英国医疗行业研究报告

healthcare sector reportJune 2010Sahill Shan0845 059 6690 sahill.shanbrewin.co.ukChris Glasper0845 059 6542 chris.glasperbrewin.co.uk1129Sector AnalystsSahill Shan 0845 059 6690 sahill.shanbrewin.co.ukChris Glasper 0845 059 6542 chris.glasperbrewin.co.ukCorporate FinanceMatt Davis 0845 213 4851 matt.davisbrewin.co.ukAndrew Emmott 0845 213 4736 andrew.emmottbrewin.co.ukRichard Jones 0845 059 6740 richard.jonesbrewin.co.ukDebt AdvisoryMiriam Greenwood 0845 213 2172 miriam.greenwoodbrewin.co.ukPaul Mason 0845 213 4268 paul.masonbrewin.co.ukBreWIN DolphIN teamEquity SalesDavid Green 0845 059 6543Oliver Knott 0845 059 6540 Jock Maxwell Macdonald 0845 059 6418Kate May 0845 059 6567Craig McDougall 0845 059 6451Rachel Newton 0845 059 6779Roland Walton 0845 059 6649Corporate BrokingJamie Cumming 0845 213 4203Elizabeth Kennedy 0845 213 4212Nick Owen 0845 059 6412Graeme Summers 0845 059 6531Sales TradingJeremy Ainsley 0845 059 6533David Loudon 0845 213 4216Gary Welford 0845 059 6780Steve Wilson 0845 059 65441130 -Healthcare Sector Report June 2010 Look for roses amongst the macro thorns Short-term caution merited - The sector has failed to make much headway YTD, underperforming the FTSE All Share by c.2%. Public sector spending concerns have negatively weighed on many of the service companies and alack of positive catalysts has left others treading water. With this situation likely to persist, we feel it is unlikely that there will be widespread outperformance in the next 6 months. but longer term fundamentals remain in place - Valuations largely appear to be discounting short-term earnings risk. In the medium term, the key sector drivers of population growth, technological advancement and emergingmarkets remain in place. In the UK, outsourcing opportunities should emergeas increased efficiencies are sought. Stock selection remains key - Given the disparities in the sector, we believe that investment decisions should focus on bottom-up fundamentals. We prefer market leaders, international earners and undervalued growth plays. Our keybuys are IDS and Synergy Health as the market is not giving sufficientcredence to growth prospects. Axis-Shield, CVS and CareTech are oversold on fundamentals. We see scope for underperformance at Consort, Dechra, Dignityand Genus on a 6m view and we remain cautious on Southern Cross. Price target changes - To better reflect the macro headwinds on a 12m view we have lowered our Price Targets for a number of stocks, although we haveincreased our valuations for Animalcare and Nestor. We have upgraded our FY11 forecasts for Corin by 7% and trimmed Debt forecasts for Optos. Initiations - We are initiating coverage of Dignity and Genus. Both havevarying degrees of investment merits, but look up with events. Since our lastreview we have also initiated on Advanced Medical Solutions with an Add. New government read across - The forthcoming emergency budget (22ndJune) and healthcare White Paper should provide a much better handle on the new Governments plans for the sector in the UK. Short term pain looks likelybut the imperative to drive efficiencies through outsourcing services lookscompelling and stronger private sector operators should ultimately prosper. A focus on chronic diseases and long term conditions - In many respects, the challenge of funding increasing numbers of patients with long termconditions is the key issue facing healthcare systems and will be so for many years to come. We take a look at the problem and some of the innovativeapproaches being adopted. Stock Price Mkt Cap Yr1 EV 12m Price Risk / Rec EV/EBITDA (x) PER (x) (p) (m) m Target Reward 11(E) 12(E) 11(E) 12(E) Adv Med Solns (A) 42 64 63 46 11% ADD 8.3 6.3 10.7 8.7 Animalcare (B)(A) 115 23.1 26.1 133 16% ADD 6.1 5.5 11.3 10.1 Axis-Shield 268 133.1 132.1 325 20% ADD 7.2 4.8 15.4 10.6 CareTech (B)(A) 352.5 174.7 256.3 457 30% BUY 8.7 7.9 9.9 9.0 Consort Medical 351 101.4 136.0 381 9% HOLD 4.9 4.5 8.6 8.3 Corin 56 24.0 27.9 67 20% ADD 3.4 3.2 15.2 12.6 CVS (B)(A) 149 83.9 123.4 224 50% BUY 5.5 4.9 8.3 7.1 Dechra 411.5 271.9 277.4 365 -11% REDUCE 6.8 6.1 13.3 11.2 Dignity 635 405.6 648.1 621 -2% HOLD 9.1 8.3 13.6 12.4 Genus 739.5 441.3 535.6 653 -12% REDUCE 10.2 9.3 18.5 16.1 IDS (B)(A) 590 164.3 171.0 756 28% BUY 7.6 5.9 15.5 12.1 Nestor 53 59.8 73.2 63 19% ADD 5.7 5.1 8.2 7.6 Optos 119 81.1 96.6 183 54% BUY 2.9 2.4 6.7 5.1 Southern Cross 46.5 87.5 68.3 50 8% HOLD 0.8 0.4 5.2 3.2 Synergy Health 616.5 337.7 471.7 737 20% BUY 5.7 5.5 11.9 11.1 (B) BD acts as broker, (A) AIM listed. Source: BD Estimates, annualised to June Annualised ratings June 11e (x) P/E EV/EBITDAHealth Care 10.8 5.7 Social Care 7.8 5.1 Medical Devices 13.6 7.0 Animal Health 15.2 6.9 Sector Average 12.3 6.2 Source: BD Analysis Summary Views IDS Key BuySynergy Key BuyAxis-Shield OversoldCareTech Oversold CVS OversoldAMS PositiveAnimalcare PositiveCorin PositiveNestor PositiveOptos PositiveConsort UnderperformDechra UnderperformDignity UnderperformGenus UnderperformSouthern Cross CautiousThis document is a Marketing Communication and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Please refer to important disclosures at the end of this document. 1131 Healthcare Sector ReportCONTENTS EXECUTIVE SUMMARY 3 SECTOR IN PICTURES 10 SECTOR VALUATIONS 14 DIARY OF EVENTS 21 HEALTHCARE & THE GENERAL ELECTION 22 A FOCUS ON CHRONIC DISEASES & LONG TERM CONDITIONS 24 SUB-SECTOR VIEWS HEALTHCARE 28 SOCIAL CARE 30 MEDICAL DEVICES & DIAGNOSTICS 32 ANIMAL HEALTH 34 COMPANY VIEWS ADVANCED MEDICAL SOLUTIONS 36 ANIMALCARE 40 AXIS-SHIELD 44 CARETECH 48 CONSORT MEDICAL 52 CORIN 56 CVS GROUP 60 DIGNITY 64 DECHRA PHARMACEUTICALS 68 GENUS 72 IMMUNODIAGNOSTIC SYSTEMS 76 NESTOR HEALTHCARE 80 OPTOS 84 SOUTHERN CROSS 88 SYNERGY HEALTH 92 1132 Healthcare Sector ReportEXECUTIVE SUMMARY KEY THEMES The sector has been a relatively weak performer so far in 2010 as concerns over healthcare expenditure in general and UK public sector funding in particular have weighed on investors minds. Operational gearing has been a mixed blessing with those companies successful at growing the top line and maintaining a tight rein on costs benefitting from strengthening margins and improved investor sentiment. The opposite is true for those who have not, proving the old adage that over-promising and under-delivering can be a fatal combination. Ongoing economic uncertainty as we move into H2 is likely to remain a feature, meaning investors should continue to stick to quality names and be ready to take advantage of any opportunities that arise. Short term caution merited uncertainty caused by the change in Government and the wider economic backdrop has not left the sector unscathed. We expect macro uncertainty to continue to be a feature in H2, but specific valuations appear to be discounting earnings risk. On a relative basis the best defensive area of our coverage has been the broad Animal Healthcare segment. Demand for medical devices is affected by movements in GDP and state healthcare spend, but there are tentative signs of improving demand. Health Care and Social Care are clearly vulnerable to public sector spending constraints, but inevitable outsourcing / market share growth opportunities are an important investment plus. Our recommendation bias remains stock specific with a strong leaning towards international earners and / or market leaders with a demonstrable growth opportunity. Medium term fundamentals remain in place at the risk of sounding like a broken record, there are five key themes that should underpin the medium term growth expectations for the sector. Firstly, an ageing population and the financial burden this places on developed economies in particular. Secondly, and somewhat allied to the first, is the trend towards better screening, prevention and more accurate diagnosis. Thirdly, outsourcing and the decentralisation of care provision. Fourthly, many markets are fragmented and smaller players are under greatest pressure. Finally, the potential boost to growth from expansion in emerging markets. A focus on chronic diseases & long term conditions - Chronic conditions such as diabetes, cardiovascular, cancer, neurodegenerative, kidney and respiratory diseases place significant burdens on society and on healthcare budgets across the globe. The long term nature of these conditions and the ongoing requirement for diagnosis and treatment means that patients can stay in the system for many years. New and innovative therapies and treatment protocols are being explored and are presenting a number of potentially lucrative opportunities for the private sector, whether in helping to streamline care pathways, providing a platform from which care can be delivered in the community or at home or in developing new technologies. This is a theme which looks likely to persist from some time to come. RECOMMENDATION MATRIX We have marginally adjusted the division of our coverage list into five categories for ease of reference. These are: Key Buys our favoured plays at the moment, all of which are on our Conviction Buy list. Positive companies which have good / improving fundamentals and where strategic direction has meaningful earnings mileage which is not adequately discounted. Oversold companies which have positive fundamentals and have been marked down unfairly or excessively on near-term macro concerns. Underperform companies which are fairly valued and there is limited scope on a 6-month view for a re-rating or earnings upside. Cautious where we feel there are fundamental risks to earnings. Key Buys IDS Synergy Positive AMS Animalcare Corin Nestor Optos Oversold Axis-Shield CareTech CVS Underperform Consort Dechra Dignity Genus Cautious Southern Cross 1133 Healthcare Sector ReportRECOMMENDATION / 12m PRICE TARGET CHANGES 12m Price Target Recommendation From To From To Adv Med Solns (A) 48 46 ADD unch Animalcare (B)(A) 125 133 HOLD ADD Axis-Shield 391 325 ADD unch CareTech (B)(A) 526 457 BUY unch Consort Medical 445 381 BUY HOLD Corin 70 67 ADD unch CVS (B)(A) 245 224 BUY unch Dechra 476 365 HOLD REDUCE Dignity New 621 New HOLD Genus New 653 New REDUCE IDS (B)(A) 842 756 BUY unch Nestor 60 63 ADD unch Optos 188 183 BUY unch Southern Cross 50 unch HOLD unch Synergy Health 737 unch BUY unch 4 1134 Healthcare Sector ReportSUB-SECTOR SUMMARIES Healthcare - Given the NHS requires meaningful efficiency savings to avoid real cuts going forward, the Healthcare Services sub-sector could see more opportunities emerge. The new Government has made an explicit commitment on patient choice and plurality of provision. We expect strong operators with lean cost structures and innovative offerings to prosper. The key risks centre around tariffs and any efforts to improve internal NHS productivity at the expense of engaging private sector providers more actively. Additionally, the ongoing role of PCTs is uncertain and there is a risk that responsibility for Out-of-Hours care will revert back to GPs, but hopefully the forthcoming White Paper will provide better clarity. Overall, investment opportunities in the UK quoted market are very limited at present, with Nestor the only play. With a number of private hospital operators mooted to be exploring an IPO option, this position could change in the next 12-18 months. Social Care - The Social Care sector is a fairly broad church. We prefer specialist and domiciliary care over elderly residential as the latter faces greater occupancy and fee rate headwinds. The overall sector will have to contend with increased fee rate pressures over the next few years and be more flexible with cost structures. Freehold backed operators are less operationally geared in this regard. Looking into FY11, we would expect winners and losers to emerge as the strong consolidate the weak and capitalise on the inevitable outsourcing opportunities. Investor sentiment towards Social Care is expected to remain muted for the rest of the year unless earnings / fee rate / occupancy trends start surprising on the upside. Since our last review the Yr1 annualised P/E of the sub-sector, after adjusting out Care UK, has fallen by 1 point to 7.8x. Medical Devices & Diagnostics - After severe curtailments to capital spending budgets in 2009, there are some tentative signs of recovery, but nothing to get too excited about just yet. We expect budgets to remain under pressure both in the UK and in the Western world given the state of public sector finances and the inexorable demand increases from an aging population. This is all relative however and we feel the sector retains its attractions for UK investors given the scale of global opportunities, high inherent margins and organic growth potential. Animal Health - The Animal Health sub-sector has retained its premium rating over the last 6m, now trading on a 12m forward P/E of 15.2x. Investors are attracted to the sector for its defensive-growth attributes, high IP-backed margins, particularly in the veterinary medicines market, decent barriers to entry and potential for consolidating a fragmented market. There has however been a slowdown in growth as some of the more discretionary purchases (such as annual vaccinations for cats and dogs) have come under pressure and footfall through veterinary surgeries has reduced. 51135 Healthcare Sector ReportCOMPANY VIEWS IN BRIEF Adv Medical Solns (A) ADD Growth at a reasonable price Share Price: 42p12m Price Target: 46pFundamental View: PositiveForecast Sensitivity: 3Market Cap: 63.6mForecast Cash/(Debt): 0.4mAMS has established a strong presence in the Advanced Woundcare market with a range of products and customers and a history of innovation. Sales of the groups existing products are growing rapidly driven by Silver Alginates and Foams in Woundcare and increasing US sales of the LiquiBand Wound Closure products. Incremental growth opportunities come from further penetration into the key US market and launching new products from the development pipeline. Animalcare (B)(A) ADD Growing veterinary medicines portfolio Share Price: 115p12m Price Target: 133pFundamental View: PositiveForecast Sensitivity: 3Market Cap: 23.1mForecast Cash/(Debt): -3.1mAnimalcare continues to deliver against both strategy and market expectations. The investment case revolves around expanding the groups portfolio of branded licensed veterinary medicines. Progress to date has been positive and we are encouraged by the new product pipeline which should help to drive medium term sales growth. Our forecasts suggest meaningful growth with EPS growth of 30% this year and 16% next. Axis-Shield ADD Confidence shaken but basic story unchanged Share Price: 268p12m Price Target: 325pFundamental View: PositiveForecast Sensitivity: 3Market Cap: 134.1mForecast Cash/(Debt): 1.1mThe fundamental story revolving around continued momentum in the Afinion roll out (were forecasting 3,500 this year, up from 2,700 in 09) is still in tact, but the first priority must be stemming the tide of forecast downgrades that has negatively impacted market sentiment. Confidence will take time to be rebuilt and much depends on launching new products from the pipeline in order to validate Afinions positioning as a genuine multi-test Point-of-Care diagnostic system. CareTech (B)(A) BUY Quality growth play Share Price: 355p12m Price Target: 457pFundamental View: PositiveForecast Sensitivity: 4Market Cap: 175.9mForecast Cash/(Debt): -81.6mCareTech ticks most of the fundamental criteria driving our stock preferences - high revenue visibility, specialist offering, a growing market and high margin characteristics. In our view its positioning high up the acuity curve across an expanded service offering should help mitigate public sector headwinds, and ultimately allow it to grow market share. It currently has c. 85m firepower to drive consolidation and we anticipate positive newsflow as the year progresses. The shares on a P/E discount to the market are undervalued, and fail to reflect the fundamental attributes of the model. 1136 Healthcare Sector ReportConsort Medical HOLD Platform established, delivery the key Share Price: 351p12m Price Target: 381pFundamental View: NeutralForecast Sensitivity: 3Market Cap: 102.1mForecast Cash/(Debt): -34.6mA newly installed management team is actively restructuring the business following a number of historical issues. With an ambition to grow the business substantially over the medium term, a number of organic and acquisitive growth opportunities have been identified. The macro picture remains challenging but stable and we are encouraged to see management being proactive in cost control. Concerns over trading at Bespak, a lack of growth and the patent expiry of Diskus-Advair means the shares are likely to remain cheap until these issues are resolved. Corin ADD On the long road to recovery Share Price: 56p12m Price Target: 67pFundamental View: NeutralForecast Sensitivity: 3Market Cap: 23.9mForecast Cash/(Debt): -4.0mNew product development is key to generating top line growth for Corin and the company is in the early stages of rolling out a range of new Hip and Knee products. The idea is to refresh a tired product portfolio and build a comprehensive offering to market to surgeons. H2 2010 will be an important period in establishing these products in the groups key markets. We are encouraged by the direction of travel and the inherent value in the shares. ADD. CVS Group (B)(A) BUY Undervalued growth play Share Price: 152p12m Price Target: 224pFundamental View: PositiveForecast Sensitivity: 3Market Cap: 85.6mForecast Cash/(Debt): -39.5mCVS is an undervalued growth play in our view. Forward looking market share analysis shows significant scope to lift profitability and augment shareholder value. Industry dynamics support the structural attractions of the veterinary market and the resilience the group has shown to date has been a key positive. We expect ongoing consolidation momentum and anticipate the recent Pet Doctors purchase to surprise on the upside. Given a 3 year EPS CAGR of 23% the shares, on an FY11 P/E of 8x, are deeply undervalued. Dechra REDUCE Waiting for the next leg Share Price: 411.5p12m Price Target: 365pFundamental View: PositiveForecast Sensitivity: 2Market Cap: 272.6mForecast Cash/(Debt): -5.5mThere is a wide spread for consensus estimates next year, but we are comfortable with our bottom of the range forecasts, believing a marked pick up in trading will be required to reach some of the higher numbers in the market. The pipeline of new drugs will not begin contributing until 2012 onwards and, in the meantime, the potential for corporate activity looks fairly high. In the absence of either, we feel the risk to consensus estimates looks to be on the downside. 71137 Healthcare Sector ReportDignity HOLD Not totally defensive, but has leverage angle Share Price: 635p12m Price Target: 621pFundamental View: PositiveForecast Sensitivity: 3Market Cap: 405.6mForecast Cash/(Debt): -242.5mWe are attracted to the dependable / secular growth profile of Dignity and the leverage angle to help augment shareholder returns. The business model on our l-f-l sales analysis, however, is not totally defensive. The key catalyst on the horizon is the real possibility of a further re-securitisation. Assuming 5.0x leverage in Jan 11, we estimate a cash return of 140p and 11% FY11 EPS accretion. In our view the shares look up with events on P/E (14x) and EV/EBITDA (9.3x) criteria. Genus REDUCE Recovery priced in Share Price: 740p12m Price Target: 653pFundamental View: PositiveForecast Sensitivity: 3Market Cap: 441.6mForecast Cash/(Debt): -94.3mGenus has attractive structural drivers, most notably rising population leading to growing global demand for meat and milk. An added attraction is the emerging market theme currently 20% EPS growth. EPS growth vs. Yr 1 P/E AMSANCRASDCTHCSRTCRGCVSGDPHDTYGNSIDHNSRSCHESYR-40%-20%0%20%40%60%80%0.0x 2.0x 4.0x 6.0x 8.0x 10.0x 12.0x 14.0x 16.0x 18.0x 20.0xNote: Optos excluded as an outlier (150% EPS growth) 151145 Healthcare Sector ReportENTERPRISE VALUE AND DEBT EV/EBITDA analysis is useful in comparing businesses with different capital structures and is more relevant where debt makes up a significant proportion of a companys Enterprise Value. Ratings on this metric again vary across our coverage universe and, whilst the average multiple to June 11 is 6.2x, there is a wide range and larger companies tend to attract more of a premium (the weighted average is 8.0x). IDS and AMS are both relatively highly rated in Yr1, but this drops rapidly in Yr2 as EBITDA growth and strong forecast cash generation feed through. CareTech is relatively highly rated on EV/EBITDA criteria but it has a very high level of freehold backing and all of its debt is long term in nature with limited financing risk. On the face of it Southern Cross looks exceptionally cheap although this does not account for the substantial lease liability the company carries. Genus on c. 10.0x looks up with events. EV/EBITDA (Annualised to June) 0.02.04.06.08.010.012.0GNS DTY CTH AMS IDH ASD DPH ANCR SYR NSR CVSG CSRT CRG OPTS SCHE11(E) 12(E)SUSTAINABILITY OF DEBT LEVELS Below, we put sector debt levels into context. Our analysis of Net Debt / EBITDA over a 2 year forecast period shows the sector is not overly stretched. Dignity and CareTech are at the top of the spectrum with 2011 ratios of c.3.0x. The bulk of the sector is trading on less than 2.5x Net Debt/EBITDA, with 5 companies forecast to be Net Cash positive next financial year. Net Debt / EBITDA 0.0x0.5x1.0x1.5x2.0x2.5x3.0x3.5xDTY CTH CVSG GNS SYR CSRT NSR ANCR CRG OPTS16 1146 Healthcare Sector ReportWe also look at FCF Yields as a proxy for debt servicing / repayment ability. From the chart below, we can see that the previously relatively indebted Nestor and Southern Cross have paid down debt rapidly over recent months thanks at least in part due to strong free cashflow. Dignity stands out as being relatively highly geared but with a modest FCF yield. Yr1 FCF Yield vs. Net Debt / EV ANCRASDCTHCSRTCRGCV SGDPHDTYGNSIDHNSROPTSSCHESYRAMS-40%-30%-20%-10%0%10%20%30%40%50%0.0% 5.0% 10.0% 15.0% 20.0% 25.0%FCF Yie ldNetDebt/EV171147 SECTOR FUNDAMENTALS Growth Rates Margins Returns Balance Sheet Strength Price Mkt Cap Sales YoY EPS YoY EBITDA EBIT ROCE ROE Net Debt / EBITDA Gearing p m Yr1 Yr2 Yr1 Yr2 Yr1 Yr2 Yr1 Yr2 Yr1 Yr2 Yr1 Yr2 Yr1 Yr2 Yr1 Yr2 Adv Med Sol 42 64 23.6% 13.3% 22.4% 24.0% 22.6% 23.9% 17.3% 19.0% 21.9% 24.3% 22.4% 23.2% n/a n/a cash cash Animalcare 115 23 7.2% 5.3% 30.7% 15.1% 17.1% 18.1% 14.5% 15.6% 10.1% 11.3% 10.1% 11.1% 0.9x 0.5x 18.5% 10.3% Axis-Shield 268 133 10.8% 11.4% -13.1% 71.9% 13.9% 17.9% 7.1% 10.5% 10.0% 16.9% 9.4% 14.8% n/a n/a cash cash CareTech 353 175 9.8% 7.8% 12.5% 8.6% 27.5% 25.0% 27.7% 25.3% 8.9% 8.8% 20.8% 16.4% 3.2x 2.9x 86.0% 74.1% Consort Medical 351 101 -4.0% 3.3% -10.9% 1.5% 22.4% 22.9% 16.1% 16.5% 5.5% 5.7% 14.3% 13.2% 1.3x 1.2x 39.0% 36.1% Corin 56 24 5.8% 4.9% 170.0% 22.6% 16.0% 16.4% 6.7% 7.5% 3.1% 3.5% 5.4% 6.1% 0.6x 0.4x 13.3% 8.7% CVS 149 84 14.1% 23.2% 19.8% 36.8% 15.6% 16.7% 13.5% 14.7% 25.1% 28.8% 8.7% 10.0% 2.9x 2.1x Dechra 412 272 5.9% 5.5% 5.1% 16.2% 7.7% 8.3% 7.0% 7.6% 19.5% 21.6% 13.7% 12.9% 0.2x cash 5.9% cash Dignity 635 406 5.0% 5.6% 9.6% 10.1% 35.5% 35.6% 30.9% 31.2% 20.1% 20.9% 51.3% 40.6% 3.5x 3.1x 437.6% 294.4% Genus 740 441 -1.1% 6.0% -3.7% 14.3% 15.2% 15.6% 14.1% 14.5% 11.9% 12.6% 9.6% 10.3% 2.2x 1.9x 50.5% 47.1% IDS 590 164 48.9% 25.5% 45.7% 47.8% 39.4% 42.5% 30.8% 35.0% 13.4% 16.9% 31.6% 39.3% 0.5x n/a 11.0% cash Nestor 53 60 7.7% 5.4% 12.3% 10.0% 7.5% 7.8% 6.7% 7.0% 8.8% 9.7% 13.0% 14.2% 1.1x 1.0x 15.6% 14.2% Optos 119 84 2.2% 5.9% 81.4% 177.1% 41.2% 40.5% 10.2% 16.2% 8.8% 19.6% 7.7% 19.4% 0.6x 0.1x 39.3% 4.8% Southern Cross 47 87 2.8% 0.3% -27.0% -21.3% 6.4% 5.4% 3.6% 2.5% 32.0% 21.9% 23.7% 13.4% n/a n/a cash cash Synergy Health 617 338 4.0% 7.0% 15.2% 12.8% 26.5% 26.5% 14.7% 15.0% 11.4% 12.8% 10.7% 11.7% 1.5x 1.0x 40.3% 32.7% 18 1148 Healthcare Sector ReportCORPORATE TRANSACTIONS Date Acquirer Target Sub Sector EV (m) EV/Sales EV/EBITDA Dec-09 Utd Health Scripswitch GP Software 50 Dec-09 Palamon ADP Dental Surgeries 136 Dec-09 Stryker Ascent Health Surgical reprocess $575 3.9x Dec-09 Smith & Nephew Nucryst Pharma Adv Woundcare 21 Jan-10 Ontario Teachers Acorn Care Child Care 150 9.4x Jan-10 Mears Supporta Domiciliary Care 40 0.7x 7.3x Jan-10 The Priory Affinity Healthcare Mental Health n/a Jan-10 Ramsay Healthcare Groupe Proclif Hospitals 138 1.1x 7.5x Jan-10 Medtronic Invatec Surgical Supplies $350 Jan-10 KKR Pets at Home Pet supplies 955 2.2x 11.6x Jan-10 Handicare Minivator Stairlifts 44 Jan-10 Danaher Genetix Diagnostic Imaging 43 1.2x 7.2x Feb-10 Bridgepoint LGC Lab Services 257 2.0x 11.2x Feb-10 Nipro Home Diagnostics In Vitro Diagnostics $220 1.7x 14.4x Feb-10 MWI Veterinary Centaur Services Vet Wholesale 29 0.2x Feb-10 Triton Ambea Residential Care 850 1.2x 9.9x Feb-10 CVS Group Pet Doctors Vet Services 12 1.0x 7.6x Mar-10 Teva Ratiopharm Generics $3,600 11.8x Mar-10 Bridgepoint Solhaga Disability Care n/a Mar-10 Avacta Reactivlab Vet Diagnostics n/a Apr-10 Bridgepoint Care UK Health Services 402 0.9x 6.4x Apr-10 Merck Millipore Lab Supplies $ 6,430 3.6x 12.7x Apr-10 Oracle Phase Forward CTO $ 685 2.8x 11.6x Apr-10 Charles River Labs WuXi Apptech CRO $1,600 5.9x Apr-10 SV Life Sciences Fulcrum Pharma CRO 12 May-10 Hg Capital Frosunda Disability Care 130 May-10 Stago Trinity (Coagulation) In Vitro Diagnostics 90 1.8x May-10 Elysian Capital IPS Specials n/a May-10 Fresenius Asian Renal Care Dialysis Care n/a Source: Company Announcements / BD Estimates 191149 Healthcare Sector ReportSelected UK Healthcare Sector deals Bridgepoint have been particularly active in the sector in the last six months, completing deals for Care UK, Solhaga and LGC for a combined c.750m+. In terms of trade buyers in the UK, Mears has acquired Supporta to significantly enhance its Care division, appointing Bernadette Walsh to oversee the combined operations. Genetix was sold to US based Danaher Corp. Consort did have a pop at Advanced Medical Solutions, although this was quickly rebuffed and Healthcare Locums has revealed it is currently in offer talks. How serious these are remains to be seen. 0.0 x5.0 x10.0 x15.0 x20.0 x25.0 x2004 2005 2006 2007 2008 2009 2010EV / LTM EBITDA DEBT / LTM EBITDAFour SeasonsWestminsterAffinityPICPrioryVoyageCastlebeckFour SeasonsHAHAllianceMedicalIDHHealthcareHomesCraegmoorThornbury CarewatchSource: Company Information / BDIB estimatesAcornThe Medical HouseClaimar CareCare UKLGCSupportaPets at Home20 1150 Healthcare Sector ReportDIARY OF EVENTS Date Stock Event 17thJune 2010 CareTech Interims 17thJune 2010 Consort Medical Prelims c.7thJuly 2010 Dechra Pre-close update c.8thJuly 2010 Animalcare Pre-close Update c.9thJuly 2010 Genus Pre-close Update w/c 12thJuly 2010 Immunodiagnostic Systems Prelims c.14thJuly 2010 CVS Group Pre-close Update c.14thJuly 2010 Synergy Health Q1 IMS c.29thJuly 2010 Dignity Interims c.30thJuly 2010 Optos Q3 IMS c.4thAugust Nestor Healthcare Interims c.10thAug 2010 Southern Cross Q3 IMS 25thAug 2010 Axis-Shield Interims 24thAug 2010 Corin Interims c.8th Sep 2010 Advanced Medical Solutions Interims Source: Company Announcements / BD Estimates 211151 Healthcare Sector ReportHEALTHCARE & THE GENERAL ELECTION With the Conservative-Lib Dem coalition now established, some difficult decisions lie ahead. The emergency budget slated for 22ndJune will give us a first indication on what the next few years are likely to have in store. Both parties agree that a full comprehensive Spending Review should be held, reporting this Autumn, following a fully consultative process involving all tiers of government and the private sector. Whilst both parties made tacit assurances that NHS funding would be protected (increasing in real terms in each year of the Parliament), the scale of the public sector deficit means any meaningful spending increases are unlikely. As such absolute savings will inevitably have to be sought given: Input cost pressures in healthcare tend to be above inflation levels in the wider economy Demand for services is forecast to continue to increase, driven by long term trends in ageing, increasing disease burden from improved survival rates and the negative health impacts from the recession David Nicholson, Chief Executive of the NHS, recently declared that “all bets are off” when it comes to preparing for 2011 and beyond. Efficiency savings of 15-20bn are crucial in maintaining provision in the face of constrained spending requirements and we are aware that many NHS and Social Care bodies are already taking action with this in mind. We set out below some of the key policies as outlined in pre-election manifestos (with Labour policies in for reference). The optimal outcome for the independent sector is in many respects the combination of the Tory pro-market bias combined with the Lib-Dem push for closer integration of Health and Social Care. Whether this is what happens is of course open to conjecture at this stage. Key Policies by Party Labour Lib-Dem Conservative Policy Initiatives Market based reforms, but with NHS as “Preferred Provider”. Doubled NHS budget from 03/04 to 2010. Introduced personalisation agenda. Abolish SHAs and replace with local commissioning groups. Locally elected health boards. Greater integration of health and social care services. Extend use of individual budgets. Pro-market orientated NHS. Increase NHS spending in real terms YoY. Separation of Commissioning & Provision to stimulate competition Social Care Creation of National Care Service. Free personal care at home for those with highest needs. Retirement levy. Personal budgets for long term conditions. Cross-party commission on social care funding. Preference for a partnership model with guaranteed minimum state contributions. Particular focus on Dementia Care. Voluntary 8k insurance scheme for Resi care and similar model for Dom care. Personal budgets for long term conditions. Primary Care Give GPs direct access to diagnostic imaging scans. Expansion of GP-led health centres and dentistry services. Incentivise GPs to work in under doctored areas. Investment in public health & prevention schemes. Renegotiation of GP contract including scrapping practice boundaries. Practice Based Commissioning, possibly with hard budgets. Nationwide network of 24hr Urgent Care Centres Secondary Care Transfer of hospital services into the community. Payments for private treatment if waiting times exceeded. Right to choose any provider (including private) at tariff. Source: Party Manifestos The new Health Secretary is Andrew Lansley. He is expected to look to gradually deepen the internal market in the NHS while managing the health service on a lean, but not shrinking budget. On appointment, he admitted the NHS will experience “real pain” achieving its efficiency saving targets. Although he confirmed overall spending on the NHS would rise in real terms. He also warned that the “substantial increase in health spending over the last decade under Labour was not sustainable for the future”. The government is now saying that it will have to go beyond the annual efficiency savings set out by Labour, which had implied savings of up to 20 billion by 2013-14. 22 1152 Healthcare Sector ReportCOALITION POLICY DOCUMENT KEY POINTS On the NHS: Guarantee of real term spending increases on healthcare Commitment to cut the cost of NHS administration by a third Strengthening of the power of GPs by enabling them to commission care on their behalf Local PCTs to commission residual services that are best undertaken at a wider level, rather than directly by GPs. Responsibility for improving public working closely with the local authority Give every patient the right to choose to register with the GP they want, without being restricted by where they live Develop a 24/7 urgent care service in every area of England, including GP out-of-hours services, and ensure every patient can access a local GP Renegotiate the GP contract and incentivise ways of improving access to primary care in disadvantaged areas Help the elderly to live at home for longer with home adaptations and community support Independent NHS board to allocate resources and provide commissioning guidelines Reform of NICE and system of value-based pricing Every patient given the power to choose any healthcare provider that meets NHS standards, within NHS prices. This includes independent, voluntary and community sector providers On Social Care: Establishment of commission on long-term care, to report within a year. A range of ideas to be considered including both a voluntary insurance scheme to protect the assets of those who go into residential care and a partnership scheme Greater integration of health and social care funding to incentivise preventative action Extend the roll-out of personal budgets and direct payments LEVEL OF PUBLIC SECTOR EXPOSURE The table below show the different sources of funding that companies in our universe have. Of these, the most exposed to NHS spending are Synergy (45%) and Nestor UK (34%). In terms of Local Authority spending, CareTech (100%), Southern Cross (79%) and Nestor (63%) all derive more than half of their annual revenues from this source. Sources of Revenue Public Private NHS L.A. Other Public Self-pay Industry Adv Med Solns 15% 85% Animalcare 80% 20% Axis-Shield 69% 31% CareTech 100% Consort Medical 34% 66% Corin 24% 48% 28% CVS Group 92% 8% Dechra 16% 84% Dignity 100% Genus 100% IDS 85% 15% Nestor 34% 63% 3% Optos 15% 85% Southern Cross 79% 21% Synergy Health 45% 20% 35% Source: BD estimates 231153 Healthcare Sector ReportA FOCUS ON - CHRONIC DISEASE & LONG TERM CONDITIONS INTRODUCTION The impact of an ageing and increasingly obese population on expected healthcare demand is well documented. The main reason why these factors are so important is not the fact that an individual is old and/or fat, but is due to the increased likelihood of developing a chronic (i.e. long term) disease. Chronic conditions such as diabetes, cardiovascular, cancer, neurodegenerative, kidney and respiratory diseases place significant burdens on society and on healthcare budgets across the globe. The long term nature of these conditions and the ongoing requirement for diagnosis and treatment means that patients can stay in the system for many years. As the population ages and becomes more obese, the incidences of these disease is rising rapidly the worldwide diabetes population for example is forecast to top 350m by 2030 from c.30m in 1985. According to Axis-Shield, the direct healthcare costs of treating diabetes range from 2.5% to 15% of annual healthcare budgets, depending on local prevalence and sophistication of treatment. SOME FACTS AND FIGURES Heart Disease Cardiovascular diseases are the number one cause of death globally with 82% of the deaths taking place in low and middle income countries. One in every four men and one in every six women die from heart disease in the UK. 38% of deaths from heart disease in women in the UK are associated with lack of physical activity, 47% are linked to high cholesterol, and 6% are caused by being overweight. More than 4 million people per year in the United States are hospitalized due to heart disease. Cancer Each year 10.9 million people are diagnosed with cancer in the world with more than 293,000 new cases in the UK. More than one in three people will develop some form of cancer during their lifetime. Lung cancer is the most common cancer in the world. Cancer Research UK estimates that the current levels of obesity in the UK could lead to around 19,000 cases of cancer each year. Diabetes The number of people diagnosed with diabetes in the UK increased from 1.4 million in 1996 to 2.6 million in 2010. This is estimated to be over 4 million by 2025. The International Diabetes Federation (IDF) estimates that in 2010 the five countries with the largest numbers of people with diabetes are India, China, the United States, Russia and Brazil. One in ten people admitted to hospital in the UK has diabetes. Can lead to other diseases if not monitored: blindness, heart disease and kidney failure. Chronic Respiratory Disease Asthma and COPD are the most common chronic respiratory diseases and kill more than four million people every year. The UK has one of the highest asthma rates of any country in the world. Asthma is the most common chronic disease in children. An estimated 210 million people have COPD worldwide. Almost 90% of COPD deaths occur in low and middle income countries. COPD is expected to become the third leading cause of death worldwide by 2020. 24 1154 Healthcare Sector ReportObesity in the United States 1990-2008 (% of population 30 BMI). 1990 1999 2008 No Data 10% 1014% 1519% 2024% 2529% 30% Source: CDC Behavioural Risk Factor Surveillance System A common factor amongst all these conditions is obesity, which is one of the fastest growing public health challenges and leads to a number of issues, increasing the risk of cardiovascular disease, cancer and type two diabetes. Currently, 65% of adults in the United States are overweight and 31% are obese. The UK has seen the fastest increase in Europe - 7% of adults were obese in 1980 increasing to 24% by 2007. The increase in childhood obesity is placing the next generation at greater risk of developing chronic diseases earlier in life. HEALTHCARE EXPENDITURE Total Healthcare spend (% GDP) Source: OECD Health Data 2009 At 16% of GDP, total U.S. health spending in 2006 was $2.1 trillion with around 75% spent on patients with one or more chronic diseases. According to the Wall Street Journal, since 1965, U.S. health spending has risen about 2.7% faster than the economy and on current trends would hit 20% of GDP within a decade. 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0United StatesFranceSwitzerlandGermanyBelguimCanadaAustriaPortugalNetherlandsDenmarkGreeceIcelandNew ZealandSwedenOECD averageNorwayItalyAustraliaSpainUnited KingdomFinlandJapanSlovakiaIrelandHungaryLuxembourgSouth KoreaCzech RepublicPolandMexicoTurkeyTotal health expenditure as a share of GDP (%)251155 Healthcare Sector ReportEMERGING TRENDS Coming at a time of financial crisis, the seemingly inexorable rise in demand for treatment could not have come at a worse time, particularly for the socialised medicine systems of Western Europe. Urgent structural reforms are therefore required to enable the NHS and other systems to cope with this demand increase within the constraints of restricted public sector spending. Various measures are therefore now on the agenda in the UK to achieve the 20bn plus efficiency savings required these are very likely (in our view) to result in increased outsourcing, a greater emphasis on community and homecare services, investment in preventative medicine / early interventions and on educating the public about the true cost of care. A report by the CBI claims that delivering more services at home and in the community could save 15 billion by 2015 by cutting unnecessary admissions. Furthermore, Dr Foster reckons delivering care at home could result in higher patient satisfaction, less risk of infection, fewer emergency admissions and improved clinical care. Example Initiatives Disease Management Programs in Germany, patients are encouraged to sign up to disease management programmes, a concept originally developed in the US. In 2009, 80% of large U.S. companies offered chronic disease management programs for workers in an effort to reduce health care costs. Companies such as Medco and Alere (part of Inverness Medical) provide programs designed to: increase compliance care plans and prescribed medications； reduce preventable utilization of healthcare services and prescription errors； improve care co-ordination and provide a support system of nurses, dieticians, pharmacists and educators who help participants proactively manage their condition. Consumer Education - There is a general lack of awareness as to the true cost of care. Patients should be exposed to the true cost of their care to avoid over consumption. If money and control was placed in the consumers hands expenditure could be managed better. This is part of the thinking behind the introduction of direct payments and individual budgets although the practice is yet to gain widespread prominence. Preventative Medicine - More than 30 organizations from across Canada are forming partnerships in a $15.5 million series of initiatives aimed at preventing chronic disease. The funded programs include: i) Harnessing electronic medical record systems and evidence based approaches to increase prevention and screening for heart disease, diabetes and cancer in participating doctors offices； ii) Tackling childhood obesity by limiting the accessibility and appeal of unhealthy food choices； iii) Working with First Nations communities in two provinces to develop chronic disease prevention training programs for community-based health workers. Home Healthcare part of the Darzi initiatives outlined last year included a commitment to take more care services out of hospital settings and into the community. By delivering services such as chemotherapy and other intravenous therapies such as for Rheumatoid Arthritis or kidney dialysis, the Department of Health estimates it can generate 2.7bn of savings, or about 2.5% of the NHS budget, over the next few years. Various schemes are underway in areas such as Birmingham East & North and in Bristol in conjunction with private sector companies like Healthcare at Home and BUPA Home Healthcare. Community Healthcare moving care out of acute general hospitals and into community-based clinics improves convenience for patients and can lead to improved innovation and access to specialist equipment. Companies such as Cancer Partners UK (radiotherapy) and Renal Services (haemodialysis) are opening community-based clinics, initially for private patients, but with the possibility of handling NHS patients in due course. Telemedicine - is another area we believe will gain increased prominence and a number of pilot programmes are underway (e.g. in Cornwall) at the moment. Technology can shorten hospital stays, lower health care costs and help patients manage their diseases. Companies such as Tunstall and Home Teleheath are providing remote monitoring and disease management services for patients with a range of long term conditions, such as diabetes and COPD. Tunstall have recently launched a new generation of long term condition management products the Integrated Care Platform. Screening and early diagnosis early identification and monitoring of long term conditions is one of the key tools in keeping treatment costs down. The increasing trend from the reactionary treatment of the symptoms of disease to a more pro-active stance in early detection and diagnosis in order to treat the underlying causes of disease requires a much higher level of diagnostic 26 1156 Healthcare Sector Reportaccuracy. Rapid testing times and reducing the requirement to send samples to off-site laboratories are key drivers underpinning growth in the Point-of-Care market. Axis-Shield (ASD.L) and Immunodiagnostic Systems (IDH.L) both offer a suite of niche diagnostic products with a range of applications for the diagnosis and monitoring of long-term conditions. Advanced Woundcare - In terms of prevalence, c.4 in every 1,000 people in the EU, will be suffering from a wound at any one point in time 2m people in absolute terms and, although many wounds can be treated with conventional bandages and gauze, more serious and persistent wounds are better served by more advanced solutions. Advanced Medical Solutions (AMS.L) provides a full range of advanced woundcare products for sale in hospitals, nursing homes and community care markets. The main indications are for chronic wounds such as venous leg ulcers and pressure sores, often cause by complications from diabetes. CONCLUSION It is clear that the increasing prevalence of patients with long term chronic diseases is placing a significant burden on already stretched resources and this increase in demand for healthcare services looks set to rise further. New and innovative therapies and treatment protocols are being explored and are presenting a number of potentially lucrative opportunities for the private sector, whether in helping to streamline care pathways, providing a platform from which care can be delivered in the community or at home or in developing new technologies. This is a theme which looks likely to persist for some time to come. 271157 Healthcare Sector ReportHEALTHCARE Given the NHS requires meaningful efficiency savings to avoid real cuts going forward, the Healthcare Services sub-sector could see more opportunities emerge. The new Government has made an explicit commitment on patient choice and plurality of provision. In the medium term, we expect strong operators with lean cost structures and innovative offerings to prosper. The key short term risks centre around tariffs and any efforts to improve internal NHS productivity at the expense of engaging private sector providers more actively. Additionally, the ongoing role of PCTs going forward is uncertain, but hopefully the forthcoming White Paper will provide better clarity. Overall, investment opportunities in the UK quoted market are very limited at present. With a number of private hospital operators mooted to be exploring the IPO option, this position could change in the next 12-18 months. MARKET SUMMARY Huge UK market worth in excess of 100bn of which c.5.5bn relates to a capital budget 80bn of the UK healthcare budget is allocated to PCTs to fund frontline healthcare provision UK healthcare spend is split: 46% Secondary Care； 25% Primary Care； 10% Elderly residential； 9.5% Mental Health and PLD； 9% Domiciliary； and 0.5% Dentistry Patient Choice remains a central theme. It is so far on offer in elective surgery via the Extended Choice Network and via the Individual Budgets initiative in social care The Darzi initiative to improve access in Primary Care in deprived areas and drive non-urgent care into community settings The National Decontamination Program has slowed OPPORTUNITIES / RISKS We expect outsourcing opportunities to be at a local level, hence individual contract sizes are likely to be relatively small Primary Care has ongoing opportunities, but there are a couple of near-term commissioning related uncertainties Divestment of PCT provider arms (community mental health, health visitors, midwifery etc.) looks to be off the agenda ISTC renewals multiple contracts coming up for renewal, mixed outcomes for private sector so far Tenders to run failing hospitals Circle estimate up to 40 More work is being carried out by private hospitals for the NHS via ECN helping counteract a drop in private elective procedures MARKET OUTLOOK The short-term picture is clouded by the macro backdrop. However, longer-term structural drivers such as rising population and increased incidence of chronic disease mean demand will continue to grow. The immediate priority facing the NHS is to generate efficiency savings to avoid real cuts and to protect “front-line services”. Savings of 20bn+ from FY11 onwards is the immediate objective. We do not anticipate the drive to make the NHS leaner to be all about staff rationalisation and curtailing back office costs. In our view the economic imperative of outsourcing services to more cost effective providers will gather pace. We also believe the initiative to move more Secondary Care into the community will remain an ongoing theme. In this respect routine check ups / drug administration, non-critical diagnosis work, to name a few, are areas of the NHS which will further migrate into community settings. We expect Secondary Care over time to become more streamlined in terms of service provision. The Extended Choice Network initiative (where private providers can put themselves forward to carry out NHS work at tariff) has been gaining traction as the public gets better educated about “choose and book” and as private providers look to fill the shortfall from a drop off in PMI work. In Primary Care, new tendering opportunities have been limited over the last few months owing to political uncertainty. Whilst we expect the tendering landscape to improve post the Election, there are two key uncertainties on the horizon - the exact role of PCTs going forward and the prospect of GP contracts being re-negotiated which could result in out-of-hours commissioning being passed back to individual practices. We also note the London polyclinic initiative has effectively been ditched. The key risks on the horizon we feel are pressure on NHS tariffs and patient volumes being curtailed, albeit population growth and incidences of rising illnesses will counter any efforts to delay treating patients. The possibility of sweating NHS assets harder to improve productivity cannot be dismissed, but we sense failing hospitals and inefficient services will not continue to be tolerated. 28 1158 Healthcare Sector ReportREAD ACROSS Nestor Healthcare (Primary Care) With Care UK taken private and Assura having sold its Primary Care services business to Virgin, Nestor is one of the very limited ways for UK investors to play the primary care outsourcing NHS theme. Nestors Primary Care division runs out-of-hours GP contracts and “Forensic” medical contracts in Prisons and for the Police. Up until 12 months ago the division had a chequered history, but the appointment of a new MD and the commencement of the Darzi Equitable Access Programme has helped revive its fortunes. To date 6 contracts worth over 5m per annum have been won, plus two dentistry contracts and the first Palliative Care contracts. At the FY09 finals in March, management cited a bid pipeline of 20m. We expect tendering opportunities to pick up following the Election and we feel Nestor is well placed to win incremental contracts although there is a clear risk that the fragmentation of the out-of-hours market will lead to further disruption in the market. Given the c.1.5m business development / tendering overhead the division is carrying, growth in the top line is imperative to increase EBIT margins from the c.6% level. Synergy Health Whilst Synergy has successfully built up an international revenue stream, the NHS related activities still account for c.35% of EBIT. This is spread across linen services, decontamination of surgical instruments and providing ancillary products of wound care and infection control. We anticipate further contract win momentum in Decontamination, and note the other main player Davis Service has had a weak start in this area. Linen is expected to continue to be run for cash with little suggestion that management are keenly focussed on driving growth. The ancillary categories are being de-sized. The key issue in relation to Synergys core NHS related activities is the risk of lower tariffs going forward. On the face of it the risk appears very minor to our mind as the price element of the contract is formulaic, based primarily on the RPI index. However, the risk of the NHS seeking contract re-negotiation cannot be dismissed. Lower patient numbers is a potential risk too but at this stage we feel it is at the margin as demographic trends and rising incidences of various illnesses will remain positive influences. On the plus side, NHS pay freezes will feed through to the TUPE related staff that Synergy employs. UK HEALTHCARE SERVICE PROVIDERS HCACare UKNuffieldCircleSpireRamsayBMI HealthcareUK Specialist HospitalsNestor (Primecare)HarmoniInHealthAlliance MedicalHealthcare at HomeBUPA Home Healthcare02468100246810Service AcuityGeographicalSpreadSource: Laing & Buisson / BD Analysis 291159 Healthcare Sector ReportSOCIAL CARE The Social Care sector is a fairly broad church. We prefer specialist and domiciliary care over elderly residential as the latter faces greater occupancy and fee rate headwinds. The overall sector will have to contend with increased fee rate pressures over the next few years and be more flexible with cost structures. Freehold backed operators are less operationally geared in this regard. Looking into FY11, we would expect winners and losers to emerge as the strong consolidate the weak and capitalise on the inevitable outsourcing opportunities. Investor sentiment towards Social Care is expected to remain muted for the rest of the year unless earnings / fee rate / occupancy trends start surprising on the upside. Since our last review the Yr1 annualised P/E of the sub-sector, after adjusting out Care UK, has fallen by 1 point to 8x. MARKET SUMMARY In the next 25 years, the over 85s are est. to triple from 1.3m in 2008 (2.2% of population) to over 3.3m by 2033. Capacity will thus need to rise significantly 16.2% of over 85s live in residential homes vs. 0.83% of 65-74 year olds The vast majority of c. 21bn Social Care spend is by LAs, split: 7bn residential； 6bn specialist； 5.1bn domiciliary care and the balance is others including child services Occupancy rates in elderly residential have fallen to their lowest in 10 years at 89%. Colliers CRE 8 yr average is 92.8% Around 55% of Social care is currently outsourced. Significant ongoing scope for further services to be outsourced All three key segments of Social care are fragmented. Top 5 players generally account for no more than 20% market share Elderly Residential 20%； Specialist 100m in annual revenues. The acquisition has also brought with it a highly regarded operational team which has significantly improved the quality of management of the combined business. Coupled with Mears bidding expertise from its Social Housing business and in house developed IT platform, this should stand it in good stead for further progression. Although a number of pilots and discussions are taking place with regard to a joined up care and repair offering, it is still at an early stage. An area to watch, although it is too early to know whether this will prove a success. (Analyst Mark Fleetwood) Southern Cross - We are cautious on the short-term prospects of Southern Cross. A near 100% leasehold model with upward only rents, average occupancy on a declining trend given the offering is not sufficiently high up the acuity curve, sub 5% EBIT margins and 1.3x fixed charge cover are key investment negatives. We concur with the 3 year strategy outlined by the new CEO Jamie Buchan. Namely, to arrest the occupancy decline and to improve the quality of earnings by lifting the private client mix from 18% currently to well over 20% and improving dementia care provision. However, the ongoing risk to earnings in the intermediate period means the shares are likely to remain lowly rated. Other than corporate action, the key catalyst would be positive dialogue with landlords to ease the rental bill until the business gets onto a firmer operational footing. However, there is nothing to suggest that this is on the agenda currently. If anything, given Southern Cross low fixed charge cover and cashflow risks, the landlords may opt to find a new tenant. Such a move could potentially eliminate earnings and the equity value. We maintain a cautious bias. UK DOMICILIARY CARE PROVIDERS ILSSLCEnaraFirst Call / Active AssistanceSevacareNestor (Social Care)Care UK Allied HealthHousing 21Mears CareCarewatchLifewaysCity & County024681012012345678910Service AcuityGeographicalSpreadSource: Laing & Buisson / BD Estimates 311161 Healthcare Sector ReportMEDICAL DEVICES & DIAGNOSTICS After severe curtailments to capital spending budgets in 2009, there are some tentative signs of recovery, but nothing to get too excited about just yet. We expect budgets to remain under pressure both in the UK and in the Western world given the state of public sector finances and the inexorable demand increases from an aging population. This is all relative however and we feel the sector retains its attractions for UK investors given the scale of global opportunities, high inherent margins and organic growth potential. MARKET SUMMARY Diverse market place covering a multitude of sectors and business models Very large market place, frequently global in nature, allows market segmentation and exploitation of niches Product innovation / differentiation is key in maintaining pricing power in what are competitive markets with a high degree of purchasers power Hence, requirement for ongoing investment R&D (often 6-10% of revenues) is crucial to driving sustainable organic top line growth and maintaining margins Reimbursement for diagnostic testing remains generally robust, providing a relatively stable backdrop OPPORTUNITIES / RISKS Balance of wealth moving east Asia likely to be a key source of growth in demand for medical devices in medium term Personalised medicine demands improved diagnostic accuracy (theranostics) and new delivery methods Key themes we have identified include a trend towards screening & early diagnosis as a means of controlling long term conditions Q1 results from the orthopaedic majors pointed to a small recovery in volumes after a relatively difficult 2009 US healthcare reform now passed with some tax and industry concessions. Additional pressures on hospital purchasing / reimbursement rates possible. Consolidation by the major global players remains an ongoing theme MARKET OUTLOOK The Diagnostics market was impacted by a relatively weak flu season over the winter and volumes in labs have been impacted by lower US hospital admissions. Longer term drivers are supportive driven by demographics, an increased focus on early diagnosis and preventive medicine and growth in developing markets. Orthopaedics markets appear to be stabilising in the US although European markets reportedly remain mixed. Metal-on-metal systems (such as Corins Cormet) remain controversial and pressured from narrowing indication ranges and negative press on possible side effects. Woundcare continues to exhibit pricing pressures driving the need for production efficiencies, either through offshoring or reconfiguring manufacturing facilities. This is offset by growth from new products such as silver dressings and NPWT. The recent decision that S&N was infringing KCIs patents was a strategic blow to the companys aspirations in this area. 32 1162 Healthcare Sector ReportREAD ACROSS Advanced Medical Solutions sales of the groups existing products are growing rapidly driven by Silver Alginates and Foams in Woundcare and increasing US sales of the LiquiBand topical Wound Closure products. Incremental growth opportunities come from further penetration into the key US market and launching new products from the development pipeline, including the InteguSeal liquid surgical drape which is awaiting publication of clinical trial data by partner Kimberly-Clark. A key area of focus for AMS R&D efforts is in the disruption of biofilms (which are believed to be a key hindrance to wound healing), where there are no current licensed products on the market. In addition, we would expect the group to deploy its cash reserves on licensing of new products and / or acquisition opportunities to enhance distribution capabilities. Axis-Shield The Q1 IMS was clearly disappointing and came after a series of currency related downgrades and increased investment that has exacerbated the operational gearing in the model. It remains to be seen whether the reported weakness in end markets is a temporary blip or symptomatic of a more prolonged squeeze on general healthcare spending. If the former, then this could be a good buying opportunity and investors should not lose sight of the growth being generated from the increase in the Afinion installed base. Nevertheless, the 25-30% downgrades we put through were of a more fundamental nature i.e. end market weakness rather than currency / investment for growth than those we had seen earlier and signs of a stabilisation in the trading outlook will be required before the shares warrant any positive momentum. The shares could also be vulnerable to a 3rd party approach. Consort Medical in the Q3 IMS, trading was reported to have recovered in Bespak in H2 with new and increased sales of valves and devices. Stock build orders have been received for the Dr Reddys auto-injector device (inherited from The Medical House) expected to gain FDA approval in mid-2010. King Systems has however had a tougher H2 due to disruption from the manufacturing reconfiguration and the severe winter in the mid-West USA. Output is reported to have returned to normal although turnover is now expected to be flat YoY (we were looking for +4% CER). Management is gradually opening up on the pipeline of new opportunities for Bespak, which should start contributing from H2 of this year, generating much needed top line growth. Ten projects have been explicitly identified, ranging from MDI valve innovations to new DPI programmes and autoinjectors. Other future potential opportunities identified involve capturing more of the device manufacturing value chain (such as drug handling/filling) and establishing a new R&D innovation centre in Cambridge. Corin Corins IMS was largely as expected and painted a relatively mixed picture on trading, with Australia in particular showing continued strength behind the LARS artificial ligament. The German market reportedly remains tough, with Corins relatively old product portfolio coming under pressure. In the UK, sales of Cormet, the groups resurfacing device, remain under pressure as the debate rages over concerns on metal-on-metal systems generally. This pressure is unlikely to ease in the short term. Pricing pressures exist generally in the industry, but we understand that these are in line with management expectations. New products are therefore the key to growth and Corin remains in the early stages of rolling out its new cementless hip portfolio, comprising the Trinity cup, the Metafix cementless stem and the Minihip. A fifth generation knee system is scheduled for launch next year. H2 will be important in establishing these products in the groups key markets. IDS The FY pre-close update confirmed that strong trading has continued, particularly for the groups lead Vitamin D products. Revenue growth for FY10 will be c.49%. 47 iSYS machines were placed in H2 bringing the total to 74 for the year. The 510k process is taking longer than anticipated as approval timescales from the FDA have lengthened over the past 18 months to 6-12 months from the time of application. The iSYS application has now been under consideration for 6 months and, although there is no reason to suggest approval will not be granted, the visibility over timing remains limited. We are however very encouraged to see that revenues per machine continue to be well ahead of expectations. Three additional tests for the iSYS were launched at the end of March (bringing the total menu to six), which should support further growth and additional product launches are expected throughout the year. Optos Recent Interims showed progress and resilience PBT of $1.8m was towards the upper range of what we were expecting and left the group on track to hit our FY10 estimate of $5.6m, assuming a return to growth in US PPP revenues in H2. Average monthly optomaps per site were 109 (H109: 102), generating average monthly revenues per site of $2,099 (H109: $2,032). Whilst the optomap procedure remains largely a discretionary consumer decision, there remains an element of uncertainty over the outlook. In the meantime, management are working to: i) establish the procedures clinical credentials； ii) introduce more flexibility into the revenue model； iii) develop ancillary services such as data storage； and iv) introduce a low cost device for use in emerging markets and smaller practices. 331163 Healthcare Sector ReportANIMAL HEALTH The Animal Health sub-sector has retained its premium rating over the last 6m, now trading on a 12m forward P/E of 15.2x. Investors are attracted to the sector for its defensive-growth attributes, high IP-backed margins, particularly in the veterinary medicines market, decent barriers to entry and potential for consolidating a fragmented market and positive structural growth dynamics. There has however been a slowdown in growth as some of the more discretionary purchases (such as annual vaccinations for cats and dogs) have come under pressure and footfall through veterinary surgeries has reduced. MARKET SUMMARY The animal healthcare market is essentially split into two categories livestock and companion animals Each is exposed to different dynamics the livestock sector to the agricultural market and companion animals more consumer oriented The UK market is worth c. 1.6bn, split c.1.0bn veterinary services and 0.6m+ veterinary medicines The veterinary services market in the UK remains hugely fragmented. Market leader CVS has a c.8% market share. The wholesale market is dominated by 3 players, with Dechras NVS commanding over 40% Services typically operate on a cash-and-carry basis, leading to negative working capital. Pet insurance market is growing Sophisticated food demand is leading to farming practices becoming more commercialised both in the western world and particularly in emerging markets OPPORTUNITIES / RISKS The market for veterinary medicine has opened up in recent years, as large numbers of proprietary drugs have come off patent Registration of animal medication in Europe has been simplified post the introduction of the Mutual Recognition Process (2004) The global livestock market is well positioned to benefit from local agricultural trends and market dynamics for food consumption The companion animal market, notwithstanding short-term macro pressures, continues to have favourable growth drivers rising pet ownership and life expectancy and an increasing propensity to spend by pet owners The application of human healthcare practices / technologies to animal health offers opportunities to sell higher margin products & services In veterinary medicines, the commoditised vaccines and anti-parasitics end of the market is dominated by a few global players. There are however a number of niche value-added opportunities for smaller players MARKET OUTLOOK Veterinary Medicines In 1986, around 70% of animal medicines were used in farm livestock. Now over half animal medicine sales, by value, are for companion animal use. This earlier swing towards companion animal medicine, which now appears to have halted, was due in part to the depressed state of UK livestock production, with some farmers having less money to invest in their livestock, and there being fewer livestock for them to invest in, although sales of preventive medicines such as vaccines have picked up. The swing was also due to new product development in the companion animal sector, a trend we expect to continue. Companion Animal market Like-for-like volumes in the UK have slowed in the last 6 months after the heavy snow restricted visits to vets and on some slowdown at the more discretionary end of the market. A similar picture is evident in the US, market leader VCA Antech reported continuing declines in its like-for-like sales in Q1, blaming softness in consumer demand and the weather. Volumes were down close to 5% although pricing inflation of +3.3% was a mitigating factor. The outlook is for a flat / slightly positive Q2 on easier comps. Veterinary diagnostics however remains firmly in growth mode - Labs operator IDEXX reported organic growth of close to 10% in Q1. Agricultural market The market is cyclical and can suffer adversely from farmers trading down and/or de-stocking at times of weaker demand and downturns in soft commodity pricing. At the Feb 10 interims Genus indicated that a degree of confidence was returning and there has been an uptick, particularly for milk and hog pricing, where supply remains tight. Animalcares Ritchey business also suffered from a weak H1 although trading has picked up since the turn of the year. 34 1164 Healthcare Sector ReportREAD ACROSS Animalcare Group The group is exposed to two key market drivers: growth in veterinary medicines for companion animals and regulatory requirements in the livestock market. The recent trading update provided reassuring commentary on trading for the first 9 months of the year. We understand the agricultural related activities, after a weak H1, have seen a noticeable pick up in trading in March and the order book for April is strong. The growth in branded, licensed Veterinary Medicines remains the key growth driver for the group and recent progress has been impressive. With the management team now free from the constraints imposed under previous ownership, the new product development pipeline is now delivering eye-catching growth in revenues and profits. CVS Group CVS is a pure play veterinary services business exclusively focussed on companion animals. With a clear remit to consolidate, it is comfortably the UK market leader with c.8% of UK veterinary surgeries. The recent deal for Pet Doctors further reinforced this position and was an important strategic move for the group, adding 27 surgeries (c.1% market share) and a diagnostic lab. It also removed a possible rival platform for consolidation we are aware of several Private Equity groups keen to gain a foothold in this market. The recent update on current trading suggests that whilst underlying l-f-l sales remain positive, the sales momentum in H2 has not been sufficiently strong to offset the loss of income following exceptional weather conditions at the start of the period. Moreover, with bolt-ons more H2 skewed than previous years, the full year outcome is anticipated to fall slightly short of previous expectations. The subsequent 2 point P/E de-rating for FY11 to c.8x in our view is overdone and the stock offers excellent value on fundamentals. Dechra Dechras IMS did nothing to change our opinion on the stock and we see little in the way of short term organic catalysts to justify the shares moving on from these levels. Management report a return of some volume growth across the board with February particularly strong although we believe new account wins are helping support this figure. European Pharma growth of 6.3% is as expected. We expect operating margins to creep up towards 30% over time, particularly as the rights to Vetoryl and Felimazole revert from the 3rd party distributors and as new products are introduced. The US operations, whilst gaining traction, are behind our expectations. There is a wide spread for consensus estimates next year, but we are comfortable with our bottom of the range forecasts and believe a marked pick up in trading will be required to reach some of the higher numbers in the market. The pipeline of new drugs will not begin contributing until 2012 onwards and, in the meantime, the potential for corporate activity looks fairly high. In the absence of either, we feel the risk to consensus estimates looks to be on the downside. In this context, we feel the shares are up with events for now. Genus Near term, much revolves around the pace of recovery in consumer demand across its two key territories of the USA (48% EBIT) and Europe (28% EBIT). Ultimately, demand for Genus products is correlated to the fortunes of farmers who rely on high livestock / milk prices to be profitable. To this end, Genus recent H2 update (4 months) cited that an improvement in hog prices had filtered through to increased demand for its porcine offering in the US, Europe and Latin America. Bovine related activities, however, remain mixed owing to limited recovery in milk prices. Overall, management anticipate progressive sales recovery and are targeting 12-15% EBIT growth from FY11 onwards. 351165 1Adv Medical Solutions (A) Health Care Equipment & Services ADD Share Price: 41.5p12m Price Target: 46pUpside: 11%Fundamental View: PositiveForecast Sensitivity: 3Shares in Issue: 153.4mMarket Cap: 63.6mForecast Cash/(Debt): 0.4mEnterprise Value: 63.2mGrowth at a reasonable price Investment Positives 9 Niche focus in Advanced Woundcare & Wound Closure 9 Sustained track record of revenue growth 9 Strong balance sheet & cash generation 9 Potential for corporate activity Investment Negatives 8 High customer purchasing power 8 Site move increases operational gearing 8 Previous M&A setback Our view - Advanced Medical Solutions designs, develops and manufactures arange of innovative products for the Advanced Woundcare and Wound Closuremarkets. This is an attractive and growing market in which AMS has established a strong presence with a range of products and customers and a history of innovation. Growth prospects, particularly in the US, are attractive and could provide meaningful upside. The advanced woundcare market is large ($12bn p.a.) and growing (in the mid-high single digits). Drivers include steady volume growth, backed by ageingdemographics and the increasing prevalence of chronic wounds requiringsophisticated treatments, product innovation and healthcare economics requiringcost effective solutions. Product lifecycles are typically long, supporting attractive margins and strong cash ge