Bouncing back from Covid-depressed levels

Bouncing back from Covid-depressed levels

Medica is the UK leader in teleradiology. Teleradiology is the electronic transmission and remote assessment of radiological images, including CT, MRI and x-ray scans. Hospitals transmit these images through Medica's platform to a network of remote radiologists who, from their own home, review and return their interpretations swiftly. This digital solution aims to alleviate capacity constraints in UK radiology. Medica's service runs 24/7 and prides itself on speed and quality. The outsourced radiology market grew strongly pre-pandemic due to chronic NHS capacity constraints and that momentum is expected to continue as hospitals now confront extensive surgical backlogs. In the UK, Medica operates through two services: NightHawk, an out-of-hours emergency service, and Elective, which supports radiology reporting for scheduled surgical procedures. There is also a service in Ireland for teleradiology and teleopthalmology. The Irish subsidiary was acquired in late FY20.

In FY21 Medica acquired US-based RadMD. RadMD specialises in teleradiology for clinical trials where stringent assessment and record-keeping are required. In Q1FY22, Medica launched the first phase of its ambitious FutureTech platform. This uses an image handling system (a PACS) from Sectra AB to improve radiologist workflow and facilitate AI tool integration.

Driven by a robust outsourcing trend and pent-up demand for diagnostic imaging, revenue in FY21 rose to £61.9mln. Underlying profits were £12.1mln. Because of COVID-19, 2020 revenues were down on 2019 but demand is now high with a total NHS (England and Wales) waiting list in March of nearly 500,0000 for MRI and CT scans (Chart 1). Immediate growth trends are therefore strong and waiting lists are likely to remain high until 2024.

Managing the radiology workflow

Medica is the UK market leader in teleradiology and has expanded strategically into two new markets, Ireland and the US, through acquisition. UK sales in FY21 were £47.1mln with Ireland adding £9.7mln. The US operation added nine months of FY21 revenue post-acquisition of £5.2mln. The gross margin was 50.8% on total revenue of £61.9mln.

Revenues were lower in FY20 due to the pandemic, but Medica remained profitable on an underlying basis at £5mln. Underlying operating profit rose in FY21 to £12.1mln; statutory post-tax profits were £5.3mln after tax of £1.9mln. Medica generated £9.7mln of operating cash in 2021. After the acquisition of RadMD (£11.4mln) and various financing movements, cash fell from £13.9mln to £9.6mln.

Medica has a current market cap of £194mln giving a 16x multiple of underlying FY21 earnings. The company proposes a total FY21 dividend of 2.68p (interim 0.89p, final proposed 1.79p) implying a yield of 1.7%.

Attractive niche market with strong growth potential

Year end Dec 31 · 2020 · 2021

Revenue (£mln) · 36.8 · 61.9

Underlying Op. Profit £-mln · 5.0 · 12.1

Dividend (p) · 0.85 · 2.68

Medica has built up an impressive network of specialist doctors, allowing the company to offer an efficient 24/7 service to over 200 hospitals and trusts. Over 1.2mln reports were generated in 2021, Exhibit 1.

Excellent market growth prospects from a strong base

Exhibit 1 - Strong network of experts with wide customer base

Source: Medica

In 2021, the 24/7 NightHawk service had sales £29.8mln, up 25% on the pandemic year 2020, compared to Elective, FY21 17.3mln sales, up 38% vs 2020. It seems likely that Elective revenues should grow more rapidly as the NHS has a backlog of cases awaiting diagnosis. The February 2022 NHS paper set a target to eliminate waits of over 12 months for elective surgery by 2025. In cancer, the NHS will invest £2.3bn in new MRI, CT, and ultrasound facilities to diagnose or eliminate 75% of suspected cancers within 28 days by March 2024. All those scans need expert interpretation. Chart 1 shows patient numbers in England and Wales waiting for an elective MRI (magnetic imaging) or CT (3D X-ray) scan. The NHS data set used for Chart 1 is based on 417 hospitals, indicating that Medica may have a c.50% share of the NHS base.

NHS demand

Chart 1 - NHS CT and MRI waiting list

Source: NHS monthly diagnostic figures online

This excludes normal 2D x-ray images. There are about 500,000 with an average wait of three months for MRI (fewer scanners) and two months for CT. These scans are common before elective surgery and especially for cancer diagnoses, treatment and postoperative assessment.

There are two main private UK competitors: 4ways (FY21 revenues £20.3mln); and Everlight (trading as Radiology Reporting Online, a partnership) with £26.6mln FY21 sales. TMC is a smaller competitor and part of the Unilabs' group imaging services. Direct comparison is not possible due to limited data.

UK competition

With a profitable US subsidiary, a strong integrated Irish operation and an unprecedented backlog buildup within the NHS, Medica appears to have multiple growth opportunities available over the next few years.

Outlook

The teleradiology market

Medica's key competitive advantage comes from its large base of more than 750 specialist doctors and clinical staff able to work on its platform.

• These specialists comprise consultant radiologists, reporting radiographers and rheumatologists, all specialising in their relevant field, reporting on the images from their own home office.
• Medica has recruited specialists from Australia and New Zealand to overcome UK capacity constraints and offer a 24/7 service; other providers also offer out-of-hours cover. This also improves reporting quality and lowers radiologist costs. This has helped deliver on a key performance indicator, average turnaround time (“TAT”), which is 23 minutes for Medica’s round-the-clock NightHawk division [Source: Annual report 2020].

• Strong NightHawk contract renewal indicates a 'sticky' customer base and the enduring attraction of Medica's offering: In June FY21 84% of the division's revenue was from customers >5 years (3-year average contract length) [Source: Interim Presentation, 2021], which suggests that hospitals are reluctant to change providers once a system is embedded. This gives Medica's market-leading position some protection.
• Information technology is a core competitive skill and the first phase of the FutureTech platform was launched in Q122; this is a digital upgrade to enhance radiologist productivity (see later discussion). Unlocking capacity though digital enhancements helps overcome the problem of radiologist shortfall. It will improve quality and speed with added functionality over 2022 and 2023.
• Medica uses some decision-support AI tools(from Qure.ai, see below) to enhance its service.
• The US clinical trial market is expected to grow at 7% CAGR up to 2028 from a base of c.$30bn. RadMD has a strong order book, implying $54mln of future sales up to 2024, a rise of +35% on 2021 [Source: Annual report, 2021].

• Irish radiology shares similar capacity constraints to the UK, with a shortfall estimated at 25% in 2020. The growth outlook is also similar to the UK, but Irish accounts tend to command higher margins due to the larger private healthcare component there.
• Medica also offers a teleopthamlogy service in Ireland. The Diabetic RetinaScreen service covers around half of the Irish population in partnership with the Irish National Screening Service.

Exhibit 2 - Teleopthamology

Source: Medica

Table 1 - M&A activity

Source: Medica

Growth and expansion by acquisition

Of the £61.9mln FY21 revenues (up from £46.5mln in 2019) £14.9mln came from recently acquired subsidiaries. A total of £47mln of revenue came from core UK operations. Although this shows minimal core growth, revenue swings during the pandemic and their unequal effect across divisions limit meaningful comparisons. In terms of momentum, stripping out the US acquisition, H2FY21 sales were £30mln, up 8.7% over H1FY21 sales of £26.4mln.

Table 1 shows acquisition costs. The US acquisition cost was £11.8mln in 2021 paid on completion; net of cash, this was booked at £11.4mln. A further £3.8mln in contingent consideration is due in June 2022.

A contingent consideration of £1.9mln on the Irish GDI acquisition is due in 2022 of which £1.7mln was paid in March. A further £1.4mln is due in H12023.

RadMD is somewhat different to the UK operation, which comprises routine and emergency scans, as it is an imaging Contract Research Organisation (iCRO). An iCRO carries out stringent analysis of images from trials. For example, in a cancer trial, a new therapy efficacy might be measured as progression-free survival — and imaging is often used to detect if a cancer tumour has grown or shrunk and if so, by how much. So, medical imaging is a vital component of many clinical trials. It is therefore a higher value service than routine scans linked to planned elective surgery.

iCROs are experts in providing advice about medical imaging in clinical trials. This includes imaging protocols, image acquisition and analysis, data management, and quality control. The reliability and reproducibility of image data interpretation are realised through consistent data review and the use of two readers. Trials are typically managed by an iCRO on behalf of a pharmaceutical or biotech sponsor and are often global. Radiologists, known as readers, have to be specially trained to be able to report imaging studies for clinical trials as this is conducted under good clinical practice protocols.

FutureTech: new information technology to assist expert radiologists

Over 2022 and 2023, Medica is investing £6mln in the FutureTech programme (Source: Annual report, 2021). The first stage went live in February 2022 with Spectra PACS; PACS is a radiology acronym for Picture Archiving and Communications System, i.e. how the network of radiologists receives, views, reports on and stores the diagnostic images. Sectra is a Swedish, listed diagnostic imaging software and cybersecurity company. The FutureTech platform is a significant improvement to the system's scalability and functionality. Medica has seen improvements in the following areas:

1. New analytics & functionality: The new PACS has enabled improvement in the quality of data and enables focused service improvements including AI integration & deployment such as qER (see below)
2. Improved reporter experience & clinical outcomes: whilst data is still being analyzed, and a reduction in the time needed to report urgent cases. As one radiologist noted, “the new PACS is much more intuitive”
3. Efficiency gains: early results indicate reduced time to report a study by an average c.10% per study for acute workflows.
4. Cost reduction: finally, Medica estimates that initial annualised savings of about £250k have been realised in technical support costs

AI systems can detect over 99% of haemoragic stroke cases

In December 2020, Medica started to use an AI tool from Qure.ai, an Indian company, called qER to detect brain haemorrhages in suspected stroke cases. This decision support software provides additional information for the radiologist and acts as a “second pair of eyes” to locate brain micro-haemorrhages. NICE did a 2020 technology review and noted five products in this software class including qER. qER is CE marked and also FDA approved under the 510(k) procedure. Medica noted that qER has reduced the time to report by 7% or 1 minute per 14-minute scan. A video review is available.

FY21 results

Medica's FY21 results showed revenues of £61.9m, up from £36.8mln in 2020. The yearly comparison is not representative as elective surgery in 2020 was heavily depressed in the COVID-19 pandemic. The 2019 figure of £46.5mln is a better benchmark.

In 2021, the 24/7 NightHawk service had sales of £29.8mln, up 25% on the pandemic year 2020, compared to Elective, FY21 £17.3mln sales, up 38% vs 2020, Chart 2.

The FY21 sales figure included nine months of contribution (£5.2m) from the US acquisition, RadMD, as well as a full 12 months of Medica Ireland sales (£9.7m).

Adjusting for these, revenue from the core NightHawk and Elective businesses, at £47mln, saw a recovery to 2019 levels, having dropped by 20% in 2020.

Chart 2 - Sales by product type

Source: Medica reports, ProActive graphic

Gross profit margin of UK 2021 revenues, at 50.2%, was an improvement over 2020 at 47.1%, with the company benefiting from a higher margin sales mix from recent acquisitions and NightHawk out-performance, Table 2. RadMD's gross profit is higher at 55%. The Irish subsidiary had a 51% gross margin. The group gross margin was 50.7%. This could improve in 2022 with a full year of higher-margin US sales. However, if the cost of the specialist reviewers rises due to inflation, Medica's margins could be squeezed.

Underlying 2021 operating profit at £12.1m showed 6.9% growth over 2019. This figure, in effect EBITDA, excludes £3.5mln of various charges of which the largest is amortization at £2.2mln with share-based payments at £0.7mln and transaction and legal fees of £0.8mln. The actual operating profit was £8.5mln.

The underlying operating profit (19.5%) was lower than in 2019 (24.3%) and the historical average of 26.5%. Medica's administration costs and the incorporation of the Irish businesses probably explain this effect. Medica Ireland's operating profit was 15.9% in 2021 and RadMD's was 13% compared to the UK 21% underlying operating profit.

Table 2 - Revenues and underlying costs

Source: Medica 2021 Annual Report

Cash and funding

The December 31 cash was £9.6mln. There was a positive operating cash flow of £9.7mln before investments of £13.5mln and net financing of £0.3mln. The net financing includes a 2021 share issue raising £16.2mln, debt repayments of £23.5mln and fresh borrowing of £11.6mln. At year-end, the rolling credit facility (of up to £30mln) had been drawn down by £5.7mln.

Investment case

Robust growth drivers

• Medica grew its top-line at an average annual rate of 20.3% from 2015-2019, demonstrating the strength of the pre-pandemic teleradiology trend. Post-pandemic, clinical pressures have intensified with backlogs growing and the radiologist shortfall widening. This should underpin strong mid-term revenue generation. The company has also added other growth levers, notably the clinical trials market in the US.

Revenue visibility

• Visibility is offered by: (1) the exclusive nature of NightHawk's three-year NHS contacts, effectively locking in a predictable number of annual reports over that period; (2) RadMD's strong and growing order book; and (3) the surge in elective surgery predicted over the next two years. In terms of NightHawk sales, 43% of revenue is from contracts signed in the last 18 months and 84% of revenue is from customers older than 5 years (Source: Interim Presentation 2021). This demonstrates strong client retention and that many contacts are still in their early stages, which reinforces sales certainty over the mid-term.

Cash

• Net cash at the 2021 year-end was £3.9m. There was a deferred consideration totaling £6.9m due in respect of Medica Ireland and RadMD acquisitions. The company has sufficient banking facilities (£30mln of which £5.8mln drawn) to cover these payments plus a positive operating cash flow.

Dividend

• Medica has proposed a total annual dividend for 2021 of 2.68p/share. Dividends are therefore likely in future years.

Margin and inflation pressures

Medica achieved impressive sales growth pre-pandemic. Strong client retention and contract renewals in the NightHawk division reflect its robust competitive position. There is some price pressure when bidding for the larger, out-of-hours tenders. Pricing pressure has not appeared in Elective as the market is heavily capacity constrained. It is possible that gross margin percentages may rise slightly given the trend towards “premium” scans. As NHS backlogs are reduced, higher volumes processed through the platform could give increased gross profits.

Conclusion

Medica is a clear UK leader in teleradiology and now has a good international basis with its entry into the higher-margin US clinical trials support business. Medica has a current market cap of £194mln giving a 16x multiple of underlying FY21 earnings. The company proposes a total FY21 dividend of 2.68p, implying a yield of 1.7%. Medica's entrenched position, the high industry entry barriers (complex IT systems, long-term contracts and innate capacity limitations) and its recent capacity-enhancing technology investments should give a strong growth profile given the need of its main customer, the NHS, for increased capacity and throughput.

Results summary

Year · 2019 · 2020 · 2021

Revenue (£m) · 47 · 37 · 62

Gross profit (£m) · 22 · 17 · 31

PBT (£m) · 11 · 2 · 7

Basic EPS (pence) · 7.12 · 1.21 · 4.56