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Virtus Health: Not so healthy

Virtus Health (ASX:VRT) listed on the Australian Stock Exchange (ASX) today, the largest IPO this year.

Investors in the float would have been pleased, with the stock trading above its offer price of $5.68. In mid-afternoon trading, shares were trading around 8% higher, at $6.15.

Virtus is the largest private equity float since Collins Foods (CKF) in 2011, with Quadrant Private Equity selling down its entire 46.5% stake in Australia’s largest provider of In Vitro Fertilisation (IVF) services. Virtus conducted approximately 35% of Australia’s IVF cycles in 2012, and has facilities representing around 80% of the population. 33 fertility clinics, 6 specialised diagnostic laboratories, 17 embryology labs, 18 andrology labs and six day hospitals are spread across Queensland, NSW and Victoria.

Assisted reproductive services accounts for the lion’s share of revenue, with some 77% of income generated by this division alone. Another 13% comes from day hospitals, while 7% is sourced from specialised diagnostics, with the remainder coming from other income.

Virtus has a similar business model to 1300 Smiles (ASX:ONT) or Vision Eye (ASX:VEI) where specialists enter into contracts with Virtus and receive management fees as well as procedural fees for the surgical procedures they perform.

But all is not what it seems. Despite appearing to be an excellent opportunity to invest in a company where growth should come every year, as the population expands, there are a couple of flies in the ointment.

Earnings are expected to be around 33 cents this  financial year and 39.5 cents in 2014, putting the stock on a P/E ratio of 17 at the $5.68 issue price, and a P/E ratio of 15 in 2014. That’s not all that cheap, for a company growing revenues at just over 10% in the past three years, and no longer term track record. Earnings before interest, tax, depreciation and amortisation (EBITDA) is expected to grow at a compound rate of 10.5% between 2012 and 2014.

And debt is an issue, which is no surprise given private equity is selling out of the company. Despite raising $339m in the float, Virtus still comes out with an estimated $149m in debt on its books, with much of the difference going to pay out Quadrant.

Virtus is also exposed to any changes in Medicare and private health funds policies. Currently, up to 59% of an IVF Cycle, the most common treatment, can be contributed by the Commonwealth, while private health insurance covers between 10-13%. In 2010, the number of IVF Cycles in Australia fell by 10%, after caps were placed on assisted reproductive services, with patients facing higher out-of-pocket expenses.

Foolish takeaway

For income-minded investors, the company expects to start paying a fully franked dividend in 2014, with the expected yield to be around 4.6%, based on the issue price of $5.68.

With a debt/equity ratio of over 70%, and goodwill representing 83% of total assets, Virtus appears to be a fairly risky stock. Add in the other issues raised above and Foolish investors might be wise to avoid this company for now.

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Motley Fool writer/analyst Mike King doesn’t own shares in any company mentioned.

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