Thursday 4th April 2019
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The former dissident Abano Healthcare shareholders are probably crowing about now, saying, see, we were right.
The news is certainly bad: last week, the company said annual net profit will fall 12.6 percent amid “challenging” conditions in Australia and that it has therefore halted its purchases of new dental practices across the Tasman.
Craigs Investment Partners analyst Stephen Ridgewell says it was more the decision to cease growing practice numbers in Australia than the downgrade that caused such a reaction in the share price – the company does intend to continue to buy practices in New Zealand.
The shares have fallen as low as $3.85 from $5.75 the day before the downgrade and are way less than half the record at $10.20 in December 2017 during dissidents Peter and Anya Hutson and James Reeve’s $9.84 per share partial takeover bid.
The Hutsons and Reeves had argued when they launched their offer in September 2017 that Abano should stop buying practices altogether, claiming the company’s strategy of building scale by acquisition had been “value destructive for shareholders” and that the company was underperforming financially.
Then, Abano had 196 practices, 92 of them in Australia, and it has 239 now, 116 of them in Australia, making it the largest Australasian corporate dental group by practice numbers, although probably not by revenue.
It raised $35 million from a rights issue in 2017 to fund that expansion and its gearing is now on the high side at 45.6 percent, suggesting the decision to cease buying Australian practices reflects its now capital-constrained position.
But saying the Hutsons and Reeves were right requires a considerable re-writing of history: less than 3 percent of Abano’s shareholders could be persuaded to accept the Hutson/Reeves view and their takeover offer.
Unlike Hutson and Reeves supporters, Ridgewell isn’t rewriting history now when he says the dissidents had the correct diagnosis back then but were offering the wrong cure.
In December 2016, he wrote that Abano’s performance in Australia had been disappointing but that he expected the company’s strategy would deliver higher returns than under the Hutson/Reeves plan.
Except that hasn’t happened. “Abano has maintained its long-term track record of disappointments,” Ridgewell writes in his latest note.
Abano has been spending about $40 million a year on acquisitions and that, in theory, should have meant spreading overhead costs over a growing number of practices and reducing costs on a per-practice level.
Instead, overheads have continued to grow while same-store sales in Australia have gone backwards and on a compounding basis.
The latest advice that same-store sales in Australia in the nine months ended February were down 1.6 percent follows falling sales every half year since the first half of 2016, with the sole exception of the second half of 2018, the six months ended May of that year, when sales were flat.
Back in 2015, same-store sales in Australia were flat after 4.7 percent growth in the second half of 2014 but an 8 percent same-store sales fall in the first half of that year. Across full years, Abano hasn’t achieved same-store sales growth in Australia since 2012.
That’s almost completely at odds with Abano’s experience in New Zealand – same-store sales in this country in the latest nine months were up 1.8 percent, an improvement on the first-half’s 1.6 percent growth and on top of 3.3 percent growth the previous year.
Chief executive Richard Keys says the New Zealand experience of increasing margins consistently between 2011 and 2018 demonstrates Abano’s strategy can work.
Precisely why the experience in Australia has been so bad is difficult to understand and is probably due to a whole raft of reasons.
One of them, certainly, is that Abano is still only about 70 percent through the process of rebranding its Australian practices as Maven while in New Zealand it has been promoting the Lumino brand since 2011 and was the first dental brand to advertise on television.
Another reason is the changing demographics of the dental industry. Many of the practices Abano is buying are from baby boomers with retirement on their minds.
The reason why so many baby boomer dentists are selling their businesses to corporates such as Abano is because so many younger dentists are women who don’t usually want to invest large sums into small businesses, tending to prioritise their families and investment in their own homes.
Forsyth Barr analyst Chelsea Leadbetter notes that a higher number than usual of senior dentists retired in the three months ended February in Australia and were replaced by lower-earning juniors, contributing to the weakness in that quarter – the sales decline accelerated from 1.2 percent in the first half.
And then there are macro-economic explanations such as the mining bust, which hit when Abano’s Australian presence was mostly in Queensland and Northern New South Wales, and now the general malaise the Australian economy is suffering with house prices falling sharply in Sydney and Melbourne.
But the opportunity in Australia is so much greater in New Zealand – last year, Abano estimated Australia’s dental market had A$9.4 billion in revenue from about 8,000 practices compared with New Zealand’s NZ$800 million, and that it had about 15 percent of the New Zealand market but less than 2 percent of the Australian market.
Plenty of other people have seen the potential too, ranging from British-based multi-national Bupa, which probably has the largest dental network in Australia by revenue, to private equity firms such as Crescent Capital – its National Dental Care chain’s website shows 60 practices. Crescent ignored a request for comment for this story.
There are a number of other privately-owned aggregators too such as Melbourne-based Ekera Dental with about 20 practices.
And then there are the listed rivals, 1300 Smiles with 35 practices, most of them in Queensland, Pacific Smiles with 82 and Smiles Inclusive, a company floated on ASX last year by a former Abano employee, Mike Timoney, who sold Abano the beginnings of its Australian dental business in mid-2008 and was later sacked.
Increased competition and rising prices for Australian practices, with ebitda multiples rising from 3-4 times, as in New Zealand, to 5-6 times, is one of the reasons Abano gave for pausing its Australian strategy.
Smiles Inclusive, a roll-up of 52 practices, has turned into a disaster zone with its former chair David Herlihy and Timoney at odds with the board and waging a battle for control, projected profits turning to losses and its share price tanking from A$1.16 to 18 cents.
1300 Smiles’ share price is flat. Although it has been reporting rising sales, it has been buying practices, including three in March, but it doesn’t report same-store sales.
Since it bought nine practices in the year ended June, the 3.9 percent rise in revenue it reported in the six months ended December most likely was only positive because of those purchases – the business was disrupted by flooding in Townsville where it has seven practices.
Pacific Smiles has a completely different business model from the “roll-up” model of buying existing practices in that it has created each of its practices from scratch, which makes a comparison of its sales growth – up 18.5 percent in the six months ended December – spurious.
A better guide to how it’s faring is what’s been happening to its profit margins since it listed in 2014 and they have declined from 15.1 percent of patient fees to 12.2 percent in the latest six months.
Its shares are also down more than 30 percent in the last 12 months, mirroring the decline of Abano’s shares until its profit downgrade.
So it’s clear there’s more going on in Australia than Abano simply executing its roll-up strategy poorly.
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