Abano Healthcare Group completed the sale of its Eldercare business to Macquarie Bank for $63.5 million, realising a $10.5 million profit on book value. The business has never earned its cost of capital since it was floated in 1999 by entrepreneur Eric Watson through a backdoor listing. Abano is returning $10 million to shareholders, leaving it with no debt and $29 million in cash. It will buy 70% of Bay Audiology for $21 million with settlement expected in early October.
Sharechat: Were you surprised at the interest in Eldercare and at the price you managed to achieve?
Abano managing director Alan Clarke: We're very happy with the outcome. We've made a capital profit, which is always a good thing.
SC: But you had previously written its value down?
AC: We had written it down from the original investment. If we had kept the original values indicated - I haven't done that exercise - there would still be a capital profit, but a much smaller one. We were happy with the price we achieved in the environment today. There were a number of interested parties both from New Zealand and offshore. There was a very careful process that we went through using Clavell. We had a number of parties we took initially through an information memorandum. Then we took a number of parties though a due diligence process. From that we selected a small group to do further due diligence and we then invited Macquarie to do further limited due dilligence. It's a pretty frustrating area. You need a very low cost of capital and a very long view and you've got to get economies of scale. From Abano's point of view, the investment needed would have been enormous. We simply couldn't get there. Someone like Macquarie Bank with its massive infrastructure investment, they've identified aged care in Canada, Australia and New Zealand as being essential community services and they clearly have a fund with a very long view.
SC: Will you still have cash on the balance sheet after the Bay Audiology purchase? What will you do with it?
AC: Yes. We will most definitely. There was about $33 million in debt that's come out. We got $63.6 million and we indicated there's around $29 million in cash. We've announced we're going to return $10 million to shareholders through an off-market pro rata share buy back and we've indicated the planned investment in Bay Audiology of $21 million. There's still acres of balance sheet capacity left in the business. (Chairman) Jim Syme said before we started this process that we need to understand we're not going to have a lazy balance sheet, we're going to have an efficient balance sheet. We're going to be looking for debt funds. At the moment, we have excess cash sitting there. When we've completed the Bay transaction, and we've indicated there's another couple of investments, we will have a small debt position. We will review that, probably at the start of next year, April or May. There are a number of attractive investments we're looking at. In the 2007 year, we would be looking to have debt on the balance sheet. Equity funds are expensive.
SC: What was the attraction of the audiology business?
AC: It's a medical area that has grown over the last 20/25 years. It's only recently been recognised as a medical and healthcare discipline. Basically, it's people who suffer from hearing disorders either through trauma or its congenital or through getting old and losing your hearing. There's a correlation between age and hearing loss so New Zealand is suffering greater and greater hearing loss. For Abano, it's very attractive because 50% of the revenue of the company is private payment. That means from Abano's point of view that we're de-risking ourselves from that reliance on district health board (DHB) and government contracts which we think is very important. The balance of revenues with audiology come from the DHBs and ACC. It's the private sector component that we see as being very significant. We were specially attracted to the company because of Peter Hutson, Anya Andrews and Scott Wright, the three principals. These people have created a fantastic national chain of clinics and in the process they've put together a very strong group a very strong group of audiologists who are all strongly aligned with what they want to do. It's the kind of investment I believe Abano can add significant value to. We've created a clinical partnership and can help them expand and extend the service from where they've taken it to currently. We see other opportunities within the radiology environment. The attraction there is there's a significant component of private payment. For example
SC: What was the attraction of the radiology business?
AC: Our initial investment with Ascot Radiology is 40% and we have a put/call option that will take us to 80% in2007. We see other opportunities within the radiology environment. The attraction there is that there's a significant component of private payment. There's a small component of ACC and almost no DHBs. Again, we're looking to position Abano in the private services area. Radiology services are as large as pathology in New Zealand. The big difference is that they're largely privately funded rather than publicly funded.
SC: You seem to be able to find plenty of acquisition opportunities. Is there any particular reason for that?
AM: These opportunities have always been there. When we started to talk in 2000, we indicated thatwe were looking to diversify into the wider medical sector, I had said to people there are a number of opportunities with businesses of significant scale that would welcome the input of a specialist medical services investor like Abano. It isn't that there are suddenly a number of businesses available. Five years ago, Bay Audiology was significantly smaller. It's gained a momentum that makes it attractive for us to acquire. These businesses and many more are there and are available. From our side, we make sure we find businesses that are attractive in terms of investment for a public company and it's very important that we can create that clinical partnership with the current owners of the business, not break the back of what's made them a very special business. Within the medical professions there are two distinct groups. There's a group that are very dedicated clinicians and doctors and we need those people and we need an environment where they feel that they're valued and that they're operating at the development edge of their field. Within that group, there's a smaller group of people who create the businesses, who have the vision to create interesting large national businesses. That's very much our model. We have a clinical partnership model now with Bay Audiology and with Ascot Radiology. We're developing a clinical partnership with our emerging dental businesses. We will hold majority holdings in these companies but we will make sure that the clinicians who've created them and provide the drive will have equity as partners with us.
SC: Are you likely to widen the range of the company's activities further or do you plan to build on the existing assets or both?
AC: Yes. That will certainly be on our radar. Why don't we simply limit it to the footprints we've got? We want to make sure we have a diversified portfolio. The New Zealand condition is such that Idon't really believe there's a risk element. There's always a scale element. You can't just sit inone sector of the medical services market. Abano is clearly developing into a specialist investor and operator of healthcare and medical services businesses. We're not just a mono product business like aged care or radiology or pathology. It's very important to have a partnership with the clinicians. We have input through the board structure and, where necessary, through the management structure.
SC: Why did you change the dental group's brand? Hadn't you already invested a lot in the Geddes brand?
AC: When we looked at the dental sector, we basically had two choices for entry. The first was to find a suitable business of clinical dentists to head up a group and have a greenfields start. But we came across the Geddes group. They had the advantage of the element of scale. Keith Pine, the original founder had put together a number of dental surgeries, he had I think 11 branches around the Auckland region. Those branches had common livery, he had fitted them out in similar colours and had marketed the Geddes brand. Geddess was a dental laboratory that made false teeth and it had been in Auckland for many, many years. It had a jingle on radio in Auckland going back to the early 1940s and 1950s, a tune to Clementine. A lot of clients were familiar with it. The elements were there for us to build on that brand. Over the last 18 to 24 months we invested a great deal in software systems, Software of Excellence, we invested in systems and structures. We also spent a lot of time through focus groups and management groups looking at how the Geddes brand was viewed by the patients and, very importantly, by dentists in our group and dentists in the community. What we found was that the Geddes name was recognised by the patients and received positively. But we found that it wasn't well received by dentists. They didn't like the connection with the dental laboratory. We had to make a marketing brand choice. I found a chap called Frank Janssen. Frank has a strong background in finance and he had worked in the pharmaceutical industry. He had a strong marketing background. Frank spent a lot of time working with the existing dental business putting in a whole lot of innovative clinical changes. There's a thing called Prime out of Australia which takes dentists through intensive clinical training to improve the quality and delivery of dentistry. We spent a lot of time looking at the staff we had and where they were positioned. Through that work, through Prime and through us securing Fly Buys, we saw an opportunity to re-launch the group. Frank came up with Lumino. It's a bit of a Fontera type word. It means nothing. The first time I saw it I thought: lightbulbs. It's reception is quietly neutral. We've made announcements of a number of new dental acquisitions since we announced that change. We continue to examine a number of opportunities nationally. We're looking to add new practices to the group at the rate of almost one every two months. We have 18 clinical sites at the moment and about 40 dentists. We create very strong clinical structures with these people, provide IT support, promotional support and continuing medical education. Basically we can remove the onus of running the business of their practice and allow them to continue to practice quality dentistry. Rather than us going out knocking on doors, our phones are now ringing with people saying, hey, we've heard about what you're doing and we're interested in talking to you. We see that as a significant opportunity.
SC: What's the dental business's return on capital now?
AC: We haven't disclosed it. If you look at last year's annual report, we indicated that we made about $100,000 EBITDA and that we had made a return on capital greater than the Eldercare business. The investment isn't that high. We've spent about $650,000 on software and we've probably spent another $300,000 or $400,000 on infrastructure. We had bought the Geddes chain very well. We had a lot of revenues for not a lot of investment. (Abano paid $2.1 million for Geddes in October 2002.) We're now buying practices that are earning an EBITDA return greater than 23% and a net profit after tax return of greater than 15%. The return on capital is the primary focus. That's the reason we left Eldercare. An EBITDA return greater than 23% is above our cost of capital which basically means every time I buy on of those things, I'm adding to shareholder wealth. As we grow, the return on investment fortheentire group will migrate towards those numbers. That's an attractive investment in anybody's books.
SC: What criteria needs to be met when you buy a dental practice?
AC: We're not interested in a practice where a dentist comes to us who's 59 and wants to retire next year, do you want to buy my chair and may patients. What we're looking for is a practice, hopefully a group practice with two, three or four or more dentists who want to continue working for at least another five years. We also look at how we can add value to that practice. The dental industry started in the fill and drill market. That's a level of care which I call the 101 level of care. That person is fixed and dispatched. If a dentist can say, the reason you've got a sore tooth is because you've got tooth decay and I can see other problems beyond the immediate one which will cause you trouble down the track, that's a much better thing for that patient. The economics of that outcome mean there's a far higher yield for the dentist. When you're working with clinicians, you never talk about money. Clinicians find a great difficulty in reconciling money and health. We're not interested in creating a dental environment where a lot of unnecessary and costly procedures are done that someone has to pay for. We don't condone that. On the other side, we're not interested in having someone come in for a patch up. That person is going to be presenting again and again with a continually falling outcome and eventually his teeth will fall out. When we bought Geddes, it had an extensive program called Dencare. It was basically the government-funded dental services where the government was paying for kids to receive dental care. The problem with that, like all good government-funded stuff, is they wanted to try to buy a Maserati for the price of a pushbike. The majority of dentists said we're not interested. It doesn't make economic sense. Geddes had a hunk of business in that area, probably around $200,000 or $300,000. It yielded absolutely no margin contribution to the group. We've walked away from it. Dentistry is effectively 90% private payment. We have small contract for mobile clinics for schools but our focus is going to be in the private patient market. We're lifting it to the higher end. Dentists are commission paid. They get a percentage of the total revenue, so they're getting more money and we're giving patients far better oral care so they're coming back to us and they're telling other people. When we came into the business, average revenue per dentist per day was around $1,300. Our average revenue per day per dentist now is north of $1,700 - the national average generally is around $1,600 per dentist per day. That's through improving the clinical care. It's taken us longer than we expected but that investment is growing
SC: Isn't talk of a merger between Abano Diagnostics and Sonic's business a euphemism for selling that business?
AC: Not necessarily. The pathology sector has been a very good investment for us over the last three or four years. It has come into an environment with the establishment of the DHBs that they're looking at change and for savings to be generated. One of the negatives of pathology is that its 100% government funded through the DHBs. We've recognised they're looking for rationalisation of services. Under the regional health authorities, there was active encouragement for more laboratories to open and to compete on price. The DHBs want fewer laboratories under a fixed term price with some risk share. Medlab has been in Wellington for over 60 years. A laboratory it's competed with is called Valley Diagnostics. It made sense for us to talk to each other about what would happen if we merged the laboratories and could get economies of scale. We said yes, that makes sense. We're not looking to exit the sector but, by working with Sonic, we will certainly de-risk our involvement in pathology. We will not sell out. In fact, we're looking for that investment to contribute quite strongly into the future. There would be a rationalisation of plant and equipment and, over time, there will be a rationalisation of the staff involved. Our cost base will go down and our productivity will go up. The outcome is an operating EBITDA improvement which will allow us to make savings for the DHBs. It may be 50% or probably more of that joint venture company - Medlab is a bigger business than Valley Diagnostics.