Siloam International Requires Long-Term Investment Horizon

Management aims to open six Siloam hospitals and at least three Siloam Medica clinics this year
We understand that its aggressive hospital expansion this year and next year would result in longer-term profitability and a much higher market share, especially for the Siloam hospitals in third-tier Indonesian cities. However, this year’s margins may be slightly impacted by start-up operations of new Siloam hospitals over the next two years. Thus, we remain NEUTRAL, with a lower TP of IDR9,200 (from IDR9,500, 10% upside).

Six new Siloam Hospitals
Management aims to kick off the operations of four new Siloam hospitals in Bogor in Greater Jakarta (2Q16), Lubuk Linggau in South Sumatera (4Q16), Sorong in West Papua (4Q16), Yogyakarta in Central Java (3Q16). Two new Siloam Hospitals that have commenced operations are in Bau-Bau, Southeast Sulawesi and Labuan Bajo, East Nusa Tenggara.

Three new 40-bed Siloam Medica clinics
This year will be the first year that Siloam would finally open the long-awaited 40-bed Siloam Medica clinics, such as the ones in Blu Plaza Bekasi (West Java), Samarinda (East Kalimantan), and Semarang (Central Java).

Rationale for opening hospitals in third-tier cities
Based on our conversation with the Siloam Hospital CEO, we understand that it is easier for young specialist doctors to start their niche practices and hone their reputations in third-tier cities (eg Kupang, East Nusa Tenggara). In big cities like Jakarta, Medan and Surabaya, patients usually flock to the more established, senior specialists. Thus, this strategy of opening hospitals in third-tier cities indeed makes sense in the longer term, as Indonesia still has a very under-served hospital market in ASEAN.

Non-preemptive rights issue
In May 2015, Siloam secured the approval for a non-preemptive rights issue of 115.6m shares (ie 9.09% of its enlarged capital). The rights issue can be executed within a 2-year time frame with the proceeds slated for organic/inorganic expansion of Siloam hospitals. Based on our meeting with its management, this rights issue scheme is not likely to happen this year.

Maintain NEUTRAL with a lower TP of IDR9,200 (from IDR9,500) to account for higher expenses from the commencement of six new Siloam hospitals and three Siloam Medica clinics. Our DCF-based TP of IDR9,200 assumes a WACC of 9.4%, TG of 3%, and beta of 0.4, which implies 18.5x/14.5x FY16F/FY17F EV/EBITDAs.

Revisions to our 2016F and 2017F earnings
We increase our FY16F and FY17F net sales by 1.5% and 1.6% respectively to reflect the higher growth in average revenue and outpatients. At the same time, we trim our FY16 and FY17 earnings estimates by 8% and 11% respectively to reflect higher expenses from doctors’ fees and salaries as Siloam opens more new hospitals this year and the next year.

Valuation
We assume a risk-free rate of 8.25%, a market risk premium of 5%, an equity beta of 0.4 and TG rate of 3%, which results in an implied WACC of 9.4%.