EMIS Group — Strengthening its position despite NHS funding pressures

In FY16, the company reported revenue growth of 2% y-o-y, with growth in recurring revenues of 4%. Adjusted operating profit of £38.8m was in line with our forecast. As the company has reduced its net debt position substantially, interest expense declined. Adjusted EPS came in 3.7% ahead of our forecast, due to lower than expected tax and interest charges and a slightly higher joint venture contribution. The final dividend of 11.7p takes full year dividend to 23.4p, as expected. Net debt finished the year above our forecast as we had not accounted for the £0.8m payment for the Intrelate acquisition in December.

Primary & Community Care (PCC) revenue and adjusted profit was in line with our forecasts. Reported operating profit includes an exceptional charge of £1.2m for the cost reduction programme. Community Pharmacy (CP) revenues were in line with our forecast and adjusted operating profit was 10% ahead of our forecast. Reported operating profit includes a £0.1m exceptional charge for the cost reduction programme. Secondary & Specialist Care (SSC) revenues declined significantly more than we expected, resulting in lower than expected adjusted operating profit. Reporting profit includes a £2.3m exceptional charge for the cost reduction programme as well as a £4.6m goodwill write-down on the Specialist Care business, reflecting a lower return than expected since acquisition. Overall, the adjusted operating margin grew one percentage point year-on-year.

EMIS maintained its 55% share of the UK GP market. In Northern Ireland, the first pilot sites went live in August 2016; rollout should be complete by the end of 2017. In Scotland, the company is engaged in pre-procurement for EMIS Web, with implementation expected in 2018. In Wales, re-procurement of primary care software has started. GPs are already using EMIS Web in Wales and existing contracts will run until 2019/20.

The Community, Child and Mental Healthcare (CCMH) business increased its market share to 16% from 12% at the end of 2015, beating its 15% target. The company is targeting an increase to 20% by the end of 2017. Contracts won in 2016 have a total contract value of more than £11m. We assume that these contracts have an average life of circa six years, which implies an additional c £2m per annum in revenues. The company has secured two contract wins year-to-date: Bridgewater Community Healthcare and Central Surrey.

The number of clinical commissioning groups (CCGs) in England using entirely EMIS Web for their GP practices has risen from 46 to 51 over the year. This is important as it makes it more likely the CCG will use EMIS for other primary care applications, due to the ease of integration. In fact, at year end, 38 CCGs used solely EMIS Web for primary care and also used EMIS as a major supplier for CCMH.

The Intrelate acquisition (bought December 2016 for net £0.8m in cash) is being integrated into the Egton business. Intrelate has developed an app called Carista that helps paid and unpaid carers to plan, monitor, manage and measure social care outcomes. This is EMIS’s first entry into the social care technology market.

The business has a Partner programme with 80 participating suppliers; charging them to integrate with EMIS systems has generated revenues of £5m in 2016.

The CP business remains strong, with a market share of 37% at year-end (number of sites increased by 181 to 5,091 over the year). The Lloyds pharmacy contract should be fully rolled out by the end of 2018, taking the company’s market share to c 50%. The company’s next generation software, ProScript Connect, is now fully accredited in England, Wales and Scotland. It had been installed in 25 independent pharmacies by end 2016.

Post year-end, the business won a supermarket customer with an estate of c 40 pharmacies – the contract is worth £1.4m over six years.

As previously reported, the Secondary Care business has suffered from delays in procurement due to NHS funding issues. One-off implementation revenues in 2015 as well as the transfer of ePEX mental health software to PCC also contributed to the revenue decline in 2016. The division was restructured in H116 to reduce the cost base.

Despite the weak procurement environment, the business managed to secure a position as one of two suppliers on the NHS Scotland Hospital Electronic Prescribing and Medicines Administration framework, which could be worth up to £15m over two years. It should also benefit from central NHS funding of upgrades to its hospital pharmacy product.

The latest round of NHS initiatives includes global digital exemplars (GDEs). The NHS will fund 12 GDEs up to £10m each to fund the transition to going paperless, with funding expected to be released in H217. EMIS is working with University Hospitals of Southampton NHS Foundation Trust, one of the GDEs, while it formulates its plans, is also engaged with three other GDEs and indirectly supports another three.

EMIS Specialist (diabetic retinopathy software) maintained its leading position with 77% market share (79% in 2015).

EMIS Care (diabetic retinopathy screening services) had an 18% share of the outsourced market in 2016, down from 19% in 2015. The business won several contracts in the year, most from the NHS (ie moved from direct to outsourced provision) and a few from other service providers. With initial contract values of £19m over three years, this should take EMIS’s share to 26%. While winning new contracts has been positive, the business has incurred higher costs in implementing the services than originally anticipated when buying the business, so it has taken action to improve the profitability of the service. Some of the recent contract wins will be implemented in H117, adding further upfront costs. Over time, the company expects the profitability on these contracts to rise.

As announced in January, the company is bringing Primary Care, CCMH and Secondary Care together as one unit under the leadership of Duane Lawrence, who previously headed up Secondary Care. This is to reflect the way that the NHS will increasingly procure IT. The reorganisation will cost £3m (treated as an exceptional charge in FY17) with a c 100 reduction in headcount. Cost savings are expected to total £3m in 2017 rising to £4m per annum from 2018.

The company hired a new head of digital in October 2016. Jason Keane has digital media experience from senior roles at Saffron Digital, Universal Networks Interactive and Yahoo! Answers. The business has been structured into its own legal entity since 1 January 2017. Visitors to Patient.info showed substantial growth in 2016, rising from 11.5m unique monthly users at the end of 2015 to 18.3m by the end of 2016 (of which 74% were international visitors). The website earned advertising revenues of £2.1m (+24% y-o-y) and a further £1m from transactional services such as appointment booking. There are 5.1m citizens registered to use Patient Access, providing a base level of potential users of transactional services.

The company plans to invest c £7m in the business over the next two years, mainly in the form of increased internal and external headcount, to develop the existing media business and to expand into a market place e-commerce platform. We expect the company to take a flexible approach to the pace of investment, hiring more slowly if revenue progression is slower than planned, and vice versa.

Expansion of the existing media business is likely to include:

The vision of the Patient business is to become the leading on-demand healthcare remedy platform. This will extend from providing information on health (starting with symptom search), to accessing a diagnosis (options to include booking to see an NHS GP or a private specialist, using a community pharmacy, or if more serious, calling 999 or 111 and/or accessing A&E) to obtaining any relevant pharmaceutical items (services to include prescriptions, over-the-counter remedies, local collection, home delivery). EMIS will then be able to earn a combination of advertising revenues from publishing services and transactional revenues from the clinical and pharmacy services.

The company sees an annual revenue opportunity of £13m for the publishing side of the business and a larger £33m opportunity from the e-commerce platform. The table below shows company estimates of how this could progress over the next five years. The company is keen to prove the concept in the UK first, before expanding to the international market.

The company expects to show better revenue growth in 2017 than in 2016, helped by growing share in CCMH, implementation of new diabetic retinopathy services, growth of the Patient business and growth in demand for integrated care solutions. On the cost side, we have reduced our profitability assumptions in SSC, reflecting the costs of implementing the new screening programmes. In PCC, we have increased our cost assumptions to take into account the new investment in Patient. This is not fully offset by the cost savings expected from the reorganisation. Overall this results in a reduction in our adjusted operating profit forecast from £41.5m (24.1% margin) to £37.5m (22.6% margin). We introduce a forecast for FY18 of £40.9m (23.3% margin). A reduced EBITDA forecast and the additional £3m exceptional reorganisation cost bring our net cash forecast down in FY17. Nonetheless, it is highly cash generative and moves to a net cash position by the end of FY17.

EMIS is trading at a small discount to its peer group on P/E, EV/EBIT and EV/EBITDA multiples. The funding situation in the NHS is delaying investment in IT, even though the strategic use of technology is likely to improve efficiency and help deliver care more cheaply. In the longer term we continue to believe EMIS Is well positioned to benefit from an increasingly integrated approach to providing care across the NHS, but in the short term, we expect that certain parts of the business will to continue to suffer from the sluggish procurement environment. There is additional uncertainty around the expansion plans for Patient, as this is taking the company out of its core area of expertise. However, we expect the company to take a flexible approach to investment, and the Patient.info website (with an already high level of visitors) provides a good base from which to build the business. With superior margins to the majority of its peers, evidence of a resumption in earnings growth should support share price upside.