Siloam International, the Fastest-Growing Indonesian Hospital Operator

We initiate coverage on Siloam with a NEUTRAL and a DCF-derived IDR13,000 TP (10% upside), implying 22x/17x FY16F/17F EV/EBITDA. Siloam is the largest private hospital operator by bed capacity and, with Lippo Karawaci’s support and a planned non pre-emptive rights issue, it can easily further outgrow its IDX-listed peers. However, there is a potential delay risk in delivering the new hospitals that management has planned.

Largest and fastest-growing private hospital operator in Indonesia
Siloam International Hospitals (Siloam or SILO) is the largest private hospital operator in Indonesia with a c.5,000 beds capacity and 20 hospitals across 13 of the country’s major cities as of June.

Support from Lippo Karawaci (LPKR IJ, NEUTRAL, TP: IDR1,460)
As Siloam’s parent, Lippo Karawaci (LPKR) offers the company three advantages in terms of lower capex, faster access to new prospective locations and rental subsidies for the first three years of a nascent hospital’s operations.

Aggressive expansion plan
Siloam has 46 sites under various stages of development: 29 are for 300-bed hospitals while 17 are for smaller 40-bed hospitals. Essentially, Siloam plans to more than double its FY14’s 4,797 bed capacity to 10,000 beds by FY17F. However, to be conservative, we forecast Siloam would only place into use four new hospitals per year which is approximately the same number of hospitals it has opened each year since FY11.

Non pre-emptive rights issue overhang
In May, Siloam secured approval for a non pre-emptive right issue of 115.6 m shares (ie 9.09% of its enlarged capital). The right issue can be executed within a 2-year time frame, with the proceeds slated for organic/inorganic expansion of the company’s hospitals.

Initiating coverage with a NEUTRAL and a DCF-based IDR13,000 TP using a WACC of 11.7%, and TG of 5%, implying a 22x/17x FY16F/FY17F EV/EBITDA respectively. As we explain in this report, due to its expansion, SILO’s earnings are abnormally low which results in some abnormally high P/E multiples.

Risks. Limited supply of specialists and delays in delivering new hospitals as scheduled.

Investment Thesis
Largest and fastest-growing private hospital operator in Indonesia. Siloam is the largest private hospital operator in Indonesia with a c.5,000 beds capacity and 20 hospitals across 13 of the country’s major cities as at June. In a nutshell, the Lippo Group – via listed Lippo Karawaci – entered the hospital industry in 1966 with the establishment of its flagship hospital in Lippo Village in Karawaci – a district of Tangerang.

This hospital eventually became the first Indonesian private medical facility to get Joint Commission International’s (JCI) accreditation in 2007. It was only in FY11, though, that Lippo Karawaci started to roll-out its hospital division’s fast expansion. In Sep 2013, the company listed its hospital operations via an IPO – this has now become Siloam.

Support from Lippo Karawaci
As Siloam’s parent, Lippo Karawaci offers the company three advantages, namely: i) lower capex, ii) faster access to new prospective locations, and iii) rental subsidies for the first three years of a nascent hospital operation.

Aggressive expansion plan
Siloam has 46 sites under various stages of development – 29 are for 300-bed hospitals while 17 are for smaller 40-bed facilities. Essentially, it plans to more than double its FY14’s 4,797 bed capacity to 10,000 beds by FY17F. It is also aiming to have 50 hospitals operational by FY17F. However, to be conservative, we forecast for Siloam to open four hospitals per year going forward, given that the company has roughly opened four medical facilities pa since FY11. We also estimate for Siloam to reach its 10,000 beds capacity target, but only later in FY19F and not FY17F as guided by management.

The non pre-emptive rights issue overhang
In May, Siloam secured approval for a non pre-emptive rights issue of 115.6 m shares, or 9.09% of the company’s enlarged capital. This issuance can be executed within a 2-year timeframe, with the proceeds slated for the organic/inorganic expansion of Siloam’s hospitals.

Initiating coverage with a NEUTRAL and IDR13,000 TP
Our DCF-based TP is derived using WACC of 11.7%, and TG of 5%, which implies 22x/17x FY16F/FY17F EV/EBITDA respectively. We corroborate our finding through a peers comparison analysis (Figure 1) and a scenario analysis.

Largest And Fastest-Growing Private Hospital Operator
Siloam is the largest private hospital operator in Indonesia with c.5,000 beds capacity and 20 hospitals across 13 of the country’s major cities as of June. To cut a long story short, in 1966, the Lippo Group, via its Lippo Karawaci unit, entered the hospital industry with the establishment of its flagship hospital in Lippo Village in Karawaci, a district of Tangerang, Java.

Eventually, this became the first Indonesian private hospital to get the JCI accreditation in 2007. However, it was only in FY11 that Lippo Karawaci started to roll-out the hospital division’s fast expansion and, in Sep 2013, it listed this group via an IPO.

Targeting the whole hospital market
SILO’s primary market was initially the upper middle income segment, but not the premium market (comprised of people that usually prefer the overseas medical treatment, mostly in Singapore or Penang, Malaysia). However, with the commencement of its RSUS hospital in FY12 (also located in Lippo Village area), SILO has been serving patients on government’s subsidies as well. With the FY13 acquisition of BIMC Kuta & Nusa Dua Hospitals in Bali, we believe SILO will also be targeting medical tourism in the longer term.

Larger contribution from new hospitals
Since FY11, SILO has been opening and acquiring roughly four hospitals per year. The revenue from mature hospitals is still growing nominally, but in terms of percentage of total revenues, contribution from the mature hospitals has been declining as SILO’s newer hospitals have been ramping-up their capacities and hence, this segment has become SILO’s revenues growth.

Lower EBIT margin compared to its peers
SILO has lower EBIT margins compared to its listed peers on IDX as it would normally take three years for a new SILO hospital to breakeven at the net income level. Five of the newer hospitals are still operating at a loss. Furthermore, as the industry leader, SILO is willing to compensate its senior and skilled key people higher than its listed hospital peers on IDX. These factors result in a lower EBIT margin for SILO when compared to its peers.

Lower net margin compared to its peers
SILO’s net margins are also lower when compared to its peers (Figure 1) for the reasons explained above but also as SILO has an IDR 417 bn intercompany loan, as of 6M15, from its parent LPKR to develop new hospitals (see next section “Support From Lippo Karawaci”).

Indonesian listed hospital operators landscape
As evidenced in Figure 9 below, SILO is currently situated in Zone B of the quadrant as five of the newer hospitals are still operating at a loss. We believe SILO will be moving to Zone A as the BPJS patients will contribute an increasingly larger amount to its total revenues and resulting in higher volume/ramp-up for SILO’s hospitals serving BPJS patients.

Patient base
Approximately 65% of SILO’s patients pay through out-of-pocket (OPE) funds. However, in FY14, the Indonesian Government launched its universal healthcare program, called Jaminan Kesehatan Nasional (JKN), which is administered by the National Social Security Agency (BPJS). Out of SILO’s 20 existing hospital, 12 can serve these so-called “BPJS patients” (Figure 12). As such, going forward, we believe the BPJS patients will contribute more than just the 5% of total revenues as incurred back in FY14.

Effects of Jaminan Kesehatan Nasional (JKN)
As JKN business is a low margin high volume business, JKN can potentially put pressure on working capital requirements and profitability of smaller private hospital operators. SILO which is a larger private hospital, can handle the cost pressure. The overall business derived from JKN patients represents only 5% of SILO’s overall revenues; also the company may benefit from economies of scale by reducing the number of drug formulary from over 8,000 down to 2,500 items, by obtaining volume discounts from its suppliers.

Support From Lippo Karawaci

As SILO’s parent, Lippo Karawaci (LPKR) offers SILO three advantages in terms of lower capex, faster access to new prospective locations, and rental subsidies for the first three years of a new SILO hospital operation.

Less capital intensive
A new 300-bed new hospital would normally costs USD25m. However, as SILO’s current business model is to lease from LPKR, it would require only USD15m for the medical equipment and working capital while the USD10m for land and buildings will be absorbed by its parent, LPKR. So far, SILO has been relying on intercompany loans from LPKR to build new hospitals with an interest rate of BI (Bank of Indonesia) Rate + 1% as there is an LPKR’s bond covenant restricting LPKR’s subsidiaries to incur indebtedness.

Rental Scheme
SILO only owns four and rents 12 out of its 20 existing hospitals indirectly from First REIT (FIRT) (FIRT SP, Not Rated) via a subleasing agreement with LPKR. The way it works is this: LPKR would sell the land and buildings of its hospitals to FIRT under sale and leaseback arrangements and subsequently LPKR would rent them back to SILO. SILO’s direct leasing agreements with LPKR is more attractive than it would have been if SILO would have leased directly from FIRT (as is the case with the Cikarang hospital, which is directly leased with FIRT).

Rental terms and risk transfer
The SILO hospitals rental agreement with LPKR is as follows: a) 1st year: 1% of gross operating revenues, b) 2nd year: 2% of gross operating revenues, and c) 3rd year onwards: 3% of previous year’s gross operating revenues. This benefits SILO as the rental agreement, effectively, transfers the risk of low ramp-ups of SILO’s new hospitals to LPKR.

Expansion Plan – Part A: New Siloam Hospitals

SILO has 46 sites under various stages of development with 29 sites for 300-bed hospitals and 17 sites for 40-bed smaller hospitals (to be termed Siloam Medica). Essentially, it plans to more than double the 4,797 bed capacity in FY14 to 10,000 bed capacity by FY17. However, to be conservative, we forecast SILO will open four hospitals per year as SILO has done since FY11; further, to be conservative we forecast SILO to reach the 10,000 bed capacity, but at a later time, in FY19F, and not in FY17F as the management guided.

Bed expansion from new 300-bed hospitals
Conservatively we forecast SILO will build only four hospitals per year in order to account for possibly delays and to maintain the past trend of SILO (per Figure 6). An example of potential delays other hospitals may incurr is the case with the new Siloam Hospital in Yogyakarta (Central Java) which although finalized, it is still awaiting to receive its operational license.

We also believe SILO’s plan for the smaller hospitals, Siloam Medica, may also take longer to realize due to the inherent difficulties of building 40-bed clinics adjacent to shopping malls; as a result we don’t include any Siloam Medica in our forecast.

Expansion Plan – Part B: Existing Siloam Hospitals

Bed expansion from existing hospitals
As shown previously in Figure 3, there are 11 Siloam Hospitals with total beds functional at less than 75% capacity. We forecast those 11 hospital to add operational beds in stages until each of them would reach 80%.

Ramp-up profile for existing Siloam Hospitals
With the operational beds ramp-up schedule above, we project for the existing hospitals to have total inpatient volume and bed occupancy rate profile as shown in Figure 19 and 20 below.

Non-Preemptive Right Issue & Capex

In May, SILO has secured approval for a non-preemptive right issue of 115.6 m shares (ie 9.09% from its enlarged capital). The right issue can be executed within a 2-year time frame and the proceeds will be used for organic/inorganic expansion of SILO’s hospitals. Since the timing of the right issue is still uncertain, we forecast SILO’s expansion to use intercompany bank loans from its parent, LPKR.

Capex and intercompany loans from LPKR
A new 300-bed new hospitals would normally costs USD25 m. However, as SILO’s current business model is to lease from LPKR, it would require only USD15 m for the medical equipment and working capital while the USD10m for land and buildings will be absorbed by its parent, LPKR. So far, SILO has been relying on intercompany loans from LPKR to build new hospitals with an interest rate of BI (Bank of Indonesia) Rate + 1%.

Free Cash Flow (FCF)
Since SILO plans to aggressively build new hospitals (in our case, we forecast four new 300-bed hospitals per year), we estimate SILO’s FCF will only turn positive in FY18F, the year in which its net gearing will also start to decline.

Working Capital Management

The cash conversion cycle increased five days in FY14 as the receivable days increased by three days, mostly due to reimbursement from BPJS. We expect the receivable days to keep increasing in the coming years. As for the payable days, SILO has been paying its drug and medical equipment suppliers more quickly to get better discounts for its larger volume purchases.

As mentioned above, SILO has been paying its suppliers faster to get better discounts for larger volume drugs. Thus, the cost of drug and medical equipment as percentage of its total COGS has been declining since FY12.

Valuation
We assume a risk free rate of 8.25%, market risk premium of 5.0%, equity beta of 1, and a terminal growth (TG) rate of 5.0%, which results in a WACC of 11.7%. We believe DCF is the most appropriate valuation methodology since SILO operates in the very defensive hospital industry with stable recurring income.

Key Risks
Conflict of Interest with parent company. As most of SILO’s board of commissioners sit on LPKR’s board, there might be a potential conflict of interest leading to overexpansion of SILO.

Higher capex due to weakening IDR against USD. As SILO relies heavily on imported medical equipment, weak IDR against USD may result in higher capex.

Competition for skilled specialists. As new hospitals outgrow the supply of specialists every year, there is increased competition to attract and retain skilled specialists.

Lack of hospital zoning regulation. New hospitals can possibly be erected next to existing hospital as the Indonesian Government does not really enforce hospital zoning regulation.

Operational license. Delays in obtaining an operational permit issuance might adversely affect projected revenue and earnings growth.

Slower than expected ramp-up rate for new hospitals. Slower than expected ramp-up trajectory could jeopardize expansion profitability and be a serious risk to the target price.

Competition from foreign hospital operators. If the Indonesian Government allows foreign doctors to practice in Indonesia, we foresee more foreign hospital operators to enter and compete in the fast growing Indonesian private hospital market.