RHC

Ramsay, the large private hospital operator, has been on the acquisition warpath for some time.

They had a tilt at Spire, and couldn’t quite get the deal over the line. This time, Elysium.

We are in an environment of record low real rates, and high equity prices.

Now is absolutely the time to use the balance sheet strength, use scrip, use whatever you can, as long as you can lock it in, to get big.

Now, the history of M&A is such that most deals don’t ever hit the target IRR, let alone the post synergy estimate.

But for many companies, the WACC is just not that high a hurdle. There’s a lot of room between the number you hit, and zero (the real funding cost on the debt side).

As such, we are pleased to see the efforts to grow inorganically.

As a follow up observation, about equities and our process more generally, consider the below slide.

It is effectively laying out the RHC “competitive advantage”. And that, many analysts would say (including us) is the reason to own such a stock, in one’s portfolio.

But why exactly?

Well, it should contribute to one’s SAA. There is an equity risk premium, embedded in stocks, and the ability to grow earnings means that the stock should generate capital gains and pay dividends and help you hit the overall SAA objective. If you can find a stock that can do those things, but doesn’t really have much of a propensity or probability to suddenly go bankrupt, than you can sleep at night, and make (some) money.

That’s 95% of what we are trying to do.

Okay, good, what else. Well, within equities, we are also trying to beat the benchmark. That means, RHC needs to either grow faster than the market expects, or, have an earnings multiple that turns out to be higher than the market expects.

How precisely this happens is a mystery, including to fund managers, most whom aren’t aware that that’s how the mechanism has to work.

Perhaps it is that people systematically underpay for those competitive advantages (the multiple bit). Perhaps people underestimate just how all of those competitive advantages lead to earnings strength.

Imagine a government putting out a tender (it doesn’t really matter how the example unfolds, just go with this one). The government has a choice between two operators, company a) which is known for clinical best practice, and, is known for providing genuinely good care.

The other, company b) is known as a ruthlessly good cost controlling operator, priced to match.

Well, perhaps that current crop of government officials cares more about the former than the latter, and overly favours (allocates) based on the perceived community feedback, and does this year after year.

And now company a) has grown quicker than you might otherwise have expected.

A fund manager couldn’t know this ahead of time, based on one example, but if it keeps happening, might twig that there’s something in the competitive mix (which we outlined above) that generates the surprise.

And that leads to outperformance, which leads to alpha, and everyone is happy [except perhaps company b)].

Those observations about the patient care. Most things, eventually, collapse back to some kind of net promoter score. We all have a “voice of the customer” metric, somewhere, in our KPI’s, explicitly or otherwise, and hospitals are no different. If your customers are telling you your product is good, you will likely get paid, and the person doing the paying will likely be happy to keep doing so.

Why write any of this. Well, because it helps to be clear on what’s the mechanism.

Our industry has too much handwaving about how the supposed magic is meant to happen.