Transcript of presentation results

14 May 2018

Netcare Limited

Unaudited Interim Group Results for the six months ended 31 March 2018

Dr Richard Friedland

Good morning Ladies and Gentlemen and welcome to this presentation of Netcare Limited’s interim results for the six months ended the 31st of March 2018. May I welcome the newly appointed Chair of Netcare, Thevendrie Brewer, members of the Netcare Board who are present and also our senior executives. Thevendrie Brewer succeeded Meyer Kahn as Chair.

Meyer Kahn retired as of the end of March this year, and we owe an enormous debt of gratitude to him for the very significant contribution he made to Netcare over several years.

Thevendrie was Chair of our Audit Committee and for the past two years has also been

Deputy Chair of Netcare. Thevendrie, we’re delighted and privileged to have you as Chair of

Netcare and look forward to your stewardship of the Board going forward.

Welcome also to the senior management team from Akeso and also present today are its two founders Alon Apteker and Allan Sweiden. At the outset may I pay tribute and thank our various senior management teams and staff across all of our divisions, for your incredible contribution over the past six months. As is usually our custom I will be taking you through an operational review of our various divisions, before handing over to our Chief

Financial Officer, Keith Gibson, who will unpack our financial results in more detail, and end by giving some guidance for the remainder of the financial year.

Ladies and Gentlemen, the past six months have been extremely busy for Netcare, and I want to begin by unpacking some of the more significant events that have occurred. Firstly, as evidenced by our results and those of our competitors, growth has returned to the South

African healthcare market and, if measured in patient days alone, it would appear that

Netcare has grown its share of the market.

Secondly, in March we were delighted to be able to announce the successful acquisition of the Akeso Group of clinics, following Competition Tribunal approval, and this provides us with an outstanding platform to grow mental health and care services in South Africa.

We’ve also been very busy over the past 18 months designing and building the Netcare of tomorrow, and I’m delighted to officially start that process today by informing you that we’ve completed contractual agreements with global experts that will lead to the full digitisation of our clinical records, our nursing and patient systems. Finally, on 28 March of this year, we announced our strategic decision to exit our UK operations.

Dealing first with that exit and the rationale behind our decision. It’s perhaps worth reflecting on the history of this acquisition. We began Netcare UK in 2001, where we successfully led the very first large initiatives to reduce patient waiting lists for the NHS, and through that initiative developed a very successful business in the United Kingdom. In 2006, together with three other partners, we acquired the General Healthcare Group in the UK.

We structured that business into a property owning company, against which we had secured most of the debt, and an operating company called BMI Healthcare, which held the hospitals. What this slide shows is essentially what transpired subsequently, and in particular the consequences of the change or structure of the market as a result of the global financial crisis, particularly in relation to our case mix within BMI, but also in terms of our debt instruments, given the extremely low interest rate climate that we have endured for several years in the UK.

Importantly, at the time of the transaction we structured the debt to be non-recourse to

South Africa. We maintained that philosophy and that ring-fenced approach when the

PropCo was due to be refinanced in 2013. As a result the property portfolio was taken over and the equity in the property portfolio was acquired by distressed debt investors. Over the years, BMI’s rent has grown and it’s become significantly over rented. In fact today the rent of BMI represents almost 20% of its turnover, and together with our partners and other shareholders we’ve spent the best part of the last five years trying to negotiate a rent reduction.

Given the poor performance of BMI in the second half of last year, we undertook a strategic review of the market in general, and our conclusion was that this market was going to remain extremely challenging, not just over the short term, but certainly over the medium to longer term. We’ve also made it very clear, and we’ve done that on several occasions, particularly in a SENS announcement we made on the 18th of January, that absent an appropriate rent reduction that was commercially viable, we would not be investing further in the UK. Towards the end of March we began to realise that, despite our very best efforts, we were not going to be able to achieve a commercially viable rent reduction that would allow the business to invest in its estate, and importantly, achieve a risk adjusted return for

Netcare and its shareholders.

In addition, the lenders to BMI insisted that in order to achieve further funding for the Opco, shareholders need to relinquish control. Netcare decided to accede to this in the best interest of BMI, and we then took the strategic decision to exit the United Kingdom and put our assets out for disposal. We believe that this is commercially the right decision for

Netcare and its shareholders. As a result, and Keith will unpack this in a lot of detail, we have deconsolidated the UK in our results, and classified the business as a discontinued operation.

So what’s the story? Given everything that’s happened in Netcare over the last six months, I want to spend some time unpacking the key tenets of our current strategy and our strategy going forward. At the moment we remain a fully focused South African operation, and our immediate and short term focus is building on the incredible platform we have in South

Africa as we prepare Netcare for the ever changing healthcare environment.

Our core strategy continues to be driving improved economic value, whilst contributing to the transformation and sustainability of our society, and we essentially achieve this in four major ways, and I’m going to take you through those now.

Firstly, by driving organic growth through our portfolio of quality healthcare assets, ensuring we provide outstanding clinical excellence and patient care, ensuring we attract and retain excellent doctors, and that we’re included in most funder networks.

Secondly, by ensuring future growth by making selected investments in new assets and verticals. We will continue to provide the most outstanding advancements in medical technology, in terms of the equipment and the facilities we provide, and we’ll continue to invest in brownfield facilities where we have high demand for our services as well as greenfield expansion in areas where we are underrepresented. We’re further developing our new verticals in cancer care, in mental health and also in day theatres, and will continue, should the prospect arise, to look for opportunities in foreign markets, providing of course they meet our financial hurdles and targets. Many of you will know that over the last few years we’ve spent extensive time on due diligences for at least four opportunities across various geographies internationally, however they have not met our hurdles and we’ve chosen not to pursue them.

Thirdly, underpinning everything we do is a disciplined approach to capital allocation and a focus on our return on capital employed. Our ‘asset lighter’ strategy, which we have spoken about before, compliments this discipline whereby we are moving hospital beds to higher demand disciplines, either within a facility or to other hospitals. We’re also currently reviewing our portfolio performance to ensure optimum returns on capital across all of our divisions. In fact our decision to exit the UK was predicated on the view that absent a rental transaction any new investment in the United Kingdom would have been value destructive for Netcare and our shareholders.

And finally, we will continue to relentlessly pursue business innovation as we prepare

Netcare for the future. We will focus on embracing innovation to improve our patient outcomes, to ensure that we’re administratively as efficient as possible. Training and development of our staff, be they nurses, paramedics or pharmacists, is core to the sustainability of the healthcare sector in South Africa in promoting both education and job creation.

We’ve been the leader and the most transformed healthcare company on the JSE for several years under the old dti BBBEE scorecard codes, we’ve embraced the new codes and have committed ourselves to substantially improving our position. We remain focused on making a contribution to our society through a broad range of community initiatives. By way of an example, we were awarded the Trilogy Award, for the best Corporate Social

Investment project, across all companies and across all sectors in South Africa, for our sexual assault and rape crisis centres. This is a nationwide network that we provide which has treated more than twelve thousand survivors of sexual assault and rape, free of charge.

Underpinning all of this, and at the centre of everything we do, is our core purpose of providing person centred quality, health and care that will be digitally enabled into the future.

Turning to a financial overview of our results, from continuing operations, reminding you that we’ve deconsolidated the United Kingdom, and also that the UK operations are shown as a discontinued operation. Revenue rose by 8.2% to R10.0 billion, normalised EBITDA rose by 8.1% to over R2 billion, and adjusted headline earnings per share from continuing operations, rose by 8.5% to 87.7cents. As a result of the strong performance in South

Africa, the confidence in our operations going forward, our strong balance sheet and also our decision to exit the United Kingdom, the Board of Netcare decided to declare an interim dividend of 44.0 cents, which represents a 15.8% increase on the comparative period.

Before turning to the operational performance of our various divisions, I want to highlight some of the global industry fundamentals that are also driving growth here in South Africa.

It should come as no surprise to you that aging, chronic illness and cancer continue to drive increased utilisation of healthcare on a global basis. In fact if we look at aging, the number of people aged over 60 is expected to double to 2.1 billion persons by 2050. What’s the relevance of that? Well, we know that people over the age of 65 are more likely to be admitted to hospital more often, and we also know that on average the cost of those episodes is 70% higher than that of younger patients, and as a result this has a knock-on effect both in terms of cost and utilisation.

We know there is an incredibly growing burden of chronic diseases, which is evidenced by this statistic on diabetes, which is expected to increase by a staggering 54% by 2040, and in terms of mental health, depression is the leading cause of ill health and disability worldwide. This increase of 18% is expected to continue into the future.

Finally, in terms of cancer, on a global level the incidence of cancer is expected to increase by 70% over the next 20 years. So how is this reflected in our own local market? We’re seeing our own local market mirroring these trends, and in fact chronic diseases are expected to increase by 57% by 2020, and the graphic on the left hand side of the screen demonstrates that 60% of this burden will occur in emerging markets. In fact 79% of deaths worldwide, attributable to chronic diseases, occur in developing countries.

Now, what’s the experience in South Africa? According to Discovery, the number of members with a chronic condition, such as diabetes or high blood pressure, will continue to increase, and it’s more than doubled since 2008. In a Medscheme submission to the

Healthcare Market Inquiry, aging, burden of diseases and new technology drives 50% of the growth in their claims, and in the words of the Council of Medical Schemes, the prevalence of bipolar disorder per 1 000 beneficiaries, has increased by 228 % over seven years.

A reminder of Netcare’s extensive operating platform. You’ll notice we now have 71 hospitals in total, including the 12 we’ve acquired from Akeso, and our five Public Private

Partnerships, which comprises 11 416 beds. And this graphic demonstrates the extensive array of services and facilities we offer throughout South Africa.

Turning now to the Hospitals and Emergency Services division. I’m pleased to say that we recorded a 3.5% growth in patient days, which translated into increased occupancies both full week and week day. In line with our ‘asset light’ strategy we commissioned no new beds in the first half of this year, but did convert 30 beds to higher demand disciplines and facilities. We granted practicing privileges to 51 specialists over this period, mainly in the surgical disciplines.

Now Ladies and Gentlemen, our organic growth follows a period of high investment. The graph on the right hand side demonstrates the rate of revenue growth from new investments in dark blue, outstripping the rate of revenue growth from our existing estate.

This also demonstrates Netcare’s appropriate allocation of capital. In terms of our financial performance, revenue grew 9.3% to R9.6 billion, as a result of a 5.1% increase in revenue per patient day, and 3.5% increase in patient days. EBITDA rose by 10.4% to just over R2 billion. I’m pleased to say that we’ve completed the restructure of our Emergency Services division, and we’ve also successfully closed our Mozambique operation as of the end of

December 2017. The EBITDA margin widened by 20 basis points to 21.5%, excluding the

Competition Tribunal costs related to the acquisition of Akeso, and UK advisory fees.

Looking at Primary Care and the financial performance, I think it’s well known that this business has gone through a significant restructure over the last 15 months, with the outsourcing of our pharmacies to Clicks on the 1st December 2016, and also the sale of the managed care businesses of Prime Cure in January 2017. As a result we’ve moved from a turnover model in pharmacy to that of a rental one, and we’ve seen quite a significant diminution in revenue as a result. I’m very pleased to announce that our underlying growth within this division, stripping out these anomalies and changes, is 7.4%. EBITDA has remained stable over the period, but pleasingly our margin has strengthened by some 260 basis points to 15.5%.

Now turning to the acquisition of Akeso, I will spend some time talking about this and introducing our shareholders and market to Akeso. It consists of 12 hospitals. At the moment our hospital in George is closed for renovations, and will reopen in January2019.

They have 811 beds, and have a market share of 28%, which provides Netcare with an outstanding platform to grow into a rapidly growing area of illness in our society. Akeso has a number of general units, including general psychiatric, dual diagnostic and young adult units, as well as units specialising in substance abuse, geriatric psychiatry, and also eating disorders. I’m delighted that the senior team of Akeso will remain on with Netcare to build up this network, and that includes Alan Sweiden, the MD, and Alon Apteker who will remain on as a consultant for the next few months.

How does Akeso differentiate itself? It does so through specialised programs that offer integrated and family orientated treatment for a range of psychiatric, psychological and addictive disorders. These are run by multi-disciplinary teams, and the guiding principle in

Akeso, and something that really appealed to us as Netcare during our due diligence, was this focus on planning for life beyond initial treatment, what they call the post containment approach. Their ultimate aim is to change the direction of patients’ lives by providing strategies for sustainable mental health.

Sitting behind all of these therapies, and designing all of these therapies is the Centre for

Psychotherapy Excellence known as COPE. This is a multi-disciplinary treatment philosophy and programme that is essentially aimed at providing patients and their families with an insight into their condition, and gaining a better understanding of the relative strengths and weaknesses, of the patients, their families and their support networks. The programme provides our patients with the skills to be able to improve their quality of life once they’re discharged from hospital. And as can be seen by these pictures this is done through extensive group therapy and work, generally with people suffering from the same conditions, including family and support members.

This graph demonstrates the incredible continued growth of Akeso. It started with 85 beds in Randburg in 2008, and over the last ten years has grown to 811 beds and 12 hospitals.

For the remaining part of 2018, another 61 beds will be added at no capital cost, and there are a further 56 beds planned for the 2019 financial year, increasing the network to 928 beds.

Ladies and Gentlemen I want to focus on four other areas of our strategy and give you examples of what I spoke about earlier, in terms of how we are delivering on our strategy, in the areas of quality, innovation and sustainability. In the past we have showcased our focus on multi-drug resistant organisms or super bugs, because we know they pose the greatest threat to healthcare globally. We never want to reach the situation where we have infections that we simply have no treatment for, the consequences would be catastrophic.

Over the years we’ve showcased our antibiotics stewardship programs to you.

Today we want to show you a new innovation that we’ve brought to South Africa, and

Africa. These are pulsed UV light robots that are used to disinfect all of our facilities. They are the first in Africa and are they’re incredibly effective. They take ten minutes to disinfect a ward. You can see the effectiveness of the robot versus a hydrogen peroxide disinfection, so called defogging, that can take anywhere between two and eight hours. We’re also the first to globally demonstrate, in a study that is yet to be published, that these pulsed UV light robots are also effective against fungi, which has never been shown before, we’re about to demonstrate this and publish the results internationally.

We also know that hand hygiene is probably the most important element in preventing infections, so we’ve developed a novel app for our nurses and staff to be able to monitor their hand hygiene and keep that “top of mind”, along with ensuring compliance with

World Health Organisations standards. We’re also the first, certainly in Africa, and possibly in our view globally, to introduce a surgical antibiotic app. An app, designed to ensure that patients get the right antibiotic, at the right time and the right dose, either before, during, or after surgery.

I mentioned earlier that we’re delighted to announce a global partnership to develop mobile electronic patient records. This will be on the Apple iOS platform, and will bring enormous advantages to our organisation. Firstly, in improving patient care and safety, the accuracy of our records and allowing patients easy and quick access to their own medical records.

Importantly, doctors will be able to access this information, away from the bedside, either at home, in theatre, or in their consulting rooms, and be able to react immediately if necessary.

Secondly, this technology is able to download, automatically from the various monitors in our ICU, high care and in our theatres, all the information that’s demonstrated on the screens. This obviates the need for our nursing staff to have to manually record all of this information. The most important advantage is that it frees up our nurses, and it gives them more time to spend on their primary function of caring for patients. It improves our administration and case management. We’re also introducing world leading drug interaction software, which will automatically flag any potential drug interaction or medication errors.

I put this slide up [slide 23] as to why digital matters, because this is a small version of a typical ICU chart. In real life this is an enormous A2 size chart, and this is all manually taken down from the various monitors. You can see how much work goes into it, and the hundreds of data points that are recorded. Next to it is the electronic version which shows you that this can now be seamlessly recorded, digitally and accurately, and removes the enormous administrative burden. On the right hand side you can see the quality of the images that we’re able to achieve on iPhones or iPads. We’re also committed, as I said in our strategy, to enhancing sustainability, and I want to give you a quick update on Netcare's ten year sustainability program, that we started in 2013.

We’ve achieved a 20% reduction in energy intensity, and we’re on track to achieve our ultimate target of 30% to 35% in the ten year period. We’ve done this by rolling out probably one of the largest solar or photovoltaic programs in South Africa at 45 facilities.

We’ve also upgraded all of our lighting and standardised it across 69 facilities, replacing over

130 000 lights, with an enormous savings achieved in intensity. There have been other programs that we’ve introduced, and importantly all of our new facilities are designed to operate at an energy intensity between 30% to 40% below our older hospitals.

We’ve been able to achieve cost avoidance over the last four years, but in this past year we’ve been able to see a real reduction, year-on-year, in electricity costs, despite electricity tariff increases and increases in patient volumes.

This is a picture of a desalination plant that we’ve put into the basement of the Christiaan

Barnard Hospital in Cape Town. As you know it’s on the foreshore which is reclaimed land.

This essentially drains sea water from underneath the hospital and desalinates it. We installed this plant as a result of the catastrophic consequences of the water shortage in

Cape Town [slide 25]. I’m pleased to say that we’ve reached total sustainability in the

Western Cape, in the event of a so called ‘day zero’, if water should run out. It includes this plant, boreholes at all of our various hospitals, Medicross and NRC facilities, and importantly across the country, we’ve introduced water saving initiatives to ensure that we reduce water utilisation per patient.

All of these initiatives have been recognised globally and we’ve recently been awarded the

2020 Healthcare Climate Challenge Award for 2017. We’re one of only two Groups globally to achieve four medals, out of the over 14 000 hospitals represented in this survey and assessment. Netcare is also included in all the major sustainability indices on a global basis.

Probably one of the biggest tsunami’s affecting South Africa is the unemployment of our youth. At Netcare we’re committed to playing our role in alleviating this crisis. As a result, we’re an active participant in the ‘YES’ campaign launched by our President, Cyril

Ramaphosa, this is the Youth Employment Service. We’ve committed to employing 1 000 unemployed youths over the next five years, and guaranteeing their employment and potential career progression. I raise this because this program has been criticised by many who say that most of the jobs given to unemployed youth are menial in nature, and are not sustainable, they don’t last. I can assure you that in Netcare, once you’re employed and part of the training cycle, you certainly have career progression. This year alone we’ve trained 14 000 of our staff in various programs, excluding the 3 500 nurses we’ve trained.

We also partnered with the Health and Welfare SETA this year to train and employ 51 previously unemployed and unskilled youths, and this is a picture of them here in our foyer during their graduation, with the Deputy Minister of Education [slide 27]. As I mentioned, we’re also actively training 3 500 nurses and allied health care professionals in South Africa.

I want to end off by showcasing a new, not for profit joint venture, between ourselves and

Adcock Ingram Critical Care, which really drives sustainability and enterprise development.

We’re going to be recycling old drip bags and other PVC products to produce brand new shoes for needy school children. We’ve been doing this at five of our hospitals at the moment and will roll it out across all hospitals. It will create enterprise development opportunities, both in the recycling, transport and the production of these shoes, and employment opportunities for sorters in our hospitals. In addition to all of these benefits it will also reduce land fill and improve sustainability. Ultimately, we hope to involve the public sector in this. Ladies and Gentlemen on that positive note I’m going to hand over to

Keith Gibson to take us through our financial performance.

Keith Gibson

Thanks very much Richard, and good morning Ladies and Gentlemen. Let’s now turn our attention to the interim Group results for the six month period ended 31 March 2018. Now

,the first six months of the 2018 financial year has been a period of significant change for

Netcare, as Richard has already described. These changes have had a notable impact in the structure and the presentation of our Group results. However, from a purely trading perspective, the SA operations have delivered a robust financial performance for the first half of 2018.

With regards to the structural changes, the first one that we need to call out relates to our strategic decision to exit from the UK market. We have included the results of the UK operations for the period prior to the date of deconsolidation, which is the 28th of March

2018. However, the UK results have been classified as a discontinued operation and they are therefore separately disclosed from the results of our continuing South African operations.

From a practical perspective we deconsolidated the UK operations at the half year end, and this has resulted in the recognition of a significant non-cash profit on deconsolidation, which has been recognised in the H1 income statement. We’ve also taken a very prudent approach by fully impairing Netcare’s economic interest in the debt of BMI Healthcare.

Lastly, the exclusion of the UK assets and liabilities has created a structural change in the

Group’s statement of financial position.

The second major change to be aware of, is Netcare’s acquisition of the Akeso Group. The effective date of this acquisition was the 27th of March 2018. In terms of the accounting standards we have included the provisional, at acquisition balance sheet of Akeso in the

Group statement of financial position at 31 March 2018. However the trading results from

Akeso’s 12 hospital facilities will only be included in Netcare’s numbers with effect from 1

April 2018. Finally Netcare’s Group statement of financial position remains in a very healthy condition and the cash generations of our continuing operations remain strong.

In unpacking the financial performance for the first half of 2018, it makes sense to deal upfront with the accounting impact of the structural changes that have taken place during the period. These changes have been stripped out and they’ve been separately disclosed on the statement of profit or loss that we’re going to look at shortly, in order to allow for a more meaningful period-on-period comparison of underlying performance. These items can be categorised into two groups, the first being discontinued operations, and the second being exceptional items. The discontinued operations consist of our emergency services business in Mozambique, GHG PropCo 2, which owns six hospital properties in the UK, and of course the results of BMI Healthcare.

From a numbers perspective the operating results of our emergency services in

Mozambique, and GHG PropCo 2, virtually offset each other and therefore the number on this slide can be attributed to BMI Healthcare. Looking at the results of discontinued operations we see that for the six month period ended 31 March 2018, discontinued operations incurred a loss of R473 million, as compared to a profit of R646 million in the comparative period. This large period-on-period swing is attributable to both a decline in the underlining UK trading performance, and also the impact of non-cash fair value adjustments arising on the revaluation of BMI’s RPI swap instruments.

In terms of trading, the decline in the UK healthcare operating environment is evident in terms of the increase in the trading losses after tax, which has grown from R5 million in H1

2017 to R388 million for the past six months. I’m going to talk you through BMI

Healthcare’s operational performance in more detail in the next slide.

As you may recall, in the comparative period Brexit fuelled changes in the UK inflation, the outlook resulted in a significant, non-cash fair value credit to the income statement of R651 million relating to the valuation of BMI’s RPI swap instruments. In H1 2018 the corresponding fair value adjustment was a far less significant non-cash charge of R85 million. Therefore the RPI swap instruments have for some time introduced an element of volatility into the numbers.

Moving onto the exceptional items. As you may recall in the comparative period we had a cash realised profit on the sale of our old Netcare CBMH land and buildings, which amounted to a net profit of R169 million after tax. The exceptional items in H1 of 2018 all relate to our exit from the UK and are non-cash in nature.

With regard to Netcare’s interest in BMI’s Healthcare’s debt, the underlying contractual and economic rights remain intact, and that includes BMI Healthcare’s obligation to repay this debt. However, from an accounting perspective, the accounting standards require that we adopt a more circumspect view. The accounting standards prescribe that when determining fair value, we are only allowed to take into consideration factors that existed at the reporting date, which in this instance is the 31st of March 2018. So at the reporting date the