As Circle’s operations move towards profitability, we continue to assess the valuation on a discounted cash flow basis, capturing the net present value of expected future profit and cash generation. We are then able to contrast the market value of Circle with the fair value of existing operations and then include the potential that could flow from new initiatives, additional hospitals and service contracts.
Our estimate of the present value of Circle’s existing activities is 32p, significantly ahead of the current share price. For the first time this includes CircleBirmingham, adding c 8p to the overall valuation, effectively accounting for the increase from a previous fair value of 24p, although there are adjustments to the values of each assets, and the central costs, reflecting our most recent estimates and time value differences from rolling forwards to calculation since we last published.
There are some assumption changes for certain assets, shown in Exhibit 7, including reductions in the mature EBITDA margins assumptions on CircleBath and CircleNottingham from 12% to 10%, in line with illustrative guidance, somewhat offset by an extension of the medium-term growth period. For the other assets the changes are small.
Similar to our earnings analysis, this 32p includes nothing as yet from:
■
the Circle Harmony Chinese joint venture;
■
rehabilitation services;
■
Harley Street proton beam therapy; or
■
additional MSK service contracts, including Greenwich until contract completion.
As discussed below, we believe there is significant potential upside to the valuation of existing activities from these initiatives.
We believe there are two main challenges that need to be overcome for this upside to be realised. The first is to demonstrate that the financial metrics for new operations set out in Exhibit 8 can be achieved in practice. The second is to maintain the improving earnings development so as to provide sufficient financial resources to support the targeted new developments.
Valuation of the existing activities well above the share price
Exhibit 6 below summarises our calculation of the current discounted cash flows (DCFs) from the existing activities and Exhibit 7 shows the key assumptions used. We have not deducted tax from the expected cash flows in view of the considerable deferred tax assets that Circle carries off balance sheet (a tax value of £30.5m at 31 December 2015). This value is not recognised in the financial statements due to the uncertainty over the timing of their potential use. However, a long-term stream of pre-tax earnings against which utilisation would be possible is implicit in the valuation analysis.
Exhibit 6: Estimated value of Circle Holdings based on existing activities
£m |
Current |
Previous |
Circle hospital services |
|
|
CircleBath |
36.3 |
34.4 |
CircleReading |
28.5 |
29.2 |
CircleNottingham |
18.2 |
16.4 |
CircleBirmingham |
19.7 |
0.0 |
|
102.7 |
80.0 |
Other Circle Services |
|
|
Bedfordshire MSK |
8.6 |
7.1 |
|
8.6 |
7.1 |
Total from operations |
111.3 |
87.1 |
Central costs |
(35.4) |
(36.0) |
Net cash |
4.2 |
8.9 |
Circle Valuation |
80.1 |
59.9 |
Number of shares (m)* |
247.8 |
247.5 |
Value per share (p) |
32 |
24 |
Source: Edison Investment Research. Note: *Including ordinary shares and mandatory convertibles owned by Circle Partnership Trust.
The leases for CircleBath, CircleReading and CircleBirmingham are due to expire in 2044, 2037 and 2042 respectively, but we believe it reasonable to assume a high probability that Circle will be able to renew the leases at expiry and continue operations beyond these dates, as the sites are unlikely to have attractively competing alternative uses. We have extended the period of cash flows captured in the valuation beyond these dates by including a terminal value based on 8x EBITDA for the final forecast year’s cash flow, as in our previous valuation work.
CircleNottingham is a five-year NHS contract expiring in 2018. Our valuation approach has been to calculate the present value of the current contract, and to then attach a probability of renewal for a further similar term, unchanged at 50%. We have applied a similar methodology to the Bedfordshire MSK contract, which is of similar duration. We note that assuming no contract renewals, the value for CircleNottingham would fall to £10.3m and that for Bedfordshire MSK to £3.9m.
Exhibit 7: Key DCF assumptions
|
Discount rate |
Medium term and long term revenue growth assumptions |
Mature EBITDA margin % and first year achieved |
CircleBath |
10% |
2018 to 2022: 5% |
2020: 10% |
|
|
2023 onwards: 2% |
|
Circle Reading |
10% |
2018 to 2022: 5% |
2020: 10% |
|
|
2023 onwards: 2% |
|
Nottingham |
10% |
2018 onwards: 4% |
2019: 6% |
|
|
|
|
CircleBirmingham |
10% |
2022 to 2026: 5% |
2022: 10% |
|
|
2027 onwards: 2% |
|
Bedfordshire |
10% |
2018 onwards: 2% |
2021: 7.5% |
Source: Edison Investment Research
In aggregate, we value the existing operations at £111.3m vs £87.1m previously. We have applied an unchanged discount rate of 10%, which is similar to the cost of equity calculation by Bloomberg for large healthcare operators. In our valuation we have deducted £35.4m for the capitalised value of the underlying (ex-Project Reset) central costs, which is based on the annualised value incurred, capitalised at 10%, and weighted at 50%. We continue to weight the central costs at 50% in our valuation on the basis that a large element of these is incurred in pursuing new business and not in running the existing activities. We note that a 100% weighting would reduce the existing business value to £44.7m or 18p per share.
Significant potential from advanced and possible future projects
The valuation of future contracts can be highly subjective, depending crucially on the specific scale, nature and contract terms, as well, of course, as their successful launch. However, we have discussed above a number of quite advanced plans for which Circle has given more specific details and guidance, in addition to more generic illustrations for incremental hub hospitals, service line contracts and rehabilitation centres.
Exhibit 8 shows the illustrative characteristics of potential new contracts of differing types, as well as our indication of potential fair value that each may be able to generate, incremental to our valuation of the existing operations above. We note that CircleBirmingham, included at an 8p NPV in our existing operations value of 41p for now falls towards the bottom of the indicative range of 8-12p for additional hub hospitals, which will in part reflect its size (we assume mature revenues of £25m) and the fact that it will not commence operations until H118. Each illustration is based on DCF, using a 10% discount rate.
Exhibit 8: Illustrative valuation of future generic business initiatives at Circle
|
Hub hospitals |
Service lines |
Circe Rehabilitation |
Such as |
CircleBath/CircleReading/Circle-Nottingham/CircleBirmingham |
Bedfordshire MSK, Greenwich MSK |
Bath and Birmingham rehabilitation clinics |
Facility requirement |
New facility |
Facility light |
Refurbished/new facility |
|
|
|
|
Revenue under management pa |
£30m |
£20m |
£10 to £14m |
Set-up costs |
£10m |
£1m |
£1-2m |
Term |
25 years |
5-10 years |
15+ years |
|
|
|
|
Mature EBITDA margin |
c 10% (20-25% EBITDAR) |
5-10% |
19% |
EBITDA contribution profile |
Year 1: -ve, Year 2: 0%, Year 3: onwards c 100% |
Year 1: 0%, Year 2: c 75%, |
Year 1: 0%, Year 2: c 25%, Year 3+: 100% |
Year 3+: 100% |
Illustrative example of the incremental value of each new hospital/contract/centre |
8-12p |
2-4p |
~3p (at 50% share) |
Source: Company data, Edison Investment Research
The £8.6m valuation of the Bedfordshire MSK contract within the existing operations value is equivalent to c 3.5p per share. Our preliminary value of the slightly smaller Greenwich MSK contract is £6.0m or c 2.4p per share, assuming a 50% probability of renewal for a further five-year period on similar terms. Additional MSK or similar service contracts could add another 2-4p to the value according to this illustration.
Using the same illustrative framework, we estimate that each fully operational rehabilitation centre may add a further c 3p of value.
Exhibit 9: Illustration of Circle Harmony Health financial metrics
|
Circle Harmony Health |
|
First clinic |
10 clinic outlook |
Facility requirement |
Refurbish existing building |
Refurbished/new facility |
Annual revenue |
£25m |
£240-250m |
Set-up costs |
£20m |
£150-200m |
EBITDA |
£5m |
£50m |
EBITDA margin |
20% |
~20% |
Membership Fee revenue |
£50m |
£500m |
|
Benefit to Circle |
|
First clinic |
10 clinic outlook |
Revenue |
0.65 |
6.5 |
EBITDA |
0.65 |
6.5 |
Cash |
0.65 |
6.5 |
In Exhibit 9 we show the financial illustrations provided by Circle for the Chinese JV, Circle Harmony. As noted above, no upfront investment is required by Circle and its expenses are to be reimbursed until the first clinic opens, expected in late 2017/early 2018. The top part of Exhibit 9 illustrates the financial metrics for the clinics to be managed by Circle Harmony. The lower part shows the benefit to Circle from its 50% share in Circle Harmony. The structure will see Circle’s share of the management fees and profit share drop straight to the bottom line. The illustrated revenue of £650k for the first clinic represents Circle’s 50% share of the annual (£300k) and its profit share of 10% on the illustrated mature EBITDA of £5.0m. Circle estimates that break-even for the facilities can be achieved within three years. If these metrics are achieved it is equivalent to c 0.26p per share (assuming no tax) per facility at a mature run rate. Attaching an 8x EBITDA multiple, similar to that used in our terminal valuation for the other Circle facilities, implies a mature value of 2p, or a potential 20p for the 10 facilities planned for the medium term. We have not attempted at this stage to put a value on Circle’s 10% entitlement to equity in the clinical operating company in a future listing. A successful roll-out of the Circle Harmony JV alone has the potential to substantially lift Circle’s value.