The debt virus is tough to treat

• South Africa
• Ascendis Health, COVID-19, Debt, Healthcare
• April 8, 2020

Investment analysis is hardly ever as simple as it initially seems. People are too quick to assume that an entire sector is going to do very well from a specific event.

Let’s take healthcare as a topical example.

With hospitals overflowing and medical infrastructure buckling under pressure in many countries worldwide, one may be quick to assume that companies in the medical value chain will benefit.

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The art of investing is simply to ask the right questions:

• • Does this company supply medical equipment, pharmaceuticals or both?
  • Is there a direct benefit from COVID-19 e.g. does this company manufacture flu medication currently being prescribed to patients?
  • Are there any negative impacts from COVID-19 e.g. the postponement of elective surgeries and therefore a decrease in demand for products linked to such surgeries?

Investment professionals will do a great deal more research than this, especially in such a complicated sector, but asking these sorts of questions will get you surprisingly far down the road in making your own sensible decision.

An excellent example of the danger of sweeping assumptions is the voluntary announcement released by Ascendis Health on 8^th April.

Debt can become a financial virus

Before unpacking the announcement, it must be noted that the company has been sick for a long time.

After listing in 2013, it followed a classic private equity model of acquiring a variety of healthcare businesses on a highly leveraged basis, which is a fancy way of saying “with a lot of debt” – risky stuff.

The market loved Ascendis initially, driving the share price hard until it peaked around October 2016. As investments started to underperform and the debt pile looked ever more ominous, the share price collapsed.

It now trades around 60c, from a peak of almost R30 per share.

Ascendis is only worth around R300m but it carries R5bn in debt. That means the market is valuing the assets at only R5.3bn. It’s been a long and painful road to deteriorate to this point.

The group is following a strategy of selling off assets to try and pay down the debt, but the margin for error is tiny.

Mark Sardi was appointed as CEO in September 2019 to lead this process, bringing with him a wealth of investment banking and other experience.

So, with that depressing context out the way, let’s consider some of the interesting points in the SENS announcement:

The FDA has given Ascendis a boost

The United States Food and Drug Administration (FDA) has authorized Chloroquine for emergency use for severely ill COVID-19 patients. This is a malaria drug that just so happens to be manufactured by Remedica, a subsidiary of Ascendis Health and among the best businesses in its stable.

The irony of all this is that Ascendis tried desperately to sell Remedica, with the deal falling through at the end of 2019.

Talk about a lucky break!

Not all medical devices are created equal

Respiratory Care Africa, a division of the Medical Devices business within Ascendis, manufacturers respiratory devices. That is the perfect product in the current environment.

Unfortunately, Medical Devices also manufactures a host of other devices where sales are suffering due to the lack of elective surgeries or investment by hospitals in anything other than COVID-19 preparedness.

The rest is a mixed bag

Some divisions will do well in this environment. Others will be negatively impacted. The operational update is heavy on medical terminology and light on financial guidance, which isn’t by accident I assure you.

In summary: look closer

Be careful of investing in the first company you find in a sector that you’ve decided you like. You have to consider the specifics of that company, ranging from product mix and trends through to financial health.

An investment in Ascendis would require you to believe that the new management team will successfully sell off assets at decent prices to reduce the crazy debt balance.

If they can’t do it, the banks are going to come knocking and shareholders could potentially lose everything. There’s no medicine they can prescribe to fix that.