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An informal Valuation of Brazil’s Rede D’Or IPO

Updated: Mar 25, 2021

Rede D’Or, one of the fastest-growing healthcare providers in Latin America, just ran its IPO( initial public shares offering). Now that the damage is done, I would like to kindly weigh in its valuation.

Shares were valued at a 24 Ebitda multiple. The traditional back of the envelope calculation suggests a 6X Ebitda… But these are different times, I reckon. Valuations are all out of Wack, no pun intended…

But a 24 X Ebitda assumes that for every BRL you put in, it should take 24 years to get it back. That is if all their margin would go to profits, and then dividends. This assumes the firm has no interest expense, nor depreciation or taxes to take away from Ebitda. For 24 years.

The firm replies that they will grow 21% per annum! And thus, it would “only” take them 15 years to pay back that original BRL you gave them at the IPO….Well, if they grow 21%, for 15 years, Rede D’Or will become the largest health care firm on the planet, ahead of United Health, and other financial giants such as JP Morgan and Bank of America. This could happen, but it is highly unlikely.

But Rede D’Or also published their operational ratios: they grew revenue in the past 3 years at 100%. They grew net income at 181%. This looks really good. They grow profitability faster than sales. So Rede D’Or is becoming more efficient quicker than its explosive growth.

This is quite impressive!

But… When you look deeper into it, you see that Rede D’Or grew yearly gross margins at 24%, and net after-tax margin at 41%. This shows that the bulk of its growth must come perhaps from tax shields (depreciation/ interest expense). And then you check for financing: Its Debt exploded by 381% in the period. So the bulk of that net income growth comes from expensing interest, i.e. tax shields, not operational gains.

So what will they do with the dough? Rede D’Or will refurbish its hospitals and buy new ones. But when you look at its huge debt, and you think: Rede D’Or will retire its old expensive debt and issue new, cheaper debt. That way its new expensive recently issued equity will not burden its WACC too much. With cheaper debt, this additional equity won’t burden the WACC too much. But why is this new debt cheaper?

New debt is cheaper because basic Brazilian government rates are really low now, from 8% in the past years to 2%. This has unleashed fixed-income capital into equity markets.Hence, Rede D’Or probably will try to switch old pricy debt for newer cheaper rates debt.

But what if rates go up? Inflation is already at 4.5%, and gov already announced this week that rates should in fact go up. This can wreck Rede D’Or’s post-IPO plans. Both equity and debt costs should rise significantly.

How large is the potential damage? Brazil nominal interest rates are at 2%. Brazil has 4.5% inflation. This yields negative 2.5% real rates. US basic rates are at 0.25%. US has currently a 1.3% CPI. This yields negative 1% real rates.

Brazil spread over the US is at 638 BP, so Brazilian real rates should be at 5.38%. Adjusted for inflation, Brazil’s nominal rates should be at 9.88%, way above its current 2%. Current rates in which this valuation was issued are not sustainable, nor the valuation itself.

The IPO prospect itself said rising rates were its biggest risk. With valuations all out of wack in many sectors globally, this is not catastrophic in the short term. But the day of the reckoning might come…


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