Things have taken a turn for the worse for shareholders in NMC Health (LSE: NMC) this week. The share price has tumbled from 2,585p on Monday to about 1,250p at the time of writing. NMC was previously well-liked, but now it is firmly out of favour.
The cause was a Muddy Waters research report that said it had “serious doubts about the company’s financial statements, including its asset values, cash balance, reported profits, and reported debt levels“.Â
At the same time, Muddy also announced that it was taking a short position against NMC shares. That position benefits from a decline in the NMC share price, and Muddy got what it wanted.
NMC has now responded to the claims. Has Muddy made a misdiagnosis? I don’t think so.
Bad medicine
NMC valued its assets at $3.47b at the end of June 2019. Goodwill accounts for $1.44b of those assets. This goodwill asset came from acquisitions and represents the premium NMC paid above the estimated market value of the acquired assets.
If NMC grossly overpaid for its acquisitions, which Muddy suggests it did, then 41% of the assets are liable to substantial write-downs in the future. That is worrying, even if, as the company has said in response to Muddy’s report, that it valued its acquisitions fairly and had third-party valuations done as well.
Fighting back
NMC has said that when its suppliers get paid by a financier, who is later reimbursed by NMC at the original invoice amount, that amount is recognised in trade payables as it should be. Muddy Waters claims these invoices are an off-balance sheet source of financing. Since NMC has not broken down its trade payables, I cannot say much more.
Muddy Waters believes NMC has inflated its cash and equivalents balances because they attract negligible interest. I took the average of the opening and closing balances for the first six months of this year, which, with the half-year finance income number, means NMC gets about 1.9% interest annually on its cash balances.
That’s not far away from the 2% NMC claims you get on cash deposits in the Middle East. The rate makes sense if NMC needs most of its cash to support working capital and therefore places it in short-term, deposit-like accounts, as it claims it does.
Diagnosis
If the bulk of those cash balances are needed to support working capital, then announcing a $200m share buyback seems potentially ruinous.
Sure, the NMC share price was in freefall, and its management probably thought a buyback announcement might shore it up. However, the buyback consumes nearly 50% of NMC’s cash and equivalents if carried out in full, which means it can’t be done in full without taking on additional debt.
Furthermore, on Tuesday NMC announced it wanted to buy back $90m of convertible bonds issued just last year. Is that going to eat into working capital cash, or is more debt going to be issued? At the very least, it means that NMC management appears to have issued $90m of debt needlessly.
NMC has not convinced me that the allegations made by Muddy Waters are baseless. There are inconsistencies in the company’s defence. The 39-page report issued by Muddy Waters is available for download and it raises many more issues than I have been able to cover here. I will avoid this stock.