Capitol Health Ltd (“CAJ”) – Healthcare upside!

[steve fleming]

I've had a 5 minute read of the half year financial statements. The biggest thing that stands out is that this company is pretty tight on cash...big working capital deficit.

There's approximately $8m of expense for the 6 months (excluding employee entitlements and depreciation), $4.5m of this is sitting in trade and other payables! Positive operating cash flow is easily achieved if you don't pay your creditors.

????

I think you have drawn completely the wrong analysis from your 5 min read, sorry!

The beauty about CAJ's business model is it is actually self-funding - the medicare rebate which accounts for over 90% of revenues is processed and paid almost immediately, (thus very little debtors) while trade payables consist pretty much of rent and accrued annual leave. Therefore, it is very unusual in that debtor balances are always going to be very small relative to creditors, giving the appearance of a working cap deficit.

Trade payables have only increased $700k over the previous period, ( and a portion of this will be accrued annual leave), which is hardly very material given you have operating cash outflows of $18m. They will get kicked out of their premises if they don't pay their rent, so, realistically, i don't think what you are suggesting is really happening.

[Corporate]

Are you sure?

Employee leave will be accrued as part of employee entitlements, not trade and other payables.

Occupancy expense was $1.3m for the 6 months ending 31 December 2010. A large part of this will be rent, of which I'd expect most to be paid in advance rather than in arrears.

Therefore very little of the $4.8m trade and other payables is likely to be rent, and none of it accrued annual leave.

I accept your point about the medicare rebate, which indicates that there is very little risk around the recovery of debtors.

I'm not suggesting that you can't, or won't make money out of this stock. I just suggest that caution could be warranted as cash looks tight.

????

I think you have drawn completely the wrong analysis from your 5 min read, sorry!

The beauty about CAJ's business model is it is actually self-funding - the medicare rebate which accounts for over 90% of revenues is processed and paid almost immediately, (thus very little debtors) while trade payables consist pretty much of rent and accrued annual leave. Therefore, it is very unusual in that debtor balances are always going to be very small relative to creditors, giving the appearance of a working cap deficit.

Trade payables have only increased $700k over the previous period, ( and a portion of this will be accrued annual leave), which is hardly very material given you have operating cash outflows of $18m. They will get kicked out of their premises if they don't pay their rent, so, realistically, i don't think what you are suggesting is really happening.

[steve fleming]

Are you sure?

Employee leave will be accrued as part of employee entitlements, not trade and other payables.

Occupancy expense was $1.3m for the 6 months ending 31 December 2010. A large part of this will be rent, of which I'd expect most to be paid in advance rather than in arrears.

Therefore very little of the $4.8m trade and other payables is likely to be rent, and none of it accrued annual leave.

I accept your point about the medicare rebate, which indicates that there is very little risk around the recovery of debtors.

I'm not suggesting that you can't, or won't make money out of this stock. I just suggest that caution could be warranted as cash looks tight.

I understood that annual leave is now to be classified as part of trade and payables while only long service leave is classified as an "employee provision"?...i forget the reason why, but thats how i understood classification of employee entitlements should be ( and in the FY10 Annual Report annual leave is definitely classified as part of trade and payables).

Anyway, lets agree to disagree - CAJ is pretty much a cash business (ie collect medicare rebates on providing service and pay out staff costs every week or fortnight....Working capital analysis is not as relevant as you are dealing with very minimal debtors and only odds and ends creditors (as by far their biggest expense (approx 2/3rds are wages).

To me, to acheive operating cash flow of $2.8m for the half (or $1.8m after capex) for a market cap of $12m they are doing OK!

[Entrep]

Was it someone from here who put their sell on the options from 1c to 0.9c and now down to 0.8c all today?

[steve fleming]

Was it someone from here who put their sell on the options from 1c to 0.9c and now down to 0.8c all today?

Well it definitelty wasn't me!! I was the buyer of that crossed 500k this afternoon....don't know who the other party selling was.

Puts me in the top 4 CAJO holders now

[Entrep]

Picked up some CAJO today. Hoping for a repeat of the performance and resilience of PGCOA.

[buns]

Nice timing - up bigtime today

3 Major clinics, and 2 small ones from local competitors IM Medical (ASX:IMI)

Some rough calcs, has this looking another good buy:

Cash $600k (payable overtime based on performance – this should be payable from retained earnings)
Shares $1.8m (45m of shares, 13% ownership/strong dilution/Knowledgeable industry investors..)

Total Consideration $2.4m

Revenue
FY11 guidance was $41m, and all signs point to CAJ exceeding this easily. Assuming $45m (conservative) for FY12 that is $6.75m from IMI.

Using a 20% gross margin, and no selling/support costs I get an EBITDA of about $1.3m.

More dirt to dig on this one though – IMI only bought this business a year ago…

[steve fleming]

Nice timing - up bigtime today

3 Major clinics, and 2 small ones from local competitors IM Medical (ASX:IMI)

Some rough calcs, has this looking another good buy:

Cash $600k (payable overtime based on performance – this should be payable from retained earnings)
Shares $1.8m (45m of shares, 13% ownership/strong dilution/Knowledgeable industry investors..)

Total Consideration $2.4m

Revenue
FY11 guidance was $41m, and all signs point to CAJ exceeding this easily. Assuming $45m (conservative) for FY12 that is $6.75m from IMI.

Using a 20% gross margin, and no selling/support costs I get an EBITDA of about $1.3m.

More dirt to dig on this one though – IMI only bought this business a year ago…

Buns, I agree that financially and strategically this acquisition makes a lot of sense.

I don't think your numbers are unreasonable, which implies a very low EBITDA acquisition mutiple and therefore significantly earnings accretive for CAJ.

What i find strange is the structuring of the transaction.

Why would CAJ want IMI as their major shareholder?? IMI is in big financial trouble and has long been considered one of the biggest dogs on the ASX.

Hopefully the shares are escrowed, otherwise the potential is for significant overhang and risk that IMI offloads to get cash.

I don't know why CAJ just didn't cash fund the purcashe - $1.8m could very easily be met from cash reserves or borrowings.....

little bit strange...will be interesting to get some explanation from the directors as to their reasoning for offering shares....

[buns]

True true

I quicky scanned IMI and realised they were a dog, thinking this is the only reason we could have got these clinics so cheap. But never thought of IMI selling out quickly to generate cash...

$1.8m is quite a bit to CAJ, it could choke their on going buying of clinics. Maybe they are closing in on something else in the short term?

With an ownership this high, I would expect someone from IMI to join the CAJ board. IMI have been in this business for a bit, and with these clinics being small operations possibly CAJ could prosper from if IMI's relationships, and in turn helping to buy more clinics.

Please share your response Flemo

[steve fleming]

True true

I quicky scanned IMI and realised they were a dog, thinking this is the only reason we could have got these clinics so cheap. But never thought of IMI selling out quickly to generate cash...

$1.8m is quite a bit to CAJ, it could choke their on going buying of clinics. Maybe they are closing in on something else in the short term?

With an ownership this high, I would expect someone from IMI to join the CAJ board. IMI have been in this business for a bit, and with these clinics being small operations possibly CAJ could prosper from if IMI's relationships, and in turn helping to buy more clinics.

Please share your response Flemo

Hi Buns,

I think Mark Scott, IMI director, and the founder of the IMI radiology group, looks like a logical appointment to the CAJ board, given his experience in the radiology industry.

He originally sold the imaging business to IMI for $3.3m so on that basis CAJ have now picked it up cheaply. IMI is, i would imagine is a distressed seller, while I-med, another logical buyer, and PE backed player is also over-leveraged and is having financial problems. So CAJ would be in a strong bargaining position. It may also be the case that CAJ bid for the Mar Scott Group assets at the time IMI purchased them, so now have the opportunity to pick them up cheaper.


Mark Scott is the largest shareholder in IMI, so he might be of the view that CAJ represents a strong long term investment and therefore is a worthwhile hold for IMI. IMI are currently undertaking a capital raise so that should alleviate any cash issues.