Go for the Siemens' Healthineers placing

The average target price according to our valuation should be around €40 per share. We recommend to subscribe.

• Attractive IPO price range between €26 and €31 per share.
• Placing volume 15% or 150m shares max. with gross IPO proceeds between €3.9bn and €4.65bn; Siemens will receive the IPO proceeds but also half of the profit, dividend and interest payments of the current financial year. Profit and loss agreement will end on 31 March 2018.

• Lock-up period of 180 days.

• Pricing, volume and 14 banks involved will guarantee a successful start.

• IPO incentive for the management is nonsense; performance is required.

• Target price €40 – subscribe

14 banks involved with 14 “BUY” recommendations, a tiny free float, a fair issue price combined with a high dividend yield and a highly motivated management team are the ingredients for a successful placing. The IPO of Siemens Healthineers AG will become a success story but not only driven by fundamentals. The company will offer in total 150m shares or 15% of total share capital including Greenshoe within a price range of €26.00 to €31.00 per share. Around 130,434,783 ordinary registered shares are from the holdings of Siemens Beteiliungsverwaltung, the selling shareholder. Around 19,565,217 shares will also be offered in connection with a possible over-allotment (Greenshoe). The offer period already started on 6 March and will expire on 15 March. The first listing is scheduled for 16 March 2018. The 1,000m existing registered ordinary shares (ISIN DE000SHL1006; ticker symbol SHL) have no par value but a notional value of €1. Each share is fully entitled with dividend rights since December 2017 (Q1 18). The listing is expected on 16 March on the regulated market (Prime Standard) of the Frankfurt Stock Exchange. As at the date of the prospectus, Siemens AG owns 66.70%, Siemens Beteiligungsverwaltung GmbH & Co. OHG around 32.38% and Siemens France Holding SAS 0.92% of the share capital of Siemens Healthineers AG. Siemens Beteiligungsverwaltung will reduce its stake in the company from 32.38% to 19.34% excluding the Greenshoe option and including the exercise of the Greenshoe to 17.38%. The free float will reach 13.04%, or 15% including Greenshoe. According to our estimates the maximum value of the free float will reach €4.65bn. The lock-up agreement will end 180 days after the first day of trading (16 March). In the mid-term, we expect Siemens Beteiligungsverwaltung to reduce its stake to zero. Siemens will remain the major shareholder with a total stake of 67.62%. Consequently, the company will be fully consolidated into Siemens’ accounts. Unfortunately, a takeover of the company, which might imply a higher valuation, will be difficult in the future. The stake of the major shareholder, Siemens, and the introduction of registered shares will make it difficult for it to be acquired. We expect Siemens’ management to follow a similar strategy as already experienced with the merger of Siemens Renewable Energies with Gamesa. The offering is intended to provide the company with enhanced entrepreneurial flexibility and access to the capital markets. Sometimes it is difficult to find arguments with substance. According to the prospectus, the offering is also intended to lay the foundation for future profitable growth and the expansion of its leading market positions. Management is hoping to shape actively the paradigm shift in the health care industry. Unfortunately, the company will not receive any proceeds from the offering but has to pay at least the bill of €106m for the IPO fees based on a calculated placing price of €28.50 (mid-range). Siemens Healthineers, however, will be able to reduce its intragroup debt. In total there are 14 banks involved in the deal. Deutsche Bank, Goldman Sachs and JP Morgan are acting as joint global coordinator. BNP Paribas, BofA Merrill Lynch, Citigroup and UBS are acting as joint global bookrunners together with the joint global coordinators. Commerzbank, Berenberg, Jeffries, HSBC, Nordea, RBC and UniCredit are acting as co-lead managers. These banks will definitely guarantee the successful placing combined with 14 “BUY” recommendations. Assuming the complete placing of the shares, the banks will receive €116.25m in IPO fees, or 2.5% of total placing volume. In general, an IPO fee of 2.5% looks not very attractive but with 14 banks involved it is just easy money. The average underwriter fee for IPOs in the USA, for example, increased from 3% in 2014, to 4.2% in 2015 and 4.7% in 2016 (for a deal size greater than US$1bn). In December 2017, Siemens received a total dividend of €230m (Q1 18), or €4.60 per share, for the financial year 2017 compared to €122m, or €2.44 per share, in December 2016. In the whole financial year 2017 (end of September), Siemens received a dividend of €352m, or a payout ratio of 26.5% in 2016 compared to 29.2% in 2015. Management is planning a payout ratio between 50% and 60% of the group’s net income based on IFRS and not on adjusted figures. Assuming a net income of around €1.2bn, the total dividend payout will reach around €676m, or €0.68 per share. Based on the average IPO price, the dividend yield will reach 2.4%, or 2.2% based on €31 which looks quite attractive. In the financial year 2017, total operating cash flow reached €1.97bn compared to €1.85bn in 2016. The company invested around €453m (€436m in 2016) in 2017. Cash flow before financing reached €1.52bn in 2017 and €1.41bn in 2016, respectively. Cash flow from financing activities is dominated by Siemens. In 2017, Siemens received a total dividend of €352m, €815m (profit and loss agreement), interest paid to Siemens Group of around €245m, and other transactions with Siemens reached €118m. In total, Siemens received €1.53bn in 2017 and €1.29bn in 2016. The profit and loss transfer agreement between Siemens and the company will be terminated on 31 March 2018. From 1 October 2017 until 31 March 2018, Siemens will have full control over the net income of Healthineers. Consequently, this will have a negative impact on the cash flow from financing. The cashing-out procedure is also reflected in the balance sheet. Cash and cash equivalents reached €184m, or 1% of total assets in 2017, and €206m in 2016. This will definitely change in the financial year ending in September 2019 at the earliest. Siemens made some necessary adjustments to carve out the health care business as a separate entity. The share capital was raised from 50,000 shares by 999,950k shares to 1,000m shares against contribution in kind. As of December 2017, total debt reached €20,086m and total shareholders’ equity of €3.53bn. The goodwill alone reached €7.99bn (end of December 2017) or 39% of total assets. In September 2017, the ratio of net debt of around €8.18bn to EBITDA (€2.87bn) reached 2.8x and is expected to reach 1.5x after the offering. Following the offering, net debt will be reduced by c.€4.3bn according to the prospectus. Total debt related to Siemens reached €12.76bn and cash and receivables to Siemens €4.58bn at the end of September 2017. Siemens transferred pension plan assets of €780m as of January 2018 to the Siemens Healthineers Trust. Consequently, net defined benefit balance liabilities have already declined from €1.73bn to €952m. Assuming net IPO proceeds of around €4.53bn, net debt will be reduced to €3.65bn. Taking the new net debt/EBITDA ratio of 1.5x into account, EBITDA should reach at least €2.43bn in the current financial year. In 2017, EBITDA already reached €2.87bn. The members of the management board and select key employees will receive a one-time incentive in the case of the completion of the offering before 30 June. The amount depends on the success of the offering and on the performance of the company’s share in the year following the offer. The targeted amount equals one-year base compensation (Dr Montag €1.05m, Dr Schmitz €645,000, and Reitermann €750,000). The target attainment can vary between 50% and 150% of the target amount (one year base compensation). The first condition is already fulfilled: the IPO will take place before the end of June 2018. It is always a good idea to give incentives to management but this should be related to the operating performance of the company and to a specific IPO date. In the current financial year management is expecting comparable revenues (EUR/USD at 1.19 compared to 1.11 in 2017) to rise between 3% to 4%. The adjusted operating profit margin should range between 17% and 18%. Non-operational expenses will range between €140m and €170m. The effective income tax rate will range between 28% and 30%. Adjusted profits, for example, excludes income taxes, non-operational expenses and the amortisation of other intangible assets acquired in business combinations. In addition, restructuring charges and one-off costs related to the IPO will also be excluded from the adjusted profit. In 2017, revenues increased 1.9% to €13.8bn. The gross margin improved from 40.4% to 41.8%. EBITDA increased 5.7% to €2.86bn and the real EBITDA margin reached 20.7% compared to 20% in 2016. Adjusted EBITDA reached €2.93bn and the EBITDA margin 21.2% compared to 20.5% in 2016. Consequently, the gap between real and adjusted EBITDA is not very large; however, in the current financial year, the gap will be widened due to the IPO costs and other extraordinary costs. In 2017, the Diagnostics division launched Atellica Solution, according to management the most comprehensive and innovative platform setting a new standard in intelligent diagnostic sample management technology. Atellica is expected to replace five legacy platforms with a single solution. The Atellica platform addresses 55% of Diagnostics’ total revenues. In 2017, Diagnostics’ total revenues remained stable at around €4.16bn with a profit of €562m. The profit margin increased from 12.4% to 13.5% (profit contribution of 22.8% and revenue contribution of 30.2% to total group results). Around 90% of Diagnostics’ total revenue is recurring. In December 2017 (Q1 of the financial year 2018), the operating profit of the Diagnostics division declined 26.7%, or €36m, to €99m. The decline was mainly related to the roll-out of the Atellica Solution. In the financial year 2017, the company had already invested €112m mainly in the USA for the new modular diagnostic platform. As of January 2018, the company has already shipped 110 analysers to customers and this number increased to 140 in February. 35% of these analysers were sold to customers. The installation target is 7,000 analysers by 2020, of which 80% will come from the existing installed base and 20% from new customers. In the current year, regulatory approval is expected in Brazil and Japan, and China in 2019. At present, the IT systems are highly integrated with the Siemens IT group infrastructure. The company will now also continue to install and implement its own IT infrastructure. According to management, around 12 separate SAP systems are running in the company. The strategy is to consolidate this number, standardise and streamline the infrastructure. The reduction in the number of systems will require additional investments of around €100m but should result in annual cost savings of between €40m and €50m. Additional cost savings of €190m are expected after the financial year 2018. Medium-term annual cost savings are expected to reach €240m. It sometimes looks rather strange that management only discovered cost savings when becoming independent. Before the IPO, there was no desperate need to reduce costs because Siemens managed to transfer prices for services and other support functions. This time, we really believe that the expected cost savings will be achieved. In the past, up to September 2017, goodwill was tested for impairments based on the cash-generating unit structure used at Siemens Group. Siemens Healthineers defined operating segments based on the new reporting structure. The relocation, however, did not result in any goodwill impairment. The Imaging division has a goodwill of €5.6bn, Diagnostics of €1.4bn and Advanced Therapies of around €878m (€7.99bn at the end of September 2017). In 2017, Healthineers was organised into six business areas: Diagnostic Imaging, Laboratory Diagnostics, Advanced Therapies, Ultrasound and Point of Care Diagnostics and Services. This new structure is not reflected in the annual reporting of 2017 but should be visible in the current financial year, according to the company presentation. In the 2015 annual report of Siemens AG, the goodwill of the Diagnostics division reached €5.1bn and of the Imaging & Therapy Systems division €2.9bn. In 2016, the goodwill of Healthineers reached €8.3bn, compared to €7.89bn in 2015. Reorganising and regrouping the business divisions will also help to improve the structure of the cash-generating units. Consequently, by using the right structure, impairments can be avoided. According to our estimates, the company is valued at 2.4x EV/Sales (peers 3.82x), 13.7x EV/EBITDA (peers 18.3x) and 17.9x EV/EBIT (peers 22.4x) based on 2018 estimates. In 2019, the ratios will improve due to lower costs and the end of the profit and loss agreement with Siemens. The company will be valued at 2.4x EV/Sales (peers 3.61x), 12.5x EV/EBITDA (peers 17.45x) and 16.1x EV/EBIT (peers 21.4x). The P/E ratio based on €31.00 per share will reach 22.7x in 2019 (peers 23.5x) and 25.2 (peers 24.8x) in 2018. We are not quite certain why the valuation of the deal and the sentiment changed during the presentation by the company. The enterprise value started with a best guess of €44bn. Then the value was reduced to range between €32bn and €40bn. Now, the enterprise value reaches €35bn (issue price of €31 per share). Siemens’ management might have been irritated about the weak stock market and, consequently, reduced the placing volume. Only 15% of the total share capital will be placed, which is at the low end of the target range between 15% and 25%. Investors are always bargaining about the issue price and the valuation. Nevertheless, the prospectus clearly indicates that Healthineers’ management has to address several problems first. The successful introduction of the Atellica platform and the admission of the system in several countries have first priority. The proof of concecpt will be visible as early as 2019. Nevertheless, management has to intensify the work on this issue. A successful launch of the Atellica platform has to have incentives and not the IPO.