Why Monash IVF is a great business

Please note: This is a slightly more personal and expanded version of the first part of the analysis received by Intelligent Investor Share Advisor members before Monash IVF’s float on the 26th of June.

‘Would you like to try some embryo glue for $150 extra?’ our doctor asked my wife and I. He explained that there was some evidence it led to better outcomes, though it wasn’t totally clear cut. Why not, we reasoned. We’d just signed off an $8,885 round of IVF (ICSI, to be technically precise), what’s another $150 if it might give us a better shot at having a child?

It was that little episode that drove home to me exactly how good, economically speaking, the assisted reproduction business is. I started thinking about all of the extra costs that we’d paid on top of our basic ICSI cycle, including various additional medications and frozen storage of semen (IVF patients quickly get comfortable with words and procedures that make most people squirm) for which we receive a $225 bill twice a year.

Assisted reproduction businesses have two powerful business dynamics working for them. The first is like the car salesman who sells you high-margin add-ons which seem small in comparison to the amount you’ve just outlaid on your new wheels.

The second is the one funeral service provider Invocare benefits from. Who wants to skimp on a loved one’s funeral arrangements or haggle over the price when you’re grieving? It’s similar when you get loaded onto what I call the ‘IVF conveyor belt’, typically by your GP.

You and your partner are likely surprised and perhaps overwhelmed by the news that you’ll need medical intervention to conceive. Emotions begin swirling and the ticking of the ‘biological clock’ becomes almost audible: it’s an inescapable fact that women’s fertility decreases with age.

Competitive advantage

A financial analyst trying to pinpoint competitive advantages in this industry might look to success rates or treatment costs. But such factors are far from the whole picture.

In our case, my wife and I simply went to the IVF provider recommended by my GP (Virtus’s IVF Australia). Soon after that, I had to grapple with the revelation from associated genetic testing that I have a mild form of Cystic Fibrosis, which had gone undiagnosed for more than 30 years.

That goes a long way to explaining why someone who normally prides himself on making rational decisions didn’t do an ounce of research into alternative providers. Things were moving quickly and we simply continued working with the clinic we were referred to.

We didn’t even compare overall success rates or even costs of alternative providers, especially after hearing from a friend that it was the particular doctor we’d been assigned to who had been responsible for their two IVF babies.

After several unsuccessful rounds of treatment, you might assume that we’d look carefully at alternatives. But while one of our provider’s competitors (Genea) claims higher statistical success rates, we’ve become very comfortable with our ‘support team’ which includes our doctor, nurses, an exceptional counsellor, staff in the day hospital who make delicious toasted sandwiches while you’re recovering and a delightful office manager who has helped with administrative items like following up Medicare rebates and rushing through blood test results at key times.

This individual ‘scuttlebutt’ seems to translate across the industry, too. Monash IVF notes in its prospectus that ‘Existing patients have also exhibited a tendency to return to the same fertility clinic for further treatment where an earlier treatment is unsuccessful, or to try for a sibling post a successful clinical pregnancy.’

In other words, there’s more to this IVF caper than just plain numbers, be they success rates or advertised costs. But one set of numbers is unambiguously attractive and those are the financial results.

Impressive financials

Profit margins are fat. Monash IVF, the industry’s third-largest player, is forecasting a margin of 32.1% for the year to 30 June 2014 and larger competitor Virtus recorded a 27.5% profit margin in its latest half-year. Returns on tangible assets are even more impressive. Monash IVF boasts a better than 30% rate of return while Virtus’s is a staggering 70%-plus.

The business dynamics and metrics described above make this an economically enviable industry but the attractions don’t end there. The demand for assisted reproductive services has been growing and is likely to do so for some time.

The trend towards women establishing their careers before procreating means that, overall, more couples will have trouble conceiving naturally due to lower fertility. Yet, simultaneously, they’re better placed financially to pay for assistance in taking on the challenge.

Since 2000, the number of treatments per year in Australia (IVF cycles and ‘Frozen Embryo Transfers’) has almost tripled and has been growing at around 5% per year since the government reduced financial assistance in 2010.

In addition to growth in the number of cycles, providers have generally been charging more per cycle. This combination of unit growth and unit price growth has meant healthy top lines for these groups.

Key risks

The two main risks to this growth continuing are a potential reduction in government assistance and increased competition. The impact of each would likely be different.

If the government were to further reduce the financial assistance to patients utilising these services, there would be a negative impact, as there was in 2010 when the number of cycles fell by 6%.

Assisted reproductive services accounted for 1.3% of all Medicare benefits paid in 2013, so it is likely an item on the government’s radar. The quantum of any dip would depend on the size and nature of any changes to such benefits. Even if such changes were significant and sudden, the likely effect would be that of a ‘one-off’ setback, which would form a new base level for growth as the broad industry tailwinds continue to blow.

Price competition

Potential price competition is a more nebulous and unpredictable threat. Primary Health Care has expressed interest in moving into the industry at the low end of the pricing spectrum. Primary has at least two key assets which could make this move a logical one.

Firstly, Primary’s network of medical centres could provide a stream of referrals to any fertility business. Secondly, its pathology business could be utilised. IVF cycles involve many blood tests, as various blood markers are monitored closely throughout the process.

Primary has made overtures to fertility specialists working for existing groups and it remains to be seen whether it will be able to lure enough of them away to gain a critical mass to start a new business.

If Primary concentrates on the lower cost end of the industry, it may be difficult for it to make the specialists an attractive enough financial and lifestyle offer compared to existing groups. That said, investors in either Virtus or Monash IVF should be aware of this is development and monitor it closely.

Virtus has already commenced a rearguard action against lower-priced competitors through a sub-brand (The Fertility Centre) offering a restricted range of services. It was actually the fastest growing part of Virtus’s business in the latest half year.

Float pricing

Monash IVF priced its shares at $1.85 each in its float. With 231.1m shares on issue, that’s a valuation of $427.5m, to which you can add $99m of net debt to arrive at an Enterprise Value (EV) of $525.5m. You can see how that flows into various valuation ratios compared to Virtus in Table 1.

Table 1: Monash IVF vs Virtus

Monash IVF (2014F) Virtus (2014F)
Price ($)

1.85

8.6

Shares on issue (m)

231.1

79.5

Market Cap. ($m)

427.5

683.7

Net debt ($m)

99.0

111.9

Enterprise Value ($m)

526.5

795.6

EBIT ($m)

36.0

56.0

NPAT ($m)

22.0

33.0

Revenue ($m)

112.1

202.0

Total tangible assets ($m)

13.1

59.8

EV/EBIT (x)

14.6

14.2

P/E (x)

19.4

20.7

EV/Revenue (x)

4.7

3.9

EV/Total tangible assets (x)

40.2

13.3

In terms of the price-earnings ratio, you can see that Monash was pitched at a lower PER than Virtus. But when you account for the relatively higher debt level by looking at EV/EBIT, you can see that it’s slightly more expensive.

Share Advisor members can find further details, financial analysis and a recommendation on Monash IVF by logging in here.

For everyone else, I hope my personal reflection has shed a little more light on what is a confusing and complex business.

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