower average length of stay (ALOS), along with higher
occupancy is the operating Holy Grail of tertiary corporate hospitals. While it is
relatively easy to achieve higher occupancy if the location and service quality of the
hospital are in order, a hospital’s commercial savvy lies in its ability to achieve these
occupancies with a superior case mix.

NOVEMBER 2010 32

Improving clinical outcomes
at private hospitals are
drawing patients away from
solo practitioners
Tertiary care hospitals are
setting up feeder networks
to compete for patients and
drive down costs
Land and building account
for ~35% of project cost
NOVEMBER 2010
IDFC Securities
Exhibit 36: Holy Grail to tertiary care hospitals
Desired case - mix
Lower ALOS
+ Higher ARPOB
Higher profitability
Source: IDFC Securities Research
‰ Strong brand recognition
The long-term success of a hospital clearly rests on the brand image it enjoys in the
addressable market. To be a success, a hospital requires significant time and
investments which many players find difficult to afford. People value hospitals by their
consistent quality service. Even as we acknowledge the huge supply shortage in the
healthcare service delivery space, we believe it is imperative for hospitals to develop
strong brand equity to succeed in the long term. With the organized private healthcare
service sector now focusing on quality of delivery and also, importantly, on clinical
outcomes, patients are increasingly preferring hospitals over solo practitioners.
‰ Hub & spoke – unconventional models emerging
The private sector in India has traditionally opted for the multi-specialty format and
has focused on tertiary care hospitals. Unregulated growth and polarization of beds
have forced hospitals to compete for patients and grapple with rising cost pressures.
To tackle the aforesaid scenario, besides setting up external feeder networks (family
physicians, etc), many tertiary care hospitals have set up spokes (secondary
hospitals) to ensure steady in-patient volumes at the hub (tertiary care unit). This
model not only improves profitability of the hubs but also ensures a steady stream of
in-patient volumes with a favourable case-mix, thereby enhancing occupancy rates
and ARPOB. The hub also realizes lower ALOS as patients are located at the
secondary care facilities (spokes) before and after surgery cases.
Real estate costs: Key to commercial viability
Real estate cost is probably the most important factor that determines the viability of
a hospital project. Land and building together account for 30-35% of the total project
cost and are among the key measures to gauge a hospital’s financial viability. On the
revenue side, location of a tertiary care unit defines the catchment area and,
correspondingly, the ability of the hospital to attract a relevant patient pool with the
desired economic profile. Treatment pricing is often dependent on economic profile
of the local populace and, therefore, impacts a hospital’s revenues.
‰ A 200-bed hospital demands two acres of land
Based on expansion plans of upcoming tertiary care units in 2010, we have estimated
that one bed would correspond to ~750 sq ft of space; so a 200-bed tertiary hospital
would broadly need 1,45,000 sq ft of constructed space to accommodate all the
facilities.
33
 IDFC Securities

Exhibit 37: Average space required for a tertiary care hospital

Hospital No. of beds Total area (000’ sq. ft) Area/bed (sq. ft/)
Apollo Hospital, Bhubaneswar 300 200 667
Fortis Hospital, Delhi 550 383 696
Global Hospital, Mumbai 425 366 862
Fortis Hospital, Kolkata 450 300 667
Vikram Hospital, Bangaluru 200 150 750
Average 728
Source: IDFC Securities Research, news-flow

A 200-bed hospital would Assuming an FSI of ~2.5x, a hospital would require 1.4 acres to set up its facility. We
require ~Rs732m for real
assume an additional 40% would be required for open spaces and landscaping.
estate and construction
Setting up a 200-bed hospital would, therefore, require 1.8-2.0 acres of land. We
assume Rs80m per acre as land acquisition cost and Rs4,000/ sq. ft as construction
cost . Extrapolating this for a 200-bed facility (145,000 sq. ft of constructed space and
1.9 acres of total land), we arrive at a total cost of ~Rs732m for land acquisition and
construction – 37% of the total capital cost for setting up a 200-bed hospital.

Exhibit 38: Land procurement and construction costs

Area required for a 200-bed hospital (sq. ft) 145,649
Assumed FSI limit (x) 2.50
Required land area (sq. ft) 58,259
Construction cost (per sq. ft) 4,000
Total construction costs (A) 583
Area required for a 200-bed hospital (acres) 1.34
Area allotted for landscaping/ gardens (acres) 0.53
Total area required (acres) 1.87
Assumed land cost per acre (Rs m) 80
Total land cost (B) 150
Total costing (A+B) (Rs m) 732
Source: IDFC Securities Research

‰ Impact of real estate cost on return ratios

Real estate cost is a key factor that determines the viability of a hospital project. Land
and building together account for 37-40% of the total project cost and are among the
key measures to gauge its financial viability. Based on our analysis, we find for a
hospital operating at 15% margins in the fifth year of operations, an increase/decrease
in land and building costs by 20% results to contraction/expansion in return ratios by
nearly 40-50bps. The impact of land & building costs is relatively lower for well-run
hospitals. i.e. return ratios for a hospital enjoying 30% margins would be impacted
only to the extent of 20bps on 20% increase/decline in land & bldg. costs.

Exhibit 39: RoCE sensitivity to real estate costs (in the fifth year of operations)
Land & Bldg. costs assumptions EBITDA margins (%)
15.0 20.0 25.0 30.0
20% decline 10.0 14.5 18.6 22.5
Base 9.6 14.1 18.3 22.3
20% increase 9.2 13.8 18.1 22.1
Source: IDFC Securities Research

NOVEMBER 2010 34
 IDFC Securities

Some have adopted the Due to high land and building costs, some private healthcare service providers have
leased model to circumvent opted for the lease model. For example, land for six of Fortis’s 10 planned Greenfield
high real estate costs
projects (underway) has been taken on lease.

Exhibit 40: 60% of Fortis’s planned hospital expansion are under lease contracts
Location No. of Beds Ownership
Shalimar Bagh* 350 Owned
Gurgaon 450 Owned
Ludhiana -2 100 Lease
Kangra 100 Lease
Ludhiana-1 200 Lease
Ahemdabad 200 Lease
Gwalior 150 Lease
Kolkata* 414 Owned
Peenya 120 Lease
Mulund 344 Owned
Source: Fortis Hospitals, commisioned in Q2FY11

Having said so, we believe high real estate lease costs weigh heavily on a hospital’s
operating cash flows. Our base case scenario for a 200-bed hospital operating in a Tier
I city and servicing Rs600/ sq. ft/ annum of lease rental would shave off as much as
60% of the cumulative EBITDA generated over the first three years of operations. A
case in point is Fortis wherein lease rentals accounted for 2% of the net sales
respectively in FY10.

Regulation may help curtail
rising land costs somewhat,
but private players are
evolving innovative models
In an environment of high lease rentals and land and construction costs, we believe
increased regulatory intervention is imperative to make healthcare delivery
affordable. We expect newer operating models to evolve as the private sector seeks
ways to tackle high real estate costs and aggressively expand footprint. We list a few
emerging trends:

• Innovative models: We expect hospitals to follow an asset-light strategy and

adopt various innovative models:

Several healthcare
providers are looking at
REITs to avoid costs of
owning properties
o REITs: These operate on the principle of a mutual fund. Like mutual funds
collect money from investors and deploy it into equities and bonds, REITs
deploy investors’ money in real estate assets. These trusts invest mainly in
commercial property and pay the rent collected from these properties to the
shareholders as dividend.
SEBI, the market regulator had issued a draft guideline on REITs a couple of
years ago, but nothing has happened since then. We believe the government’s
renewed focus on affordable healthcare could speed up progress on this front.
We understand that several healthcare companies are evaluating the
possibility of listing such REIT entities in overseas markets (like Singapore)
where there is an appetite for these asset classes.
o BOT and BLT (build-operate-transfer or build-lease-transfer). Under these
models, a private player builds and operates the hospital on land owned either
by a private entity or the government for a fixed period of time.

NOVEMBER 2010 35
 IDFC Securities

"To overcome high land and real estate costs, we operate either on leased land or set up our
hospitals on acquired nursing homes. This significantly reduces our cost base."
-Vaatsalya
"We work on quick payback models with a focus on minimizing initial outlay of
investments. Of our 11 premises, only one is owned with the remaining on leased land"
-A leading hospital chain in South India

Hiking FSI limits, subsidies
and tax rebates are key
policy measures that can
make medicare affordable
• Regulatory intervention: We expect the government to take the following
regulatory measures soon to make healthcare affordable.
o Increase in FSI limit for hospitals in metros.
o Land subsidy for hospitals with reserved beds for people below the poverty
line.
o Tax rebates for setting up hospitals in select geographies and catchment areas.

Medical equipment: High obsolescence costs

Industry estimates indicate that medical equipment accounts for the largest chunk of
capital costs (up to 30-40%) towards setting up a tertiary care unit. The healthcare
industry is characterized by frequent product innovations and evolving technology.
That leads to redundancy of expensive medical equipment every 5-7 years, compared
with a depreciable life of up to 14 years (based on accounting periods). The problem
is compounded by the fact that there is practically very limited indigenous medical
device manufacturing industry in India which necessitates purchase of significantly
expensive imported equipment.

Hospitals, to recover the cost of expensive imported medical equipment over its short
life cycles, resort to higher treatment pricing. That often leads to a vicious cycle of
lower utilization rate, which dents profitability due to negative operating leverage.

Exhibit 41: Industry faces high depreciation costs The vicious loop of higher pricing
(%)
Depreciation
12.0

9.0
Pay back

6.0

Utilization
3.0 Pricing
levels

0.0
FY04 FY05 FY06 FY07 FY08 FY09

Source: Emerging markets database, IDFC Securities Research

NOVEMBER 2010 36
 IDFC Securities

‰ Solutions for equipment obsolescence

Most large Indian private healthcare service providers have adopted the strategy of
having ‘state-of-art’ technology, partly to target lucrative medical tourists and also to
provide the best available treatment to domestic patients. A side effect of this has
been that as hospital administrators strive to achieve their target return ratios and
with overseas medical tourists still a small fraction of overall patient base, the
domestic patient base bears the brunt of high treatment charges. This tends to result
in a portion of in-patient volumes shopping for more affordable alternatives.

Hospitals tend to buy costly
hi-tech equipment to attract
doctors, resulting in higher
fixed costs
Many tertiary care units also often embrace high-end technology to retain the best of
doctors and to showcase their “leading edge” treatment. We note that these “latest
technologies” may not be the most appropriate ones for the recommended treatment.
This results in a higher fixed cost base and loss of in-patient volumes.

“We got out of the arms race a few years ago… Fortis now promises only that its scanners
are world class, not the newest”

-Fortis

Govt could encourage However, we expect private healthcare service providers to formulate operating
domestic manufacture of models that rationalize the cost of imported medical equipment. Help from the
equipment by providing
sops for R&D
government can also be expected in the form of regulations that incentivize R&D
further and encourage domestic manufacturing/sourcing.

"To rationalize high medical equipment costs, we operate on a variety of models like “pay
per use”, “percentage of revenue share”, “cost plus basis” as well as outsourcing model
depending on the location and facility offerings"
- Fortis

"Vaatsalya, as a policy, has restricted medical equipment purchases to bare essentials like
ultrasound machines, ventilators, X-ray machines, etc. This helps us reduce pay-back
periods."
- Vaatsalya

Measures we expect from the government

• The government should stress on the use of ‘appropriate technology’ over ‘latest
technology’, thereby restricting price escalation wherever possible.
• Medical equipment imports have seen a large 18% CAGR over 2000-07. The
government needs to encourage domestic manufacturing and sourcing, which
could considerably reduce end-product prices.

The equipment market is • Incentivizing R&D further: Most domestic medical device markets continue to be
dominated by foreign flooded by low-cost Chinese equipment or serviced by majors like GE and
majors and low-cost Siemens. None of the domestic manufacturers, barring a few likes L&T, are
Chinese brands
involved in R&D. We believe the government needs to further incentivize R&D.

Initiatives from the private sector

• Equipment leasing: High medical equipment costs and risks related to earlier-
than-expected redundancy of costly imported equipment should force this trend.
Global majors like GE and Siemens have already taken the first steps in this
direction to provide equipment lifecycle management as well as manage
technology obsolescence through planned equipment renewals.

NOVEMBER 2010 37

Deferred payment, part
upfront payment, etc, for
purchases are some new
trends in the private sector
‘Right people at the right
cost’ is crucial for the
success of any hospital…
…and critical for tertiary
care, as it demands
specialized doctors and
other personnel
Exhibit 42: Healthcare infrastructure – bad or worse
Per 10,000
High income
High middle
income countries
Low middle
18
income countries
Low income 15
India 9 India
World Avearage 27
Source: WHO, IDFC Securities Research
NOVEMBER 2010
IDFC Securities
• Alternate financing models: Several global medical equipment manufacturers
(e.g., GE and Siemens) have come up with alternate financing mechanisms for
larger hospitals chains. Deferred payment on equipment purchases, part upfront
payment with profit sharing, fixed rate reagent volume supplies contract, etc are a
few innovative methods that have come to the fore. We expect more such
solutions to emerge.
• Others: To cope with technological advances and enhance the life of medical
equipment, larger hospitals operating on the hub & spoke model often pass on
equipment from hubs (in large cities) to spokes (facilities in Tier II/ III cities), or
sell them in the secondary, unorganized market. We believe there is a huge
second-hand medical equipment market in India.
Right People: A challenging proposition
Along with the well-known challenges like high upfront capex requirements and
long gestation periods, we believe managing people issues – i.e. finding the right
people and at the right cost – will be a critical scale-up challenge for tertiary care
hospital operators in India. Doctors, nurses and paramedics are the key enablers of
the success of any hospital, and retention of key personnel is an imperative –
especially for tertiary care hospitals.
In our view, while there are clear indications of shortage in the overall pool of
doctors required going forward, these shortages will be particularly acute in the case
of specialized and experienced doctors required for manning the newer tertiary care
set-ups. This will logically lead to aggressive wage inflation which will further stress
the economics of successfully running tertiary care hospitals.
‰ General availability of medical resources – not enough
Prima facie, India has a rich pool of medical practitioners. But when considered from
a resource density perspective, they trail even some poorer developing nations.
Medical infrastructure in India includes 757,377 physicians, an equal number of
AYUSH doctors, 93,332 dental surgeons, 1,652,561 nurses and 655,801 pharmacists
(as on 31 Dec’08). India’s medical infrastructure currently includes more than 750,000
physicians, 15,533 hospitals, and >700,000 hospital beds.
Beds Per 10,000 Physicians Per 10,000 Nurses
58 High income 28.0 High income 81
High middle High middle
39 24.0 40
income countries income countries
Low middle Low middle
10.0 14
income countries income countries
Low income 4.0 Low income 10
6.0 India 13
14 28
38
 IDFC Securities

Educational capacity highly
inadequate to meet the
burgeoning needs of the
Indian healthcare industry
We believe lack of adequate infrastructure, qualified teaching staff and high entry
barriers to medical education have contributed to the poor growth in medical staff.
The number of allopathic doctors (registered with the Medical Council of India) has
grown at a dismal 3.5% CAGR over the past four years. There are more than 250
medical colleges in the modern system of medicine and >400 in the Indian system of
medicine and homeopathy (ISM&H). The country produces ~35,000 doctors annually
in the modern system of medicine and a similar number of ISM&H practitioners,
nurses and para-professionals.

Exhibit 43: Supply increasing steadily; but not fast enough

No. of students enrolled to MBBS Course
36,000

33,000

30,000

27,000

24,000
FY06 FY07 FY08 FY09 FY10

Source: Medical Council of India, IDFC Securities Research

India would need an According to a survey by FICCI, India would need to add 0.7m doctors by 2025. At
incremental 0.7m doctors the current rate of doctor addition each year, we see significant shortage of skilled
by 2025
resources in the times ahead.

Exhibit 44: Healthcare infrastructure shortfall from 13-41%

As per 2001 consensus (nos.) Required Shortfall % shortfall
Sub -centres 158,792 20,903 13
PHCs 26,022 4,803 18
CHCs 6,491 2,653 41
Source: NSSO

‰ Compensation models in tertiary care hospitals

Hospitals need to balance After consumables, employee expenses form the biggest cost component that
between high salaries and
influences a hospital’s operating margins (see exhibit below). Doctors are the most
their need to have the best
doctors important factor of a tertiary care set-up, as most often it is the doctor’s reputation
that is the key deciding factor for where a patient goes for treatment. Having reputed
doctors is fairly critical for a new hospital set-up to gain traction, which effectively
means paying significant payouts to these doctors to switch over. This leads to fairly
high upfront costs and thereby strains the financials of a newly commissioned
hospital.

NOVEMBER 2010 39
 IDFC Securities

Exhibit 45: Margin profile for a hospital – base-case scenario

Margin profile - for base case scenario
Consumables Personnel Other Costs OPM
120

90

60

30

0
YR1 YR2 YR3 YR4 YR5 YR6

Source: IDFC Securities Research

Our interaction with industry experts indicates that employee cost structure for
hospitals follow pareto charts, with 20% of the employees (mostly doctors)
responsible for ~80% of the total employee costs. Given the challenges on key
employee availability and constantly escalating costs, hospitals have been forced to
come up with innovative performance structures.

"Over the past three years, salaries have increased ~2x with overall compensation
increasing 3x. This has been on the back of increased competition in Delhi/NCR”

-A leading South Delhi Hospital

We believe ‘one size fits all’ doesn’t work in the hospital sector and it is imperative
for hospital managements to maintain a judicious mix of compensation structures for
doctors (full time/ part time) and cost structures (fixed pay/ fee for service/ revenue
sharing, ESOPs etc) to rationalize the employee costs.

"To manage employee costs, we have 50% of the doctors on full time basis and balance as
visiting consultants. Full time doctors contribute 65-70% of our revenues"
-A leading South Delhi Hospital

"Doctor engagement for us is very location-specific. For example, Bangalore's COE has
majority of full time doctors, while Vashi facility has more of visiting consultants. We
operate on a combination of fixed fee and fee for service model to retain and incentivize
doctors. Our attrition rates are definitely below industry benchmarks"
-Fortis

"Unlike industry which follows fee-for-service model, we have full time exclusive
consultants at Vaatsalya. There is enough supply of doctors in secondary care unlike for
tertiary care specialties. However, to retain the talent is always a challenge"
-Vaatsalya

NOVEMBER 2010 40
 IDFC Securities

Exhibit 46: Various performance models for medical staff

• Model I: The entire staff is on the rolls of the institution and has a
largely fixed salary structure – similar to the practice in the
public sector.
• Model II: The consultant medical staff is on the rolls on a retainer basis
and is paid a fixed retainership along with either an
incentive plan or sharing of revenues over and above the
fixed component (retainership). The non-consultants are
treated as employees (as in Model I).
• Empanelled model: Primarily used for consultant medical staff who are paid on
the basis of 'fee for service' with a deduction of service
charges depending on the policy of the individual hospital.
For example, the hospital may deploy the entire medical
staff in clinical disciplines on this model and keep the
consultant medical staff in diagnostics and anesthesiology
on a staff model (model 1) (salary basis with or without an
incentive plan).
• Mixed model: A mix of staff and empanelled models for consultant
medical personnel. This is used to offset the fixed high cost
of senior medical staff with a bigger variable component
linked to the volume of work.
Source: Express healthcare Magazine, IDFC Securities Research

A 200-bed hospital would need 700 employees to start with: According to our
analysis based on industry benchmarks, a tertiary care bed would require 3.5
employees and 3.5 shifts operating all the time at 70% occupancy. Of the 3.5
employees, 20% would be doctors, 35% nurses and paramedics, and the remaining
technicians and those involved in accounts, housekeeping, etc. Therefore, a 200-bed
tertiary care unit would need 700 employees to start with.

Exhibit 47: Employee cost distribution

Employee distribution per bed (%) No. of employees for a 200-bed tertiary care unit
350

280
Doctors
20% 210
Others (technicians,
pantry, housekeeping,
accounts, etc)
140
35%

70

0
Nurses Doctors Nurses Others (technicians,
45% pantry,
housekeeping,
accounts, etc)

Source: CRISIL, Industry, IDFC Securities Research

NOVEMBER 2010 41
 IDFC Securities

‰ Addressing the human resource availability gap

Govt has allowed private Until recently, only state governments, universities, government-promoted
hospitals to set up colleges autonomous bodies, registered societies and public religious and charitable trusts
and has also eased land
requirement policy were permitted to set up medical colleges. Also, a minimum of 25 acres land was
mandatory for a hospital to set up a medical college. To address the huge resource
demand-supply gap, the government has recently allowed private hospitals to set up
medical colleges and as also lowered the land requirement to 10 acres for metros and
20 acres for smaller cities.

What to expect:
• Greenfield medical colleges: Based on recent changes in regulation, we expect
leading healthcare service providers like Fortis, Apollo and MAX to set up captive
medical colleges in the years to come.
With corporate chains • Reverse brain drain: Hospital chains like Apollo, Fortis and Manipal Hospital
offering higher salaries, have been witnessing increased enquiries from doctors of Indian origin who are
expat doctors are looking to
return to India looking to come back to India. We expect this trend to pick up as the larger
hospitals not only offer attractive salaries but also the latest medical technology,
which was not the case a few years ago. This trend catching up pace, we believe,
could help assuage the supply shortage.

Exhibit 48: Indian-origin doctors are are the backbone of healthcare in UK and the USA
Indian IMG's (2005) Rank No. of IMG's % of workforce
In US 1 40,838 4.9
In UK 1 15,093 10.9
In Canada 3 1,449 2.1
In Australia 2 4,664 4.0
Total 62,044
Source: The new england journal of medicine, IDFC Securities Research

The number of Indian medical college graduates practicing (as of 2005) in the US,
UK, Canada and Australia stood at 62044, equivalent to ~9% of the number of
physicians registered by the Medical Council of India in 2005.

"The reverse brain drain trend is picking up. We see several applications from overseas
doctors. This should, to some extent, address the supply gap."
-A leading hospital chain in South India

“…over the last six months, we have recruited 17 doctors from overseas – many of them
coming from the United States, from the United Kingdom, the Middle East as well.
Indian doctors are returning home and these doctors are adding a tremendous amount in
terms of value to the organization from a best practices, clinical outcomes and results”
-Fortis

NOVEMBER 2010 42

Exhibit 49: Only 13 states mandate registration of hospitals / nursing homes under the Nursing Home Act
Source: BW Survey, 2008
Patients bear the brunt of
high costs driven by lack of
regulation in private
healthcare
NOVEMBER 2010
IDFC Securities
An evolving regulatory scenario…
The growth of Indian healthcare sector has been unplanned and unregulated, and
lacks accountability. Surprisingly, the Centre as well as states have provided tax
incentives and concessions to hospitals and nursing homes to promote healthcare
delivery, but have completely failed to regulate the sector and ensure a minimum
level of patient care quality. According to a Business World Survey [Who Cares...
2008], only 13 states in India [as indicated in the map below] register nursing homes/
hospitals under the Nursing Home Act, whereas the remaining states register
nursing homes/ hospitals either under the Shops and Establishments Act or even the
Societies Act. In the absence of consistent and relevant regulations in most of the
states, a patient with a grievance would have to approach a consumer court, which in
effect is putting a patient on par with a person complaining about, say, adulterated
washing powder.
State Applicable regulation
Andhra Pradesh Private Medical Care Establishment Act, 2002
Delhi Nursing Homes Registration Act, 1953
Karnataka Private Nursing Home Act, 1976
Madhya Pradesh Clinical Establishments Regulation Act, 1973
Maharashtra Nursing Homes Registration Act, 1949 (only
applies to Mumbai, Pune, Nagpur and Solapur)
Manipur Nursing Home and Clinics Registration Act, 1992
Mizoram Clinical and Health Establishment Act, 2007
Nagaland Health Care Establishments Act, 1997 No.3 of
1997
Orissa Clinical Establishments Regulation Act, 1991
Punjab State Nursing Home Registration Act, 1991
Sikkim Clinical Establishments Act, 1995
Tamil Nadu Private Clinical Establishment Act, April 1997
West Bengal Clinical Establishment Act, 1950
Consequences: Decades of unregulated growth in the private healthcare market has
made the incumbent medical fraternity quite powerful and vociferous. On the
premise of professional independence, incumbents declare the profession
accountable only to themselves (specifically nursing home practitioners). This has
manifested in serious problems like opaque pricing, overcharging and inefficiencies
in the system. We believe secondary/ tertiary care treatment costs have risen sharply
in the recent years not only due to higher investment costs but also due to the
unregulated nature of the industry.
43

Clinical Establishment Bill is
a step in the right direction,
but now applies only to a
few states in India
NABH is an attempt to bring
global quality checks to the
Indian landscape
Better regulation will weed
out unscrupulous players
and drive in-patient volumes
to the organized sector
NOVEMBER 2010
IDFC Securities
‰ The government’s role on the aforesaid issues
Regulating private healthcare delivery systems: The central government passed the
Clinical Establishments Bill, 2010. The bill makes it mandatory for all clinical
establishments to register under the Clinical Establishment Act (see details in
Annexure 1 of the Appendix section). However, this would be applicable only to four
states – Arunachal Pradesh, Mizoram, Himachal Pradesh and Sikkim – and Union
Territories for now.
"We do not want to impose a licence raj on the health sector... we need to go slowly and not
take harsh measures which may be problematic."
Health Minister Ghulam Nabi Azad, 3August 2010,
reacting to Opposition charges that the legislation would be toothless.
Ensuring minimum quality standardards: The Ministry of Health and Family
Welfare (MoHFW) and the Indian healthcare industry have established a National
Accreditation Board for Hospitals and Healthcare Providers (NABH). NABH
accreditation of facilities confirms quality assurance and its standards focus on
patient safety and quality of patient care. NABH standards are based on a
comparative analysis of various aspects of healthcare, including those in Australia,
Thailand, the United Kingdom and the United States, and have been adapted to meet
Indian requirements. NABH standards include 49 applicable licenses and statutory
obligations under Indian law.
Regulating medical devices: The Department of Health and Family Welfare
currently has nominal jurisdiction over medical devices with detailed regulation
under consideration and sale of medical devices yet to be fully regulated. The limited
regulation that has been introduced till date covers sterile medical devices under the
Drugs and Cosmetics Act 1940. The Drug Controller General of India (DCGI) has
formulated guidelines for the import and manufacture of medical devices with effect
from July 2006. These guidelines were amended in 2007 in terms of; (a) required
regulatory clearances for the imported equipment, and (b) addition of 10 categories
of sterile devices under the Drugs and Costmetics Act.
"Mushrooming nursing homes (unorganized sector) has definitely impacted the corporate
hospitals. Increased competition would see a steady increase in pressure on standalone
nursing homes and thereby drive consolidation in the unorganized sector"
–A leading hospital chain in South India
What to watch for:
• Nationwide implementation of Clinical Establishment Act, 2010 (CEA, 2010):
CEA, 2010 would be implemented only in four states and all Union Territories.
Assuming the act is eventually implemented nationwide and strictly enforced,
there may be a spate of closure of nursing homes.
• Nursing homes have been proliferating in the unorganized private healthcare
delivery space. Enforcement of strict regulations/ guidelines pertaining to
minimum area/ beds, minimum number of qualified doctors/ nurses per bed,
maintenance of records, checks on medical equipment, accreditation
44
 IDFC Securities

requirements, etc could mount cost pressures on nursing homes – thereby forcing
many to close. This bodes well for organized healthcare service providers, as that
would not only drive higher in-patient volumes, but also improve the supply of
medical fraternity.

"Indian healthcare delivery is going through a transformation seen in retail akin to the
coming of Big Bazaar and its impact on kirana shops. The end result would be good for
patients"
-A leading hospital chain in South India

NABH is now mandatory for • Only 54 hospitals in the county have got NABH accreditation of the 450 that have
empanelment in the Central applied for it so far. We believe the recent surge in applications is both a reflection
Govt Health Scheme
of rising awareness among consumers and minimum requirements set by the
government for participation in its healthcare schemes. According to a recent
health ministry directive, NABH accreditation is now mandatory for hospitals
seeking empanelment in the Central Government Health Scheme (CGHS).

NOVEMBER 2010 45
 IDFC Securities

BUSINESS MODELS: INNOVATION AHEAD

¾ Till recently, organized private sector healthcare models in India were largely
one-dimensional with focus on multi-specialty tertiary care in metros,
supplemented with a few secondary and primary care set-ups.
¾ Escalating competitive intensity in metros as also an increasingly tough
operating environment due to inflation in real estate and personnel cost in
these areas forcing a rethink
¾ Strong case for exploring innovative business models to tap into less-
penetrated geographies as well as newer patient segments.
¾ We are encouraged by unconventional models being tried out by some of
recent entrants as well as increased willingness of incumbents to experiment
with new healthcare delivery formats
¾ Some of the innovative formats include single specialty tertiary hospitals, day
care centers, secondary care focused models etc.

Healthcare models: Expect increased innovation

‰ Currently, bed distribution is lopsided
Most of the existing beds are largely located in metros/ A class cities. Our channel
checks indicate pockets of temporary oversupply in tertiary care building up in
places like Hyderabad and NCR (especially Gurgaon), where significant capacity
addition in specific therapies has happened over the last few quarters.

Exhibit 50: Bed distribution skewed towads the urban/ affluent class
(Hospital beds/10,000 population)
4.0
WHO recommended

3.0

2.0

1.0

0.0
All-India Mumbai - Low Mumbai - Middle Mumbai - High
income segment income segment income segment

Source: Industry, IDFC Securities Research

While the larger incumbents remain fairly convinced that this is a temporary
situation and demand will soon begin to outpace supply, their plans to start looking
beyond the conventional “multi specialty tertiary care focused on metros” model has
certainly helped.

NOVEMBER 2010 46
 IDFC Securities

‰ Innovation is in the air

A broad scan of the operating environment indicates presence/ emergence of
multiple new models. We have listed the more interesting ones:

• Existing tertiary healthcare providers experimenting with setting up

secondary/ primary tertiary care hospitals in Tier II/ III towns – Apollo with
Apollo Reach
• Single specialty tertiary care hospitals, e.g. Healthcare Global
• Day care surgery centers, e.g. Nova Day Care Centre
• Hospital chains solely focused on primary/ secondary care in Tier II/ III
towns, e.g. Vaatsalya
• Healthcare cities, e.g. Dr Trehan’s Medicity
• O&M contracts, e.g. Fortis’ contract with SL Raheja in Mumbai
• JV Structures – Apollo’s proposed Thane hospital in JV with Yash Birla
Group

‰ Existing players expanding into Tier II / III towns…

Exhibit 51: Larger private hospitals spreading their wings

Hospital name Tier II and Tier III plans

Apollo plans to set-up upto 200bed hospitals in Karimnagar, Chit toor (Andhra Pradesh), Karur, Karaikudi
Apollo Hospitals (Tamil Nadu) and Andaman& Nic obar Islands. Apollo has huge plans to set-up 250 Apollo Reac h hospitals
across non-urban India

Plans to st art a new model of healthcare delivery for tier II and III cities. It intends to set-up small
hospitals with capacity up to 200 beds and by reducing the investment costs to half per bed in these
areas in order to provide treatment at nearly 50% less cost than present facilities in tier I cities. It has
Fortis Healthcare
presence in Mohali, Raipur, Amritsar and Srinagar. Besides with Wockhardt acquisition, Fort is got access
to hospit als in Rajkot, Surat, Nagpur (2). Erstwhile Wockhardt had plans to set up facilities in Goa,
Nashik and Ludhiana.

Max Healthcare plans for a three-phase expansion plan to t ier II and III cities. It started green field
MAX Healthcare projects in Mohali, Bhatinda and Dehradun with bed strength of 150-250. It also plans to expand to
Muradabad or Rohtak

It plans to expand to tier II and III cities through acquisitions and tie-ups. The pan is to build 100-150
Global Hospitals bed hospit als The list of cities include Nagpur, Ahmedabad, Trivandrum, Chandigarh, Bhubaneswar,
Coimbatore, Ludhiana, Sholapur and Pune

The Group invested Rs4 bn in tier II projects in places like Goa, Vizag, Salem, Tumkur, Mysore,
Manipal Group Vijayawada and Jaipur. Salem and Vijayawada have brown field projects while all others are green field
projects

Source: IDFC Securities Research, Industry news flow

NOVEMBER 2010 47

Super specialty hospitals
are not equipped to tackle
case complications…
… but could be a viable
model for a few segments
like oncology and
ophthalmology
Traditional bias towards
metros has exposed a huge
opportunity in tier II/ III cities
NOVEMBER 2010
IDFC Securities
‰ Single specialty tertiary hospital chains
Single-specialty tertiary hospital chains have evolved from hospitals looking to
leverage the credibility generated by offering “best in class” treatment in certain
defined therapy areas and positioning those hospitals as center of excellence in those
therapies. This enables them to attract the best of the specialists in those segments
and clearly helps these hospitals drive in-patient volumes overriding geographical
constraints. However, single super-specialty chains face the disadvantage of being
inherently ill-equipped to tackle case complexities which require several types of
surgeons. Additionally, single-specialty hospitals may not be able to optimally utilize
the diagnostic infrastructure, etc which can be utilized/ shared by other therapies in a
conventional multiple-specialty hospital set-up.
So, in our view, single super-specialty model may be effective only for select therapy
segments like ophthalmology and oncology. Some of the hospital chains adopting
this model include HCG (Healthcare Global) focused on oncology and Shankar
Netralaya and Arvind Eye Hospital focused on ophthalmology.
‰ Models focusing on secondary/ primary care in Tier II/ III cities
A largely unregulated industry and skewed bed addtions biased towards the metros
have resulted in 80% healthcare facilites servicing less than 30% of the country’s
population. Eying the huge opportunity, private players like Vaatsalya are working
on innovative models to tap the unmet healthcare needs of the majority of the
population by setting up the secondary care hospitals in Tier II/ III cities. These
models offer standardized secondary care with limited specialities including
gynaecologists, obstretricians and dermatologists, operate on leased facilites and with
limited capital investments. Given the relatively less complex nature of facilities
provided, these set-ups do not require highly specilaized doctors, and thereby have a
relatively large pool of doctors to tap into.
Exhibit 52: Setting up a secondary care facility costs 40-70% less than a tertiary care facility
Particulars Secondary Low cost secondary Tertiary care
Care care facility in metro
Floor space/bed (sq. ft) 800-900 700-800 950-1050
Building cost (US$/sq. ft) 70 45 89
Equipment cost (US$/bed) 50,000 30,000 77,778
Total Cost (US$) 109,500 63,750 162,222
Total cost per bed (Rs m) 4.9 2.9 7.3
Source: IDFC Securities Research
"Pressure due to oversupply in certain mature markets is visible with a few larger hospitals
and new entrants already suffocating. We won’t be surprised to see consolidation in single
doctor practice (nursing homes) in times to come and newer operational models come to
fore"
-Vaatsalya
‰ Daycare surgery centres
This involves setting up of healthcare units which essentially focus on conducting
procedures where the patient is discharged on the same day and does not need to be
hospitalized. While the number of procedures that such a set-up can execute are
48
 IDFC Securities

relatively limited compared to a full-fledged tertiary care centre, the roster of possible
procedures is significant enough to keep such centers reasonably occupied. Larger
tertiary care chains like Apollo are particularly focused on setting up these centers as
it enables them to free up capacity in their core tertiary care hospitals and increase
the ARPOBs while retaining the patients in the network. Also, the returns are
attractive as the capex required is significantly limited in such set-ups. Additionally,
we believe such daycare centers will bring in more efficiency in the execution of
several procedures which currently involve multiple days of hospitalization but can
be conducted more efficiently.

“We expect the Indian healthcare delivery landscape to change substantially going forward,
e.g., knee surgery in India takes 4-5 days unlike in the West where it is a daycare surgery."
-A leading hospital chain in Delhi/NCR region

‰ Healthcare cities – still on the drawing board

Many corporates have “Medicities” are one-stop shops. They offer all healthcare services, including
drawn up plans to set up
medicities…
wellness centers, preventive medicine facilities, clinical research centers, research &
development centers, educational & training institutes, retail & hospitality,
commercial & residential complexes, etc.

We believe a step towards setting up healthcare cities has already been taken in
India, though not completely aligned to the western concept of medicities. Until
recently, the government of India did not even allow private hospitals to set up
medical colleges. However, with recent changes in regulation, we believe the entire
concept is ready to be truly replicated in India.

Exhibit 53: Several planned health cities

Health Cities Beds Area (acres) Investment (USD m)
Dr. Naresh Tehran's Medi City, Gurgaon 1,600 93 293
Fortis Medi City, Gurgaon 600-800 na 293
Fortis Medi City, Lucknow 800 52 122-195
…with regulatory changes Apollo Health City, Hyderabad 700 33 246
that allow private players Nagpur Health City, Nagpur 2,000 100 na
to replicate Western
Chennai Health City, Chennai 1,000 46 245
models in India
Bengal Health City, Durgapur 50,000 800 487
Narayana Health City, Bangalore 5,000 100 488
Narayana Hrudayalaya Health City 1,000 5 22
Source: news flow, IDFC Securities Research

More importantly, the success of a health city would depend on its location and the
ability of the hospital administrator to drive in-patient volumes. Due to large land
requirements, health cities are often situated on the outskirts of a city and, hence,
attracting patients could be a challenge.

O&M and PPP models allow
hospitals to gauge new
territories before infusing
large funds
‰ O&M contracts
We expect private healthcare service providers to increasingly use PPP models and
O&M contracts. Healthcare service providers seeking entry into Tier I markets, but
wanting to avoid the high real estate costs, have been veering towards these models.
These models are also used by healthcare providers, seeking to widen their presence
in India, to gain an initial understanding of new territories before making large
investments.

NOVEMBER 2010 49

Medical trusts have huge
land assets in tier I cities
but lack expertise, a gap
corporates can efficiently fill
NOVEMBER 2010
IDFC Securities
Hospitals which have a presence in this segment include corporate chains like Apollo
and Fortis. Recently, Fortis entered into an O&M contract with S L Rajeha Hospital in
Mumbai. Apollo, Fortis, etc have typically been undertaking the management
responsibility of such hospitals and overlooking several functions like marketing,
operations, finance and administration. These administrators get a fixed annual
management fee and enter into revenue/ EBITDA-sharing arrangements.
Exhibit 54: A typical O&M model
Manages mrktg. finance
operations & other functions
Corporate hospital
Target hospital
(like Fortis, Apollo) Fixed mgmt. fee or revenue / EBITDA
sharing arrangement
Source: IDFC Securities Research
‰ JV structures
Larger hospital chains looking to establish presence in Tier I cities and overcome high
real estate costs have opted for the JV route by collaborating with trust hospitals.
Traditionally, trust hospitals have been allocated prime tracts of lands at nominal
lease rentals. However, given operating model limitations and lack of professional
management, several trust hospitals have failed to keep pace with the private
hospital sector in terms of technology and occupancy. Of late, some trust hospitals
have formed JVs with leading corporate hospital chains like Apollo and Fortis.
Under a JV agreement, a trust hospital leases out the entire building and medical
equipment to the newly-formed SPV or company. The corporate hospital chain (new
administrator), which has a certain equity stake in the SPV, infuses capital and
undertakes management responsibility of marketing, finance, administration,
operations, etc. In return, the corporate hospital receives a share of profits.
Exhibit 55: JV structure between a corporate hospital (new administrator) and target hospital
Lease rental +
Corporate / trust share of profits Corporate hospital
hospital (Operator)
Infuses cash
SPV
Lease bldg & medical Manages marketing
equipments operations, finance &
other functions
Source: IDFC Securities Research
50
 IDFC Securities

‰ Aravind Eye Hospital

Aravind Eye Hospital (AEH) derives its success from scale of operation, innovation, technology, focus on operational
efficiencies, cross-subsidization of costs and, most importantly, philanthropy.

Motivation: Cataract is the most common cause of preventable blindness. India has 6m cataract blind people with an
estimated 2m cases being added every year. Though the condition is curable, many remain blind due to the huge
demand-supply gap. Dr. Govindappa Venkataswamy started Aravind Hospital in 1976 with 11 beds to address this
gap. Aravind now has more than 4000 beds.

“ If Coca-Cola can sell billons of sodas and McDonald’s can sell billions of burgers, why can’t Aravind sell millions of sight
resotring operations and eventually belief in human perfection?"
– Dr Govindappa Venkataswamy

AEH’s eye care system

Aravind Eye
Hospitals
Lions Aravind
Community Institute of
Outreach Community
Programmes Ophthalmology
(LAICO)

Mission:
To eliminate needless
Education &
blindness by providing Aurolab
Training
compassionate & high
quality eye care to all, rich
and poor

Aravind Medical
Telemedicines Research
Foundation
Rotary Aravind
International
Eye Bank

Source: Company

Method:
• Leveraging efficiencies: AEH has an assembly-line approach. Its surgeons perform 2000 surgeries annually, 10x
the national average, made possible by efficient division of labour and innovative use of equipment.
• Equipment: Each surgeon works on two tables, one for the patient undergoing surgery and the other for the
patient being prepped. AEH’s surgeons use state-of-the-art equipment like operating microscopes that can swivel
between patients.
• Manpower: Trained manpower and optimization of tasks are key to Aravind’s success story. For example, each
operation theatre has a team of qualified opthalmic assistants and intermediate-level specialists who prepare the
patient for surgery. This takes care of ~70% of the activities in a normal operaton and the surgeon, the most scarce
resource, only has to focus on the most crucial activity in the operation theatre.
• Global quality: Contrary to the perception that scale compromises quality, Aravind’s single-speciality focus has led
to sharpening of surgeons’ skill sets. As a result, Aravind boasts of quality comparable to the best in the world.

NOVEMBER 2010 51
 IDFC Securities

Aravind Eye enjoys high success rates across treatments

Adverse events during surgery (%) Aravind, Coimbatore (N=22932) UK National survey (N-18472)
Capsule rupture & vitreous loss 2 4.4
Incomplete cortical clean-up 0.75 1
Iris trauma 0.3 0.7
Persistent iris prolapse 0.01 0.07
Anterior chamber collapse 0.3 0.5
Loss of nuclear fragment into vitreous 0.2 0.3
Choroidal hemorrhage na 0.07
Loss of intra-ocular lens into vitreous 0.01 0.16
Source: Aravind Eye

Technology-driven inclusion to drive scale: AEH faces two distinct problems: 1) it needs a continuous flow of
patients to feed the efficiencies and scale it has created, and 2) despite offering free treatment to two-thirds of its
patients getting people to hospital has been a challenge. The hospital has been using technology and health camps in
partnership with local groups to reach out to patients. It also transports needy patients seeking surgery from villages
to its Madurai center.

Eye camps and technology to ensure steady demand

Lowering treatment costs: AEH mainly performs two types of cataract surgeries, ICCE and ECCE. ICCE is the more
common type wherein patients are advised spectacles post diagonisis. ECCE requires replacing natural lens with
intraocular lens (IOL). AEH, in its early days, found it difficult to provide free ECCE tratment even to the most needy
due to the high cost of imported IOL. In 1992 AEH set up the AURO lab which manufactured quality IOL at a cost of
US$5 per lens, vs US$200 for imported lens. Not only does AEH now offer free ECCE treatment but AURO now
exports IOL lenses to more than 85 countries.
Free treatment for ~75% patients: Innovative strategies and benefits of scale have helped AEH develop an
economically viable model. The hospital now offers 75% of its patients free treatment via cross-susbsidization of
costs.

Innovation through cross-subsidization

Consulting fee Poor patients Free
Paying patients Rs50 (valid for 3months)
Cataract Surgery with IOL Poor patients Rs0
(70% of all surgeries): Subsidized rate Rs750 53% of surgeries
Regular rate Rs3500-6000 22% of surgeries
Phaco surgery Rs6500-12000 25% of surgeries
Source: Aravind Eye, IDFC Securities Research

NOVEMBER 2010 52
 IDFC Securities

Aravind performs 59% of NHS surgeries AEH leverages its strong resource pool
NHS*-UK Aravind NHS*-UK Aravind

60,000 70.0

71%
45,000 52.5
59%

30,000 35.0

15,000 17.5

0 0.0
No. of eye surgeries Ophthalmologists graduating annually
Source: NHS, Aravind Eye, IDFC Securities Research

‰ Narayana Hrudayalaya
Narayana Hrudayalaya (NH) started in 2000 with the sole motive of providing affordable and quality tertiary care to
people irrespective of financial status. It built a formidable brand equity by process innovation and best-in-class
treatment at affordable rates helped by cross-subsidization and high capacity utilization.

“Japanese companies reinvented the process of making cars. That's what we're doing in healthcare. What healthcare needs is
process innovation, not product innovation”.
- Dr. Devi Shetty, chairman, Narayana Hrudayalaya

Reducing costs and driving scale: Most tertiary care providers are in wont to buy costly medical equipment. NH
leases them at a monthly rental, which saves it huge upfront capital investment. It also has an arrangement to source
reagents from the lessor on a continious basis, which makes the proposition attractive for both parties. The
management has indicated that bulk purchases have helped it get 30-35% discount on consumables, which account
for the largest cost component for a hospital (upto 35% of sales).
NH has also continously replaced costly imported medical equipment with indigineous technology. It sources part of
its medical equipment from domestic players (eg, Centennial Equipment) which offer best-in-class quality at nearly
half the price offered by MNCs like GE or Siemens.

Best-in-class treatment: NH has an uncompromising view on best-in-class treatment. It sources high-end imported
technology from MNCs if substitutes of similar quality are unavailable domestically. This has helpd NH retain even
its elite customer base.

Creating scale: The benefits of efficient capacity utilization makes NH’s operating model financially viable. Surgeons
at NH peform an average 19 open heart surgeries and 25 catherization procedures a day, 8x the national average.
Employee costs are ~22% of sales, compared with 30-35% for comparable private sector hospitals. NH says its
surgeons are paid on par with market rates, but employee costs (as a percentage of sales) look lower due to surgeons
operating longer hours. Surgeons at NH perform an average 200 surgeries an year, nearly twice that of surgeons in
the US.

NOVEMBER 2010 53
 IDFC Securities

Price comparisons for coronary bypass surgery

Narayana Hrudayalaya 2,000

Indian private hospitals 5,000

US Medicare 20,000 to 42,000

0 10,500 21,000 31,500 42,000 ($)

Source: WSJ, IDFC Securites Research

NH clearly leveraging benefits of scale

Particulars Cleveland Clinic Mass General Hospital NH
No. of CABG surgeries a year 1151 1000 3570
Average surgeries a day 3 3 10
Number of cardiac surgeons 11 9 18
Average surgeries per surgeon 105 111 198
Source: HBS Case Study, IDFC Securities Research

Inclusivenss through technology, insurance and parterships

NH has smartly leveraged technology, embraced local partnerships and initiated micro-insurance schemes to reach
the rural and needy populace. It operates one of the largest telemedicine networks in the world in partnership with
ISRO. To enhance its rural reach, NH initially launched nine cardiac care units (CCUs) which were connected to it via
teledensity networks. Given the success of teledensity-CCUs, the Karnataka government sponsored 29 CCUs for
Narayana. In partnership with the Karnataka government, NH launched a micro-finance scheme, Yeshasvini, to
deepen its reach. The scheme provides each member (or cardholder) access to free treatment at 150 hospitals spread
across 29 districts at just Rs5 a month.

The way forward: Providing affordable treatment through higher capacity utilization of assets has been behind NH’s
success. Dr. Shetty says there is a limit to reducing costs and leveraging benefits of scale for a particular speciality.
NH has now forayed into other specialities like neurosurgery, orthopaedics, bone marrow transplants, etc. And it has
sucessfuly reduced costs and provided affordable health care in each of these tertiary care segments too. Dr. Shetty
also plans to set up a ‘health city’ to provide tertiary care at affordable prices.

‰ Vaatsalya Hospital
Vaatsalya Hospitals aims to address the healthcare needs of millions by adopting a no-frills operational model with a
focus on standardization of procedures and lower capital costs. Ironically, 80% of India’s healthcare facilities are
located in urban areas or metros while ~70% of the Indian population lives in semi-urban and rural areas. Vaatsalya is
India's first hospital network focused on Tier II and III towns providing primary and secondary care services with an
emphasis on disease prevention.

NOVEMBER 2010 54
 IDFC Securities

Vaatsalya’s footprints across tier II cities

Source: Company

Afforable treatment in spite of lower scale: Vaatsalya’s focus is to provide primary and secondary care treatment
to the masses. However, Vaatsalya does not have the advantage of scale that Aravind or Narayana do. So how
does Vaatsalya provide affordable treatment and retain doctors in rural/ sem-urban areas?

• Standardization of operations: Vaatsalya has classified operations into four segments – gynaecology, pediatrics,
general medicine and general surgery. Standardization of operations has helped Vaatsalya’s centralized
procurement team to achieve significant cost savings.
• Restricting investments: Vaatsalya has opted for a no-frills model with standardized 50-bed hospitals, each
equipped with a pharmacy, diagonistic lab and ICU. To control upfront investments, Vaatsalya leases hospital
facilities, substantially lowering payback periods. Also, it has restricted medical equipment purchases to
essentials like ultrasound machines, ventilators, x-ray machines, etc.
• Empowering doctors: Vaatsalya’s biggest challenge, in our view, is to retain doctors. Vaatsalya pays its doctors
up to 20-25% higher than what they would have got in larger cities. Vaatsalya also offers doctors higher
responsibilities and autonomy, a key variable which has helped it retain doctors.
The way forward: We believe steady expansion would make Vaatsalya’s operating model more economically viable
as it would be able to leverage the benefits of scale while sourcing consumables and medical equipment. Having said
so, the key risk lies in retaining star doctors and enhancing mass outreach.

‰ Healthcare Global (HCG)

HealthCare Global Enterprises Ltd, headquartered in Bangalore, is South Asia's largest cancer care network. HCG has
more than 600 beds across 18 centers. HCG has diversified into CRO to enhance its oncology offerings.

Motivation: HCG’s vision is to transform cancer care by bringing core clinical services to one place and offering
comprehensive care.

Model: HCG operates on a hub & spoke model with super specialty hospitals supported by daycare centers. HCG
has JVs with local partners to set up and run spokes with the JV partners bearing the land, building and equipment
costs. HCG has been able to expand geographically using this model. It has eight spokes supporting three hubs in
Bangalore, Ahmedabad and Delhi.

NOVEMBER 2010 55

Indian corporate hospitals
industry relatively nascent
Corporate hospital chains
have adopted diverse
strategies
NOVEMBER 2010
IDFC Securities
ADVANTAGE INCUMBENTS
¾ We are positive on the near- and medium-term outlook for Indian healthcare
sector and believe that private sector hospitals are the best proxy to play the
opportunity
¾ Corporate hospital space in India is still nascent as most players have entered
only recently. However, entry barriers (land, people, etc) are clearly going up,
making it increasingly difficult for new entrants
¾ This state of affairs is positive for the larger incumbents that have already
created formidable footprints and have the critical mass to grow
¾ We are positive on two of the leading incumbents, Apollo (top pick in the
space) and Fortis as they have acquired a strong national brand equity and
have difficult-to-replicate geographical footprint and capacity
¾ The fact that two of the largest and most relevant healthcare stocks in the
country have a combined market capitalization of <$5bn underlines the
inherent growth potential in these companies
Competitive landscape still evolving
The corporate hospitals industry in India is relatively nascent as most of the
corporate groups, barring Apollo, having entered the business in the last few years,
are still in relatively early phases of growth. Currently, there are three major listed
players in the space:
• Apollo Hospital Group
• Fortis
• Max Healthcare (a subsidiary of Max India – a listed entity)
While all the players – Apollo, Fortis and Max – have a hub-and-spoke model based
around tertiary hospitals, we notice variations in their strategy.
• Apollo is the largest and the oldest corporate hospital player in India with ~8000
operational beds after two decades of inception. Apollo has chosen a strategy of
establishing multi-specialty tertiary hospitals across locations and to scale-up
gradually.
• Fortis commenced operations in 2000 with a hospital in Mohali, Punjab. Fortis has
acquired an almost national footprint in a short period of time, primarily through
aggressive inorganic growth with a series of acquisitions including Wockhardt
Hospitals, Escorts Delhi, Malar hospital, etc. While Fortis currently operates 3250
beds, it aims to operate 5000+ beds with pan-India presence by 2013.
• Max Healthcare started operations in 2000. Max Healthcare’s strategy focuses on
leveraging its two single-specialty tertiary hospitals and consolidating the existing
hospital network in the NCR before seeking to expand nationally. According to
expansion plans, Max is likely to have 2450 hospital beds in NCR by 2016 – up
from 1100 beds currently.
56

Newer players face high
entry barriers and
formidable competition from
well-financed incumbents
Processes cannot
effectively substitute
personal credibility and
stature of individual doctors
NOVEMBER 2010
IDFC Securities
Also, there are other large unlisted players like Manipal Health (strong presence in
South India), Narayan Hrudayalaya (another predominantly South India based
entity), and HealthCare Global (oncology focused tertiary care hospital chain).
Given that the corporate hospital industry is in an early growth phase, we believe it
will take some time before the implications of their diverse strategies get crystallized
and start becoming evident to investors.
Rising entry barriers…advantage incumbents
We strongly believe that running private sector hospitals in India is difficult given
the myriad challenges involving land procurement, staff recruitment as well as an
evolving regulatory scenario. Given that existing players have already firmly
entrenched themselves in most of the high potential pockets and shooting land/
people costs, it is increasingly tougher for new entrants. Further, the incumbents are
poised to grow from strength to strength as their operations start increasingly self-
sustaining in this capital hungry business.
‰ Private sector hospitals – An increasingly tougher business
The private sector hospitals business is arguably quite a challenge to run in India.
Such projects entail fairly complicated project management issues (in terms of
obtaining the right land parcels at right prices, doing an efficient job of executing the
hospital construction and then ensuring that the right mix of doctors comes on board)
and complex people management issues (growing shortage of trained medical
personnel) on an ongoing basis. Shooting real estate prices, especially in metros, and
increasing shortages in recruiting both highly qualified super specialists (required for
running high-end tertiary hospitals) as well as the lower skilled para medics add to
the challenge. Thus, it is becoming increasingly difficult to run a commercially
successful private healthcare business. These issues are further accentuated by the
fact that existing players have already entrenched themselves in most of the high
potential geographies across the country.
‰ The people angle adds to the complexities
While these challenges sound similar to the ones in the hospitality business, we
believe the situation is more complicated by the big role played by doctors in the
healthcare business. It is relatively easy to institutionalize the hospitality business
and thereby decrease the reliance on individuals, but the same is not possible in
healthcare, as processes cannot effectively substitute personal credibility and stature
of individual doctors.
In our view, the fact that most of the larger Indian corporates have chosen to stay
away from healthcare, despite the inherent potential in this business, is yet another
indicator of the challenges/ entry barriers in this business. We expect these entry
barriers to only increase going forward – making it incrementally difficult for new
entrants to build up a successful healthcare business, particularly in tertiary care.
Advantage Incumbents
In our view, this state of affairs essentially means significant advantages for
established incumbent players like Apollo, Fortis, Manipal, etc. These players have
57

The large players have built
unassailable positions, both
in terms of beds and
geographical spread…
Organic growth faces
operational challenges while
inorganic opportunities of
relevant size are limited…
…justifying our valuation
premiums for
Apollo and Fortis
NOVEMBER 2010
IDFC Securities
had the early mover advantage to accumulate sizeable hospital assets on land
acquired at historical prices and create solid brand equity which enables them to
acquire talent from India as well as abroad. These existing players have built up
significant franchise in the key metros, the key markets for high-end tertiary care,
which makes it relatively difficult for new players to make inroads in these markets.
Additionally, their operations are now reaching a stage where internal cash flows can
take care of further expansions to a large extent.
Apollo and Fortis: Leaders today…and of future
We believe it is difficult, if not impossible, for a new entrant to break into the top
league. In our view, there are innumerable hurdles to scalability and economic
viability in the hospitals business. Even among the incumbents, we believe two of the
largest players in the industry today – i.e. Apollo Hospitals and Fortis Healthcare
with ~10000 and ~5000 beds respectively under operation by 2013 – are significantly
ahead of the pack. These companies offer scale (in terms of their bed capacities) and a
pan-India footprint that they have built up over the years. While Apollo has
gradually built up its network over the last few decades through the organic route,
Fortis has leapfrogged in the last few years on the back of its aggressive inorganic
growth strategy.
For a new entrant, replicating the achievements (scale and scope) of Apollo and
Fortis looks increasingly difficult. There are limitations to the pace of scale-up
achievable through the organic route given the challenges involved in
operationalizing a Greenfield hospital. Also, we see limited inorganic growth
opportunities (of relevant size) on the horizon unless one of the larger players
intends to sell out.
We believe Apollo and Fortis will continue to dominate the Indian private healthcare
landscape for the next several years followed by players like Manipal and Max.
‰ Initiating coverage on Apollo and Fortis with Outperformer
We are positive on the near- and medium-term outlook for the Indian healthcare
sector. We believe that private sector hospitals are the best proxy to play the
healthcare opportunity in India which is poised to grow by leaps and bounds over
the next several years and decades.
In the private sector hospitals space, we are particularly bullish on two of the leading
incumbents – Apollo Hospitals and Fortis Healthcare – as they are well-entrenched in
the industry with strong national brand equity as well as a difficult to replicate
geographical footprint and capacity. Given that these two are the only relevant listed
entities in the Indian healthcare space and the ones that are likely to dominate the
market (with a secular growth story) for the next several years, we believe these
stocks deserve to command a significant premium with respect to the broader
market.
Interestingly, while the healthcare market in India is poised to double to US$125bn
by 2015, the two largest and most relevant healthcare stocks in the country have a
combined market capitalization of <$5bn. This clearly underlines the inherent growth
potential in these companies.
58
 IDFC Securities

APPENDIX
Annexure 1: Regulatory landscape

‰ Extract from Clinical Establishment Act, 2010

1) For registration and continuation, every clinical establishment shall fulfill the following conditions, namely:
(i) the minimum standards of facilities and services as may be prescribed; (ii) the minimum requirement of
personnel as may be prescribed; (iii) provisions for maintenance of records and reporting as may be
prescribed; (iv) such other conditions as may be prescribed.

2) The clinical establishment shall undertake to provide within the staff and facilities available, such medical
examination and treatment as may be required to stabilize the emergency medical condition of any individual
who comes or is brought to such clinical establishment.

Source: Loksabha documents

‰ Doctors protest against Clinical Establishment Bill;

Patiala, 15 July
…Doctors were opposing the Clinical Establishment Bill. They demanded the restoration of the Medical Council of India (MCI)
without any delay. According to the IMA leaders, the implementation of the Bill on private clinics will cost a huge monetary
burden to them, which will ultimately pass on to the patients making the health services beyond the reach of a common man….

Malerkotla, July 15

Members of the local unit of Indian Medical Association (IMA) today closed their clinics to protest implementation of the
Clinical Establishment Bill. General Secretary of the association said, “The government should have asked the medical fraternity
before introducing the Bill, as there were apprehensions that it will only cater to the needs of the people, but it should meet the
needs and concerns of both, the doctors and the patients.”

The members said the expenses for meeting the provisions of the bill would significantly increase treatment fees.

NOVEMBER 2010 59
 IDFC Securities

Annexure 2: Key takeaways from FY09-10 budget

We believe the government needs to focus on; 1) encouraging public-private partnership for the creation/
upgradation of health infrastructure, 2) capacity building in manpower, 3) health insurance penetration, and d)
setting minimum quality standards for healthcare delivery and implementation/ enforcement of regulations.

‰ Key positive steps

We list some key positive steps taken by the government:
• The government has increased the weighted average deduction for scientific research. According to industry
estimates, India’s medical device exports grew at 18% CAGR over FY00-07. We see higher deduction for research
as a step that could significantly boost domestic R&D.
• The government has extended the exemption under Section 80D from contributions to health insurance schemes
to contributions under the Central Government Health Scheme (CGHS). This will likely to increase the
disposable income of families covered by CGHS.
• The finance ministry rationalized import duty at 5% for all items from only 37 items earlier. This should help the
industry reduce import costs, helping reduce the cost of healthcare delivery. Exemption of service tax for
healthcare services to individual patients will also help contain the cost of medical check-ups.
• The finance minister’s Budget speech cites a plan to conduct an annual health survey and prepare district-wise
health profiles of the rural populace. We believe using the compiled data efficiently for budgetary allocation
would be a step in the right direction.

‰ A negative surprise
Even as budgetary allocation for healthcare saw a 22% yoy increase for 2010-11 to Rs223bn, the government reduced
allocation for premier institutions like AIIMS, PGIMER, Dr Ram Manohar Lohia Hospital and Safdarjung Hospital by
5-11% yoy. We believe this is worth monitoring going forward.

Healthcare budget allocation – a snapshot

Source: Union Budget documents

NOVEMBER 2010 60
 IDFC Securities

Annexure 3: NABH-accredited hospitals

NABH accredited Hospitals Fortis Hospital, Mohali General Hospital, Gandhinagar, Gujarat

Escorts Hospital and Research Centre Ltd., Faridabad,

B.M. Birla Heart Research Centre, Kolkata Medwin Hospitals, Hyderabad Haryana

Advanced Medicare And Research Institute (AMRI),

MIMS Hospital (MIMS Ltd.), Calicut Kolkata Ruby Hall Clinic, Pune, Maharashtra

Kerala Institute of Medical Science,

Thiruvananthapuram Sevenhills Hospitals Ltd., Visakhapatnam Sterling Hospitals, Vadodara, Gujarat

Max Super Speciality Hospital, New Delhi Dharamshila Hospital & Research Centre, Delhi Artemis Health Institute, Gurgaon, Haryana

Sparsh Hospital for Accidents, Orthopaedic, Plastic &

Moolchand Hospital, New Delhi Chacha Nehru Bal Chikitsalaya, New Delhi Maxillo Facial Surgery, Bangalore, Karnataka

Narayana Hrudayalaya, Bangalore Kailash Hospital & Heart Institute, Noida, U.P. Apollo Speciality Hospital, Chennai, Tamil Nadu

Dr. L. H. Hiranandani Hospital, Mumbai G. Kuppuswamy Naidu Memorial Hospital, Coimbatore Shalby Hospitals, Ahmedabad, Gujarat

Fortis Hospital, Noida Sterling Hospitals, Ahmedabad, Gujarat Wockhardt Hospital, Bhavnagar, Gujarat

Sagar Hospitals, Bangalore Amrita Institute Of Medical Sciences, Kochi Wockhardt Hospitals Ltd. Kalyan

Columbia Asia Medical Centre – Hebbal, Bangalore Apollo Speciality Hospitals, Madurai Wockhardt Hospitals Ltd , Nashik

Manipal Hospital, Bangalore Paras Hospitals Pvt Ltd., Gurgaon, Haryana Rockland Hospital, New Delhi

Nethradhama Superspeciality Eye Hospital,

Bangalore Wockhardt Hospitals Ltd, Nagpur, Maharashtra K.G. Hospital, Coimbatore, Tamil Nadu

P.D. Hinduja National Hospital & Research Centre,

Lakeshore Hospital & Research Centre Ltd., Kochi Mumbai Holy Spirit Hospital, Mumbai, Maharashtra

Baby Memorial Hospital, Calicut N.M. Virani Wockhardt Hospital, Rajkot, Gujarat Batra Hospital & Medical Research Centre, New Delhi

Escorts Heart Institute And Research Centre, New

Delhi Godrej Memorial Hospital, Mumbai PSG Hospitals, Coimbatore, Tamil Nadu

Sir Ganga Ram Hospital, New Delhi Fortis Flt. Lt. Rajan Dhall Hospital, New Delhi Frontier Lifeline Hospital, Chennai, Tamil Nadu

Fortis Escorts Hospital, Jaipur Kasturba Hospital, Manipal B.L. Kapur Memorial Hospital, New Delhi

NABH accredited Hospitals Fortis Hospital, Mohali General Hospital, Gandhinagar, Gujarat

Escorts Hospital and Research Centre Ltd., Faridabad,

B.M. Birla Heart Research Centre, Kolkata Medwin Hospitals, Hyderabad Haryana

Advanced Medicare And Research Institute (AMRI),

MIMS Hospital (MIMS Ltd.), Calicut Kolkata Ruby Hall Clinic, Pune, Maharashtra

Kerala Institute of Medical Science,

Thiruvananthapuram Sevenhills Hospitals Ltd., Visakhapatnam Sterling Hospitals, Vadodara, Gujarat

Max Super Speciality Hospital, New Delhi Dharamshila Hospital & Research Centre, Delhi Artemis Health Institute, Gurgaon, Haryana

Sparsh Hospital for Accidents, Orthopaedic, Plastic &

Moolchand Hospital, New Delhi Chacha Nehru Bal Chikitsalaya, New Delhi Maxillo Facial Surgery, Bangalore, Karnataka

Narayana Hrudayalaya, Bangalore Kailash Hospital & Heart Institute, Noida, U.P. Apollo Speciality Hospital, Chennai, Tamil Nadu

Dr. L. H. Hiranandani Hospital, Mumbai G. Kuppuswamy Naidu Memorial Hospital, Coimbatore Shalby Hospitals, Ahmedabad, Gujarat

Source: NABH

NOVEMBER 2010 61
 IDFC Securities

Annexure 4: Comparaitve healthcare spend – India and global

Composition of World health expenditure Composition of Healthcare spend in India

Out of pocket spend, Private Insurance, 18% Local Govt., 2%

State Govt., 14%
18%
Central Govt., 7%

Others, 4% NGOs, 0%
Banks, 0%

External funds, 2%
Private firms, 3%
Public firms, 2%
General Govt. Expd., Social Insurance, 25%
35%
Households, 69%

Source: WHO -2007, Reserve Bank of India, IDFC Securities Research

Annexure 5: Corporate hospitals – strategies to target primary markets

The business models of the larger hospital chains in India have steadily evolved from tertiary care to serving the
entire healthcare delivery network. They are clearly positioned to grab a larger pie of the market opportunity by
diversifying revenue streams to de-risk the business while pursuing an asset-light strategy.

‰ New strategies
We list some measures adopted by incumbents to enhance their presence in the healthcare delivery chain. Private
players seeking to maximize returns on capital employed have turned to asset-light strategies – hospital management
(O&M contracts) and consultancy services. Meanwhile, larger players have set up captive diagnostic labs and
pharmacy centers to tap high margins in diagnostics, radiology and pharmacy.

Incumbents stepping up presence across the healthcare delivery chain

Tertiary
care
Secondary Primary
care care

Diversified Diagnostic
Pharmacies
offering labs

Consultancy Healthcare
insurance
Hospital
management

Source: IDFC Securities Research

NOVEMBER 2010 62
 IDFC Securities

Next-door clinics: 50% of healthcare expenditure occurs outside hospitals. Therefore, larger hospital chains have
begun targeting primary healthcare markets by setting up ’next-door clinics‘. Apollo, for instance, has adopted a
franchising model and has set up a chain of Apollo Clinics all over the country. We believe the motive goes beyond
enhancing its reach to the urban masses – it is also looking to enhance the feeder network for its secondary care
hospitals (in tier II cities) and specialty hospitals (in metro cities).

The Apollo Clinic: The ‘next door’ franchise partner bears all the investment-related costs of setting up the clinic and
makes a one-time franchisee payment to Apollo (for a specified tenure). In exchange for this fee and a 5% royalty on
sales, Apollo offers comprehensive support services like selection and training of all medical and support staff
including physicians, procurement of necessary medical equipment and IT systems and also designing of the clinic.
Apollo advises on setting the prices for medical services offered at the clinic and helps evolve marketing strategy.

Apollo clinic – reception, consulting room and lab

Source: The Apollo Clinic

Diagnostic labs: India boasts of ~45,000 diagnostic laboratories, which conduct over 2m tests daily. However, this
industry is highly fragmented and we see a huge opportunity for organized private providers. As per industry
estimates, pathology tests account for up to 5-6% of hospital revenues and enjoy attractive margins. Larger hospital
chains and also several standalone players have already entered this space by offering captive services and setting up
standalone pathology labs and radiology centers. We highlight a couple of models:
The Apollo Clinic, part of Apollo Health and Lifestyle Limited, an initiative of Apollo Hospitals, offers several
diagnostic services including clinical pathology, radiology, imaging and cardiology. A few Apollo clinics are also
equipped with facilities like CT scan, MRI and endoscopy. Apollo operates these clinics on a franchisee model.

Super Religare Laboratories Limited (formerly SRL Ranbaxy Ltd.) claims to be the largest pathology laboratory network
in India covering nearly 4,000 hospitals and more than 50,000 doctors. SRL has said that owning these laboratories
has helped it ensure uniformity in standards and practices.

NOVEMBER 2010 63
 IDFC Securities

SRL’s pathology network – steady expansion

Source: SRL

SRL operates a hub & spoke model – its clinical reference lab and 50 satellite labs are supported by more than 1000
collection centers spread across 450 cities in India and abroad. Recently, SRL acquired Piramal Healthcare’s 107
diagnostic lab network for a consideration of Rs6bn valuing the transaction at 2.9x EV/sales and 15.8x EV/EBITDA.

Pharmacy chains: India’s retail pharmacy sales for CY07 were estimated at Rs488bn, with organized retail garnering
3.2% of total sales. The highly fragmented nature of the industry has thrown up an attractive opportunity for
retailers. According to industry estimates, pharmacy chains enjoy gross margins (ex-corporate costs) as high as 30%+
at standalone levels. Large hospitals chains like Apollo and Fortis have opted for different models to grab a pie of this
attractive opportunity. Besides Apollo and Fortis, several pharmacy chains like Aushadhi, CRS Health, Dial for
Health, Dr. Morepen, Global Healthline, Guardian Pharmacy, Health and Glow, Lifeken, Medicine Shoppe, 98.4o, etc.
have also come up. In a market flooded with spurious drugs, we believe organized pharmacy chains with strong
repute would emerge winners.

Indian pharmacy market growing rapidly

(Rs bn) Indian retail pharmaceutical market (LHS) Organized retail as % of total retail market (RHS)
500 488 3.4

3.2
455 3.1

422
410 2.7

2.6
365 2.4

320 2.0
2006 2007
Source: Industry, IDFC Securities Research

Several organized players have been providing value-added services like weight measurement, blood pressure,
diabetes, etc. to consumers to enhance margins and lower payback periods. Apollo pharmacies, for instance, offer
several value-added services (see exhibit below) to retain its customer base. Apollo intends to maintain a desired
sales mix between Rx drugs and consumer products to enhance its margin profile.

NOVEMBER 2010 64
 IDFC Securities

Value added services provided by Apollo pharmacies

Source: http://www.apollopharmacy.in/services.html

Consulting operations
The evolving healthcare landscape has led to a huge demand for healthcare consultants, both in India and globally.
Domestic hospital chains with vast experience in building and maintaining facilities have set up consultancy
divisions to tap this opportunity. Apollo, for instance, has a consultancy arm that undertakes projects primarily
classified as ‘transition management’ and ‘operations management’. Transition management involves helping clients
design and build facilities. Under operations management, the consultancy division runs facilities, often also
recruiting and training staff. We expect several reputed hospitals to enter this segment, as it is an effective alternate
revenue stream.

Hospital consultancies in India – the key players

Hosmac, Mumbai H-PAMCO, New Delhi
MedicontriversIndia PvtLtd Mumbai KSA Technopak, New Delhi
Ace Vision Health Consultant PvtLtd, Jaipur NOUS Hospital Consultancy (P) Ltd, New Delhi
Professional Health Planners, New Delhi Apollo Hospital Enterprise Ltd, Chennai
Hospic, Mumbai Total Hospital Solutions, Jaipur
Source: IBEF, IDFC Securities Research

International hospital management

Private healthcare service providers with limited capital to invest and seeking to widen their geographic presence
have entered into hospital management contracts. This has allowed hospitals to leverage successfully their
operational expertise while remaining asset light. This model would also help private healthcare providers
understand new markets. Apollo and Fortis, for instance, manage several hospitals across Asia and the Middle East.

NOVEMBER 2010 65
 IDFC Securities

Companies

NOVEMBER 2010 66
 IDFC Securities

Apollo Hospitals Rs509

Pole position! Mkt Cap: Rs63.1bn; US$1.4bn

Reason for report: Initiating coverage OUTPERFORMER

Apollo Healthcare (Apollo) is Asia’s largest healthcare group with 8,000+ operational beds and
1,000+ retail pharmacies. With 47 owned hospitals and focus on clinical outcomes, Apollo is a
formidable brand in the Indian healthcare space. However, its cautious approach has prevented
Apollo from effectively leveraging its first mover advantage beyond Southern India till now.
Bolstered by growing internal accruals (EBITDA of Rs5.9bn in FY13E) and increasing ability to
raise resources, Apollo’s traditionally conservative management is now looking to step up pace
through planned expansions beyond South India as well as newer delivery formats like Apollo
Reach for entry in Tier II/ III markets. This, we believe, will drive accelerated growth for Apollo
(19% CAGR in revenues as well as earnings) over FY10-13. Value unlocking in non-hospital
businesses may provide further upside triggers. Initiating coverage with Outperformer and an
18-month SOTP-based price target of Rs651.
Leader of today and tomorrow: Apollo seeks to extend its leadership position in Indian healthcare
market by adding ~1,000 beds a year over the next three years, taking its total bed count to over
10,000 by 2013. While further fortifying its presence in its traditional Chennai/ Hyderabad clusters,
Apollo now seeks to make inroads in western India as well as enter Tier II / III towns through
Apollo Reach format. With mature beds ARPOB growing 2% sequentially, we expect 19% revenue
CAGR for Apollo over FY10-13.
Margins to expand: Despite steady new bed additions (which depresses profitability in initial
years), we expect margins to expand by 227bp over FY10-13 as Apollo drives a consistent
improvement in operating metrics for existing beds. Over FY06-10, Apollo’s ARPOB grew at CAGR
of 10%+ as it worked on increasing occupancies and optimizing case mix across its network.
Good getting better; Outperformer: Its cautious approach to growth and a defined Southern Indian
tilt notwithstanding, Apollo remains the most formidable healthcare play in the Indian market. With
clear signs of management’s intent to step up investments/ growth, Apollo is set to enhance its
dominance. With return ratios set to improve (400bp gain over FY10-13) as proportion of mature
beds keeps growing, along with value unlocking in non-core businesses including Apollo Pharmacy,
we see a strong case for re-rating of the stock. Apollo is our top pick in the space.

Key valuation metrics Price performance

Apollo Hospitals Enterprise Sensex
Year to 31 Mar FY09 FY10 FY11E FY12E FY13E 220

Net sales (Rs m) 16,142 20,264 25,357 28,831 34,408 185

Adj. net profit (Rs m) 1,065 1,377 1,868 2,068 2,724
150
Shares in issue (m) 120 124 124 124 124
Adj. EPS (Rs) 8.8 11.1 15.1 16.7 22.0 115

% growth 34.5 26.0 35.7 10.7 31.7 80

12-Oct-10
12-Dec-09

12-Jun-10

12-Jul-10
12-Apr-10

12-May-10

12-Aug-10
12-Jan-10

12-Feb-10

12-Mar-10

12-Sep-10
12-Nov-09

12-Nov-10

PER (x) 57.6 45.7 33.7 30.4 23.1

Price/Book (x) 4.1 3.8 3.5 3.2 2.9
EV/EBITDA (x) 29.8 23.0 17.0 15.3 12.5
RoE (%) 7.5 8.7 10.7 11.0 13.2 Bloomberg: APHS IN 6m avg daily vol. (m): 0.15
RoCE (%) 7.3 8.5 11.0 11.1 12.6 1-yr High/ Low (Rs): 560/228 Free Float (%): 66.5

Nitin Agarwal Ritesh Shah

nitin.agarwal@idfc.com ritesh.shah@idfc.com
91-22-6622 2568 91-22-6622 2571

NOVEMBER 2010 67
 IDFC Securities

INVESTMENT ARGUMENT
¾ AHEL is Asia’s largest healthcare group with 8,000+ tertiary/ quaternary care
beds and 1,000+ pharmacy stores across India; plans to add ~2,700 beds by FY14
¾ Apollo brand epitomizes superior quality and clinical outcomes in healthcare;
management’s philosophy is to pursue clinical excellence
¾ Generates decent return ratios despite the traditional approach of growing
organically and owning assets even while using cutting-edge technology –
evidence of a calibrated growth strategy and operational skills
¾ We value Apollo’s healthcare business at 15x two-year forward earnings and
pharmacy at 1x EV/sales to build in the growth premium as well as quality and
scale of Apollo’s assets

No. 1 end-to-end healthcare service provider in Asia

Apollo pioneered high-end
private healthcare in India
Apollo is Asia’s largest healthcare group in terms of number of beds. From humble
beginnings as a 150-bed hospital in Chennai in 1984, AHEL today has over 8,000 beds
in 47 hospitals across India and services that span the healthcare delivery chain. Most
of this growth has been largely organic and business has been practically built
hospital by hospital, bed by bed. Promoted by Dr Parthap Reddy, one of most well-
known doctors in India, Apollo has pioneered the concept of delivering high-end
private healthcare in India. Over the years, the Apollo brand has become
synonymous with tertiary healthcare which is reflective of the group’s success.

Exhibit 1: Apollo – organically increasing capacities

Apollo Dhaka
Apollo Ludhiana
Apollo Bangalore
Apollo Bilaspur Apollo Kakinada
Apollo Colombo Apollo Karim Nagar
Apollo Speciality Apollo Kolkata Apollo Karur
Apollo Madurai Apollo First Med Apollo Children’s Hospital
Apollo Aragonda Apollo Mysore Apollo Mauritius
Apollo Chennai Apollo Vizag Apollo Ahmedabad Apollo Bhubaneshwar
Apollo Hyderabad Apollo Indraprastha Apollo Samudra Apollo Lavasa

Started with
1983-88 1989-00 2000-04 2005-10
150 beds
Source: Company, IDFC Securities Research

Today, Apollo services the entire healthcare delivery chain from primary care to
tertiary/ quaternary care. Apollo reaches masses via a chain of Apollo Clinics.
Additionally, hospitals under Apollo Reach initiative and multi-speciality/ super-
speciality hospitals offer secondary and tertiary/ quaternary care.

NOVEMBER 2010 68
 IDFC Securities

Exhibit 2: Apollo offers services from primary to quaternary care

Apollo’s diversified offering

Apollo MS / SS
Apollo reach Hospitals
Apollo Clinics Hospital

Primary Secondary Tertiary

Source: IDFC Securities Research

Besides owning and operating tertiary and secondary hospitals (Apollo Reach
Initiative), the group has established its footprint in several segments like primary
healthcare services (Apollo Clinics), retail pharmacies (Apollo Pharmacy), medical
BPO services (Apollo Health Street), health insurance & TPA (Apollo Munich RE),
project consultancy and clinical research divisions working at the cutting edge of
medical science.

Exhibit 3: Apollo – presence across the entire healthcare delivery chain

Primary Care Clinics Health Insurance and TPA

Health Education & e-

Owned & Managed Hospitals
Learning

Apollo
Clinical Research &
Standalone Pharmacies
Site Management

Technology Services &

Global Projects Consultancy
Solutions

Source: IDFC Securities Research

Over a period of three decades, Apollo has created strong brand equity and is
synonymous with quality healthcare and clinical outcomes. Apollo is a partner of
choice of several domestic/ international companies as well as countries looking to set
up or maintain high-end tertiary healthcare facilities (Parkway Hospitals, Yash Birla
Group, etc). Importantly, Apollo is at the forefront of India’s growing stature on the
global healthcare map backed by the management’s philosophy of pursuing clinical
excellence. Apollo has been able to achieve world-class success rates (e.g., >49,000
cardiac surgeries with a 98.5% success rate) in complex tertiary/ quaternary care.

NOVEMBER 2010 69
 IDFC Securities

‰ Uncompromising focus on clinical outcomes and quality

Operational and clinical Over the years, Apollo’s strategy has been to expand organically with sharp focus on
efficiency benchmarks clinical outcomes. Brand Apollo is synonymous with quality healthcare delivery and
Apollo with the best
hospitals globally clinical excellence. Apollo’s quality consciousness and patient-centric approach have
resulted in steady improvement in operational and clinical efficiency over the years,
benchmarking it with the best globally. That Apollo owns seven JCI-accredited
hospitals across specialties is also clear evidence of its focus on clinical processes and
outcomes.

Exhibit 4: Apollo owns 50% of JCI accredited hospitals in India

Delhi Chennai Banaglore Hyderabad

Kolkata Ludhiana Dhaka

Source: Company, IDFC Securities Research

Multi- and super-specialty
hospitals continue to bring
75% revenues even as the
group ventures into
secondary care
Focus on core specialties: Via its multi-specialty and super-specialty hospitals, Apollo
continues to focus on CONCORT, i.e. Cardiology, Oncology, Neurology, Critical care
& Trauma, Orthopedics, Radiology and Transplants. Cardiology, Oncology and
Orthopedics together contribute 70-75% of Apollo’s revenues. In addition to
CONCORT, Apollo has set up Apollo Children’s Hospital in Chennai – specifically
offering pediatric care for children from birth to adolescence. Even as Apollo begins
to venture into secondary care (via Apollo Reach), the management seeks to retain its
focus on core treatment offerings – CONCORT + pediatrics.

Exhibit 5: Apollo derives 65% of revenues from Cardio, Ortho and Onco therapies
Cardiology
Others 30%
35%

Oncology Orthopaedics
15% 20%

Source: Company, IDFC Securities research

Initiatives like ACE@25 and Measurable approach to achieve clinical excellence: The group has implemented
Apollo Way measure ACE@25, a balanced scorecard that analyzes patient experience in terms of care
outcomes to ensure strict
clinical standards are quality and environment safety. This approach has also helped the group strengthen
maintained functional efficiency and benchmark it against international standards. Importantly,
all hospital heads under the Apollo network are accountable to the outcomes at the
end of each month. Apollo also runs a pilot project “Apollo Way” with international
consulting firms like McKinsey to ensure operational excellence (revenue
management, lean operations, etc) and quality healthcare delivery.

NOVEMBER 2010 70
 IDFC Securities

Exhibit 6: Roster representing Apollo’s focus on clinical outcomes

• Apollo Hospitals, Ahmedabad, completed successful 20 stem cell transplants; also conducted the first
successful "Autologous Stem Cell Transplant for Acute Leukemia" in Gujarat.
• Instituted a contemporary Neuro Rehabilitation Programme at the main hospital in Chennai, the first of its
kind in India; to introduce robotics in neurorehab for the first time in India in association with Hocoma.
Jan-Mar10
• Revolutionary Ceramic Coated Knee Replacement was performed for the first time in South India at Apollo
Specialty Hospital, Chennai.
• Apollo Centre for Liver Disease and Transplantation completed 50 liver transplants, a key milestone for
Chennai.

• Apollo Bramwell Hospital in Mauritius, a JV with BAI, clocked numerous firsts within its first 100 days of
operations, conducting innovative surgeries in urology, general surgery and orthopaedics.
Oct-Dec09
• Apollo Group completed a record 268 organ transplants in the nine months ending Dec 2009.
• Apollo Knee Clinic’ was launched in all the major Apollo hospitals

• Apollo Hospitals, Chennai, completed 10,000 coronary bypass operations using the beating heart
technique.
• The Chennai orthopaedic team successfully performed an Arthroscopic Brachial Plexus Catheterization, a
Jul-Sep09
first in India.
• Apollo Hospitals, Chennai, crossed the milestone of having performed the largest number of cadaver Liver
Transplants in a single year.

• Apollo Hospitals, Chennai, conducted the first heart transplant on a US citizen in India.
• Apollo BSR Hospitals, Mysore, performed its 100th renal transplant.
Apr-Jun09
• The Apollo Hospitals Group finalized a roadmap for NABH accreditation for five more hospitals.
• 27 six-sigma projects completed across various locations in India.

Source: Company

A new, more aggressive, Apollo emerging…

‰ Hitherto, strongly focussed on Southern India
Regional focus has helped About 85% of Apollo’s 3,330 owned beds are in the three southern states of Tamil
the hospital chain to
Nadu, Andhra Pradesh and Karnataka. The Chennai and Hyderabad clusters (1,970
significantly increase
profitability beds) account for 60% of Apollo’s total owned beds and 82% of its standalone
revenues as of FY10. Apollo has adopted the hub & spoke model, under which its
network of multi-specialty hospitals and day care centers (spokes) support its super-
specialty hospitals (hubs), most of which are located in the larger metro cities in
South India. Apollo has a strongly entrenched network in this part of the country and
the regional focus has enabled Apollo to significantly enhance its profitability over
the years as it has been able to garner the full benefit of the hub & spoke model.

NOVEMBER 2010 71
 IDFC Securities

Exhibit 7: Chennai and Hyderabad clusters account for 60% of Apollo’s owned beds
Operating since Name of hospital Type* Capacity % of total
owned beds
Chennai cluster
1983 Apollo Hospitals, Gerams Lane SS 619
1994 Apollo Specialty Hospitals, Nandanam SS 251
2000 Apollo Hospitals, Thondiarpet MS 61
2002 First Med Hospital MS 120
2003 Apollo Hospitals, Sowcarpet MS 17
2008 Apollo Children’s Hospital 81
Total beds 1,149 35
Hyderabad cluster
1988 Apollo Hospitals, Jubilee Hills SS 405
1996 Apollo Centre, Vikrampuri MS 50
1996 Apollo Emergency, Hyderguda MS 38
2000 Apollo Medical Emergency Centre, Malakpet DC 4
2000 Apollo Medical Emergency Centre, Medhipatnam DC 4
2000 Apollo Emergency Medical Centre, Kukatpally DC 20
2001 Apollo DRDO MS 150
2010 Apollo Hospital, Secundrabad MS 150
Total beds 821 25
Source: Company, IDFC Securities Research

Exhibit 8: AHEL's other owned beds in South India

Location Name of hospital Type Capacity
Tamil Nadu
Madurai Apollo Hospitals SS 185
Karur Apollo Loga reach Hospital MS 70
Andhra Pradesh
Vizag Apollo Heart & Kidney Hospital SS 65
Aragonda Apollo Hospitals MS 54
Kakinada Apollo Hospitals MS 150
Karim Nagar Apollo Reach Hospital MS 120
Karnataka
Mysore Apollo BGS Hospitals and Medical Centre SS 176
Total beds 820 25
AHEL's owned beds in other regions

Chhattisgarh
Bilaspur Apollo Hospitals SS 250
Orissa
Bhubaneswar Apollo Hospitals SS 290
Total beds 540 16
Total owned beds 3,330 100
Source: Company, IDFC Securities Research * SS: super specialty; MS: multi specialty

‰ Relatively limited presence in other parts of the country

JVs and O&M contracts Over the last few years, Apollo has started to work on increasing its geographical
characterize Apollo’s low-
reach beyond the southern region. However, unlike its strategy in southern India
risk approach in regions
outside South India where it owns most of its hospitals, most of the hospitals (total 12 hospitals currently)
in northern, western and eastern regions are run either on a contractual basis (O&M
contracts) or as part of JV structures with partners. For example, to establish its

NOVEMBER 2010 72
 IDFC Securities

presence in the East, Apollo set up Apollo Gleneagles, a JV with Parkway Hospitals,
in Kolkata in 2002. Its foray into western India was marked by a 50:50 JV with Cadila
Pharma to set up a 300-bed super-specialty hospital in Ahmedabad, Gujarat. This
clearly reflects the low-risk approach adopted by Apollo over the years as it seeks to
go to newer geographies.

Overall, in terms of beds under operation across various categories, i.e. owned,
franchise, JVs, etc, Apollo has created a formidable geographical footprint and
remains an eminent private healthcare provider in India.

Exhibit 9: AHEL in rest of India – subsidiaries/ JVs/ associate partnerships

Location Name of hospital Ownership (%) Type Since Capacity
Owned beds
Bilaspur Apollo Hospitals 100 SS 2001 250
Bhubaneswar Apollo Hospitals 100 SS 2009 290
JVs/Associates
Delhi Apollo Hospitals (IMCL) 20 SS 1996 632
Kolkata Apollo Gleneagles Hospitals 50 SS 2002 470
Ahmedabad Apollo Hospitals (AHIL) 50 SS 2003 300
Noida Apollo Hospitals (IMCL) 28 MS 2005 100
Bangalore Apollo Hospitals 50 SS 2007 250
Lavasa Apollo Hospitals 7 MS 2010 67
Source: IDFC Securities Research, Company

Exhibit 10: AHEL in the rest of India - managed and franchise beds
Location Name of hospital Type Since Capacity
Managed beds
Ranchi ARAM Hospital SS 1996 137
Pune Jehangir Hospital SS 1998 331
Bacheli NMDC Hospital SS 1998 100
Raichur Rajeev Gandhi SS Hospital SS 2002 350
Ranipet Apollo KH Hospital MS 2003 100
Ludhiana Apollo SS Hospital SS 2005 350
Dhaka Apollo Hospitals, Dhaka SS 2005 330
Agra Apollo Pankaj Hospitals SS 2006 150
Bhilai Apollo BSR Hospitals SS 2007 150
Total beds 1,998
Franchisee Hospital Beds
Margao Apollo Victor Hospitals SS 2003 150
Indore Convenient Apollo Hospitals SS 2001 140
Total beds 290
Source: Company, IDFC Securities Research

‰ Overcautious approach = opportunity missed?

Limited presence outside
South India points to lost
opportunity in leveraging its
brand advantage
nationwide…
Apollo’s keen focus on the home market (South India) reflects the management’s
cautious approach to building the business – e.g., with the exception of Indraprastha
Apollo, Delhi (set up in 1996), Apollo does not have owned beds in North, West and
East India. In our view, it implies that Apollo has not been able to effectively leverage
its first mover advantage as well as strong brand equity to create a strong footprint of
hospitals in other part of the country. The opportunity arising due to Apollo’s
relatively limited presence outside of South India has been lapped by new entrants
like Fortis and Max that have created strong footholds in the lucrative NCR region
and are beginning to make in other parts of the country too.

NOVEMBER 2010 73

…but is also indicative of
restricted access to capital
and limited cash flows
Large bed-addition target
and entry into new formats
point to new-found
aggression, which we see as
positive
‘Reach’ is a no-frills initiative
aimed at expanding Apollo’s
presence in Tier I/ II towns
Planned additions targeted
at cementing leadership on
the home turf and nationally
NOVEMBER 2010
IDFC Securities
Having said that, we also believe that management’s decision-making would have
been influenced by restricted access to capital in the past as limited internal accruals
would not have been sufficient to meet the high capex involved in setting up owned
facilities.
‰ Turning a new leaf
In a break from its past characterized by slow and steady growth, we believe Apollo
is set on shifting the growth gears up by several notches. This is reflected in its plan
to add as many as 2668 owned beds over the next three years on top of the ~750 beds
and six new hospitals (Chennai, Karur, Bhubaneswar, Secunderabad, Hyderabad and
Madurai) added over the last six quarters. Considering that in the last 25 years of
existence, Apollo has set up a cumulative 5,376 owned beds (overall 8,000+ beds
including O&M, etc), growth plans are quite aggressive and may well mark a
dramatic shift in Apollo’s future growth trajectory.
Further, there are clear signs of Apollo management now willing to experiment with
newer delivery formats like Apollo Reach hospitals, day care centers, dialysis centers,
etc. With this, the company seeks to build on its leadership position in the Indian
healthcare market and experiment with innovative formats to increase effectiveness
of the network. We are particularly excited on the possibilities offered by Apollo
Reach initiative, Apollo’s vehicle for entering into Tier II / III town, as it can add a
new dimension to the future growth trajectory. We like this newfound aggression in
the management and believe it bodes well for Apollo’s future growth outlook.
Apollo Reach Hospital Initiative
Apollo Reach Hospitals (ARH) are positioned as a no-frills model providing quality
healthcare and extending Apollo’s presence to Tier II / Tier III towns where it is not
economically feasible to set up the conventional high-end tertiary care hospitals. The
‘Reach’ hospitals would be in the higher secondary and acute care categories and
capable of developing into tertiary care centers. Apollo plans to add >500 beds under
this initiative over the next three years. Successful execution of the same will enable
Apollo to further strengthen its footprint pan-India and fortify the Apollo brand.
These hospitals will cost Rs5m-6m per bed compared to Rs8m-12m for conventional
tertiary care hospital in a metro. The hospitals are expected to start breaking even by
the second year and generate attractive 20-22% EBITDA margins in steady state,
leading to strong return ratios. ‘Reach’ hospitals would also ensure a steady stream of
screened inpatient flow to Apollo’s multi-specialty/ super-specialty hospitals –
leading to higher ARPOB and lower ALOS in those higher-end hospitals.
‰ Targeting 10,000+ beds by 2013
From its present base of 8,000+ beds, Apollo has embarked on an ambitious plan to
set up 2,668 beds (including ~825 beds under Apollo Reach) over the next three years
with most of the additions to be owned beds. This would take total operational beds
under the Apollo brand to 10,000+ by 2013. The planned bed addition, while
cementing its position on the home turf (Chennai and Hyderabad), would also
expand Apollo’s national footprint.
Interestingly, unlike peers that are increasingly adopting the unconventional models
like leasing land & building as also machinery so as to reduce the capital intensity of
74
 IDFC Securities

the business, Apollo continues to prefer the traditional approach of growing by

owning hospitals and equipment.

While fortifying presence in Southern India…

Apollo plans to add 850 beds in the Chennai and Hyderabad, taking the total number
of beds in the clusters to 2,820 over the next three years. Of the planned 1,000-bed
addition in South India over the next three years, 50% would be under the Apollo
Reach initiative.

…a major thrust on Mumbai is on the cards

About 90% of the planned
1000 beds in western
India would be in Mumbai
Apollo plans to set up ~1,000 beds to augment its presence in western India. About
90% of the new beds would be in Mumbai, where it currently does not have a
meaningful capacity. The management recently indicated that it would set up two
wholly-owned facilities in Mumbai with a total 650 bed capacity. In addition, Apollo
is currently setting up a 250-bed super specialty facility in Thane in a joint venture
with the Yash Birla group. Apollo also plans to expand its capacities in Delhi and
Chhattisgarh by 150 beds each by FY12.

These plans would, in our view, help Apollo maintain its numero uno position on the
domestic landscape.

Exhibit 11: Ambitious expansion plans to help Apollo maintain its numero uno position
Location Ownership Type By Bed capacity
Hyderabad cluster
Hyderabad - international Owned Expansion Mar-11 100
Secundrabad Owned SS Apr-10 150
Hyderguda Owned SS Jun-11 175
Chennai Cluster
Chennai – MAIN Owned Expansion Sep-12 30
Ayanambakkam Owned ARH Jun-12 200
Karaikudi Owned ARH Sep-10 100
Others
Bangalore JVs - 50% Expansion Oct-10 52
Nellore Owned ARH Oct-12 200
Vizag Owned ARH Jun-13 300
Trichy Owned ARH Mar-13 200
North India
New Delhi JVs - 50% Expansion Oct-10 136
West India
Nashik Owned ARH Mar-12 125
Mumbai* Owned SS Jun-13 650
Thane JV – Yash Birla SS Sep-12 250
Central India
Bilaspur-Oncology Owned Expansion Sep-11 NA
Total 2,668
Source: IDFC Securities Research, Company, *two different hospitals

‰ Some more new delivery formats

Apollo is at the forefront of Given the growing challenges of managing real estate and personnel costs,
evolving new delivery development of newer delivery formats is the need of the hour for Indian private
formats…
sector healthcare providers, and we expect Apollo to be on the forefront of this trend.
Along with Apollo Reach format, Apollo is also adopting three more formats.

NOVEMBER 2010 75
 IDFC Securities

…like day care surgery
centers, which would ease
the burden on its super-
specialty and
multi-specialty hospitals
Apollo’s dedicated pediatric
foray achieved EBITDA
breakeven in the first year
™ Day care surgery centers: Day care surgery centers involve carrying out
procedures where the patient can be discharged in a day and which do not
require overnight stay. Apollo plans to open these day care centers close to its
high-end super-specialty and multi-specialty tertiary care hospitals. This would
enable Apollo to shift the relatively less complex procedures to these centers and
free up capacity in the tertiary hospitals, which can then target more valuable and
complex procedures. Currently, Apollo operates one day care surgery center in
Kolkata offering non-invasive treatment. The pilot projects seem to be doing well
and are witnessing high occupancy rates improving the ARPOB for the overall
network. The management plans to have alteast 1 day care surgery centre in
Metros and category A cities in near future.
™ Dedicated pediatric hospitals – Apollo has recently established a dedicated 81-
bed pediatric hospital in Chennai. The hospital has been extremely successful –
evident in the fact that it became EBITDA positive in the first year of operations.
While the format was initially set up with the intent to reduce the load at tertiary
care hospitals in Chennai, Apollo may experiment with this format on its own
merit across different cities.
™ Dialysis clinics: Apollo has also initiated Apollo Dialysis Clinics – India’s first
out-of-hospital dialysis clinic. The format provides high-end dialysis facilities
designed to address specific issues in this segment of medical care in India.

Apollo Pharmacies: India’s largest organized chain

India’s combined Rx and OTC medicine sales were estimated at US$22bn in 2010.
BMI estimates pharmaceutical sales to reach US$39bn and US$66bn in 2014 and 2019
respectively. Industry estimates indicate that India has >700,000 pharmacies,
indicating that the pharmacy retailing industry is largely unorganized. These are
represented by regional associations or unions. The organized pharmacy segment is
dominated by 10-12 big players, but they form a miniscule proportion of this industry
(see exhibit below).

Exhibit 12: Apollo – India’s largest retail pharmacy chain Indian pharmacy market growing rapidly
(Nos) Indian retail pharmaceutical market (LHS)
700 (Rs bn) (%)
Organized retail as % of total retail market (RHS)
500 3.4
488

525
3.2
455 3.1

350 422

410 2.7

175 2.6

365 2.4

0
Apollo Medplus Guardian Medicine Global Fortis
320 2.0
Lifecare Shoppe Healthline Healthworld 2006 2007

Source: CRISIL – 2008 report, Industry

NOVEMBER 2010 76

AHEL believes pharmacies
will add value to the
business; plans to add ~600-
700 stores to its existing
1110 by FY13
Increase in mature stores,
high-margin products and
bulk distribution to drive
profitability
NOVEMBER 2010
IDFC Securities
‰ Pharmacies – adding value to the business
Apollo Pharmacy (SAP) is by far the largest organized pharmacy chain in the India
with 1,066 stores across 21 states. The management strongly believes the segment can
add value to the business while capitalizing on the Apollo brand. It plans to expand
its reach to 1,700+ stores by FY13. Apollo Pharmacy offers a wide range of medicines,
surgical & hospital consumables and healthcare products. Additionally, it provides
several value-added services to customers, including free delivery, appointment with
doctors at hospitals, etc. Most of Apollo’s pharmacies also have nursing stations to
provide basic medical services like measuring blood pressure, dressing, etc. Many of
Apollo’s standalone pharmacies operate on a 24-hour basis.
Exhibit 13: Value-added services provided by Apollo Pharmacy
Source: http://www.apollopharmacy.in/services.html
Expect SAP to be EBITDA positive in FY12
Apollo Pharmacy’s total store count stood at 1,110 as of 30 September 2010. It reports
financials in two batches – matured pharmacies, i.e. stores set up before 2007 and
stores set up after 2007. Apollo Pharmacy achieved EBITDA breakeven in Q4FY10
and we expect the business to be EBITDA-positive in FY12. We expect overall
EBITDA margins to improve to 5% by FY13. We expect steady improvement in
operating metrics on the back of: (i) progressive improvement in the ratio of matured
stores to new stores; (ii) introduction of generic and self-branded products which
command higher margins (management plans to increase share of private label
brands to 20% from 8% now); and (iii) higher bulk distribution of medical supplies
and disposable equipment to healthcare service providers including hospitals.
77
 IDFC Securities

Exhibit 14: SAP to grow to 1,700+ by FY13E EBITDA margins steadily improving

No. of stores (%)

1800 Stores upto 2007 Stores after 2007
10

1350 5

0
900
-5

450
-10

0 -15
FY07 FY08 FY09 FY10 FY11E FY12E FY13E Q1FY10 Q2FY10 Q3FY10 Q4FY10 FY10 Q1FY11 Q2FY11

Source: IDFC Securities Research, Company

Exhibit 15: Apollo Pharmacy – state-wise distribution (as of 2009)

State HBP SAP Total
Andaman & Nicobar 1 1
Andhra Pradesh 8 231 239
Assam 2 2
Chandigarh 3 3
Chhattisgarh 1 8 9
Goa 1 3 4
Gujarat 1 63 64
Haryana 10 10
Himachal Pradesh 1 1
South India accounts for a
bulk of pharmacy stores Jharkhand 3 3
Karnataka 9 81 90
Madhya Pradesh 0 5 5
Maharashtra 0 103 103
New Delhi 5 47 52
Orissa 0 14 14
Puducherry 0 6 6
Punjab 1 4 5
Rajasthan 3 24 27
Tamil Nadu 17 210 227
Uttar Pradesh 2 12 14
West Bengal 1 42 43
Total 49 873 922
Source: Company, IDFC Securities Research, HBP – Hospital Based Pharmacies, SAP- Standalone Apollo Pharmacy

Apollo management has been contemplating value unlocking in the SAP business for
some time now. The SAP business has acquired critical size, and we believe value
unlocking is now imminent through either induction of strategic investors or an IPO.
While reflecting the value of SAP, the largest organized pharmacy in one of the
largest pharma markets globally, this event will also generate cash for the parent.

NOVEMBER 2010 78
 IDFC Securities

JV with global leader Munich
Health to tap the fastest
growing non-life
business
Other Ventures
‰ Apollo Munich Re Insurance
According to industry estimates, health insurance is the fastest growing and second
largest non-life insurance segment in the country. IRDA estimates 25% CAGR in
health insurance premiums over FY09-14, with insurance premium collections for
FY10 at US$1.3bn. Apollo entered the thinly-populated health insurance space
through a JV with Munich Health to tap the significant opportunity. Munich Health
is a subsidiary of Munich Re, a world leader in health insurance with >5,000
employees catering to clients in more than 40 countries. Apollo holds a 19.72% stake
in the JV and will not be investing any further equity in the JV, which implies that its
stake in the venture will keep coming down progressively.

Exhibit 16: Apollo Munich Re – key financials

(Rs m) FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 FY10 Q1FY11 Q2FY11
Gross written premium 481 194 294 310 349 1,147 421 454
Earned premium 216 124 153 197 226 700 280 317
Other income (inc. interest income) 74 24 23 26 23 96 30 37
Total income 290 148 177 223 248 796 311 353
EBITDA (675) (102) (208) (194) (321) (825) (160) (232)
Depreciation 43 15 18 18 21 72 20 22
Interest - - 1 (1) - -
PBT (718) (117) (227) (212) (341) (897) (180) (217)
Tax (4) (1) (2) 3 -
PAT (722) (118) (229) (212) (338) (897) (180) (217)
Source: Company

Apollo Munich Re doubled its gross written premium to Rs1.1bn in FY10 from
Rs481m in FY09.

‰ Apollo Health Street – a ‘medical BPO’

We expect Apollo to divest
its stake in the business as
it is non-core
Apollo Health Street (revenues and EBITDA of Rs4.5bn and Rs511m respectively in
FY10) is a medical BPO offering a range of outsourcing services and IT solutions to
hospitals and physicians. AHS’s service offerings include medical coding, billing,
medical transcription, claims generation and patient follow-ups. Apollo has a 39.38%
stake in Apollo Health Street operations. The management is positive on the
prospects of this business as it continues to add clients and expand service offerings.
We expect the business to be eventually divested as it is not core to Apollo’s
healthcare offerings.

Exhibit 17: AHS – key financials

(Rs m) FY09 Q1FY10 Q2FY10 Q3FY10 Q4FY10 FY10 Q1FY11 Q2FY11
Revenues 4,994 1,205 1,137 1,125 1,110 4,577 1,076 1,333
Other income 94 3 1 5 49 58 18 4
Total income 5,088 1,208 1,138 1,130 1,159 4,635 1,094 1,337
EBITDA 849 185 154 164 8 511 151 166
PBT 134 -30 53 30 53 106 41 13
PAT 147 -39 42 23 57 83 33 7
Source: Company

NOVEMBER 2010 79
 IDFC Securities

‰ Projects and consulting

Apollo Global Projects is Apollo Global Projects is among the most renowned hospital consultants. It is the
among the most renowned planning, implementation and operations management arm of the Apollo Hospitals
hospital consultancies; it
contributed Rs205m in Group. The venture provides project management and operations consulting services
revenues to other hospitals. It deploys staff and shares hospital management expertise with its
clients, and derives revenues either as a flat fee or as percentage of the value of the
project. Apollo Global Projects generated revenues of Rs205m in FY10.

Exhibit 18: Apollo Global Projects – consultancy revenues have been largely flat
(Rs m)
Consultancy revenues
300

225

150

75

0
FY08 FY09 FY10

Source: Company

NOVEMBER 2010 80

Healthy core return ratio of
~15% despite owning assets
in a capital-intensive
industry
Occupancy has increased
and AHEL’s ARPOB growth
rates are among the best in
India...
... bolstered by the classic
hub & spoke model
NOVEMBER 2010
IDFC Securities
FINANCIAL ANALYSIS
¾ We expect 19% sales CAGR for Apollo over FY10-13 driven by strong
growth in heathcare services and Apollo Pharmacy
¾ EBITDA margins to expand by 227bps over FY10-13 as we expect steady
roll-out of new bed beds and declining losses at Apollo Pharmacy
¾ Aided by margin expansion, we expect Apollo’s consolidated net profits to
grow at a CAGR of 25% over FY10-13
¾ Strong internal accruals (Rs10bn of cash profits over FY11-13) to support
addition of 2,500 beds over the next three years, equivalent to 90% of
Apollo’s existing net block position; net gearing to reduce to 0.48x by FY13E
‰ A profitable business model
With its prudent approach towards managing growth over the years, Apollo has put
in place a sustainable operating model in the capital-intensive hospital industry.
Despite its significant expansion over the years and adherence to the strategy of
owning hospital beds and medical equipment while also using the latest technology,
Apollo has been clocking core return ratios of ~12-13% over the past three years.
While the headlines return ratios do look subdued due to the significant investments
undertaken which are yet to mature, an analysis of Apollo’s key operating metrics
over the last five years clearly underlines the quality of the business model and is a
validation of its calibrated growth strategy.
Exhibit 19: Key operational metrics at the group level
Particulars FY06 FY07 FY08 FY09 FY10
No. of beds (owned - Apollo standalone) 1959 2135 2237 2502 2717
Occupancy (%) 0.72 0.77 0.77 0.76 0.76
ALOS (Days) 5.7 5.5 5.18 5.13 5.25
Net ARPOB per day (Exc. HBP revenues) 7245 7563 8767 9666 10,750
Net ARPOB per day (incl. HBP revenues) - - - 16310 17940
Source: Company, IDFC Securities Research
Even while owned beds under operations have gone up by ~50% over FY06-10,
Apollo’s overall occupancy is up to 76% from 72%. With occupancy rates comfortably
above 75% over the last four years, Apollo has had the leeway to consistently increase
its treatment prices over the past several years. This has reflected in a steep growth in
ARPOB over this period which has grown at 10%+ CAGR over FY06-10. These data
points are even more encouraging when viewed for Chennai and Hyderabad
clusters, Apollo’s traditional strongholds.
Considering that Apollo’s ARPOB is net of the fees paid to doctors (22-23% of
ARPOB), this is among the highest in the industry despite having a diverse mix of
beds under operation. This is again testimony to Apollo’s operating model. The
improvement in ALOS is impacted by the commissioning on several new beds.
Higher ARPOB via the hub & spoke model: Apollo follows a classic hub & spoke
model – its super-specialty beds (at COE) are supported by multi-specialty hospitals
and day care centers. Of the total 1,970 beds in the Chennai and Hyderabad clusters,
65% are super-specialty (at COE) and the remaining are multi-specialty and day care
81
 IDFC Securities

surgery beds. As a result of the strong bed network and careful screening of patients,
Apollo has been able to ensure a desired case mix at its capital intensive COE
(Chennai Main and Jubilee Hills). This has resulted in higher ARPOB and occupancy
rates as also lower ALOS at the mature clusters.

Exhibit 20: key operating metrics for mature clusters

Particulars Chennai Hyderabad
FY09 FY10 FY09 FY10
ARPOB (Rs/day) 9492 10749 13265 16218
ALOS (days) 5.23 5.25 5.08 4.8
Occupancy (%) 0.76 0.76 0.8 0.77

Revenues (Rs m) 4023 5056 1437 1656

EBITDA (Rs m) 1196 1519 322 356
OPM (%) 30 30 22 21

% contribution to standalone revenues 61 62 22 20

Source: Company, IDFC Securities Research

‰ Expect 19% consolidated revenue CAGR over FY10-13

We expect revenues of
Rs31bn in FY13, including
Rs10.8bn from the SAP
business
We expect 19% consolidated revenue CAGR for Apollo to Rs34.4bn over FY10-13
driven by strong growth in both heathcare services and Apollo Pharmacy. We expect
the two businesses to contribute 61% and 35% respectively to standalone sales in
FY13, from 72% and 26% in FY10. Apollo has been seperately reporting HBP
revenues for standalone clusters as well as those derived from subsidiaries/ JVs from
Q1FY11; our forward estimates have factored in the new available data points. We
expect standalone revenues of Rs31bn in FY13, including Rs10.8bn from SAP. Of the
remaining Rs18.9bn, we expect hospital revenues of Rs15.9bn and pharmacy (HBP at
subsidiaries and JVs) revenues of Rs3.1bn.

Exhibit 21: Hospital & SAP to contribute 61% and 35% to standalone revenues by FY13
Rs m)
Consolidated Revenues
Standalone Revenues (FY13E)
35,000
Revenues from
HBP from ARH
28,000
sub's/Jvs 4%
10%
21,000

14,000
Hospital
7,000
Revenues
(includes HBP)
SAP 51%
0 35%
FY08 FY09 FY10 FY11E FY12E FY13E

Source: IDFC Securiteis Research

™ By FY13, we expect hospital revenues (Rs19bn) to contribute 65% of standalone

revenues. Of this, we expect the Chennai and Hyderabad clusters to contribute
Rs8.9bn and Rs4.3bn respectively. We epxect Rs2.9bn contribution from relatively
newer hospitals at Madurai, Mysore, Vizag, Pune, Karur, Karimanager, Bilaspur
and Bhubaneshwar.

NOVEMBER 2010 82
 IDFC Securities

™ From a quarterly run rate of Rs1.5bn and Rs492m of hospital revenues (ex-HBP
revenues) from Chennai and Hyderabad (Q1FY11), we expect Apollo’s exit rate to
increase to Rs1.8bn and Rs877m by Q4FY13. We believe our exit rate estimate is
conservative as we factor in a 2% qoq increase in ARPOB in each of the clusters
and a steady increase in opeational beds. We expect tertiary operational beds at
the Chennai and Hyderabad clusters to increase by 30 and 350 respectively from
existing levels. We factor in bed additions under Apollo Reach as a separate head.
We expect ARH to contribute 4% to standalone revenues by FY13.
™ We expect HBP revenues from Apollo’s standalone hospitals at Rs3.8bn in FY13
from a quarterly run rate of Rs768m in Q1FY11. We expect HPB revenues derived
from subsidiaries/ JVs to increase to Rs2.9bn in FY13 from Rs643m in Q1FY11.
™ We expect revenue contribution from SAP to increase from Rs4.8bn in FY10 to
Rs10.8bn in FY13 owing to an increase in the number of stores and potential
higher revenues from each store. We expect 5% CAGR in per store revenue
contribution over FY10-13.
™ We estimate revenue contribution of Rs3.8bn from subsidiaries/ JVs in FY13.

‰ Margins to steadily expand over FY10-13E

Steady increase in We expect Apollo’s consolidated EBITDA margins to expand by 227bps over FY10-13
operationalized bed, with EBITDA registering 25% CAGR over the period to Rs5.9bn in FY13. We expect
declining losses at Apollo
Pharmacy to aid margin Apollo’s EBITDA margin to steadily expand on back of steady increase in
expansion operationalized beds and declining losses at Apollo Pharmacy.

We expect Apollo’s Chennai and Hyderabad clusters to report conservative EBITDA

margins of 34% and 20% respectively in FY13. We expect other facilites (in Madurai,
Mysore, Pune, Vizag, Karur, Karimanagar, Bilaspur and Bhubaneshwar) to operate at
30% margin by FY13. Factoring in bed additions in FY12, we expect Apollo Reach
margins to be lower in FY12 and then rising to 22.5% in FY13.

Reflecting strong topline growth, we expect Apollo’s EBITDA to grow 1.95x over the
next three years to Rs5.9bn in FY13.

Exhibit 22: AHEL’s EBITDA margins to remain flat in FY11 and FY12
(%)
Consol. OPM
17.5

16.5

15.5

14.5

13.5
FY08 FY09 FY10 FY11E FY12E FY13E

Source: IDFC Securities Research

NOVEMBER 2010 83
 IDFC Securities

‰ Working capital – stays lean

Strong rise in working While there are significant upfront costs, private sector hospital players have a lean
capital cycle will support working capital cycle due to the low levels of debtors and inventories. Apollo’s
AHEL’s expansion plans
working capital cycle has improved significantly over FY09-10 with redcution in net
working capital cycle from 17 days in FY09 to five days in FY10. The sharp decline in
working capital cycle is primarily on the back of a propotionate increase in payable
days over the duration with inventory and recievable days largely constant. This
further strengthens Apollo’s ability to undertake expansions.

‰ PAT to almost double by FY13E

We expect Apollo’s consolidated profit to post 25% CAGR in FY10-13. With a meagre
60bp expansion in EBITDA margin over the period, we expect profitability to largely
track topline growth. Our estimates do not factor in tax benefits for setting up
hosptials in tier-II and tier-III cites. Apollo plans to add 825 beds under Apollo
Reach. We factor in an effective tax rate of 33.4% over FY10-13. Overall, we expect
Apollo’s consoldiated PAT to increase 2x over FY10-13 to Rs2.7bn by FY13.

Exhibit 23: Apollo’s consolidated PAT to grow 2x over FY10-13

(Rs m)
Consol PAT
2,700

2,200

1,700

1,200

700
FY08 FY09 FY10 FY11E FY12E FY13E

Source: IDFC Securities Research

‰ Return ratios to expand by 400bp

Healthy growth in turnover
and thereby improved
capital efficiency to support
RoE
Over FY10-13, we expect AHEL’s consolidated RoE and RoCE to expand by 450bps
and 407 bps to 13.2% and 12.6% respectively. Expansion in RoE would primarily be
driven by a higher asset turnover and steady expansion in margins over the next two
years. With turnover at Apollo Pharmacy expected to increase 2.2x times over FY10-
13, we expect improved capital efficiency to support RoE expansion. We expect
AHEL’s asset turnover to increase from 1.77x in FY10 to 2x by FY13.

NOVEMBER 2010 84
 IDFC Securities

Exhibit 24: RoE to expand by 400bps over FY10-13

Du-Point Analysis FY09 FY10 FY11E FY12E FY13E
PAT 1,065 1,377 1,868 2,068 2,724
Sales 16,142 20,264 25,357 28,831 34,408
PAT/Sales (%) 6.6 6.8 7.4 7.2 7.9
Sales 16,142 20,264 25,357 28,831 34,408
Assets 20,157 23,822 26,584 28,566 31,291
Sales/Assets (%) 80.1 85.1 95.4 100.9 110.0
Assets 20,157 23,822 26,584 28,566 31,291
Equity 13,841 15,650 17,212 18,576 20,433
Assets/Equity (%) 145.6 152.2 154.5 153.8 153.1
RoE (%) 7.5 8.7 10.7 11.0 13.2
Source: IDFC Securities Research

‰ Planned capex for FY11-14E at 90% of existing net block

Apollo has ambitious plans to add 2,668 beds over the next three years. The cost of
the planned expansion would be Rs13.5bn, with Apollo likely to incur a capex of
Rs11.6bn (its proportionate share). The planned capex of Rs11.6bn over FY11-14
translates into ~90% of its existing net block position as of end-FY10.

Exhibit 25: Apollo’s ambitious expansion plans

(Rs m) Own projects Project Total JV AHEL AHEL Estd.
Description Cost Debt Share invstd. Completion
Hyderabad Cluster
Hyderabad - international Expansion 1225 0 1225 1029 Mar-11
Secundarabad SS 370 0 370 370 Apr-10
Hyderguda SS 443 0 443 40 Jun-11
Chennai Cluster
Chennai - MAIN Expansion 100 0 100 0 Sep-12
Ayanambakkam ARH 700 0 700 66 Jun-12
Karaikudi ARH 260 0 260 238 Sep-10
Others
Bangalore Expansion 60 0 60 0 Nov-10
Nellore ARH 667 0 667 85 Oct-12
Trichy ARH 655 655 136 Mar-13
Vizag SS 1150 1150 80 Jun-13
North India
New Delhi Expansion 400 250 0 0 Nov-10
West India
Nasik ARH 520 0 520 34 Jun-12
Belapur SS 3500 0 3500 700 Jun-13
Masina SS 1400 0 1400 0 Jun-13
Thane SS 2000 1000 500 0 Mar-13
Central India
Bilaspur-Oncology Expansion 80 0 80 0 Sep-11
Total 13530 1250 11630 2778
Source: Company, IDFC Securities Research

Operational cash flow of
Rs7.2bn over FY11-13 will
contribute significantly to
capex needs
Apollo’s strong operational cash flows would allow it to comfortably fund its
massive capex rollout. We expect Apollo to generate operating cash flow of Rs7.2bn
over FY11-13 as against our capex estimate of Rs10bn. To maintain its targeted
financial leverage, Apollo continues to fund its expansions by raising incremental
debt (US$15m recently raised from IFC via issuance of FCCBs at a conversion price of

NOVEMBER 2010 85

We believe Apollo Pharmacy
is a prime candidate for a
stake sale or an IPO, which
will boost expansion plans
Apollo’s ability to
successfully execute
projects in new geographies
like Mumbai will be a key
metric to track
NOVEMBER 2010
IDFC Securities
Rs303 per share). However, strong internal accruals, along with cash flows expected
from issuance of promoters’ warrants, should limit debt requirement. Overall, we
expect Apollo’s balance sheet position to grow stronger hereon, with consolidated net
gearing at 0.48x by FY13 (0.36x as of FY10).
Exhibit 26: Gross OCF estimated at Rs7bn vs estimated capex of Rs10bn (FY11-13)
Cash flows
(Rs m)
OCF Capex FCF
3,500
1,500
-500
-2,500
-4,500
FY08 FY09 FY10 FY11E FY12E FY13E
Source: IDFC Securities Research
‰ Timely divestitures to enhance shareholder value
Apollo management has reiterated its intention of timely divestiture/ value unlocking
of its non-core business (Apollo Pharmacies and Apollo Health Street) to enhance
shareholder value. Apollo attempted to list its BPO operations in 2008, but decided to
back out due to the unfavorable market conditions. With Apollo Pharmacy having
already achieved EBITDA breakeven, a strategic stake sale or IPO launch of the retail
pharmacy business should not come as a surprise. We expect proceeds from the
planned transactions to be utilized to retire debt or fund incremental expansions.
Key risks
‰ Venturing into new geographies
While we are positive on Apollo’s strategy to venture into newer and challenging
geographies like Mumbai as it seeks to reduce the dominance of its Southern India
footprint in the business mix, we believe it will likely test Apollo’s project execution /
operational management capabilities. Apollo’s ability to successfully manage this
geographical expansion will be a key metric to track.
‰ Innovating with newer formats
Further, Apollo is also seeking to aggressively invest in newer delivery formats
including Apollo Reach as well day care centers etc. Given that the sustainability of
these newer models is yet to conclusively proven, Apollo’s ability to successfully
execute the same remains a key risk to monitor.
‰ Risk of spreading resources too thin
Over the past few years, Apollo has sought to accelerate the pace of capacity addition
while managing to ensure quality delivery standards. However, with aggressive
expansion plans in place, Apollo could be spreading its resources too thin across
86
 IDFC Securities

newer facilities and which may impact quality. Even as we believe in the
management’s ability to deliver on scale and superior execution skills, we would
continue to monitor the situation.

‰ Resource availability poses operational and financial risk

Getting specialists for India produces 35,000 MBBS doctors on an average each year, but the number of
super-specialty hospitals MDs (super-specialists) is far lower. Apollo’s hospital network includes several
continues to be a challenge
multi-speciality and super-speciality centers, which require highly skilled human
resources (MBBS and MD doctors). A strong brand equity has enabled Apollo to
attract good doctors. However, getting super specialist doctors for the newer super-
speciality units would be a challenge given the scarcity of this highly qualified talent.
Given the nature of Apollo’s service offerings, we see that as a key operational and
financial risk (higher employee costs) for the company.

NOVEMBER 2010 87

Strong balance sheet and
healthy margins give an
edge to Apollo’s scale and
geographical spread
We value Apollo using EV/
EBITDA given hospitals’
capital intensiveness and
long gestation periods
Hospitals is a play on Indian
healthcare, which offers
better growth potential for
than developed markets
NOVEMBER 2010
IDFC Securities
VALUATIONS & VIEW
¾ Apollo Hospitals is India’s largest and probably the best known healthcare
provider with a proven business model
¾ Internal accruals attaining critical mass, which would be used to fund the
ambitious expansion plans of the hitherto conservative management
¾ Potential strategic stake sale/ IPO in Pharmacy business as well as
divestiture of non-core assets further triggers for value unlocking
¾ Indian hospitals, particularly leaders like Apollo and Fortis offering
immense growth potential, deserve to trade at premium to global peers
¾ We initiate coverage on Apollo with an 18-month price target of Rs651share
‰ Apollo – stepping on the gas
With 47 owned hospitals and ~8,000 beds under operation in prime spots across key
cities, along with its phenomenal brand equity for quality healthcare, Apollo has
created an enviable and difficult to match footprint in India. With increasing real
estate costs as well as manpower shortages, Apollo’s competitive edge vis-à-vis the
new entrants is bound to increase further. Apollo’s strong balance sheet and healthy
EBITDA margins add to the edge.
While Apollo’s relatively conservative approach to growth in the past, involving
focus on its Southern India strongholds, may have provided an opportunity for some
other new players to create strong foothold in North India, we sense a change in the
air. Having built a strong base (operating profits likely to cross ~Rs4.75bn by FY12),
we believe the company is now willing to step on the accelerator so as to encash on
its first mover advantage. This is reflected in its decision to commence operations on
a large scale in western India as well as a willingness to experiment with innovative
business models like Apollo Reach, Day Care Centers, etc. Overall, Apollo is looking
to add ~2,700 beds over the next three years against ~8,000 beds opertionalized so far.
With opportunities aplenty in the Indian healthcare space, we believe Apollo
management’s aggression in pursuing the same bodes well for the stakeholders.
‰ Indian players deserve growth premium
Given the capital-intensive nature of the business and long gestation periods (steady
margins attained only by fourth or fifth year of operations), we prefer to value Indian
private hospital operators on EV/EBITDA rather than based on DCF and PE
multiples. Further, most of these players are in an aggressive growth phase – leading
to regular upscaling of medium-term growth plans, which have the potential to
dramatically alter the business profile in the later years.
Hospital operators in developed economies (USA and EU) trade 8-9x one-year
forward EV/ EBITDA, reflecting an average 8% EBITDA CAGR over the next two
years. In contrast, we expect EBITDA for leading Indian players like Apollo and
Fortis to register a significantly higher CAGR of 26% an 34% respectively over FY10-
12. As Indian players are in their early growth phase in a market offering tremendous
potential available as compared to the relatively limited growth opportunities for
players in developed markets, we believe Indian hospital players should trade at a
significant premium (14-15x one-year forward EBITDA) to global peers
88
 IDFC Securities

Exhibit 27: Global peer valuation matrix

(US$ m) PE (x) EV/EBITDA (x) RoE (%) OPM (%)
Company CY09 CY10 CY11 CY09 CY10 CY11 CY09 CY10 CY11 CY09 CY10 CY11
US
Universal Health Services-B 15.8 16.5 13.5 7.0 7.1 5.6 15.8 13.3 13.9 13.9 13.2 14.1
Health Mgmt Associates Inc-A 15.5 13.5 12.0 7.2 6.7 6.2 36.1 34.5 27.8 14.9 14.3 14.2
Community Health Systems Inc 12.1 10.9 10.0 7.2 6.7 6.4 13.7 13.4 13.0 13.5 13.6 13.2
Lifepoint Hospitals Inc 13.0 11.6 10.7 6.3 6.4 6.0 7.7 8.3 8.2 16.6 15.5 15.3
Tenet Healthcare Corp 12.2 12.5 15.1 6.4 6.4 5.7 87.2 32.5 15.8 10.9 10.6 11.5
Thailand
Bangkok Dusit Med Service 32.1 22.9 19.3 13.4 9.9 8.8 13.0 14.3 15.4 22.4 24.1 24.8
Bumrungrad Hospital Pub Co 22.9 20.8 18.2 15.0 11.3 10.1 24.1 21.7 22.5 21.9 23.4 24.0
Bangkok Chain Hospital PCL 18.2 16.8 14.6 10.3 8.8 7.8 24.6 20.9 21.9 27.9 29.6 32.7
Australia
Ramsay Health Care 26.1 17.2 15.1 11.3 8.4 7.7 18.1 15.3 16.0 13.3 13.8 13.9
Primary Health Care 12.8 11.1 10.0 8.4 6.8 6.3 5.8 5.6 6.1 24.9 25.6 26.3
India
Fortis Healthcare * 94.3 38.1 26.0 56.4 24.7 16.3 4.7 6.6 7.0 19.3 16.1 16.2
Apollo Hospitals Enterprise * 45.7 33.7 30.4 23.0 17.0 15.3 8.7 10.7 11.0 14.8 16.5 16.5
Singapore
Raffles Medical Group 37.0 28.6 24.5 25.7 20.0 16.9 16.1 16.4 17.3 23.9 24.1 25.2
Thomson Medical Centre 45.9 33.2 29.6 33.4 22.3 20.4 11.6 13.1 12.7 24.9 27.5 26.9
Malaysia
Kpj Healthcare Berhad 20.5 15.6 14.1 14.5 11.0 10.3 18.3 17.3 17.5 12.4 12.7 12.0
Source: Bloomberg, IDFC Securities Research ; Note: * For years FY10, FY11, FY12

‰ Valuing retail phamacy:

Apollo Pharmacy is a leader
in one of the fastest growing
pharma markets in the world
Like the hospital business, retail pharmacies also have long gestation periods due to
high upfront real estate and other costs. Therefore, retail chains achieve EBITDA and
PAT breakeven after suffering losses for a few years. In this context, we prefer to
value the pharmacy business on EV/ sales basis. Given the leadership position of
Apollo Pharmacy in the one of the fastest growing pharma markets globally and
factoring in 31% revenue CAGR over FY10-13E, we value Apollo Pharmacy at a
premium to global peers.

‰ Initiating coverage with an 18-month price target of Rs651/share

Apollo deserves command a
significant premium to peers
Leading private healthcare service providers like Fortis and Apollo, we believe,
deserve to command significant valuation premium to peers as well as the broader
Indian market as they are the only relevant proxies to the rapidly growing and highly
attractive domestic healthcare industry (US$125bn by 2015E). Further, we strongly
believe that with ~10,000+ beds operational by 2013E, Apollo will continue to be
among the leading players in the domestic market for years (and even potentially
decades) as the entry barriers keep on going up. The economic benefits of this
enviable leadership position will be visible in the years to come.

We assign a valuation of 15
FY13 EV/ EBITDA to Apollo’s
healthcare business
We value Apollo’s consolidated business using SOTP of its hospital and retail
pharmacy businesses. Given the quality and scale of assets, along with its strong
brand equity and 25% earnings CAGR over FY10-13E, we value Apollo’s healthcare
business (including HBP) at 15x FY13 EV/ EBITDA, which is in line with its historical
two-year forward multiples.

NOVEMBER 2010 89
 IDFC Securities

Exhibit 28: Historical EV/EBITDA and PE (x) band charts

PE (x) EV/EBITDA (x)
600 Apollo 15.0 25.0 35.0 Apollo 5.0 10.0 15.0
80,000

450 60,000

300 40,000

150 20,000

0 -
Mar-05

Nov-05

Mar-06

Nov-06

Mar-07

Nov-07

Mar-08

Nov-08

Mar-09

Nov-09

Mar-10

Nov-10
Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10

Mar-05

Nov-05

Mar-06

Nov-06

Mar-07

Nov-07

Mar-08

Nov-08

Mar-09

Nov-09

Mar-10

Nov-10
Jul-05

Jul-06

Jul-07

Jul-08

Jul-09

Jul-10
Source: IDFC Securities Research

Our target multiple of 15 Initiating coverage on Apollo with Outperformer and an 18-month SOTP-based price
FY13E EV/ EBITDA is in line target of Rs651/share (valuing the hospital business at 15x FY13E EV/EBITDA, in line
with those of leading Indian with our target multiple for leading Indian healthcare providers; and valuing the
healthcare players
Apollo Pharmacy business at 1x EV/ sales (FY13E) – implying an upside of 21% from
the current levels. Ability to accelerate margin improvement in existing hospitals, a
faster-than-expected pick-up in newer hospitals and value unlocking in non-core
assets will lead to upsides on the target price.

Exhibit 29: AHEL’s SOTP valuation

Deriving price on FY13
Hospital business
Target EV/EBITDA (x) 15
EBITDA (non-SAP operations) 5,339
Enterprise value (A) 80,080
Retail pharmacy
Revenues 10,786
Target EV/sales (x) 1
Enterprise Value (B) 10,786
Total Enterprise Value (A+B) 90,865
Debt 10,867
Cash 460
Derived Market cap 80,459
FDE (no. of shares) 124
Fair value 651
Upside 28%
Source: IDFC Securities Research

NOVEMBER 2010 90
 IDFC Securities

ANNEXURE 1 – Asia’s largest healthcare group

Apollo enjoys pan-India presence

with >8,000 beds

Source: Company

NOVEMBER 2010 91
 IDFC Securities

Income statement Key ratios

Year to Mar (Rs m) FY09 FY10 FY11E FY12E FY13E Year to Mar (Rs m) FY09 FY10 FY11E FY12E FY13E
Net sales 16,142 20,264 25,357 28,831 34,408 EBITDA margin (%) 14.0 14.8 16.5 16.5 17.1
% growth 32.7 25.5 25.1 13.7 19.3 EBIT margin (%) 10.1 11.1 13.1 12.7 13.2
Operating expenses 13,875 17,259 21,162 24,082 28,525 PAT margin (%) 6.6 6.8 7.4 7.2 7.9
EBITDA 2,267 3,005 4,194 4,749 5,883 RoE (%) 7.5 8.7 10.7 11.0 13.2
RoCE (%) 7.3 8.5 11.0 11.1 12.6
% growth 23.5 32.6 39.6 13.2 23.9
Gearing (x) 0.4 0.4 0.4 0.5 0.5
Other income 208 323 176 148 153
Net interest (459) (602) (685) (829) (869)
Depreciation 632 750 875 1,085 1,330 Valuations
Pre-tax profit 1,499 2,016 2,821 3,087 4,045
Year to Mar (Rs m) FY09 FY10 FY11E FY12E FY13E
Deferred Tax (22) 93 - - -
Reported EPS (Rs) 9.2 11.1 15.1 16.7 22.0
Current Tax 512 583 961 1,019 1,311
Adj. EPS (Rs) 8.8 11.1 15.1 16.7 22.0
Profit after tax 1,009 1,340 1,861 2,067 2,735
PER (x) 57.6 45.7 33.7 30.4 23.1
Minorities 56 36 7 0 (11) Price/Book (x) 4.1 3.8 3.5 3.2 2.9
Non-recurring items 40 - - - - EV/Net sales (x) 4.2 3.4 2.8 2.5 2.1
Net profit after EV/EBITDA (x) 29.8 23.0 17.0 15.3 12.5
non-recurring items 1,105 1,377 1,868 2,068 2,724 EV/CE (x) 2.8 2.4 2.3 2.1 1.9
% growth 43.3 24.6 35.7 10.7 31.7
Shareholding pattern
Balance sheet Public & others
6.9%
Year to Mar (Rs m) FY09 FY10 FY11E FY12E FY13E
Paid-up capital 602 618 618 618 618
Reserves & surplus 14,086 15,917 17,193 18,722 20,908
Total shareholders' equity 14,953 16,776 18,052 19,581 21,767
Total current liabilities 2,148 3,340 3,804 4,325 5,161 Promoters
Total Debt 6,706 9,131 9,131 10,367 10,867 33.5%
Foreign
Deferred tax liabilities 446 536 536 536 536 54.4%
Other non-current liabilities 1,989 2,633 3,550 4,036 4,817
Non-promoter
Total liabilities 11,289 15,640 17,021 19,264 21,381 corporate holding
Total equity & liabilities 26,243 32,416 35,072 38,845 43,148 1.4%
Net fixed assets 12,590 15,757 17,845 20,261 22,431
Govt holding Institutions
Investments 5,914 4,166 4,166 4,166 4,166 0.3% 3.5%
Total current assets 7,445 11,993 12,561 13,919 16,051
As of September 2010
Other non-current assets 294 500 500 500 500
Working capital 5,297 8,653 8,758 9,594 10,890
Total assets 26,243 32,416 35,072 38,845 43,148

Cash flow statement

Year to Mar (Rs m) FY09 FY10 FY11E FY12E FY13E
Pre-tax profit 1,499 2,016 2,821 3,087 4,045
Depreciation 632 750 875 1,085 1,330
Chg in Working capital (1,183) (1,116) (2,149) (1,053) (1,690)
Total tax paid (512) (583) (961) (1,019) (1,311)
Ext ord. Items & others 609 644 917 486 781
Operating cash Inflow 1,046 1,710 1,503 2,585 3,154
Capital expenditure (3,738) (4,123) (2,963) (3,500) (3,500)
Free cash flow (a+b) (2,693) (2,412) (1,460) (915) (346)
Chg in investments 328 1,749 - - -
Debt raised/(repaid) 1,384 2,425 - 1,236 500
Capital raised/(repaid) 875 1,050 - - -
Dividend (incl. tax) (538) (538) (538) (538) (538)
Misc 237 (34) (46) 0 (11)
Net chg in cash (407) 2,240 (2,044) (217) (395)

NOVEMBER 2010 92
 IDFC Securities

Fortis Healthcare Rs161

Forging Ahead… Mkt Cap: Rs69.7bn; US$1.6bn

Reason for report: Initiating coverage OUTPERFORMER

Fortis Healthcare (Fortis) is India’s second largest healthcare player with 49 hospitals, ~3,250
beds and a pan-India footprint built over just ~10 years – aided by aggressive inorganic growth.
Fortis is on track to achieve a 6,000+ installed bed capacity by FY13 as 8 new hospitals go on
stream. This should drive 41% CAGR in Fortis’s revenues and 75% CAGR in earnings over FY10-
13. While the backing of well-funded promoters (erstwhile Ranbaxy owners) and a strong
balance sheet have enabled Fortis to make bold moves like bidding for Parkway, the group’s
innovative streak is also reflected in its willingness to adopt novel models to reduce resource-
intensity in its future expansion. However, subdued return ratios, limited track record of
executing Greenfield hospitals and pending integration of Wockhardt hospitals are key risks to
monitor. Initiating coverage with Outperformer and 18-month price target of Rs206.
Second largest and growing: In addition to organic growth, Fortis has aggressively pursued
inorganic growth (Escorts, Wockhardt, Malar, etc) as also O&M contracts to build ~3,250 bed
network (~46% in Greenfield facilities). With a national footprint in place, Fortis is looking to
consolidate presence across different regions by adding ~2,000 new beds over FY10-13. Growth in
mature beds and new additions should drive 41% revenue CAGR for Fortis over FY10-13. The recent
decision to pursue international growth through promoter entities is a positive as it leaves Fortis
free to focus on tapping the opportunities in the domestic market.
Margins to be impacted by new bed additions: With the planned addition of ~2,000 Greenfield
beds, which typically take 6-8 quarters to breakeven, we expect Fortis’ margins to decline by 160bp
over FY10-13 but improve sharply thereon as the new beds begin to mature. We expect 37% CAGR
in EBITDA over FY10-13 to Rs4.95bn in FY13, creating a solid platform for funding future growth.
An exciting growth story despite the execution risks: A 75% earnings CAGR over FY10-13, strong
balance sheet, an aggressive promoter/ management with demonstrated ability to innovate in its bid
to create value and a still nascent market that offers multiple growth opportunities, Fortis is a
company to watch for. While caution is warranted given Fortis’s limited execution history, we rate
the stock as Outperformer with an 18-month price target of Rs206 per share.

Key valuation metrics Price performance

Year to 31 Mar FY09 FY10 FY11E FY12E FY13E 180
Fortis Healthcare Sensex

Net sales (Rs m) 6,589 9,872 14,914 21,156 27,961 155

Adj. net profit (Rs m) 145 695 1,721 2,520 3,809
130
Shares in issue (m) 406 406 406 406 407
Adj. EPS (Rs) 0.4 1.7 4.2 6.2 9.4 105
% growth (126.1) 379.0 147.6 46.5 50.8
80
PER (x) 451.8 94.3 38.1 26.0 17.3
12-Oct-10
12-Dec-09

12-Jun-10
12-Apr-10

12-May-10

12-Jul-10

12-Aug-10
12-Jan-10

12-Feb-10

12-Mar-10

12-Sep-10
12-Nov-09

12-Nov-10

Price/Book (x) 6.0 3.5 1.9 1.7 1.6

EV/EBITDA (x) 61.3 56.4 24.7 16.3 10.7
RoE (%) 1.3 4.7 6.6 7.0 9.5 Bloomberg: FORH IN 6m avg daily vol. (m): 2.162
RoCE (%) 4.1 2.9 2.7 5.4 8.3 1-yr High/ Low (Rs): 188/92 Free Float (%):18.5

Nitin Agarwal Ritesh Shah

nitin.agarwal@idfc.com ritesh.shah@idfc.com
91-22-6622 2568 91-22-6622 2571

NOVEMBER 2010 93
 IDFC Securities

INVESTMENT ARGUMENT
¾ India’s second largest (listed) healthcare player in the secondary/ tertiary
segment is on track to take total installed capacity to >6,000 beds by FY13
¾ Through aggressive inorganic growth, FHL has doubled its operational bed
capacity in two years; a track record of successfully integrating acquired
assets (Escorts Delhi, Fortis Malar, etc)
¾ FHL has embraced innovative strategies to reduce resource intensity (land,
employees, equipment, etc) and freed up capital to fund expansion plans
¾ Growth set to accelerate backed by a strong balance sheet and well-funded
promoters (erstwhile Ranbaxy owners); however, we perceive risks of
spreading resources too thin and operational integration challenges
¾ Our 18-month price target of Rs206 on the stock corresponds to 15x FY13E
EV/EBITDA, in line with peers’ average historical 2-year forward multiples

India’s second largest healthcare service provider

Achieved pan-India Fortis Healthcare (FHL), promoted by the erstwhile owners of Ranbaxy Labs, is
presence rapidly and
India’s second largest healthcare service provider (listed) and a key player in the
transformed Indian
healthcare in the process… secondary and tertiary care segment. Since setting up Fortis Hospital at Mohali
(Punjab) in 2001, the group’s first flagship venture, FHL has attained an all-India
footprint in a relatively short period of time. In the process, it has significantly altered
the traditionally-staid Indian healthcare landscape. Within 10 years of starting
operations, the group has a network of 49 hospitals and >4,053 installed beds (of
which 2,973 beds are operational) across the country. Fortis’s network hospitals
include multi-specialty and super-specialty centers providing comprehensive tertiary
and quaternary healthcare covering cardiac care, orthopedics, neurosciences,
oncology, renal care, gastroenterology and mother & child care among many others.

‰ Mr Unconventional…
… by adopting new FHL, we believe, has been among the most innovative of the leading private
paradigms in the largely healthcare service providers, willing to experiment with non-conventional strategies
conservative healthcare
business to build capacity and adopt new paradigms of doing business. This is reflected in the
company’s willingness to pursue aggressive inorganic growth in an industry where
gradual organic growth was the established norm. FHL’s willingness to push the
envelope is also evident in its bid for Parkway Assets, a fairly unthinkable
proposition for an India-based healthcare operator. Further, by bringing senior
managers from non-healthcare backgrounds to run the business, we believe FHL has
upped the “management quotient” in the Indian private healthcare industry – a
domain of medical professionals so far. While some of these unconventional moves
have proved effective, their sustainability over the long run needs to be monitored.

NOVEMBER 2010 94
 IDFC Securities

Exhibit 1: FHL – India’s second largest private healthcare service provider

(Nos) Speciality Mix (FY10)
9000

MSH, 16%

6750
Others, 4%

Gynae, 3%
4500 Pulmo, 2%
Cardiac, 42% Others, 21%

OPD, 9%

2250
Gastro 2%
Renal
Ortho 4%
0 Neuro Onco
Apollo Fortis CARE Manipal Max 8%
6% 2%
Source: IDFC Securities Research, Company, Industry

Exhibit 2: FHL’s bed additions – historical timeline

Year Hospital Ownership Category Total
of inception (%) capacity
2001 Fortis Hospital, Mohali* 100 Greenfield 300
2004 Fortis Hospital, NOIDA 100 Greenfield 350
2005 EHIRC - Delhi 90 Brownfield 331
Fortis Escorts Hospital, Jaipur 100 Greenfield 320
Fortis Escorts Hospital, Faridabad 100 Brownfield 250
Fortis Escorts Hospital, Amritsar 100 Brownfield 166
Escorts Hospital, Raipur 100 Brownfield 50
2007 Fortis La Femme, GK - II, New Delhi 31 Associate 45
Hiranandani Hospital, Vashi 40 Associate 148
2008 Fortis Malar Hospital, Chennai 51 Associate 250^
2009 Clinique Darne, Mauritius 29 Associate 120
Fortis Hospital, Bengaluru 67 Brownfield 100
BG Road, Bengaluru 100 Brownfield 451
Cunningham Road, Bengaluru 100 Brownfield 128
Chord Road, Bengaluru 100 Brownfield 40
Kalyan, Mumbai 100 Brownfield 60
Mulund, Mumbai 100 Brownfield 567
Nagar Bhavi, Bengaluru 100 Brownfield 55
Source: IDFC Securities Research, Company, * Land on lease, ^capacity ramped by 70 beds post acquisition

‰ Bed count has doubled in the past two years…

Bed capacity increased from
1483 in 2008 to 2973 in
2010, driven mainly by
inorganic means
FHL’s network beds have doubled in the past two years, from 1,483 in 2008 to 2,973
in 2010. Unlike Indian hospital operators’ approach of largely focusing on organic
growth, FHL has aggressively pursued inorganic growth to complement its organic
growth trajectory. This has enabled FHL to acquire a national footprint within a short
period of time and strengthen its brand franchise.

Exhibit 3: Recent acquisitions

Date Acquired Consideration paid (Rs m) No. of beds
2005 Escorts Hospitals 5850 1000
2008 Fortis Malar 560 180
2009 Wockhardt Hospitals 9090 1902
Source: IDFC Securities Research

NOVEMBER 2010 95
 IDFC Securities

Notably, bed acquisitions have mainly been in tertiary space in metro areas. With
long timelines associated with setting up of these acute care facilities and growing
challenges in procuring real estate at appropriate locations, these acquisitions have
jumpstarted FHL’s progress as a leading hospital player in India. While there could
be issues around the valuation paid for these assets, the acquisitions are indeed a
sound strategic asset.

‰ …greenfield beds <50% of overall beds

Only 46% of FHL’s overall operational beds (as of end-FY10) are greenfield with the
Managing Greenfield
facilities is a key challenge remaining either acquired or operated by JVs/ associates or under O&M contracts.
going forward… This is in sharp contrast to peers like Apollo and Manipal, whose network primarily
consists of beds built up through the Greenfield route. Over the next few years, as
FHL’s own Greenfield beds come on stream, it will need to demonstrate the ability to
manage growth by building hospitals from scratch.

Exhibit 4: Only 46% of FHL’s operational beds are Greenfield

Bed distribution (FY10)

HCC O&M
2% 12%
Associate
10%
Brownfield
30%

Greenfield
46%
Source: IDFC Securities Research, Company

‰ FHL‘s installed capacity – over 6,000 beds by 2013E

…as planned capacity FHL has come a long way from 150 beds in 2001 to ~3,000 in 2010 including 2,311
additions will be owned beds. The company plans to add 2,075 owned beds over the next two years,
mainly organic
taking the total owned bed count to 4,386 by 2013. FHL’s installed capacity will
increase to 6,000 beds (of which 5,000 would be operational beds) by FY13. As most
of this incremental capacity addition will be through Greenfield hospitals, it will be
interesting to watch FHL’s ability to successfully manage this sharp growth over the
next few years.

NOVEMBER 2010 96
 IDFC Securities

Exhibit 5: Fortis seeks to expand operational beds to 5000 by FY13 Fortis planned owned bed expansion over FY11-13

(Nos)
Date of No. of
5400
Location Commencement beds
Mulund Q2FY11 344
4300 Kolkata* Q2FY11 414
Shalimar Bagh* Q2FY11 350
Gurgaon Q4FY11 450
3200
Kangra Q1FY12 100
Ludhiana-1 Q2FY12 200
Peenya Q3FY12 120
2100
Ahmedabad Q4FY12 200
Ludhiana-2 Q4FY12 100
1000 Gwalior Q2FY13 150
FY2006 FY2007 FY2008 FY2009 FY2010 FY2011E FY2012E FY2013E

Source: IDFC Securities Research, Company, * already commissioned

‰ Improving operating metrics; imparts confidence on execution

Has unblemished track
record in integrating
acquired assets
FHL has not only created excellent physical assets over the past few years but has
also managed to grow and integrate assets within the wider Fortis network. FHL has
doubled its bed count and network revenues have almost doubled from Rs6.5bn in
FY08 to Rs12.4bn in FY10. Besides scaling up its Greenfield facilities, FHL has
seamlessly integrated its acquired facilities (Fortis Malar and Escorts Delhi). This, in
our view, underlines the group’s excellent project execution capabilities.

Tertiary care hospitals typically break even by the fourth year of operations. FHL has
demonstrated the ability to break even by the second year in several cases. Its Jaipur
hospital achieved EBITDA breakeven in the 14-16th month of operation. This proves
FHL’s capability to ramp up scale and achieve superior operating margins much
earlier than the conventional norms. While these are early days yet, the data points
enhance our comfort on FHL’s execution capabiilties.

Initiatives to standardize
services across its facilities
have helped improve
margins
To ensure standardized services across its network and derive gains from economies
of scale, FHL has implemented Fortis Operating System (FOS) and Purchase Supply
Management (PSM) programmes. This has helped FHL demonstrate steady
improvement in margins across the network including Greenfield and acquired
facilities. For example, Escorts Delhi’s (EHIRCL) revenues recorded 28% CAGR over
the past two years and the hospital now contributes 23% to FHL’s consolidated
revenues. EHIRCL’s operational margins too improved by 1690bps to 21% in FY10.

NOVEMBER 2010 97
 IDFC Securities

Exhibit 6: Revenues have tracked bed count

Fortis Mohali Fortis Noida Escorts Delhi Escorts Faridabad

(Rs m)
Esc Jaipur Escorts Amritsar Fortis Malar Wockhardt acquired
10,000

7,500

5,000

2,500

-
FY08 FY09 FY10

Escorts Delhi Fortis Malar

Revenues (Rs m - LHS) OPM (% - RHS) Revenues (Rs m - LHS) OPM (% - RHS)
2900 24
700 18

2550 18 550 16

2200 12 400 14

1850 6 250 12

1500 0 100 10
FY08 FY09 FY10 FY08 FY09 FY10

Source: IDFC Securities Research, Company

A well-crafted strategy to support scale

¾ Supported by well-funded promoters (erstwhile Ranbaxy owners) and a
strong balance sheet position (net cash of Rs6.6bn, end-FY11E), FHL seeks
to grow aggressively via all means
¾ Promoters remain keen on expanding global reach by acquiring assets at a
right price. Management recently indicated that FHL (listed) would focus
on expanding scale at home, while promoters’ ambition of gaining a global
footprint would be routed through their own holding company
¾ Withdrawal from the Parkway deal due to expensive valuations enhances
comfort in the management’s ability to manage inorganic growth
¾ FHL has embraced an innovative asset-light strategy to garner resources
(land, employees, equipment, etc.). This should free up capital, leaving
ample bandwidth for future growth

NOVEMBER 2010 98

FHL aims to tap the wide
variety of opportunities in
Indian healthcare using a
mix of growth strategies
A dedicated team scouts for
and assesses acquisition
and O&M opportunities
NOVEMBER 2010
IDFC Securities
‰ Aiming to build scale; capital not a constraint
FHL has been aspiring to firmly establish itself on both the domestic and global
healthcare map. The group believes that there is a huge untapped market for quality
tertiary healthcare services in India and remains upbeat on its ability to grab these
opportunities through organic and inorganic growth strategies. In this pursuit to
build scale and establish a leadership position, FHL has employed a fairly broad-
based approach for network expansion via building new hospitals, acquiring existing
ones, and entering into O&M contracts for both existing and new hospitals.
Analysis of FHL’s bed mix over the years clearly reflects its multi-pronged growth
strategy with simultaneous increase in beds across multiple categories.
Exhibit 7: FHL’s network has grown across multiple dimensions
(Nos)
Greenfield O&M Associate Brownfield HCC
3200
2400
1600
800
0
FY06 FY07 FY08 FY09 FY10
Source: IDFC Securities Research, Company
Supported by well-funded promoters and a strong balance sheet (net cash of Rs6.6bn
as of end-FY11E), we believe capital constraints would be the least of FHL’ concerns.
‰ Inorganic route remains a key growth imperative
Despite consummating a series of high-ticket deals, FHL continues to see significant
consolidation and expansion opportunities in the domestic market. FHL has a
dedicated team which continously scouts for and evaluates potential acquisition and
O&M opportunities with a pre-defined assessment matrix (exhibit below).
Exhibit 8: What FHL looks for while acquiring a new facility
Cost Specialties at existing facility
Quality of infrastructure Location population base
Work culture Availability of leading doctors
Source: IDFC Securities Research, Company
“As we move forward, yes the focus on growth in India will continue through organic and
inorganic opportunities.. “
–Mr. Malvinder Singh, Fortis Healthcare
99
 IDFC Securities

‰ Synopsis of key recent inorganic growth transactions

FHL’s recent acquisitions of Escorts Hospitals and Wockhardt Hosptials has
significantly enhanced its profile and accelerated its journey towards becoming a
leading hospital player in India.

Exhibit 9: FHL’s significant acquisitions over the past few years

Target Consideration (Rs m) Rationale
Sep-05
Escorts Heart Institute & Research Centre Ltd. (EHIRCL) 5850

2nd largest private health care provider in the country

Bed capacity (operational) No. of beds Largest player in cardiac care in terms of depth of
EHIRC – Delhi 331
coverage
Fortis Escorts Hospital, Jaipur 150
Fortis Escorts Hospital, Faridabad 250
Fortis Escorts Hospital, Amritsar (under Escorts Delhi) 166
Escorts Hospital, Raipur 50
Target Consideration (Rs m) Rationale
Dec-09
Wockhardt 9,090
Bed capacities (under construction) No. of beds
Yeshwantpur, Bengaluru 120
Anandpur, Kolkata 414
Total Beds 534 COE in the cardiac, neurology and orthopedic segments
Three specialties account for 54-58% of revenues
Bed capacities (operational) No. of beds Largest cardiac care and joint replacement centre in India
Mulund, Mumbai 567 Improved purchase and supply management
Kalyan, Mumbai 60 Integrated marketing and customer acquisition
BG Road, Bengaluru 451 Supports depth of coverage given long-term plans
Cunnigham Road, Bengaluru 128
Chord Road, Bengaluru 40
Nagar Bhavi, Bengaluru 55
Rashbehari Avenue, Kolkata 67
Sarat Bose Road, Kolkata 0
Total existing bed capacity (856 operational) 1,368
Total bed capacity 1,902
Source: IDFC Securities Research, Company

Exhibit 10: Valuation of major acquisitions

Wockhardt acquisition valuations (2009) Rs m
Total amount paid 9090
Total no. of beds 1368
EV/BED (Rs m) 6.64
Consideration towards Operational Beds 7190
No. of operational beds 856
EV/BED (Rs m) 8.40
Consideration towards ongoing projects 1900
Non-operational beds 534
EV/BED 3.71
Escort acquisition valuations (2005) Rs m
Enterprise value (Rs m) 6500
Acquired 90% at 5850
No. of beds acquired 1000
EV/bed (Rs m) 6.50
Source: IDFC Securiteis Research

NOVEMBER 2010 100

 IDFC Securities

‰ FHL’s global plans; the ‘Parkway saga’

Parkway acquisition is a Besides creating a formidable position in the domestic market, FHL has aspired to
clear indication of FHL’s establish a global footprint. In 2008, FHL marked its first major international foray by
global ambitions…
joining hands with a diversified Mauritiuan group to jointly acquire a controlling
stake in Mauritius’ largest private hospital – Clinique Darné. Clinique Darné is one of
the most modern medical centres in Mauritius with hi-tech facilities and offering a
wide range of specialized medical services.

On 19 March 2010 FHL acquired a strategic stake (23.8%) in Parkway Holdings

(PHL), Singapore, for US$685.3m from TPG Capital.

… would have led to its Incorporated in 1974, Parkway Holdings is a leading healthcare provider with
emergence as a leading presence in Singapore (1,022 beds), Malaysia (1,900 beds), India (425 beds), UAE (260
player in Asia
beds), Brunei (20 beds) and China (14 beds). It also has a GP clinic network (Parkway
Shenton) and provides radiology (Medi-Rad Associates) and lab services (Parkway
Laboratory Services). Besides, it owns a 35.4% stake in Parkway Life REIT, which
invests in healthcare and related real estate assets.

Sucessful closure of the deal could have seen FHL emerge as a leading player in Asia
with a network of 62 hospitals and 10,000+ beds.

… Khazanah counterbid..
After Fortis acquired a strategic stake in Parkway Holdings at SGD3.56 per share in
March 2010, M/s Khazanah, a Malaysian sovereign fund and the second largest
shareholder of Parkway, came up with a Voluntary Partial Conditional Open Offer
(VPO) on 27 May to increase its stake to 51.5%. The offer was earlier priced at
SGD3.78 and later increased to SGD3.95 in response to FHL’s raised offer.

The Khazanah offer priced
Parkway much higher than
Fortis’ other comparable
acquisitions
Khazanah’s offer of SGD3.95 per share valued Parkway at SGD3.3bn, translating into
31x CY09 EV/EBITDA. At this price, a rough analysis indicates that Parkway would
be valued at EV of Rs29m per bed comapred to Rs8.4m per bed and Rs6.5m per bed
paid by FHL for Wockhardt and Escorts acquisitions respectively.

Exhibit 11: FHL – Parkway deal

Details of Parkway foray (2009) (in SGD m)
Value attributed to Parkway based on Khazanah’s bid 3,307
Valuing Parkways investment in Parkway Life REIT 228
Valuation attributable to hospital beds and others 3,079
No. of beds to be acquired (nos.) 3,643
EV/ Bed (Rs m) 28.8
Source: IDFC Securities Research

With Khazanah seemingly determined to seize the asset as part of its broader pan-
Asia healthcare strategy, the bidding war threatened to go out of hand.

…FHL’s withdrawal…
At that stage, in realization that valuations were getting expensive, FHL decided to
pull out of the price war and exited Parkway by selling its 25.4% stake to Khazanah
at USD840m (our estimates) as against a purchase price of USD760m (our estimates).
Post transaction costs, Fortis made net gains of Rs180m on the parkway exit.

NOVEMBER 2010 101


Exit from Parkway
underscores the company’s
uncompromising focus on
financial discipline
FHL will continue to hone
core strengths; global forays
will be executed at
promoter level
East and central India to be
brought within the ambit of
Fortis’ growth plans
Plan to build low-cost
tertiary care units in tier I/ II
metros
NOVEMBER 2010
IDFC Securities
…a positive move
We take a lot of comfort from FHL mangement’s decision to withdraw from the
Parkway deal as it undelines its adherence to financial discipline even while
pursuing an aggressive inorganic growth strategy. It allays fears of managerial hubris
prevailing over business economics and aggressive aspirations
Focus reorienting towards the domestic market
The management recently indicated that FHL would focus only on the domestic
market while the promoters’ plans to expand globally would be executed via their
own private companies. In our view, this delineation of growth strategies will help
sharpen the growth focus in FHL and also reduce the complexities associated with
the limited disclosures, etc available on foreign acquisitions.
Recently, Fortis Healthcare Global (a promoter company) recently bought a Hong
Kong based primary clinics chain Healthcare Asia Limited (QHA) for US$193m.
QHA is the largest private integrated healthcare service platform in Hong Kong,
providing medical services and allied health services. The acquired businesses
comprise a network of over 60 wholly-owned medical centers, over 500 affiliated
clinics, over 40 dental and physiotherapy centers, and a private nursing agency with
a database of over 3,000 nurses. For the financial year ending 2009, QHA recorded
consolidated revenues and EBITDA of US$131m and US$13.1m respectively.
“Fortis Global Healthcare will be our vehicle of growth for international healthcare businesses
outside India, allowing Fortis Healthcare in India to continue to focus on the tremendous
growth in the Indian hospital business.”
– Mr. Malvinder Singh, Fortis Healthcare
However, we do not rule out the possibility of FHL and healthcare business acquired
through promoter entities exploring some sort of synergies at a later stage in time.
‰ Hub & spoke – the mainstay of expansion strategy
FHL is using the hub & spoke model to reinforce its presence in existing regions as
well as enter new geographies. As part of the strategy, FHL seeks to establish super
speciality “centre of excellence (COE)” facilities in key cities in a region (“hub for the
region”) and then build a series of feeder hospitals across the region to feed these
high-end hospitals. Having established its presence in parts barring East and Central
India, we believe incremental growth strategy will involve creating COEs in Eastern
and Central regions while further strengthening the feeder hospital network across
other regioss to strengthen the hub & spoke.
As part of this strategy to expand its reach and strengthen the feeder network, FHL
plans to set up low-cost secondary/ tertiary care facilities in Tier-2 cities. It has
already set up pilot projects in several cites to guage the market and build active
feeder networks for its super-speciality “COE” facilities at the hubs (metros). The
exhibit below shows FHL’s targeted bed capacity and pan-india presence by FY13.
102
 IDFC Securities

Exhibit 12: Expected pan-India presence by FY13

Particulars No. of Hospitals Operational Beds Capacity / Total Beds
North India 20 1,241 3,739
Western India 9 777 1,801
Central India 6 68 273
South India 7 710 1,144
Eastern India 3 67 481
Total - India 45 2,863 7,438
Overseas 2 110 120
Source: IDFC Securities Research, Company

Success of EHIRCL Northern India: FHL has reinforced its brand equity, enhanced delivery capabilities
vindicates the efficacy of the and driven up in-patient volumes in the region through successful execution of its
hub & spoke model
hub & spoke model and using a mix of organic and inorganic route. FHL established
a network of super-speciality ’centers of excellence‘ and multi-speciality hospitals by
acquiring EHIRCL as well as through its own greenfield hospitals like Mohali. More
than 50% of EHIRCL’s in-patient volumes are from geographies beyond NCR and
Delhi. This, in our view, vindicates the credibiltiy of FHL’s hub & spoke model.

Exhibit 13: Dominating presence in North India

Hospital Territory Care Total capacity Focus area
Fortis Hospital, Mohali Punjab Quaternary 300 Cardiac
Fortis Hospital, Noida NCR Quaternary 350 Orthopedics, Neurosciences, Oncology
EHIRC - Delhi* NCR Quaternary 331 Cardiac
Fortis Escorts Hospital, Faridabad* NCR Secondary 250 Multi-speciality hospital
Fortis Escorts Hospital, Amritsar * Punjab Secondary / Tertiary 166 Multi-speciality hospital
Fortis La Femme, GK - II, New Delhi NCR Quaternary 45 Healthcare needs of women
Fortis Flt. Lt. Rajan Dhall Hospital, NCR Quaternary 200 Cardiac, renal care, joint replacement,
Vasant Kunj, New Delhi pulmono-thoracic surgery and diabetec care
Fortis Jessa Ram Hospital, New Delhi NCR Secondary 150 Oncology
Shalimar Bagh, New Delhi^ NCR 550 Cardiac sciences, orthopedics, neuro-
sciences, renal care, mother & child
care and gastroenterology
Gurgaon, Haryana^ - FIIBMS NCR 1,000 Oncology, trauma, pediatrics, mother &
child care, cosmetology, gastroenterology,
neuro-sciences and renal care
Ludhiana 1, Punjab^ Punjab Tertiary 200
Ludhiana 2, Punjab^ Punjab Quaternary 75
Escorts Kalyani Hospital, Gurgaon* NCR Secondary 18
Yashoda Hospital, Ghaziabad* UP Secondary 5
GNRC, Guwahati* NCR Secondary 4
Total 3,644
Source: IDFC Securities Research, * satellite centre, ^under progress

NOVEMBER 2010 103

 IDFC Securities

Acquisition-led expansion in
South India
South India: FHL established its presence in South India by acquiring a stake in
Malar Hospital, Chennai in 2008. FHL then acquired a majority stake in RM Hospital,
a multi-specialty hospital located in central Bengaluru. This was followed by the
acquisition of Wockhardt in 2009, which cemented FHL’s position in South India.
FHL now has six hospitals and 532 operational beds in Bengaluru. FHL is also
setting up a 120-bed tertiary care facility in Yeshwantpur, Bengaluru.

Exhibit 14: Steadily gaining ground in South India

Hospital Territory Care Total capacity
Fortis Malar Hospital, Chennai Tamil Nadu Secondary / Tertiary 250
Fortis Hospital* Bengaluru Secondary / Tertiary 100
BG Road* Bengaluru Quaternary 451
Cunningham Road* Bengaluru Tertiary 128
Chord Road * Bengaluru Tertiary 40
Nagarbhavi* Bengaluru Tertiary 55
Yeshwantpura Bengaluru Tertiary 120
Source: IDFC Securities Research, Company, *erstwhile Wockhardt

Ambitious plans to expand
installed capacity in Mumbai
will further strengthen
western India presence
Western India: FHL has four hospitals in Mumbai. Two of these were part of the
Wockhardt transaction. The group plans to have a total installed capacity of 1,055
beds in Mumbai by FY13. Its has two hospitals in Rajasthan, Fortis Modi Hospital in
Kota and Fortis Hospital in Jaipur. The Kota hospital’s strategic location enables it to
attract patients from Madhya Pradesh and Gujarat as well. FHL is also setting up a
200-bed tertiary care hospital in Ahmedabad, which will be its first unit in Gujarat.

Exhibit 15: Increasing foothold in the western region

Hospital Territory Care Total capacity
Fortis Modi Hospital, Kota Rajasthan Secondary 200
S L Raheja Hospital Mumbai Tertiary 280
Kalyan, Mumbai Mumbai Tertiary 60
Mulund, Mumbai Mumbai Quaternary 567
Ahmedabad Gujarat Tertiary 200
Goyal Heart Institute, Jodhpur* Rajasthan Secondary 11
Arneja Heart Institute, Nagpur* Maharashtra Secondary 15
Hiranandani Hospital, Vashi Mumbai Secondary / Tertiary 148
Source: IDFC Securities Research, Company, *Satellite Centers

A 414-bed tertiary care
facility to cater to patients
from the eastern states and
also neighboring countries
Eastern and central India: This region has so far remained out of focus for Fortis. The
company only has a 44-bed tertiary care facility at Rashbehari Road, Kolkata and has
recently commisioned another 414-bed tertiary care facility in Anandpur. Through
this new facility, FHL aims to attract patients from the eastern states as well as
neighbouring countries like Banglandesh and Burma.

‰ An asset-light strategy provides enough leeway for growth

The hospital industry is inherently capital intensive. Acknowledging this, FHL has
adopted a diffrentiated asset-light strategy built around the following:

Overcoming land/ building costs: Prohibitive land and building costs have driven
FHL to embrace the lease model over the traditional practice of owning property. The
following exhibit shows that 60% of FHL’s incremental hosptial properties (36% of
beds) are leased.

NOVEMBER 2010 104

 IDFC Securities

Exhibit 16: Fortis adopting asset light strategies to reduce land and building costs
Date of No. of Land &
Location Commencement beds Bldg. ownership
Mulund Q2FY11 344 Owned
Kolkata* Q2FY11 414 Owned
Shalimar Bagh* Q2FY11 350 Owned
Gurgaon Q4FY11 450 Owned
Kangra Q1FY12 100 Bldg. Lease
Ludhiana-1 Q2FY12 200 Bldg. Lease
Peenya Q3FY12 120 Bldg. Lease
Ahmedabad Q4FY12 200 Bldg. Lease
Ludhiana-2 Q4FY12 100 Bldg. Lease
Gwalior Q2FY13 150 Land lease
Source: IDFC Securities Research, Company, *commissioned in Q2FY11

This is quite a variation from the usual practice of owning assets – an essential
element of strategy with peers like Apollo.

Several facilities have Technology – contemporary, yet cost efficient: FHL uses some of the most advanced
partners to manage technologies to provide best-in-class healthcare facilities, which also helps attract
diagnostic and radiology
services reputed doctors and medical tourists. Importantly, FHL has adopted innovative
operating strucutres to ensure that it stays at updated on the technology front while
sustaining its asset-light model. For example, several of its network hospitals have
active tie-ups with Super Religare Laboratories (SRL) to manage diagonostic and
radiology services. FHL is also reportedly in talks with several international medical
equipment majors like GE and Siemens to implement ‘pay-per-use’ and ‘leasing’
models at its network hospitals. FHL is employing a combination of owned, leased
and outsourced models to provide modern technology while retaining its asset-light
model.

"…the MRI machine that is being used at our hospitals should be the most modern. We
may not need cutting-edge or innovative technology; we don't need to be trail blazers, but
we do need to be sufficiently modern and contemporary."
-- Mr. Daljit Singh, Fortis Healthcare

Has ‘fee for service’
arrangement with reputed
doctors to rationalize costs
while ensuring quality
Resources: ‘Availabilty of renowned doctors’ is among the key criteria FHL looks at
while assesing potential acquistions. FHL believes in bringing reputed doctors on
board while starting new operations, which often implies hefty remunerations. To
keep fixed costs low, FHL has adopted a ‘fee for service model’ for its key doctors,
wherein a certain portion (55-60%) of the compensation is fixed and the remaining is
variable and marked to performance. With innovative methods like these, FHL has
sucessfuly managed to keep fixed costs low while linking variable compensation to
topline growth.

By adopting the aforementioned asset-light strategies, FHL strives to minimize its

upfront capex spend – especially on projects – going forward. This strategy should
free up capital to support the group’s aggressive expansion plans.

NOVEMBER 2010 105


Driving operational
efficiencies and consistent
quality across the network
are key to success
Initiatives like NEXT and
JOSH ensure best practices
across hospitals and
improve clinical outcomes
NOVEMBER 2010
IDFC Securities
‰ Standardizing quality across the network
Rapid scale-up at FHL over the past few years makes it a challenge for the company
to efficiently manage this growth by putting in place the requisite systems and
processes. The challenges were compounded by the fact that more than 50% of FHL’s
current operational capacity has been acquired/ under O&M contracts with varying
standards/ processes. The healthcare industry in India has, in general, been weak on
institutionalizing processes, etc. In this backdrop, FHL’s ability to effectively
standardize processes and quality will be the key to its success.
In realization, standardization of processes and quality has been a priority at FHL.
The company has undertaken initiatives such as FOS (Fortis Opertating System),
Project NEXT and JOSH to standardize processes across the network and drive
operational efficiencies. With this focus, Fortis has not only steadily improved
operating metrics of its standalone greenfield/ acquired facilites but also managed to
seamlessly integrate the myriad facilites across the Fortis network.
“It's always a challenge if your aspirations are to grow very fast. We need to train people
to be able to cater to the requirements of patients and to the standards of the hospital. We
have a program called FIELDS (Fortis Institute of Enhanced Leadership Development),
which provides internal training. We cannot get people with common standards readymade,
so we are looking at creating this capability ourselves.”
– Mr.Daljit Singh, Fortis Healthcare
Project NEXT: Project NEXT, an initiative in collabration with HCL, is aimed at
standardizing processes to facilitate consisent delivery of high quality services. The
project also seeks to centralize shared services and provide analytical capabilities to
identify and replicate best practices among the network hospitals. FHL expects to
complete the project by Q2FY12.
Project JOSH: FHL has implemented project JOSH to simplify and standardize
nursing to improve patient outcomes, quality of patient care and enhance efficiency.
106
 IDFC Securities

FINANCIAL ANALYSIS
¾ We expect 41% CAGR in FHL’s consolidated revenues over FY10-13 with
50% of consolidated revenues from new beds by FY13
¾ Aggressive bed additions to lead to margin compression; we estimate
EBITDA margin to decline by 161bp to 17.7% by FY13
¾ PAT expected to grow 5x to Rs3.8bn by FY13, led by strong topline growth
and investment yields from accumulated cash accruals; interest income to
account for ~56% of consolidated PBT over FY11-13E
¾ We expect FHL’s RoE and RoCE to expand by 477bp and 540bp to 9.5% and
8.3% respectively on high margins and a rise in asset turnover ratio

‰ Expect 41% revenue CAGR over FY10-13

Matured and new beds to FHL’s consolidated revenues recorded 23% CAGR over FY07-10, which we expect to
contribute equally to
accelerate to 41% CAGR over FY10-13 with 37% CAGR in network revenues. The
consolidated revenue
by FY13E robust consolidated growth would be driven by incremental contribution from new
bed additions (FY11 onwards) and sustained topline growth at matured beds. We
estimate 18% revenue CAGR from matured beds over FY10-13 on the back of a
steady improvement in occupancy rates and 2-3% qoq increase in ARPOB. Overall,
we expect matured and new beds to contribute 50% (Rs13.7bn) each to consolidated
sales by FY13.

Exhibit 17: New beds to contribute 50% of consolidated revenues by FY13

(Rs m) FY08 FY09 FY10 FY11E FY12E FY13E

Fortis Mohali 1,330 1,574 1,719 2,131 2,556 3,079
Fortis Noida 832 956 1,184 1,583 1,955 2,190
Escorts Delhi 1,718 2,081 2,821 3,126 3,833 4,293
Escorts Faridabad 512 594 740 772 910 1,038
Esc Jaipur 169 382 637 799 969 1,248
Escorts Amritsar 259 412 501 628 717 807
Fortis Malar 181 324 644 775 878 1,026
Mulund Extension - - - 174 784 1,520
Fortis Kolkata - - - 133 783 1,423
Fortis Kangra - - - - 106 197
Fortis Ludhiana-1 - - - - 166 441
Fortis Peenya - - - - 39 194
Fortis Ahmedabad - - - - - 294
Fortis Ludhiana-2 - - - - - 321
Fortis Gwalior - - - - - 100
Fortis Shalimar Bagh - - 12 277 1,221 1,945
Fortis Gurgaon - - - - 495 992
Wockhardt acquired - - 1,085 4,109 5,355 6,436
Total revenues 5,480 6,589 9,872 14,813 21,158 27,963
Source: IDFC Securities Research

NOVEMBER 2010 107

 IDFC Securities

Exhibit 18: Consolidated revenues expected to register 41% CAGR over FY10-13
(Rs m)
30,000

22,500

15,000

7,500

0
2008 2009 2010 2011 2012 2013
Source: IDFC Securities Research

Expect new beds to clock We consider Wockhardt beds (acquired in Q4FY10) and new beds added by Fortis
164% revenue CAGR
from FY11 as total ‘new bed addtions’. We expect new beds to register 164% CAGR
over FY10-13
in revenues over FY10-13 on the back of a 70% increase in bed capacity (by 2,075 to
5,048) even as we factor in conservative occupancy rates and ARPOB on the
incremental capacity. We estimate 16% CAGR in FHL’s O&M revenues with 16%
contribution to consolidated revenues in FY13.

Exhibit 18: Strong revenue growth on back of contribution from new beds
Particulars (Rs m) FY10 FY11E FY12E FY13E
Network revenues 12,410 17,914 24,793 32,259
Consolidated revenues 9,343 14,646 20,926 27,731
From matured cluster 9,343 9,766 11,817 13,681
From new beds 0 4,740 8,948 13,862
Contribution from O&M contracts - 3.482 4,028 4,717
Source: IDFC Securities Research, Company

‰ Margins to slip in the interim

Aggressive bed additions to FHL’ s consolidated EBITDA margin has expanded by 760bp over FY07-10 to 19.3%
suppress EBITDA margins
with absolute EBITDA growing 3x to Rs1.9bn in FY10. However, we expect EBITDA
until FY13E
margin to decline by 161bp to 17.7% by FY13 due to the impact of aggressive bed
additions over the next three years. Despite lower margins, we expect 37% CAGR in
consolidated EBITDA over FY10-13 to Rs4.9bn led by strong topline growth.

NOVEMBER 2010 108

 IDFC Securities

Exhibit 19: FHL’s OPM to contract by 161bp over FY10-13E

(%)
Operating margins
20.0

17.5

15.0

12.5

10.0
FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Source: IDFC Securities Research, Company

FHL’s new hospitals to
achieve EBITDA breakeven
in 7-8 quarters, vs 2-3 years
for most tertiary care units
Conventional tertiary care facilities typically achieve EBITDA breakeven by the
second or third year of operations. However, we have assumed that FHL’s newer
hospitals would achieve EBITDA-neutral status by the seventh or eighth quarter of
launching operations because of the asset-light business model. We factor in new
tertiary/ quarternary hospitals to operate at negative 7.5-15% EBITDA margins in the
first two quarters of operations and improve steadily thereon. Our estimates factor in
FHL’s matured cluster to witness 50-100bp margin expansion every year driven by
improved operational parameters and higher pricing.

‰ Expect PAT to grow 5x over FY10-13E

Investment gains should
offset the impact of margin
contraction, helping strong
earnings growth
We expect FHL’s consolidated net profit to grow 5x to Rs3.8bn in FY13. We expect
37% CAGR in EBITDA owing to strong top-line growth, with the impact of
contracting margins getting offset by investment yeilds from accumulated cash
accruals. Over FY11-13, we estimate interest income to account for ~56% of FHL’s
consolidated PBT. Overall, we expect FHL’s consolidated net profit to clock 75%
CAGR over FY10-13 to Rs3.8bn.

Exhibit 20: Net profit to register 75% CAGR over FY10-13E

(Rs m)
4,000

3,000

2,000

1,000

(1,000)
FY07 FY08 FY09 FY10 FY11E FY12E FY13E

Source: IDFC Securities Research, Company

NOVEMBER 2010 109

 IDFC Securities

‰ Return ratios to expand by > 450bp; low compared to peers

Big-ticket acquisitions and
massive expansion plans to
damp return ratios
We expect FHL’s RoE and RoCE to expand by 478bp and 540bp to 9.5% and 8.3%
respectively, driven by sharp potential improvement in asset turnover ratio (FATR)
and net profit margin. FHL’s persistent focus on sweating assets has resulted in
FATR improving from 0.61x in FY08 to 0.76x in FY10. We expect FHL’s FATR ratio to
increase to ~1.6x by FY13. Also, robust revenue growth and strong other income
would lead to 660bp improvement in net profit margin over FY10-13 to 13.6%.
However, overall return ratios will continue to be lower than for peers like Apollo in
the near term due to the impact of FHL’s large ticket acquisitions as well as massive
planned expansion over the next few years.

Exhibit 21: FHL has among the lowest return ratios in comparison to Asian peers
(%)
RoE - Asian Peers (FY10)
25

20

15

10

0
Bangkok Bumrungrad Bangkok Ramsay Primary Healthscope Fortis Apollo Raffles Parkway Thomson Kpj
Dusit Med Hospital Chain Health Care Health Care Healthcare Hospitals Medical Holdings Medical Healthcare
Service Hospital Enterprise Centre Berhad
Source: Bloomberg, IDFC Securities Research

Exhibit 22: RoE to expand by 478bp over FY10-13E Du Pont analysis

(%) RoCE RoE
12.0 (Rs m) FY08 FY09 FY10 FY11E FY12E FY13E
PAT (601) 178 700 1,403 2,470 3,771
Sales 5,071 6,305 9,379 14,813 21,158 27,963
6.0
PAT/Sales (%) (11.8) 2.8 7.5 9.5 11.7 13.5
Sales 5,071 6,305 9,379 14,813 21,158 27,963
0.0 Assets 14,960 18,068 46,956 62,202 47,639 46,609
Sales/Assets (%) 33.9 34.9 20.0 23.8 44.4 60.0
-6.0 Assets 14,960 18,068 46,956 62,202 47,639 46,609
Equity 9,880 13,562 16,920 28,215 37,031 40,185
Assets/Equity (%) 151.4 133.2 277.5 220.5 128.6 116.0
-12.0
FY08 FY09 FY10 FY11E FY12E FY13E RoE (%) (7.2) 1.3 4.7 6.5 7.0 9.5
Source: IDFC Securities Research, Company

NOVEMBER 2010 110


Proceeds from the Parkway
exit and strong internal cash
will help reduce gearing
Ability to execute and
manage ambitious organic
capacity addition is the main
concern
Margin decline at Wockhardt
post acquisition is
a cause for concern
NOVEMBER 2010
IDFC Securities
‰ Improving balance sheet health
Strong internal accruals, proceeds from the Parkway exit, and an efficient working
capital cycle should strengthen FHL’s balance sheet. FHL has indicated that it would
utilize the Parkway proceeds to repay debt, which will reduce gearing from 2.9x in
FY10 to 0.28x in FY11E.
Assuming organic growth to be largely in line with ongoing plans and no major
inorganic growth initiatives in the near term, we believe the confluence of growing
scale and steady improvement in operating metrics should allow FHL to generate
cumulative free cash flows of ~Rs5.5bn over FY11-13 (after factoring in a capex of
Rs5.2bn over the same duration). Overall, we expect FHL’s consolidated gearing to
drop to 0.1x with net cash of Rs13bn by FY13.
Exhibit 23: FHL’s balance sheet to grow stronger with Rs13bn of net cash by FY13
Net debt (Rs m - LHS) Net gearing (x - RHS)
50,000 3.50
40,000 3.00
30,000 2.50
20,000 2.00
10,000 1.50
0 1.00
(10,000) 0.50
(20,000) 0.00
FY09 FY10 FY11E FY12E FY13E
Source: IDFC Securities Research
Key risks
‰ Limited track record of successfully running greenfield hospitals
While FHL has shown commendable improvement in operating parameters over the
last few quarters, we believe ability to sustain this performance over the next 6-8
quarters will be critical as ~2,000 greenfield beds become operational over the next
three years. This will arguably be one of the most aggressive bed rollouts in the
Indian hospital industry. Also, given that most of FHL’s recent growth has been
through the inorganic route, there has been limited evidence on FHL’s ability to
manage such elevated levels of organic growth. Therefore, FHL’s ability to
successfully implement its mega organic bed rollout over the next three years will be
a key monitorable and remains a key risk going forward.
‰ Inorganic growth – operational integration challenges
FHL’s growth trajectory has amply illustrated the management’s appetite for
inorganic growth. Fortis has sucessfuly integrated assets it acquired in the past, as
demonstrated by the seamless integration of Escorts Delhi and Fortis Malar. Having
said so, Fortis has not quite delivered in line with expectations related to Wockhardt
Hospitals – its largest acquisition till date. Prior to the acquisition, Wockhardt
111

Management remains
confident that litigations will
be resolved favorably
Getting MDs for
super-specialty hospitals
continues to be a challenge
NOVEMBER 2010
IDFC Securities
Hospitals enjoyed an EBITDA margin of 18%. However, post the management
change at Wockhardt, EBITDA margin dropped to 15% in Q1FY11 and 12% in
Q2FY11. This was in contrast to FHL mangement’s guidance of an expansion in
margins (18%+) from Q1FY11 even after factoring in planned capacity expansion at
its hospital in Mulund, Mumbai. The management attributes the drop to a change in
accounting policy which demanded higher provisioning for debt and allowances for
deductions. Though we believe a part of the margin decline could be due to
accounting changes, we will monitor FHL’s operational integration capabilities –
specifically for acquired assets. We expect Wockhardt’s operating margin to steadily
expand from 15% currently to 17.5% by FY13. Given the complex nature of heatlhcare
business, we see integration of assets, processes and resources as a key operational
risk.
‰ Uncertain outcome of pending litigations and contingent liabilites
FHL’s 89.9% subsidary, Escorts Heart Institute and Research Centre (EHIRCL), is
beset by several litigations, some of them even questioning the validity of the
acquisition. The litigations include: (i) EHIRCL’s right on leasehold on the land on
which EHIRCL’s Delhi hospital is currently located, (ii) provisioning of free
treatment to indigent patients at EHIRCL Delhi, and (iii) income tax exemptions
claimed by EHIRCL’s predecessors. Proceedings of several of these litigations are at
various stages and outcome is yet uncertain.
FHL’s auditors have expressed their inability to comment on; (i) an ongoing litigation
of EHIRCL with Delhi Development Authority (DDA) pertaining to a leasehold
arrangement with the latter, and (ii) the IT department’s claims of Rs1.2bn. An
adverse court judgement on EHIRCL, in our view, would significantly impact FHL’s
financials and also lead to potential loss of the entire fixed asset investment at
EHIRCL Delhi. FHL has indicated contingent liabilites of Rs982m pertaining to
income tax litigations with EHIRCL, but has not provisioned for the same. FHL’s
management remains confident of the litiagtion being resolved in its favour.
‰ Risk of spreading resources too thin; standardization issues
Over the past few years, FHL has expanded capacity at a rapid pace while managing
to ensure quality delivery standards. However, with aggressive expansion plans in
place, FHL could be spreading its resources too thin across newer facilities and which
may impact quality. Inititives like FIELD, FOS, Project NEXT and Project JOSH
provide comfort and even as we believe in the management’s ability to deliver on
scale and superior execution skills, we would continue to monitor the situation.
‰ Resource availability poses operational and financial risk
India produces 35,000 MBBS doctors on an average each year, but the number of
MDs (super-specialists) is far lower. FHL’s hospital network includes several multi-
speciality and super-speciality centers, which require highly skilled human resources
(MBBS and MD doctors). A strong brand equity has enabled FHL to attract good
doctors. However, getting MDs for super-speciality units would be a challenge.
Given the nature of FHL’s service offerings, we see that as a key operational and
financial risk (higher employee costs) for the company.
112

FHL doubled capacity and
trebled EBITDA in the last
three years by constantly
pushing conventional norms
Leading Indian players
including Fortis offer better
earnings growth than
their global peers
NOVEMBER 2010
IDFC Securities
VALUATIONS & VIEW
¾ Despite being one of the youngest hospital chains in the industry, Fortis
has carved out a niche for itself and entered the top-3 club in the industry
¾ With an aggressive management willing to explore uncharted areas in the
industry, we expect Fortis to create significant value for stakeholders
¾ Indian hospitals, particularly leaders like Apollo and Fortis, deserve to
trade at a premium to global peers in view of their future growth potential
¾ We value FHL at Rs206/share, implying 15x FY13 EV/EBITDA, in recognition
of its growth possibilities as well as leadership position in the domestic
healthcare space
‰ Fortis Healthcare – youngest and among the brightest…
Backed by well-funded promoters with the willingness and ability to unlock the
hitherto untapped potential in the Indian healthcare space through unconventional
models, Fortis is one of the companies to watch out for among private hospital care
providers in India. Propelled by its big-ticket acquisitions of Escorts Delhi, Fortis has
leapfrogged into the big league of Indian healthcare space within 10 years of
existence. Over the last three years, FHL’s bed under operations and revenues and
have grown ~2x (to 2,311beds) and 23% CAGR respectively while EBITDA has grown
3x over this period.
The management’s willingness to push the envelope on traditional strategic thinking,
as demonstrated in its decision to hire a CEO from a non-healthcare background and
intent to explore newer models of delivering healthcare as well as unlocking value
for shareholders, is commendable. However, the company’s limited execution track
record in setting up and scaling up Greenfield facilities remains a risk – especially
given its aggressive bed rollout plans over the next few three years.
‰ Indian players should command growth premium over global peers
Given the capital-intensive nature of the business and long gestation periods (steady
margins attained only by fourth or fifth year of operations), we prefer to value Indian
private hospital operators on EV/EBITDA rather than based on DCF and PE
multiples . Further, most of these players are in an aggressive growth phase – leading
to regular upscaling of medium-term growth plans, which have the potential to
dramatically alter the business profile in the later years.
Hospital operators in developed economies (USA, EU, etc) trade 8-9x one-year
forward EV/EBITDA, reflecting an average 8% EBITDA CAGR over the next two
years. In contrast, we expect EBITDA for leading Indian players like Apollo and
Fortis to register a significantly higher CAGR of 26% an 34% respectively over FY10-
12. As Indian players are in their early growth phase in a market offering tremendous
potential available as compared to the relatively limited growth opportunities for
players in developed markets, we believe Indian hospital players should trade at a
significant premium (14-15x one-year forward EBITDA) to global peers.
113
 IDFC Securities

Exhibit 24: Global peer valuation matrix

(US$ m) PE (x) EV/EBITDA (x) RoE (%) OPM (%)
Company CY09 CY10 CY11 CY09 CY10 CY11 CY09 CY10 CY11 CY09 CY10 CY11
US
Universal Health Services-B 15.8 16.5 13.5 7.0 7.1 5.6 15.8 13.3 13.9 13.9 13.2 14.1
Health Mgmt Associates Inc-A 15.5 13.5 12.0 7.2 6.7 6.2 36.1 34.5 27.8 14.9 14.3 14.2
Community Health Systems Inc 12.1 10.9 10.0 7.2 6.7 6.4 13.7 13.4 13.0 13.5 13.6 13.2
Lifepoint Hospitals Inc 13.0 11.6 10.7 6.3 6.4 6.0 7.7 8.3 8.2 16.6 15.5 15.3
Tenet Healthcare Corp 12.2 12.5 15.1 6.4 6.4 5.7 87.2 32.5 15.8 10.9 10.6 11.5
Thailand
Bangkok Dusit Med Service 32.1 22.9 19.3 13.4 9.9 8.8 13.0 14.3 15.4 22.4 24.1 24.8
Bumrungrad Hospital Pub Co 22.9 20.8 18.2 15.0 11.3 10.1 24.1 21.7 22.5 21.9 23.4 24.0
Bangkok Chain Hospital PCL 18.2 16.8 14.6 10.3 8.8 7.8 24.6 20.9 21.9 27.9 29.6 32.7
Australia
Ramsay Health Care 26.1 17.2 15.1 11.3 8.4 7.7 18.1 15.3 16.0 13.3 13.8 13.9
Primary Health Care 12.8 11.1 10.0 8.4 6.8 6.3 5.8 5.6 6.1 24.9 25.6 26.3
India
Fortis Healthcare * 94.3 38.1 26.0 56.4 24.7 16.3 4.7 6.6 7.0 19.3 16.1 16.2
Apollo Hospitals Enterprise * 45.7 33.7 30.4 23.0 17.0 15.3 8.7 10.7 11.0 14.8 16.5 16.5
Singapore
Raffles Medical Group 37.0 28.6 24.5 25.7 20.0 16.9 16.1 16.4 17.3 23.9 24.1 25.2
Thomson Medical Centre 45.9 33.2 29.6 33.4 22.3 20.4 11.6 13.1 12.7 24.9 27.5 26.9
Malaysia
Kpj Healthcare Berhad 20.5 15.6 14.1 14.5 11.0 10.3 18.3 17.3 17.5 12.4 12.7 12.0
Source: Bloomberg, IDFC Securities Research; Note: * for years FY10, FY11, FY12

‰ Initiating coverage with a 18-month price target of Rs206/share

Fortis will continue to
dominate Indian healthcare
scene for the long term
We value the stock at 15
FY13E EV/ EBITDA, which
implies 28% potential
returns from current levels
Leading private healthcare service providers like Fortis and Apollo, we believe,
deserve to command significant valuation premium to peers as well as the broader
Indian market as they are the only relevant proxies to the rapidly growing and highly
attractive domestic healthcare industry (US$125bn by 2015E). Further, we strongly
believe that with 5,000+ beds operational by 2013E, Fortis will continue to be among
the top 2-3 players in the domestic market for years (and even potentially decades) as
entry barriers keep rising. The economic benefits of this enviable leadership position
will be visible in the years to come.
We initiate coverage on FHL with Outperformer and an 18-month price target of
Rs206/share (valuing it at 15x FY13 EV/EBITDA; in line with our target multiple for
leading Indian healthcare providers). Our target price implies an upside of 28% from
current levels. Ability to accelerate margin improvement in existing hospitals as well as a
faster than anticipated pick-up in newer hospitals are key upside triggers on the target price.

Exhibit 25: Valuing FHL at Rs206/share

Particulars (Rs m) on FY13
Assumed EV/EBITDA 15
EBITDA 4,949
Enterprise value 74,229
Debt 7,733
Cash 22,500
Market Cap 88,996
Fair value 206
% upside 28
Source: IDFC Securities Research

NOVEMBER 2010 114


ANNEXURE
Fortis – organizational structure
31.26%
Sunrise Medicare Private
Ltd
Associate hospital and
O&M contract: Fortis La
Femme
100%
Fortis Healthcare Fortis Hospital
International Ltd Management Ltd
(FHIL)
28.89%
Medical and Surgical
Centre Ltd (MSCL)
Associated hospital
and O&M contract:
Fortis Clinique Darne
Source: Company
NOVEMBER 2010
IDFC Securities
Fortis Healthcare Ltd (FHL)
Owned hospitals: Fortis Hospital – Mohali
O&M contracts: Jessa Ram Hospital, Fortis Modi
Hospital
Other facilities: 2 satellite and heart command
centers
39.99% 89.99% 100% 100%
Fortis Hospotel Ltd
Hiranandani Healthcare Escorts Heart Institute & Research International Hospital Ltd
(formerly, Oscar Bio-Tech
Private Ltd (HHPL) Center Ltd (EHIRCL) (IHL)
Private Ltd) (EHTL)
Associate Hospital: Owned hospital: Escorts Hospital – Delhi O&M contract: Fortis Flt. Owned hospital: Fortis
Hiranandani Hospital - Collaboration with Government of Lt. Rajan Dhall Hospital Hospital - Noida
Vashi Chattisgarh: Fortis Escorts Hospital – Projects under
Raipur development: Fortis
Other facilities: 3 satellite and heart Shalimar Bagh Gurgaon
command centers hospital
100%
100% 100%
Escorts Heart nad Super
Escorts Heart Center Ltd Fortis Health
Speciality Institute Ltd
(EHCL) Management Ltd (EHML)
(EHSSIL)
Owned hospital: Fortis Other facilities: 7
Escorts Hospital - Amritsar satellite and heart
command centers
47% 100% 100% 50.02% 67.23%
Escorts Heart and
Escorts Hospital and
Super Speciality Malar Hospitals Ltd Lalitha Healthcare
Research Center Ltd
Hospital Ltd (MHL) Private Ltd (LHPL)
(FHoML) (EHRCL)
(EHSSHL)
Owned hospital: Owned hospital: Associate hospital: Owned hospital and
Fortis Escorts Fortis Escorts Fortis Malar Hospital O&M contract: Fortis
Hospital - Jaipur Hospital - Faridabad Hospital
Seshadripuram
115
 IDFC Securities

Income statement Key ratios

Year to Dec 31 (Rs m) FY09 FY10 FY11E FY12E FY13E Year to Dec 31 (Rs m) FY09 FY10 FY11E FY12E FY13E
Net sales 6,589 9,872 14,914 21,156 27,961 EBITDA margin (%) 17.3 19.3 16.1 16.2 17.7
% growth 20.3 49.8 51.1 41.9 32.2 EBIT margin (%) 9.7 13.1 10.7 11.4 13.6
Operating expenses 5,447 7,966 12,509 17,730 23,013 PAT margin (%) 2.2 7.0 11.5 11.9 13.6
EBITDA 1,142 1,906 2,405 3,426 4,949 RoE (%) 1.3 4.7 6.6 7.0 9.5
RoCE (%) 4.1 2.9 2.7 5.4 8.3
% growth 85.1 66.8 26.2 42.5 44.4
Other income - - 1,120 1,260 1,190
Gearing (x) 0.4 2.9 0.3 0.2 0.1
Net interest (437) (573) (752) (619) (334)
Depreciation 505 616 811 1,006 1,136 Valuations
Pre-tax profit 213 749 2,006 3,132 4,743
Deferred Tax 35 (120) - - - Year to Dec 31 (Rs m) FY09 FY10 FY11E FY12E FY13E
Reported EPS (Rs) 0.5 1.7 4.7 6.2 9.4
Current Tax 6 153 266 582 887
Adj. EPS (Rs) 0.4 1.7 4.2 6.2 9.4
Profit after tax 172 716 1,740 2,551 3,856
PER (x) 451.8 94.3 38.1 26.0 17.3
Minorities 216 345 364 395 442
Price/Book (x) 6.0 3.5 1.9 1.7 1.6
Non-recurring items 63 (0) 180 - - EV/Net sales (x) 10.6 10.9 4.0 2.6 1.9
Net profit after EV/EBITDA (x) 61.3 56.4 24.7 16.3 10.7
non-recurring items 208 695 1,901 2,520 3,809 EV/CE (x) 4.5 1.5 1.4 1.2 1.2
% growth (137.5) 233.5 173.6 32.6 51.1

Shareholding pattern
Balance sheet Public &
Foreign
others
Year to Dec 31 (Rs m) FY09 FY10 FY11E FY12E FY13E 7.8%
5.9% Institutions
2.7% Non-promoter
Paid-up capital 2,387 3,217 4,050 4,050 4,050
corporate holding
Reserves & surplus 10,799 17,438 31,881 34,401 38,210
2.1%
Total shareholders' equity 10,917 18,550 33,846 38,181 42,037
Total current liabilities 2,462 3,693 5,873 8,331 11,010
Total Debt 4,790 54,706 9,400 7,733 3,931
Deferred tax liabilities 12 3 3 3 3
Total liabilities 7,265 58,402 15,276 16,067 14,945
Total equity & liabilities 18,181 76,952 49,122 54,248 56,982
Net fixed assets 10,045 16,649 17,582 18,076 18,940
Investments 541 34,485 500 500 500
Total current assets 3,635 17,069 22,290 26,923 28,793 Promoters
Deferred tax assets - 124 124 124 124 81.5%
Other non-current assets 3,961 8,626 8,626 8,626 8,626 As of September 2010
Working capital 1,173 13,376 16,417 18,592 17,783
Total assets 18,181 76,953 49,122 54,248 56,982

Cash flow statement

Year to Dec 31 (Rs m) FY09 FY10 FY11E FY12E FY13E
Pre-tax profit 213 749 2,006 3,132 4,743
Depreciation 505 616 811 1,006 1,136
Chg in Working capital 684 331 (155) (175) (190)
Total tax paid (6) (153) (266) (582) (887)
Ext ord. Items & others 63 (0) 180 - -
Operating cash Inflow 1,459 1,543 2,576 3,382 4,802
Capital expenditure (1,050) (11,886) (1,744) (1,500) (2,000)
Free cash flow (a+b) 410 (10,344) 832 1,882 2,802
Chg in investments (222) (34,632) 33,984 71 (0)
Debt raised/(repaid) 1,035 49,916 (45,306) (1,667) (3,802)
Capital raised/(repaid) (778) 7,485 13,376 - -
Dividend (incl. tax) - - - - -
Misc (26) 108 - 1,714 -
Net chg in cash 419 12,534 2,887 2,000 (1,000)

NOVEMBER 2010 116

 IDFC Securities

CARE Hospitals NOT LISTED

Care Hospitals is a multi-specialty hospital chain started by cardiologists Dr. B Soma Raju and Dr. N Krishna Reddy
in 1997. Quality Care India Ltd (QCIL) is the holding company of Hyderabad-based CARE group. Financial investors
like Matrix Group, Ashmore Investments and Rakesh Jhunjhunwala together own 55% stake in CARE. The balance
45% lies with doctors (20%) and other smaller corporates (25%).

Motivation: CARE philosophy is to provide quality healthcare services at affordable prices. CARE treats several patients
under state insurance scheme at subsidized rates (upto 35%).

“If there is one thing that we have demonstrated over the last decade at CARE, it is that a ‘good conscience’ can actually translate
into ‘good businesses.”
– Dr. B. Somaraju

Model: CARE has restricted capital cost per bed to Rs2.5m to keep costs low and provide affordable care. CARE’s
hospitals are largely built on leased land and buildings to reduce upfront capital costs. CARE has 11 hospitals but it owns
land and building of only one hospital in Nampally, Hyderabad.

Expansion plans: CARE has more than 1500 beds across 11 hospitals and plans to double bed count over next few years.

CARE hospitals enjoys a pan-India presence

CARE no. of beds
Banjara, Hyderabad 430
Nampally, Hyderabad 200
Musheerabad, Hyderabad 100
Secundarabad, Hyderabad 33
Vizag 140
Vijaywada 100
Nagpur 105
Raipur
Bhubaneswar 100
Surat 110
Pune 110
Total 1,428

Financials: According to media reports, QCIL’s revenues grew at a CAGR of 35% over FY06-09. The group reported a net
profit and operational income of Rs98.4m and Rs 3.3bn respectively in FY09. CARE’s mature hospitals have operating
margins of more than 20%.

NOVEMBER 2010 119

 IDFC Securities

Manipal Hospitals NOT LISTED

Manipal Hospitals is a leading healthcare service provider in South India. It also has presence in other parts of India
and Nepal and Malaysia. Manipal Hospitals operates across the healthcare value chain and offers primary, secondary
and tertiary healthcare services. It has more than 8000 beds spread across 23 hospitals and several primary clinics.

Model: Manipal has a hub & spoke model comprising a mix of owned hospitals as also JV and managed units. The
exhibit below lists its key operational facilities.

Manipal hospitals
Particulars No. of beds
KMC Hospital, Attavar, Mangalore 580
Kasturba Hospital, Manipal 1,230
Shirdi Sai Baba Cancer Hospital, Manipal 250
KMC Hospital, Ambedkar Circle, Mangalore 165
Manipal Northside Hospital, Bangalore 120
Manipal Hospial, Bangalore 600
TMA Pai Hospital, Udipi 180
Manipal Hospital, Goa 40
Govt. Hospital, Ajjarkad, Udipi 240
Women and Child Hospital, Udipi 70
Manipal Hospital, Tumkur 25
TMA Rotary Hospital, Karkala 100
Central Referral Hospital, Sikkim 500
STNM Hospial, Sikkim 375
Uma Hospital, Kasargod 40
Manipal Teaching Hospital, Nepal 700
Western Regional Hospital, Nepal 350
Green Pastures Leprosy Hospital 75
Govt. Wenlock Hospital, Mangalore 515
Muar General Hospital 800
Tangkok Hospital 80
Melaka General Hospital, Malaysia 800
Govt. Lady Goschem Hospital 170
Total 8,005
Source: Company

NOVEMBER 2010 120

 IDFC Securities

MAX Healthcare NOT LISTED

Max Healthcare, promoted by Max India, is among the leading hospital chains in North India with over 1100 beds,
including 324 ICU beds, in eight hospitals. Max Healthcare is a 75.6% subsidiary of listed entity Max India. Warburg
Pincus and IFC Washington hold 16.4% and 3.1% respectively in Max Healthcare. Max has centers of excellence in a
wide rage of specialties, including cardiac, minimal access, metabolic and bariatric care, orthopedics and joint
replacement, neurosciences, pediatrics, obstetrics & gynecology, oncology and aesthetic & reconstructive surgery. It
plans to add other specialties like organ transplant, cord blood banking and stem cell research.

Model: Max predominantly operates in North India. It has a conventional hub & spoke model, with tertiary healthcare
facilities supported by secondary care hospitals and primary care clinics.

MAX operating model

• Max Heart and Vascular Institute
• Max Super Specialty Hospital
• Max Hospitals – 4
• Specialty Centers - 2
• Heart and Vascular
• Neuosciences
• Joint Replacement and Orthopaedics
• Aesthetics and Reconstructive surgery
TERTIARY
• Oncology
• Surgery and inpatient facilities
• Mother and Child
SECONDARY • Doctor consultation
• Eye and Dental Care

• Specialist doctor constult

PRIMARY • Basic diagnostics like
• Clinics /
pathology collection
Implants - 9

Source: MAX

Expansion plans: MAX has lined up aggressive expansion plans to fortify its presence in North India. It plans to increase
its bed count from 1100 to more than 2450 by FY16. The land required for the expansion plans is already in place,
according to the management.

Max hospitals expansion plans

(nos) 2,450
2,500 2,150

Max Hospitals No. of beds Date of commencement 2,000

Dehradun 150 Jun-11
Shalimar Bagh 300 Sep-11 1,500
1,100
Mohali 300 Sep-11
770
Bhatinda 300 Sep-11 1,000
Greater Noida 300 FY16
500

0
FY09 FY10 FY12E FY16E

Source: MAX, IDFC Securities Research

Financials: Max Healthcare’s revenues have grown at a CAGR of 42% in the past three years to Rs5.6bn in FY10, mainly
driven by an increase in operational beds and improvement in ARPOB. Max steadily increased its operational bed count
from 346 in FY06 751 in FY10. Improved case mix and higher volumes translated into a CAGR of 8% in ARPOB over

NOVEMBER 2010 121

 IDFC Securities

FY06-10 to Rs20,431 now. Contribution margins have steadily improved over years on back of operational efficiencies
and benefits of scale, expanding by 660bps over the past four years to 57.2% in FY10.

Revenues have grown at a CAGR of 42% over the past four years

Revenue (Rs m - LHS) contribution margin (% - RHS)

6,000 58

4,500 56

3,000 54

1,500 52

0 50
FY06 FY07 FY08 FY09 FY10

Source: Company, IDFC Securities Research

NOVEMBER 2010 122

 IDFC Securities

Analyst Sector/Industry/Coverage E-mail Tel. +91-22-6622 2600

Pathik Gandotra Head of Research; Financials, Strategy pathik.gandotra@idfc.com 91-22-662 22525
Shirish Rane Construction, Power, Cement shirish.rane@idfc.com 91-22-662 22575
Nikhil Vora FMCG, Media, Mid Caps, Education, Exchanges nikhil.vora@idfc.com 91-22-662 22567
Nitin Agarwal Pharmaceuticals nitin.agarwal@idfc.com 91-22-662 22568
Chirag Shah Metals & Mining,Telecom, Pipes, Textiles chirag.shah@idfc.com 91-22-662 22564
Bhoomika Nair Logistics, Engineering bhoomika.nair@idfc.com 91-22-662 22561
Hitesh Shah, CFA IT Services hitesh.shah@idfc.com 91-22-662 22565
Bhushan Gajaria Automobiles, Auto ancillaries, Retailing bhushan.gajaria@idfc.com 91-22-662 22562
Salil Desai Construction, Power, Cement salil.desai@idfc.com 91-22-662 22573
Ashish Shah Construction, Power, Cement ashish.shah@idfc.com 91-22-662 22560
Probal Sen Oil & Gas probal.sen@idfc.com 91-22-662 22569
Chinmaya Garg Financials chinmaya.garg@idfc.com 91-22-662 22563
Abhishek Gupta Telecom, Metals & Mining abhishek.gupta@idfc.com 91-22-662 22661
Ritesh Shah Pharmaceuticals ritesh.shah@idfc.com 91-22-662 22571
Saumil Mehta Metals, Pipes saumil.mehta@idfc.com 91-22-662 22578
Vineet Chandak Real Estate vineet.chandak@idfc.com 91-22-662 22579
Kavita Kejriwal Strategy, Financials kavita.kejriwal@idfc.com 91-22-662 22558
Anamika Sharma IT Services anamika.sharma@idfc.com 91-22-662 22680
Varun Kejriwal FMCG, Mid Caps varun.kejriwal@idfc.com 91-22-662 22685
Swati Nangalia Media, Education, Exchanges, Midcaps swati.nangalia@idfc.com 91-22-662 22576
Sameer Bhise Strategy, Financials sameer.bhise@idfc.com 91-22-662 22574
Nikhil Salvi Construction, Power, Cement nikhil.salvi@idfc.com 91-22-662 22566
Dharmendra Sahu Database Analyst dharmendra.sahu@idfc.com 91-22-662 22580
Rupesh Sonawale Database Analyst rupesh.sonawale@idfc.com 91-22-662 22572
Dharmesh R Bhatt, CMT Technical Analyst dharmesh.bhatt@idfc.com 91-22-662 22534
Equity Sales/Dealing Designation E-mail Tel. +91-22-6622 2500
Naishadh Paleja MD, CEO naishadh.paleja@idfc.com 91-22-6622 2522
Paresh Shah MD, Dealing paresh.shah@idfc.com 91-22-6622 2508
Vishal Purohit MD, Sales vishal.purohit@idfc.com 91-22-6622 2533
Nikhil Gholani MD, Sales nikhil.gholani@idfc.com 91-22-6622 2529
Sanjay Panicker Director, Sales sanjay.panicker@idfc.com 91-22-6622 2530
Rajesh Makharia Director, Sales rajesh.makharia@idfc.com 91-22-6622 2528
Nirbhay Singh SVP, Sales nirbhay.singh@idfc.com 91-22-6622 2595
Suchit Sehgal AVP, Sales suchit.sehgal@idfc.com 91-22-6622 2532
Pawan Sharma MD, Derivatives pawan.sharma@idfc.com 91-22-6622 2539
Jignesh Shah AVP, Derivatives jignesh.shah@idfc.com 91-22-6622 2536
Suniil Pandit Director, Sales trading suniil.pandit@idfc.com 91-22-6622 2524
Mukesh Chaturvedi SVP, Sales trading mukesh.chaturvedi@idfc.com 91-22-6622 2512
Viren Sompura SVP, Sales trading viren.sompura@idfc.com 91-22-6622 2527
Rajashekhar Hiremath VP, Sales trading rajashekhar.hiremath@idfc.com 91-22-6622 2516

Disclaimer
This document has been prepared by IDFC Securities Ltd (IDFC SEC). IDFC SEC and its subsidiaries and associated companies are a full-service, integrated investment banking,
investment management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities.
This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction.
The information contained herein is from publicly available data or other sources believed to be reliable. While we would endeavor to update the information herein on reasonable basis,
IDFC SEC, its subsidiaries and associated companies, their directors and employees (“IDFC SEC and affiliates”) are under no obligation to update or keep the information current. Also,
there may be regulatory, compliance, or other reasons that may prevent IDFC SEC and affiliates from doing so. We do not represent that information contained herein is accurate or
complete and it should not be relied upon as such. This document is prepared for assistance only and is not intended to be and must not alone be taken as the basis for an investment
decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigations as it deems necessary to arrive at an
independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved). The investment discussed or views expressed
may not be suitable for all investors.
Affiliates of IDFC SEC may have issued other reports that are inconsistent with and reach different conclusions from, the information presented in this report.
This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where
such distribution, publication, availability or use would be contrary to law, regulation or which would subject IDFC SEC and affiliates to any registration or licensing requirement within
such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to a certain category of investors. Persons in whose possession this document may
come are required to inform themselves of, and to observe, such applicable restrictions.
Reports based on technical analysis centers on studying charts of a stock's price movement and trading volume, as opposed to focusing on a company's fundamentals and, as such, may not
match with a report on a company's fundamentals.
IDFC SEC and affiliates may have used the information set forth herein before publication and may have positions in, may from time to time purchase or sell, or may be materially
interested in any of the securities mentioned or related securities. IDFC SEC and affiliates may from time to time solicit from, or perform investment banking, or other services for, any
company mentioned herein. Without limiting any of the foregoing, in no event shall IDFC SEC, any of its affiliates or any third party involved in, or related to, computing or compiling
the information have any liability for any damages of any kind. Any comments or statements made herein are those of the analyst and do not necessarily reflect those of IDFC SEC and
affiliates.
This document is subject to changes without prior notice and is intended only for the person or entity to which it is addressed and may contain confidential and/or privileged material and
is not for any type of circulation. Any review, retransmission, or any other use is prohibited.
Though disseminated to all the customers simultaneously, not all customers may receive this report at the same time. IDFC SEC will not treat recipients as customers by virtue of their
receiving this report.
Explanation of Ratings:
1. Outperformer: More than 5% to Index
2. Neutral: Within 0-5% to Index (upside or downside)
3. Underperformer: Less than 5% to Index
Disclosure of interest:
1. IDFC SEC and affiliates may have received compensation from the company covered herein in the past twelve months for issue management, capital structure, mergers & acquisitions,
buyback of shares and other corporate advisory services.
2. Affiliates of IDFC SEC may have received a mandate from the subject company.
3. IDFC SEC and affiliates may hold paid up capital of the subject company.
4. IDFC SEC and affiliates, their directors and employees may from time to time have positions or options in the company and buy or sell the securities of the company(ies) mentioned
herein.
Copyright in this2010
NOVEMBER document vests exclusively with IDFC Securities Ltd
123