Rolling the dice on Descendis Health
The company is actually called Ascendis Health, but one look at a share price chart and you’ll understand why I laughed when an ex-banking colleague called it Descendis Health in a chat we had a few weeks ago. With a nod to his genius, I’ve borrowed the name.
If there was ever a poster child for a high-risk acquisitive strategy gone wrong, pushed by private equity shareholders, Ascendis Health is it.
The private equity house in question was Coast2Coast. They had the most over-sized team of professionals I’ve seen in my life, focusing on finding deals for their two horses in the race: Ascendis Health and Bounty Brands.
I simply couldn’t understand how so many expensive people could work in one place, paid for by companies that were sucking cash flow themselves to pay for acquisitions. Where was all the money coming from?
Turns out my gut feel was right. Google Coast2Coast Capital and you won’t even find a website. As I often say on The Finance Ghost, investing is about common sense above all else.
Platforms – banker style
Corporate financiers ran around the South African market for years talking about “operating pillars” and “platforms” with “the right jockeys” – if investment banking became a game of drinking bingo, everyone would be in hospital on an IV drip after the first day. It’s the same terminology over and over again.
To be clear, these aren’t platforms in the context of tech companies. Tech platforms are businesses like Facebook and Twitter that enjoy network effects and become exponentially more valuable as more people use the service.
No, when bankers used the word platform, they were talking about a colourful block on a PowerPoint slide that said “healthcare” or “consumer” – think of it more as a corporate filing system than a specific revenue strategy. Each block had a specialised management team that focuses on finding assets to buy in that industry.
Buy for 5x. Trade at 10x.
There was an entire school of thought in the South African market that if you mopped up a bunch of companies and paid a multiple of 5x earnings, the combined listed company would miraculously be worth 10x those same earnings. “Multiple arbitrage!” the dealmakers cried, before asking the bank for money to finance the acquisitions.
After all, the best kind of multiple arbitrage is the one you can achieve with the bank’s money. It’s a case of get rich or die tryin’, to borrow the term from rapper 50 Cent (which is approximately the current share price of Ascendis).
To give an idea of the value destruction, in September 2016 Ascendis was trading at over R28 per share. It’s lost over 98% of its value. The Descendis joke should make sense to you now.
Multiple arbitrage is a nonsense strategy. It turns out that a basket of things bought for 5x is likely worth 5x. When the economy turns sour, those companies cannot service the debt used in the acquisitions.
The only time that an industry aggregator strategy works is when there are clear scale benefits or the companies can work together and… wait for it… ”unlock synergies” (have another drink). The best example I can think of is Bidvest.
There is still meat on Ascendis’ bones
For all the shareholder value destruction we have witnessed at Ascendis, there are businesses in the group that are worth owning.
The largest is Remedica, a pharmaceutical company in Cyprus (no, really) which develops, manufactures and markets generic medicines with a focus on antiretroviral and oncology treatments.
It’s a solid operation that saw revenue increase around 20% in the six months to December 2020 and normalised EBITDA expected to show a 20% to 40% increase to over €20 million. Remember, EBITDA a measure of earnings before interest payments, so it reflects the true company performance ignoring the unsustainable debt.
Including the other European businesses, Ascendis’ international portfolio generated interim normalised EBITDA of somewhere between €30 million and €35 million. The South African portfolio of businesses generated normalised EBITDA of between R323 million and R372 million. These are interim numbers i.e. for six months.
In round numbers and with a reasonable assumption of growth over the next six months, but without being too aggressive, Ascendis should generate around R1.5bn in normalised annual EBITDA. With over R7bn in debt (admittedly an outdated number last reported at June 2020) and a market capitalisation of around R250m, the market is valuing Ascendis’ assets at 5x EBITDA in round numbers.
Remember, the formula for the market capitalisation (or equity value) is EBITDA * EBITDA multiple, less net debt.
It’s worth touching on big pharma EBITDA multiples: Pfizer (15x), Johnson & Johnson (15.8x) and Merck & Co (11.2x). These are massive companies but it’s not unreasonable to think that Ascendis’ European assets could fetch 7x – 8x EBITDA in a properly run asset sale process.
In my opinion, a case could be made that Ascendis should be trading at more like 6.5x forward EBITDA which would imply strong upside in the share price for those willing to take a big risk here.
So, let’s talk about those risks.
Vultures are circling the carcass
At the helm of this business is Mark Sardi, a highly respected ex-investment banker who previously served as CFO of Truworths and CEO of Cipla South Africa. After a stint at House of Busby, he clearly felt like a challenge and took the top job at Ascendis in October 2019.
The shareholders need someone like Sardi in charge because there are corporate raiders at the gate.
Ascendis has a >R7bn debt problem. Combined with the strong results in the underlying businesses, it makes the company a sitting duck for opportunistic operators who make a living from plucking quality assets out of broken balance sheets.
There’s nothing wrong with this of course. There need to be checks and balances in the system for companies like Ascendis that played fast and loose for years. If you want to operate with a ridiculous balance sheet then you need to be prepared to lose everything.
Blantyre Capital has a one-page website. It simply says that the company is focused on “partnering with European companies in relaunching good businesses with temporary financial challenges”.
The other party you need to know about is L1 Health, a company that “partners with entrepreneurs and industry executives to invest in long-term, global trends that transform healthcare.”
In other words, Blantyre is the pit bull and L1 Health is the perfectly groomed poodle that arrives once the dirty work is done and the assets have been taken.
In the space of just a few weeks, Blantyre and L1 managed to increase their exposure as a “Consortium Lender” from one third to over 75%. In other words, they bought the Ascendis debt from other lenders. This gives these raiders the power to provide or withhold all important waivers, deferrals and consents that require approval by the majority of lenders.
They now hold all the power over the group’s restructure.
The best interests of the company
Sardi has a fiduciary duty towards the company, not the shareholders. In company law, the company itself is sacrosanct. His primary goal must be to preserve the company, not to protect the current shareholders. If the shareholders win as a by-product of that fiduciary duty, it is through luck rather than by design.
There are numerous laws in South Africa as well as JSE regulations that try to protect minority shareholders. This gives some comfort that a proper process will be followed.
In a February announcement, Ascendis noted that the lenders do not want to break up the company but would rather seek alternative ways to restructure it. In an update on 9th March, further details were given of a recapitalisation and restructure which sounded a lot like breaking up the company.
If we look through all the noise, the position is fairly simple:
- Ascendis is in default of its debt obligations
- A forbearance period has been agreed to until 30 April 2021 in which lenders agreed not to take enforcement action
- A group recapitalisation is being envisaged where debt is paid off by giving the lenders sufficient underlying companies in settlement of the debt
It doesn’t take a rocket scientist to work out that these international corporate raiders want to get their hands on Ascendis’ European companies in exchange for settling the debt.
But what does that mean for shareholders?
It may not be as bad as it appears to be
As already noted, there’s possibly some upside in the share price, but you need to form a view on what the European assets are worth in settling the debt. Then you need to value the South African assets and compare the value to any residual debt. The difference is the value of the equity, which you can then compare to the market cap of Ascendis.
Of course, without the full details of the debt agreements, we can’t be sure about the downside risk and whether shareholders could lose further money. I’m contemplating buying into Ascendis with the speculative portion of my portfolio, hoping for a share price pop.
In my opinion, the way this all ends is as follows:
- The international assets will be sold to the lender consortium in exchange for the debt to be discharged
- The South African assets will be able to service the debt costs on any remaining debt
- Ascendis will live to fight another day as a JSE small cap
- Shareholders who bought at current levels might see an uptick in value and shareholders who bought in at previous levels can wave that value goodbye forever
To ensure that shareholders are treated fairly in this process, there is a shareholder activist group that has been set up on Twitter. Follow @AscendisI and email email@example.com if you own Ascendis shares and wish to have your voice added to the mix. As I understand it, their goal is to avoid a rights issue and ensure that any assets offloaded to the lenders are done so at fair value.
With so much uncertainty in Ascendis at the moment, buying now would be a speculative play of note. The upside potential is balanced by substantial downside risk.