Medica Group - Expanding the growth opportunity

Medica Group - Expanding the growth opportunity

Medica Group is the UK market leader in teleradiology — the transmission, interpretation and reporting of radiological images, such as X-rays, magnetic resonance imaging (MRI) and computerised tomography (CT) scans, remotely from where the patient is imaged. This market has been growing strongly across the globe in recent years. In the UK the National Health Service (NHS) is increasingly turning to outsourcing to accommodate rising demand against constraints on in-house radiologist capacity. The company offers two main services: NightHawk, which is the reporting of urgent scans from night-time hospital admissions where a turnaround time of less than one hour is required; and Elective, which as the name suggests, provides reporting for routine procedures where the report is required within a day or two.

Also, the company has the potential to expand into the wider telemedicine space. The market stands at US$7bn globally and has been exhibiting strong double-digit growth rates in recent years. In this report, we examine the growth prospects for Medica within the UK teleradiology market and in the wider global telemedicine context.

In November 2020 Medica announced the acquisition of a company called Global Diagnostics Ireland, which offers teleradiology services, radiology managed services and diabetic retinopathy screening. The terms of the transaction appear to be significantly financially enhancing for Medica both in terms of exceeding the company’s cost of capital and in terms of earnings per share (EPS) accretion. The deal provides a template for how Medica can use selective acquisitions to expand its market reach.

Current trading and COVID:

During 2020 the UK healthcare system experienced sharp levels of deferral of routine medical procedures due to COVID-19. This had a significant impact on Medica’s revenue stream from elective procedures, while revenue from emergency procedures remained more stable. We expect a significant revenue benefit for Medica from catch-up work for the NHS during the second half of 2021 and full-year 2022, and we examine these dynamics on p8.

Leader in a fast growing market

Medica shares currently trade on a price/earnings (P/E) ratio of 15.9x based on our 2022e earnings forecast. We note that our forecasts are based only on the current business footprint, and do not include any benefit from potential future acquisitions. We argue the current P/E looks conservative, given that Medica offers:

• Low ‘beta’, meaning low correlation with the economic cycle
• Highly cash generative business model
• A strong balance sheet position, with net debt / EBITDA (underlying earnings) of 0.3x (2021e, average debt level)
• An asset-light business model, with a ratio of 4x revenue to fixed assets (FY 2019 figures)

On p10 we present a valuation scenario analysis. This presents a central range of 136p to 189p would imply up to 40% upside to the current share price.

Valuation upside

Year end Dec 31 · 2019 · Current · 2021 · 2022

Revenue (£mln) · 46.5 · 36.8 · 55.9 · 64.3

EPS (p) · 8.1 · 3.5 · 6.9 · 8.5

Net cash/ (debt) £M · 4.4 · (4.0) · (4.0) · (1.0)

Medica Group is a company that specialises in the fast-growing market for telemedicine — the remote provision of healthcare services. The shares offer investors exposure to growth in end-demand and an ongoing trend towards outsourcing, and we argue that the current valuation multiple offers and attractive entry point (valuation analysis on p10).

Some main strengths of the investment proposition include:

• Leading market position as number one in the UK and Ireland for teleradiology
• Strong profitability with gross margins in the range 45-50% since listing and continuous positive operating margins
• Revenue growth - it has a compounded annualised growth rate (CAGR) of 14.4% for the period 2016-2021e
• A strong balance sheet position with net debt / EBITDA of 0.3x (2021e, average debt level)

The main revenue driver is the teleradiology market in the UK (see p4-6). The company added further revenue streams with the acquisition of Global Diagnostics Ireland (GDI) announced in November 2020 and has an active strategy to explore growth opportunities in additional service offerings and geographies.

Teleradiology is the remote analysis of medical scans including X-rays, computerised tomography (CT) and magnetic resonance imaging (MRI). Medica uses a network of well over 500 radiologists to provide reporting services for hospitals and healthcare trusts throughout the UK and in Ireland. The reporting radiologist analyses the images and provides an analytical report that is sent back to the practitioners at the healthcare facility and integrated within their reporting systems.

Investment summary

The following schematic outlines the workflow:

Medica's process integrates with the healthcare provider's systems

Operational model - teleradiology

Source: Proactive Research

New JV expands the radiology reporter network and the market opportunity

Medica’s radiologists are engaged on a contractor basis, mostly based in the UK but some also across other European countries, as well as in Australia and New Zealand, and are typically operating on a work-from-home basis.

Medica recently announced an equal joint venture (JV) partnership, called MedX, with the Australian market leader Integral Diagnostics, to provide teleradiology reporting services and increased reporting capacity in Australia, New Zealand, the UK and Ireland. The primary short-term focus will be for MedX to provide access to a pool of dual-qualified radiologists who can operate in both markets and will support both companies’ acute, out-of-hours reporting services. The two partners will also collaborate in areas of mutual interest, including the deployment of augmented intelligence (AI) solutions. In future, there will be potential to expand the scope of the JV, including combining Integral Diagnostics’ existing reporting capabilities and resources with Medica’s experience in teleradiology, meaning MedX will have the potential to bid directly for teleradiology reporting contracts using its combined network of reporters. In time, there is also the potential for MedX to leverage its scalable and secure operating model and reporting system to offer its services outside of its core markets (UK, Ireland, Australia and New Zealand).

Through its MedX joint venture, Medica is expecting to expand the number of reporters in Australia and New Zealand thereby taking advantage of the fact that urgent, NightHawk images taken at night in the UK, can be reported during daytime hours.

Strong double-digit organic revenue growth rate

Growth outlook

Since listing in 2017 Medica has demonstrated the ability to deliver strong revenue growth, with annual growth averaging 17.7% for the years 2017, 2018, 2019.

We argue that Medica has a potential organic growth rate of 15% over the next three years, where ‘organic’ means existing customer markets and service offerings and excluding acquisitions. This growth expectation is underpinned by

• Growth rate of 8-10% in NHS activity volumes for complex scans including CT and MRI
• Continued trend towards more outsourcing to meet demand
• Medica’s number one market position supported by high levels of service quality and a market-leading technology platform which continues to evolve with client needs
• Catch up phase as the NHS recovers from COVID-19 and turns attention to the huge backlog of elective cases

During 2020 Medica’s revenues were affected by the deferral of large numbers of elective procedures in the UK healthcare system as a result of COVID-19. These procedures include operations such as hip and knee replacements that require a radiology report. We examine the impact of COVID and the recovery trajectory on p8.

We expect some continued weakness in revenue from elective procedures in H1 2021, but from H2 onward we anticipate a catch-up effect as the UK healthcare system begins to address its backlogs. Furthermore, the 2021 results will benefit from the inclusion of the acquired GDI business in Ireland (see p7). Taking these factors into account we are confident of a return to top-line growth in 2021.

Resumption of growth driven by NHS catch-up work

Revenue growth

Source: Proactive Research

Our forecast implies a revenue CAGR of 14.4% for the period 2016-2021e notwithstanding the residual impact of COVID-19 in H1 2021.

Our revenue forecasts drive our forecasts for earnings per share (EPS) growth of 98% and 32% in 2021e and 2022e respectively.

We argue that the current valuation does not fully capture the level of earnings recovery in 2021 and 2022 or the ongoing growth outlook thereafter. We examine the valuation case on p10.

The teleradiology business

Teleradiology is the transmission, interpretation and reporting of radiological images, such as CT and MRI scans, as well as X-Rays, in a location remote from where the patient is imaged. It allows specialist doctors (radiologists) to provide an expert and timely report to allow clinicians to decide on the best treatment for their patients.

Radiology demand grows faster than overall healthcare spending growth

The growth rate in radiology procedures in the UK has run ahead of growth in demand for healthcare overall. The volume of procedures has increased by 3.5% per year over the last five years; however, this understates the growth in demand for radiologist man-hours. More complex scans such as CT and MRI scans have been growing at 8-10%.

Even more importantly from Medica’s perspective, NHS capacity for radiology reporting services has been unable to keep up with demand, and the shortfall of available resources in-house has led to strong increases in outsourcing. The following chart shows the growth in NHS outsourcing for these services.

Strong growth in NHS outsourcing of radiology reporting services

Growth in UK outsourcing of radiology reporting services

Source: Royal College of Radiologists workforce census

Since the UK general election in 2019, the government has committed to increasing headcount across a range of NHS functions; however, according to the Royal College of Radiologists, the capacity to train or import radiologists will likely be insufficient to keep up with demand, leading to a cumulative shortfall of 3,300 radiologists by 2024. To put this into context, there are around 3,750 full-time equivalent radiologists working in the NHS so this represents a shortfall approaching 50%.

The following schematic highlights some of the main statistics around radiology supply constraints in the UK healthcare system.

Supply constraints - shortage of radiologists in the NHS

Source: Royal College of Radiologists workforce census

Outsourcing opportunity continues to grow driven by strong demand + supply constraints

We believe the radiology outsourcing market in the UK is set for continued demand growth in the coming years, driven by rising demand for scans together with a supply constraint for radiology reporting services within the NHS.

Within this growing market, Medica competes with three main outsourcers, as well as effectively competing with NHS ‘insourcing’ schemes that allow radiologists to provide reporting to their base hospital at overtime rates and allows NHS trusts to outsource to other NHS trusts. The following chart illustrates the market shares.

Medica is the market leader in teleradiology outsourcing in the UK

Market shares for teleradiology outsourcing, UK

Source: Proactive Research

Overall we argue that strong demand drivers, combined with Medica’s market-leading position in the UK, provide a supportive environment for revenue growth for the company’s UK teleradiology business in the coming years.

Additional growth opportunities

In addition to its position in teleradiology, Medica has the potential to address other segments of the wider telemedicine space. The company has a proven track record as a trusted outsourcing partner to the NHS, and the ability to operate a technology platform that can securely distribute imaging data to clinicians and deliver reports back to healthcare providers.

The telemedicine market stands at US$7bn globally

The total market for telemedicine globally stands at US$7bn per year, including the following categories:

• Teleradiology - diagnostic
• Teleradiology - clinical trials
• Telepathology
• Teleophtalmology
• Telecardiology
• Teledermatology
• Tele-endoscopy

Inroads into other service segments beyond radiology could be achieved by acquiring businesses or by acquiring or developing additions to the current technology suite.

Furthermore, Medica has the potential to address other geographic markets beyond the UK and Ireland. The company’s network of radiologists already included individuals in Australia and New Zealand, although currently focussed on servicing the UK client base, and the recently announced joint venture with Integral Diagnostics in Australia will expand their network and coverage in this market as well as opening up the opportunity to jointly bid for teleradiology tenders in Australia and New Zealand and, in time, further afield.

The GDI acquisition represents an important strategic move into new markets

In November 2020 the company announced a strategic move into a new geographic customer base and also a new discipline within telemedicine through the acquisition of a company called Global Diagnostics Ireland (GDI). GDI provides teleradiology services and also ophthalmology services for the detection of diabetes via retina scans.

The following table summarises the acquisition:

Medica acquisition of GDI, summary

Source: Proactive Research

The acquisition of GDI offers a template for potential future acquisitions to expand Medica’s market reach. In addition to the close strategic fit, other notable aspects of the deal include:

• Return on capital at 2x Medica’s weighted average cost of capital (WACC) in the near term
• Acquisition multiple of only 8x EV/EBITDA
• Immediately double-digit enhancing to Medica’s earnings per share

We note that our financial forecasts do not include any benefit from any future acquisitions, which would represent potential upside to our numbers.

Internal investments positioning the business for the future

New technology investments

Medica will continue to examine opportunities to invest externally in business expansion, where the investment returns exceed the company’s hurdle rate. In addition, the company has strategic initiatives to invest internally in the technology platform. These investments will help Medica to maintain its market leadership in the teleradiology business and provide a solid platform for continued organic growth.

The two major technology initiatives are:

The FutureTech programme will deploy a new Picture Archiving and Communications System (PACS) and orchestration system for the automated allocation of the workflow to reporting radiologists. The programme will also roll out a new proprietary software system to integrate Medica’s platform with the client. The new system will facilitate a reduction in manual processes, enhanced speed of image allocation and tracking, reduction of currently manual processes and improved productivity and reporting experience for the radiologists.

The Augmented Intelligence programme uses artificial intelligence (AI) tools to assist the radiologist in improving speed and quality in their reporting. Medica announced an agreement in March 2020 to partner with a company called Qure.ai on the AI element of the project. The Qure.ai technology has now been successfully deployed in analysing CT scans for intercranial haemorrhage and already well over 15,000 patient scans have been analysed using the qER decision support tool.

Medica will invest up to £6m in capital expenditure (capex) over the next five years to support the implementation of the FutureTech project with the new PACS scheduled to go live in the first quarter (Q1) of 2022.

Deferred procedures within the NHS affected Medica's business during 2020 and H1 2021

Current trading

During 2020 the UK healthcare system experienced large scale deferrals of elective procedures due to COVID-19. This was partly due to resources being diverted to address COVID, and also due to some medical services being suspended in the interest of patient safety during the pandemic. Many hospitals across the UK and Ireland ceased any non-urgent elective work such as hernia operations, hip and knee replacements and focused instead on more urgent cancer work.

For Medica, this led to a significant decline in 2020 revenues from routine procedures and by the end of March 2020, around 95% of all elective work had ceased, although this steadily recovered as lockdowns were eased. The company identifies its revenue streams under two separate service offerings:

• The ‘Nighthawk’ service provides 24/7 availability of teleradiology services for fast turnaround in support of emergency interventions, including traumatic injury and stroke.
• The ‘Elective’ service provides reliable and cost-effective teleradiology services for scheduled procedures.

The following chart shows the progression of the two revenue lines since January 2020.

The Nighthawk emergency service has already recovered to full demand. The Elective service is expected to recover during 2021

Impact of COVID on elective procedures, Medica revenue

Source: Medica Group to September 2020, Proactive Research estimates Oct-Jan

The Elective service experienced a sharp decline in revenues in Q2 2020 with the first UK lockdown, and renewed weakness with the additional lockdowns beginning at the end of 2020 and into Q1 2021. The Nighthawk service encountered a relatively brief disruption of revenues at the start of the first lockdown, and has subsequently recovered.

We expect a steady recovery in Elective revenues from summer 2021 onwards as the UK lockdown unwinds and as hospitalisation with COVID declines (our expectation) allowing the NHS to begin addressing backlogs of routine work.

Backlogs for routine procedures are a very big issue now for the NHS, with at least 4.5 million people now on waiting lists, and some 200,000 people having waited more than 12 months for a procedure. We believe that clearing these backlogs will require the NHS to increase its use of outsourced radiology services, and this provides a material revenue tailwind for Medica in H2 2021 and FY 2022. With this in mind, Medica continued to recruit radiologists throughout the pandemic and is well-positioned to support clients to process this huge backlog of imaging exams once they resume.

Financials

We are forecasting a rapid recovery in earnings per share (EPS) for Medica in 2021e and 2022e. The following chart shows our forecasts.

Earnings per share to grow strongly in 2021e and 2022e

EPS outlook

Source: Proactive Research

Our EPS forecasts are driven by our revenue growth expectations (see p2), with gross profit margins remaining in the 45-50% corridor. The increase in the absolute level of gross profit feeds into improved EBITDA (earnings before interest, tax, depreciation, and amortisation) margins and this drives our expectation for EPS growth. The following chart summarises our expectations for gross profit and EBITDA.

Profit margins

Source: Proactive Research

Overall profit to increase with volume growth and efficiency gains

We are allowing for some decline in gross profit margins in 2021e and 2022e as indicated by management. This reflects a likelihood that increasing levels of outsourcing will drive NHS trust managers to take a price-sensitive approach to placing new contracts, and Medica’s aim of increasing market share with a balanced but competitive approach to bidding for new contracts particularly in NightHawk services which then provide a good base for growing Elective revenues from the same NHS Trusts. This is balanced also by Medica’s ability to extract some efficiency savings in its client servicing costs as reflected in its cost of sales. In spite of this modest erosion of gross margin, we expect EPS to recover beyond its 2019 level by 2022e, with continued growth thereafter.

Valuation

Medica shares currently trade on a price/earnings (P/E) ratio of 15.9x based on our 2022e earnings forecast. We argue that this is a low multiple for a company with a leading market share in fast growing end markets and with strong profitability.

Some additional factors could justify a P/E multiple nearer 20x:

A higher valuation to reflect: Strong balance sheet, asset-light business model, low 'beta'

• Low ‘beta’, meaning low correlation with the economic cycle
• A strong balance sheet position, with net debt / EBITDA of 0.3x (2021e, average debt level)
• An asset-light business model, with a ratio of 4x revenue to fixed assets, excluding goodwill (FY 2019 figures)

The following table provides a sensitivity analysis showing the share price at various levels of 2022e EPS and different valuation multiples applied.

P/E multiples - valuation scenarios

Source: Proactive Research

Our central range of 136p to 189p would imply up to 40% upside to the current share price.

We argue that during 2021, as the residual COVID headwind turns into a catch-up tailwind, and as the company makes further progress in the resumption of growth, the market may be willing to apply more of a growth multiple in valuing the shares. Further, the continued diversification into Ireland, Australia and in time, other telemedicine services, could drive a re-rating of this stock as investors take a new look at the evolving Medica business model.