Virtus Health is Australia’s largest assisted reproductive services (ARS) business in a competitive market. Demand for such services is growing and VRT is seeking to expand its service suite in adjacent disciplines such as genetics. VRT’s acquisition of Adora Fertility is waiting on ACCC approval.
VRT has a well-established history providing ARS in Australia and overseas, and currently has 128 fertility specialists operating out of 44 fertility clinics across 5 countries. The business is supported by scientists, nurses, counsellors, patient support and operational staff. As with many medical service businesses, there are adjacent businesses that sit comfortably alongside a fertility clinic and VRT now has 7 day hospitals and 64 diagnostic laboratories within its sphere.
The IVF sector is prone to boom-bust cycles historically, due to high out-of-pocket expenses (prices can range from $1,700-$5,000 per IVF cycle), modest private healthcare insurance coverage and a tendency for patients to defer treatment during periods of economic uncertainty. In that context, the market had a big year in FY21 as fresh cycles increased 32% to a record 58,392 (VRT growth was +26% to 18,589). This was initially on pent-up demand and treatment deferrals generated in lockdowns, but subsequently boosted by new patient growth in the back end of the year. Frozen embryo transfers increased 25% in FY21.
The surge in demand was driven by some familiar features in other industries. Changes to household spending away from travel and leisure towards ‘big ticket’ items such as property, cars and luxury goods. The reprioritisation of family planning was consistent with the behavioural change in spending due to lockdowns.
Other structural issues driving ARS demand include an increasing maternal age amongst new patients which include same-sex couples, single parents and families seeking genetic screening.
In the medium to long term, it is reasonable to expect growth in fresh cycles around 2.5% pa. VRT will continue to invest in clinic expansion, the genetics strategy and precision fertility (a mixture of capex and opex) which should see EBITDA margin incrementally grow towards 28%.
VRT’s earnings are mostly derived in Australia with FY21 representing 86% of EBITDA. The company’s international assets have not performed to expectation in recent years due to local market headwinds, doctor resourcing issues, restructuring and COVID disruptions. Earnings rebounded in FY21 as cycle volume recovered and execution improved. VRT has operations in Ireland, Denmark, UK and Singapore.
Adora Fertility acquisition
In August this year, VRT agreed to acquire Adora Fertility from Healius for $45 million. Adora will add four fertility clinics to VRT’s network of 44 clinics, plus 3 day hospitals in Australia. VRT funded the acquisition with a $35 million institutional share placement at $6.80 per share which was significantly oversubscribed.
Adora’s market share of approximately 10% will give VRT 42% of the Australian IVF market on completion. But the deal has yet to pass scrutiny of the ACCC and this remains a risk to the outlook for VRT for now.
The Adora transaction is the latest in a string of acquisitions since 2014 for VRT in Australia and overseas.
Adora will entrench VRT’s market leadership in Australia, provide a new market in WA, increase its fresh cycle mix from 20% low cost to about 39% and becomes the only domestic player to offer bulk-bill through to premium IVF services.
The ACCC’s intervention has dented the share price well below the placement price, so if the acquisition is stymied by the regulator, a share buyback in lieu could be highly accretive for VRT. Obviously, ACCC approval is the desired outcome enabling VRT to integrate Adora and extract revenue and cost synergies.
Growth strategies
With a refreshed management team, VRT is looking to build a less cyclical and higher margin business through strategic investments in clinical infrastructure, genetics and precision fertility.
VRT wants to optimise its core operations including clinical infrastructure expansion to upgrade cycle fertility capacity at selected clinics. The establishment of further embryology and andrology labs under the One Lab brand will occur across the network. Subject to the ACCC decision, the integration of Adora will be important.
VRT is repositioning itself to become a leading reproductive genetics service in Australia. This encompasses skills such as genetic pathologists, counsellors, and andrologists. A simplified preconception carrier test is now available from GPs and specialists and VRT is establishing research collaborations in this area. The increased awareness and use of genetic testing will help to growth the ARS market as a whole.
The introduction of Medicare reimbursement from 1 November 2021 will mean patients can claim a rebate for 5 new MBS items covering pre-implantation genetic testing services within the IVF process. The Government is allocating $96 million over FY22-25 for this purpose and VRT is likely to access around $6-7 million of this to add to its current diagnostics revenue of approximately $25 million although some of this will just replace previously out-of-pocket expenses.
VRT expects the Australian market for genetics diagnostics to increase from $98 million in CY18 to $177 million in CY24f.
Precision fertility is based on the development of digital data utilisation to offer patients a completely digitised and automated experience from start to finish (pregnancy). The idea is to improve clinical processes and success rates. VRT is working to commercialise this process so it can be licensed globally. VRT has had early success with its Singapore business in this regard suggesting the approach is working.
Investment view
VRT is already a big player in the global IVF market with 44 clinics, 128 doctors and approximately 24k fresh cycles annually. Adora Fertility would add another 11 fertility specialists, 4 clinics and 3 day hospitals with an estimated 6k fresh cycles in FY21.
The key earnings risks for VRT include its reputation and ability to attract and retain skilled staff in a highly competitive market. Regulatory and funding issues are subject to government policy that can change. Economic conditions do play a part in customer demand for IVF which has traditionally made this a volatile industry.
VRT’s share price has declined around 25% since August 2021 shortly after the Adora acquisition was announced and following the ACCC’s intervention. The current price has the stock trading on 12.4x FY22f PE ratio based on consensus forecasts which is a big 36% discount to the ASX Small Ordinaries PE ratio. It has historically traded at a 24% discount and we think this is an overreaction to the ACCC concern over the Adora acquisition. The stock also trades at a PE discount to its Australian peer, Monash IVF (MVF) which is on 15x FY22f eps.
The ARS market continues to grow in Australia and globally with expanding services and broader demand. VRT has positioned itself as a key player across the spectrum of demand for IVF and has carefully developed its strategy to cater for improved services such as genetics and digital data platforms.
The Adora acquisition notwithstanding, we think VRT is a well-run business with a good long term strategy and prospects. We begin our coverage of VRT with a Buy recommendation.
