Bringing Wesfarmers back to health

Walmart, the world’s biggest retailer, is reported to be considering the acquisition of health insurer Humana, a potential $US37 billion deal.

And while the plan might seem to be a purely US event, it takes on a different perspective when you think about an Australian company with retail roots in search of something else to do – Wesfarmers.

Whether Wesfarmers mimics Walmart is a question that might be asked soon, because a move by the giant American retailer into health insurance was only aired in the US media just before the Easter long weekend.

Why Walmart would make a move into a totally new business is one aspect of the possible realignment of business interests.

What in the Australian health, or health insurance sector, might attract the eye of Wesfarmers as it prepares to ditch its Coles retail business is another question.

Who might be driving a move by Wesfarmers into healthcare is a third (and easiest to answer) question, given that the recently appointed head of business development at the Perth-based conglomerate is Ed Bostock, a former senior executive at the private equity firm, KKR, with a special interest in health.

The answer to the question about potential Wesfarmers takeover targets starts with Healthscope, Australia’s second biggest private hospital operator, and a business said to have been on the Wesfarmers radar screen several years ago.

However, in order to understand Walmart’s interest in Humana and Wesfarmers possibly dusting off its Healthscope files, it’s best to start by looking at events in retail.

Like every other retailer in the world, Walmart is facing an existential test of its business model courtesy of the internet invasion, particularly by the giant American retailer Amazon.

Because Amazon largely operates without legacy assets such as shops and supermarkets, it is able to undercut almost everyone else in retailing.

While Walmart has fought back and has created a successful internet offering, it will always be burdened by its property assets – unless it is able to scale back and focus on internet sales.

As it adapts to the internet threat, the pressure is on Walmart to develop alternative business interests, including those in areas where is has some knowledge through its pharmaceutical (drug store) operations.

Exposure to dispensing drugs has shown Walmart that healthcare, and its peripherals such as health insurance, is a strong and growing industry, especially with an ageing population and increasing referrals by doctors for expensive treatments or surgical procedures.

According to a number of investment banks, Wesfarmers ran the ruler over Healthscope when it was floated out of a period in the hands of two private equity firms – Carlyle Group and TPG.

That was in 2014, only six years after Wesfarmers had paid a small fortune for the Coles business and was busy digesting what is now widely seen to have been an expensive, albeit not fatal, error in capital allocation.

In fact, retail has not always been a happy place for Wesfarmers. Coles has chewed up a vast amount of capital for a modest return. Bunnings in Australia has been fabulous, Bunnings in Britain far less so. And then there’s the investment senior management at Wesfarmers wishes oldtimers would simply forget – the adventure with the Charlie Carters supermarkets in WA, which turned out to be a real dog.

Healthcare, either through a business that owns 45 hospitals but is in need of a management transfusion, or health insurance like Humana, which is Walmart’s target, could be the change of focus Wesfarmers needs once it rids itself of Coles (and Bunnings in Britain).

A few days before the reports about Walmart and Humana surfaced, analysts at investment bank Macquarie revived the Healthscope speculation, describing it as a ‘reasonable opportunity’ thanks to it being in a business with long-term positive characteristics as well as having high barriers to entry.

In other words, a healthcare business could be just what Wesfarmers wants after the bruising encounter with Coles and the major failure in British hardware retailing.

As it currently stands, Healthscope has been underperforming, which means there’s room for Wesfarmers to add value. Short-sellers have been active in the stock, and with 13.9 per cent of its shares sold short, Healthscope is the fifth most heavily shorted company on the Australian market.

With a share price limping along at $1.94 the company is valued on the market at $3.36 billion. Annual revenue is approaching $2.5 billion but profit was down 13.9 per cent to $136.8 million in the December half.

If Wesfarmers did move on Healthscope, it would need to pay at least $4 billion.

However, that possible entry price into healthcare could turn out to be just the start, given the potential to grow the existing hospitals business and to set out in pursuit of the private hospital leader, Ramsay Health Care, and to possibly make a bid at some stage for Ramsay to create an Australian healthcare giant with global expansion ambitions.