A happy arrival – Virtus Health IPO

Financial journalist
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In-vitro fertilisation (IVF) is a life-changing miracle of medical technology for some people; for others, it is an ethical dilemma; for others still it is a career.

Now it is an investment too.

IVF business – make that “assisted reproductive services provider” – Virtus Health Limited is joining the Australian Securities Exchange (ASX) through a $339 million float. It is the first IVF company in the world to float on the stock market.

And it will go off like hot cakes.

The reason why is – as with iSelect, which we looked at last week – unsatisfied demand.

A virtuous shortage

Everyone wanted Virtus shares in the primary market (the issue of shares). The issue was over-subscribed by seven times. Two fund managers’ combined bids for shares would have bought the whole lot: but the vendors – Quadrant Private Equity owns 43%, while IVF doctors own about 51% – wanted a wider spread of shareholdings than that, which meant that those who did get shares receive far less than they wanted. That means strong demand in the secondary market (when the shares list).

The joint lead-managers of the float are big hitters – Morgan Stanley and UBS. Broker ‘firm’ offers close next Friday (June 7) and the shares will hit the ITS screens on Tuesday, 11 June.

Several things have excited the market about the Virtus listing.

Firstly, it is a strong business.

Virtus Health is the largest provider of assisted reproductive services in Australia, with a market share of about 35% of the 39,000-plus IVF cycles performed in Australia last year, from which about 4,000 babies a year are born. It operates 34 fertility clinics, six day hospitals and 39 laboratories across New South Wales, Victoria and Queensland. Assisted reproductive services accounted for 77% of Virtus’ revenue in FY12; specialised diagnostics and day-procedures conducted in its hospitals made up the rest.

This means that Virtus slots in with the likes of Cochlear, Primary and Healthscope as a defensive healthcare stock, both recession-resistant and with growth prospects. And it has government subsidies involved: an IVF cycle is typically funded between 42%–59% by the Commonwealth, between 10%–13% by insurers, and from 27%–49% by the patient.

Virtus has demographics in its favour: the female population is growing, and more Australian women are having babies later in life. The social acceptance and awareness of IVF services have increased, as has the accessibility of those services.

A unique proposition

The company has a wide economic ‘moat’: IVF treatment is a highly specialised business, so while Virtus certainly does not have the field to itself, it is a difficult business for new entrants to gain a significant foothold in.

It has sound growth prospects, in three areas. The first is in bolt-on acquisitions; the second is in its low-cost TFC clinics, established in 2012, which targets a new segment of the market for which fertility treatments were previously unaffordable; and the third is in international expansion. Virtus says the IVF markets in Asia-Pacific, China, India and the Middle East are very immature and fragmented, and offer attractive opportunities.

Virtus has an impressive record of growth in revenue and EBITDA (earnings before interest, tax, depreciation and amortisation). On pro forma numbers, consolidated revenue is forecast to grow at a compound annual rate of 9.6% between FY12 and FY14, to $206 million, with EBITDA growing at a compound annual rate of 10.5% over the same period, to $63 million. Cash flow generation has been strong, running at 89% of EBITDA to free cash flow in FY12.

No dividend will be paid for FY13, but the prospectus says the company intends to start paying dividends at the December 2013 half-year. The implied dividend yield for FY14 at the $5.68 issue price is 4.6%, based on the current intended dividend payout ratio of 65% of what the company calls its statutory NPATA (net profit after tax and after adding back the tax-affected amortisation expense) in FY14.

Beyond FY14, Virtus says it intends to target a payout ratio of between 50%– 70% of statutory NPATA. It expects that “all future dividends will be franked to the maximum extent possible.”

Delicate pricing job seen as fair

And importantly for a private equity sell-down, the market thought the final price for the shares – although it was at the top end of the indicated range – was fair. Quadrant Private Equity, which bought into Virtus in 2008 for $33 million, sold out entirely, after originally flagging that it might stay in with 10%. Doctors and staff will own about 23% of the company.

The market has good reason to be wary of private equity IPOs. Everyone knows that private equity firms are hard-nosed and they use IPOs to exit investments. If they are perceived to be too greedy – as they were in floats such as Myer, Emeco Holdings and Boart Longyear – it leaves a bad taste in the mouth of the investors who take the stock off their hands. Quadrant has done well out of Virtus – it will make more than three times its money from the share sale – but the $5.68 share price, equating to 14.4 times FY14 forecast earnings and a 4.6% dividend yield was largely seen by the market as fair to the vendors and buyers. Earlier in the year, the vendors reportedly hoped to get up to $6.82 a share for Virtus.

The maintenance of government subsidies is a risk for the business. A 2012 report by the Australian Institute of Health and Welfare showed that the number of women using IVF fell 13% in the year after the caps on IVF use were introduced in 2011, doubling the cost of an IVF cycle from about $1,500 to $3,000. That was the first fall in the number of IVF treatments in Australia in almost 30 years.

A happy arrival

But what Virtus really has going for it, is that its product is not really subject to discretionary spending – demand for it is driven by one of the most basic, but strongest, human needs. In effect, Virtus sells hope.

Usually the stock market is wary of unique investments, because there are not ready comparisons able to be made, but we think Virtus is different.

With pent-up market demand for IPOs that are not related to mining, heavy unsatisfied demand for this particular issue, and a strong niche position in a booming health sector, Virtus looks a good bet for both a successful float, and a new life on the stock market.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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