After last week’s brief introduction on SHL Telemedicine (SHL), the following analysis will give some more detail on the reasons why I believe that SHL provides an attractive investment opportunity at the current market price.
SHL offers remote diagnosis and monitoring services for heart and lung patients suffering from chronic heart failure (CHF) and chronic obstructive pulmonary disease (COPD):
CHF manifests itself in reduced ability of the heart to function as an efficient pump receiving blood and sending it to all parts of the body, while COPD means reduced functioning of the lungs as an organ absorbing oxygen and expelling carbon dioxide, as a result of heavy smoking or high exposure to smoke and environmental pollution. CHF and COPD are leading factors in impairment of quality of life, and as causes of death, and so treating them creates large costs for health funds. For instance, in Germany there are almost 3 m COPD patients which is equal to 3.7% of the total population.
SHL’s monitoring solutions, enabling the patients at home to be weighed, to have their blood pressure and blood oxygen measured or to carry out a partial ECG on themselves, leads to financial saving for the health funds and better quality of life / longer life expectancy for patients.
SHL offers solutions to (i) subscribing self paying patients in Israel, the US and Japan, (ii) health insurance companies in Germany and (iii) hospitals in the US and India.
SHL in Israel
SHL’s medical facility in Israel operates telecardiological and face-to-face professional medical assistance to its 70,000 subscribers (most of them self pay). SHL operates 24 hours per day, 365 days per year through a monitoring centre managed by specially trained care nurses who are authorized to dispatch to subscribers mobile intensive care units (ambulances) also operated by SHL and staffed by physicians and paramedics.
Subscribers are predominantly CHF patients. All the subscribers carry a device by which they can transmit an electrocardiogram to the monitoring centre on a regular basis. The newly transmitted electrocardiographic data will be interpreted by a nurse or a physician. If the examination shows any abnormalities, the nurse / physician may either dispatch an SHL ambulance or instruct the patient according to the established medical or behavioural protocol.
From an operating perspective the business is generating between USD 20 m to USD 25 m of stable revenue per annum and roughly 20% operating segment margins. According to SHL, the comapny is the market leader in Israel for telehealth services. The business was founded in 1987.
SHL in Germany
In Germany the company is contracted not by the patients themselves but by both public health funds (AOK Bayern, AOK Nordost, IKK Südwest and Barmer) and private health insurance companies (DKV). The services provided to patients are similar to Israel with the exception of not operating their own fleet of ambulances.
SHL entered the German market in 2005 and grew revenues to more than USD 20 m until 2010 when it lost an important customer, a health fund that merged with another one, resulting in the cancellation of its contract with SHL. The merger is the outcome of reforms with the aim of reducing the number of funds in Germany leading to more efficiency and therefore savings. In this way, the number of funds fell from 267 in 2005 to 124 in 2015. According to the company, the contract would renew annually and when a merger takes place, a contract with a company like SHL would automatically be cancelled.
It took the company until 2012, when SHL won two tenders by German health funds. The first win was with IKK Sudwest, which has about 700,000 insured persons. The second was a five year contract with AOK Bayern, one of Germany’s two largest health funds, with four million insured persons. Since then SHL has provided its services to COPD patients insured with AOK, while in the case of IKK Südwest the service has been mainly for CHF patients.
In 2013, SHL acquired almeda from ERGO Versicherungsgruppe AG which is a subsidiary of Munich RE for EUR 1. Under the agreement, DKV, the largest customer of the almeda telehealth business and one of the largest German private health insurers and a subsidiary of ERGO, committed to retain the provision of almeda’s telehealth services for a 7 year period. At that time management expected almeda to contribute annual revenues of USD 7 m to USD 10 m to SHL’s German business. At the beginning of 2015, almeda won an 8 year contract valued at EUR 16 m to EUR 20 m with health fund Barmer.
In April 2015, SHL announced the completion of the takeover of GPH (Gesellschaft für Patientenhilfe) for a cash purchase price of EUR 7.6 m. GPH’s nationwide German telemedicine programme Cordiva cares for about 10,000 CHFP patients in daily regular care. Interestingly, GPH in addition to AOK Nordwest has also AOK Bayern amongst its major clients. In 2014, GPH generated USD 9.2 m in revenues and USD 0.8 m in profit.
Due to the GPH acquisition, segment revenues in Germany should have increased in 2015 to more than USD 20 m with operating margins being close to 20%.
For SHL to be able to renew its existing contracts and to win market share, health funds need to be able to save money by contracting SHL as a service provider. According to management, the economics of the German contracts look as follows: SHL’s service is measured according to the economic saving it generates for the health fund. For instance, the cost of hospitalizing one COPD patient in Germany is around EUR 10,000 per annum, and SHL can save 30% to 50% of this for the insurer. Since SHL is entitled to half this saving, the company can receive EUR 1,500 to EUR 2,500 per patient a year. In addition, patients need to accept the services. I believe that many but not all patients prefer being monitored at home than seeing a doctor regularly. More importantly patients seem to feel safer and more confident when using telehealth services.
To earn acceptable returns in the future, SHL needs to be able to renew and add contracts at attractive terms. The company claims to be in a leading market position in Germany. Currently, the market for telehealth in Germany is nascent, although a series of trials are underway to improve patient care and reduce costs through telemedicine. One of the likely consequences of telehealth being rolled out on a larger scale is that both private and public health insurance will probably opt to cooperate with managed services like SHL as this allows them to keep their administrative costs to a minimum. This would provide more opportunities to grow the business. At the same time, the market seems to be fragmented with a number of small service providers to the telehealth market already existing, providing services such as operation of telehealth call centres (e.g., SHL, Vitaphone, Sanvartis, AnyCare), production of medical devices (e.g., SHL, Getemed, Bosch Healthcare), and data transfer (e.g., Biotronik, Aipermon) to hospitals and health insurers. So from my perspective leaving aside the entrance of a large player, SHL might be well positioned to grow its business in Germany and to keep the current margins.
In 2007, SHL sold its US affiliate Raytel for USD 110 m to Phillips. After the disposition, SHL still received payments until 2011 due under the agreement with Philips totalling USD 24 m. SHL had acquired Raytel in 2002 for a purchase price of USD 31 m.
In 2013, management decided to re-enter not only the US market but to target India and other Asian markets. The expansion plan is mostly based on the company’s smartheart™ technology which is also explained here. As such, the smartheart™ is being used by roughly 100 clinics and hospitals in the U.S. and India. In tandem, SHL has been working on establishing sales channels, both directly to consumers and to medical professionals, through customary distribution channels and partners. So far, two distribution agreements were signed with USCI and FUJIFILM Sonosite in Japan. USCI’s focus will be on the physicians and the professional market. FUJIFILM SonoSite will distribute the smartheart™ to its professional healthcare customers in the US, Japan and Germany, using its point-of-care ultrasound solutions.
However, up to now revenues in this segment are negligible. Furthermore, expansion costs have already reached almost USD 10 m which is substantial for a company of this size. As a consequence, the company’s true earnings potential on a consolidated basis is much higher than shown in the consolidated financials. While I believe that the company has a good perspective in Israel and Germany this might not be the case for the smartheart™ expansion strategy. Although management states that smartheart™ has a technological advantage compared to other products, I believe that the large industry players will react fast by either acquiring / partnering with SHL or smashing SHL with their own product in case smartheart™ shows signs of potential success. Therefore, it will depend on the board of directors to decide how much capital will be allocated to international expansion in the future. With the new board composition (see below) I am quite confident that the right decisions to maximize long term value for shareholders will be made.
Recent events put into context
SHL is incorporated in Israel and listed on the Swiss stock exchange. The financial statements are presented in USD, while the company mostly operates with NIS and EUR.
The company’s largest shareholder is the Alroy family which is holding 26% of shares outstanding. Two of their family members have been sharing the position of the CEO since 2000. In addition to that, there is a group of different shareholders representing together 28% of shares outstanding.
It seems that some members of this group enforced a change in the board’s composition with the two co-CEOs leaving the board at the end of 2014 and a new Chairman being appointed in March 2015. In addition to that, it was announced that the contracts for the co-CEOs will not be extended and that a new CEO will be identified. In April 2015 the company confirmed that the management is looking to sell or merge the company. In May 2015, it was announced that the co-CEOs will continue to hold their position “until further notice”. In July 2015 it was announced that an unknown Chinese investment company will acquire SHL for CHF 10.5 per share paying roughly USD 110 m for the company’s equity. In September 2015 SHL’s shareholders approved the transaction. However, at the beginning of December 2015 SHL announced that the transaction has failed. The reason for the failure remains unclear. The company stated that the Chinese investor was not able to obtain Chinese government approval for the transaction on time. It is also unknown whether a termination fee had to be paid by the Chinese investor.
Consequently, the following questions have been arising:
(1) Will the co CEOs resign? Yes. Last Friday the board announced that it has appointed Yuval Shaked as the new CEO. Mr. Shaked is joining from the US cardiology business of GE Healthcare. The acting co-CEOs have already stepped down. I think that this is a very positive development. However, it is noteworthy that the operations in Israel and Germany are run as stand-alone businesses with their own management teams enjoying a high degree of autonomy. As far as I understand, the same applies to the US business. Hence, SHL’s CEO seems to be more involved in corporate strategy and capital allocation than in day to day operations.
(2) Will the international expansion continue? I believe that the new board members are not interested in empire building. Many of them are large shareholders of the company. With the Alroy family now playing a more passive role and not having access to the company’s funds via compensation agreements any more, the return on their investment in the company might play a more pronounced role for them going forward. After three years of expansion activity the success or failure of this project should become clear over the next 12 to 18 months. I expect that the new management / the board should be able to make a rationale decision by then.
(3) Is there another buyer at the horizon? I think this is rather unlikely. Investment bankers might have approached most of the eligible potential buyers before meeting with the Chinese investor.
Shortly before the announcement on April 20, 2015, that the board is evaluating options regarding a merger or disposition of SHL, the share price was trading at CHF 8.3. Shortly before the press release that the Chinese investor will acquire SHL on July, 27, 2015 the share price stood at CHF 9.3. Currently, shares can be bought at CHF 6.6 or a discount of 20% / 29% to the undisturbed price. Apart from that, operating prospects further improved over the last six to nine months as it became clearer that Germany should contribute a larger portion to total profits going forward.
SHL has a market cap of USD 68 m and USD 10 m net debt. I expect 2015 revenues to come close to USD 44 m and EBITDA to be USD 9.5 m (8 times multiple). International business expansion cost reduced EBITDA by roughly USD 3 m in 2015. Hence, without business expansion, EBITDA might have reached up to USD 12.5 m leading to a 6 times multiple for the German/Israel business units. At the same time I expect free cash flow to equity holders to reach USD 4.5 m in 2015 (7% FCFE yield). Again without costs for international expansion FCFE could have reached USD 7.5 m being equal to an 11% yield.
After the failed takeover attempt at the end of last year, SHL’s market value tumbled to a level not seen since 2013. In 2013, SHL was struggling due to the German contract expirations and the board was dominated by the Alroy family who might have been following their own agenda ignoring other shareholders’ interests.
By now, SHL seems to be well positioned to profit from increasing cost awareness of health funds in Germany, still owns a stable business in Israel and the board’s new composition seems to be better aligned with minority shareholder interests. The appointment of the new CEO points towards this direction. From my perspective contract renewal risks in Germany and a potentially unsuccessful outcome of the international expansion are well reflected in SHL’s current market price.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!