Circle: A New model For Independent And NHS Markets

Circle (CIRC.L:LSE) is a disruptive new entrant in the UK healthcare market, seeking to benefit from both additional NHS operating contracts and new private hospitals. It brings a partnership-style operating model and efficient, appealing, newly built facilities, supported by committed consultant volumes, to challenge an existing oligopoly in local markets. Expanding the number of Circle hospitals to drive profit growth will be greatly assisted if the cost of the third-party financing for new hospitals (and the rent that Circle pays) falls. A growing operational track record will help, but there is also a potential inefficiency in the real estate market to be corrected.

New model for independent and NHS market
In February 2012, Circle became the first private sector operator of an NHS hospital at Hinchingbrooke. The operating deficit has been substantially reduced (from an underlying c £10m to c £3.7m during the first year) while care quality measures have improved. With many NHS trusts struggling financially, Circle sees further opportunity in supporting the efficient provision of NHS treatment, targeting improved clinical outcomes at lower cost, as well as growing its differentiated new offering in the independent market. Circle is now the preferred bidder for a renewed five-year contract at its existing Nottingham NHS Treatment Centre.

Hospital build is key
Circle’s NHS contracts provide additional profits, scale and diversification, but we believe the further roll-out of independent hospitals offers the greatest potential for value creation (see page 14). Circle’s growing track record should support the convergence of real estate funding costs on those of established operators, making this possible. We would also expect real estate investors to develop structures (eg specialist funds) to exploit the pricing differential that exists between the UK and other established markets (eg US), as well as the pricing differential between Circle’s newly built and efficient hospital assets and those of established operators. Circle notes an increasing appetite in the financing markets for the planned CircleManchester hospital.

Valuation
The start-up phase is difficult to value, but more hospitals with lower rents increases the valuation significantly. Assuming a 6.0% rental yield, similar to the funding costs of peers, we estimate each new hospital adds c 19p per share (net of the 50% minority) and that a fair value of £2.0, after central costs, requires c 10 independent hospitals (two in current forecasts), alongside the two existing NHS operating contracts.

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