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INDEPENDENT RESEARCH UPDATE Fresenius SE

18th December 2014 FMC visibility might moderate FRE uncertainties Healthcare Fair Value EUR42 vs. EUR40 (price EUR42.19) NEUTRAL

vs. BUY

Bloomberg FRE GR Reuters FREG.DE 12-month High / Low (EUR) 44.1 / 35.0 Market capitalisation (EURm) 25,730 Enterprise Value (BG estimates EURm) 39,562 Avg. 6m daily volume ('000 shares) 1 162 Free Float 25.0% 3y EPS CAGR 13.0% Gearing (12/13) 181% Dividend yield (12/14e) 3.51%

Having undergone some major changes in 2014, we expect Fresenius SE’s transformational efforts to materialise in 2015. Nonetheless, we point out growing uncertainties at Kabi which could offset efficiency gains expected from major acquisitions as well as portfolio expansion. In the short term, we would favour Fresenius Medical Care which we believe benefits from a strong visibility on the bundle rate, set to ease from 2016 despite a tightened reimbursement environment. Moreover, the Care Coordination strategy is set to significantly increase FMC’s scope of operation by covering the whole dialysis business value chain. Although still obscure at the moment, we put the spotlight on expansion opportunities in APAC.

Following the complete integration of RHK’s hospitals last year, Helios now has a market leader position in acute care hospitals in Germany with a 40% market share. The first synergies should materialise in 2014 with a roughly EUR80m gain in EBIT.

Kabi is Fresenius SE’s major contributor to net income (48%) and 2nd contributor to margins with a sustainable 17-18% 2014 EBIT margin (EUR916m in 2013) accounting for 30% of the group’s EBIT (i.e. EUR3.2bn in 2013). Cross selling expected from the gradual introduction of Kabi’s extended portfolio should drive cost synergies estimated in the EUR50-70m range. Nonetheless, we see the recovery of its competitors in the IV drug segment as well as uncertainties regarding the Grand Island facility, as a short time threat.

During its last CMD, FMC unveiled its ambitious development plan to become a major player in the dialysis-related business beyond just the dialysis: Care Coordination. This is set to fuel revenues and account for 18% (USD5bn) of FMC’s sales in 2020e vs. 3% (USD500m) in 2013. Alongside the GEP set to offset margin dilution from intensive M&A operations, we put the spotlight on underestimated opportunities in APAC as well as payers and EPO issues for DaVitaHCP.

We downgrade Fresenius SE to NEUTRAL (FV EUR42 vs. EUR40) and would favour FMC, BUY reiterated (FV EUR71 vs. EUR58) which has a stronger visibility in the short term and is poised to outperform DaVita in 2015 in our view.

YE December 12/13 12/14 12/15e 12/16e Revenue (EURm) 20,331 24,006 25,866 27,535 EBIT (EURm) 2,991 3,325 3,748 4,156 Basic EPS (EUR) 1.89 2.13 2.49 2.83 Diluted EPS (EUR) 1.96 2.31 2.49 2.83 EV/Sales 1.9x 1.6x 1.5x 1.4x EV/EBITDA 9.7x 9.3x 8.4x 7.6x EV/EBIT 12.6x 11.9x 10.5x 9.4x P/E 21.5x 18.3x 16.9x 14.9x ROCE 4.0 4.0 4.1 4.4

27.6

29.6

31.6

33.6

35.6

37.6

39.6

41.6

43.6

45.6

14/06/13 14/09/13 14/12/13 14/03/14 14/06/14 14/09/14 14/12/14

FRESENIUS (XET) SXX EUROPE 600 HEALTH CARE

Analyst: Sector Analyst Team: Hugo Solvet Eric Le Berrigaud 33(0) 1 56 68 75 57 Pierre Corby [email protected]

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Simplified Profit & Loss Account (EURm) 2011 2012 2013 2014e 2015e 2016e 2017e Revenues 16,522 19,290 20,331 24,006 25,866 27,535 29,396 Change (%) 3.4% 16.8% 5.4% 18.1% 7.8% 6.5% 6.8% Adjusted EBITDA 3,237 3,759 3,888 4,252 4,684 5,128 5,569 EBIT 2,563 2,983 2,991 3,325 3,748 4,156 4,532 Change (%) 6.0% 16.4% 0.3% 11.2% 12.7% 10.9% 9.0% Financial results (631) (701) (584) (633) (682) (726) (775) Pre-Tax profits 1,932 2,391 2,407 2,692 3,066 3,430 3,757 Exceptionals NM NM NM NM NM NM NM Tax (604) (659) (669) (781) (889) (995) (1,090) Profits from associates NM NM NM NM NM NM NM Minority interests (638) (806) (727) (762) (831) (906) (1000) Net profit 690 926 1,011 1,150 1,346 1,530 1,668 Restated net profit 770 938 1,051 1,245 1,346 1,530 1,668 Change (%) 16.7% 21.8% 12.0% 18.5% 8.1% 13.7% 9.0% Cash Flow Statement (EURm) Operating cash flows 1,689 2,438 2,320 1,602 3,222 3,226 3,479 Change in working capital (445) (129) (288) (1,237) 109 (181) (225) Capex, net (758) (952) (1,047) (1,176) (1,267) (1,349) (1,440) Financial investments, net 607 1,521 1,796 0.0 0.0 0.0 0.0 Dividends (365) (446) (491) (1,017) (1,082) (1,200) (1,289) Other NM NM NM NM NM NM NM Net debt 9,164 10,143 11,940 13,832 13,460 13,283 13,033 Free Cash flow 931 1,486 1,273 425 1,954 1,877 2,039 Balance Sheet (EURm) Tangible fixed assets 4,210 4,918 5,082 6,361 6,932 7,435 7,937 Intangibles assets 13,650 16,298 17,048 20,185 21,157 21,908 23,322 Cash & equivalents 635 885 864 (228) 144 321 571 current assets 7,151 8,113 7,972 8,655 9,021 9,458 9,879 Other assets NM NM NM NM NM NM NM Total assets 26,321 30,664 32,758 36,511 38,420 40,111 42,448 L & ST Debt 15,427 17,508 21,082 19,717 19,614 19,535 19,591 Others liabilities NM NM NM NM NM NM NM Shareholders' funds 10,894 13,156 11,676 16,794 18,806 20,576 22,857 Total Liabilities 9,439 12,310 14,380 14,380 14,380 14,380 14,380 Capital employed 20,333 25,466 26,056 31,174 33,186 34,956 37,237 Ratios Operating margin 15.51 15.46 14.71 13.85 14.49 15.09 15.42 Tax rate 31.26 27.56 27.79 29.00 29.00 29.00 29.00 Net margin 4.66 4.86 5.17 5.19 5.20 5.56 5.67 ROE (after tax) 7.07 7.13 9.00 7.41 7.16 7.43 7.30 ROCE (after tax) 3.79 3.68 4.03 3.99 4.06 4.38 4.48 Gearing 142 133 181 117 104 94.94 85.71 Pay out ratio 22.54 21.17 -22.26 69.53 64.22 64.22 64.22 Number of shares, diluted 488 519 536 540 540 540 540 Data per Share (EUR) EPS 1.41 1.78 1.89 2.13 2.49 2.83 3.09 Restated EPS 1.58 1.81 1.96 2.31 2.49 2.83 3.09 % change 23.5% 14.6% 8.5% 17.6% 8.1% 13.7% 9.0% BVPS 22.31 25.35 21.78 31.10 34.83 38.11 42.33 Operating cash flows 3.46 4.70 4.33 2.97 5.97 5.97 6.44 FCF 1.91 2.86 2.37 0.79 3.62 3.48 3.78 Net dividend 0.95 1.10 1.25 1.48 1.60 1.82 1.98

Source: Company Data; Bryan, Garnier & Co ests.

Company description Fresenius is a health care group with international operations, providing products and services for dialysis, hospital and outpatient medical care. In 2013, Group sales were €20.3bn billion. With the recent RHK acquisition, the Fresenius Group will have more than 200,000 employees worldwide.

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1. A healthcare conglomerate 1.1. Structured around four divisions Fresenius SE has four divisions: Fresenius Medical Care (FMC) in which it has a 31.4% stake, Kabi, Helios and Vamed (77% stake, the remaining 23% belonging to the Austrian government). Note that Fresenius SE recognise both of Vamed’s and FMC’s total sales. The group generated more than EUR20.3bn in revenue in 2013 and a 14.7% EBIT margin (EUR3bn). The family foundation, Else-Kroner, owns 27% of the outstanding share capital.

Fig. 1: Fresenius & Co KGaA Structure

Source: Company Data.

Fresenius Medical Care is a global leader in the dialysis business. The division is listed on the German stock exchange under the ticker FME:GY and is part of our coverage universe (BUY – Fair Value EUR70). The division, which reports in US dollars, posted USD9.6bn in revenue in 2013 with a 15.4% EBIT margin accounting for 54% and 55% of Fresenius SE’s revenues and EBIT respectively. Note that Fresenius SE & Co KGaA’s 31.4% stake in FMC is unlikely to go below 25% otherwise it would lose its controlling interest. In this report, we return to FMC’s investment case and raise our Fair Value from EUR58 to EUR70, offering a 20% upside on the stock price as of 16th December 2014’s closing price.

Fresenius’ Kabi brings together four businesses aiming to provide: 1) IV drugs, 2) Clinical nutrition, 3) Infusion therapy packages, as well as 4) Medical devices and Transfusion technologies products to hospitals mainly. The division accounts for 24% of Fresenius SE’s revenues (EUR5bn in 2013) and contributed to 30% of the group’s EBIT (EUR916m, 18.5% EBIT margin in 2013).

Fresenius Helios is one of the leading private hospital networks in Germany after Rhön Klinikum’s acquisition in 2013. It has a market share of roughly 40% in this segment and a 6% market share in the global German hospital network. The group manages 110 healthcare facilities and is actively participating in the ongoing privatisation of hospitals. It accounts for 17%, 13% and 27% of Fresenius SE’s revenues, EBIT and net income respectively.

Fresenius Vamed is specialised in hospital consulting and management through two divisions. The project management division focuses on hospital construction and engineering while hospital management handles hospital maintenance and management.

Fresenius Medical Care, leader in the dialysis business

Kabi, main contributor to the group’s net income

Helios, leading German private hospital network after Rhön Klinikum’s acquisition

Vamed offers project management and services to hospitals

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Fig. 2: Fresenius SE & Co KGaA in a nutshell


Although FMC contributes more than half of revenues, its contribution has shrunk to only 21% of net income, highlighting both a higher tax rate (32.1% tax rate for FMC in 2013 vs. 26% for Kabi, 18% for Helios, 27% for Vamed) and important minority interests related to its 31.4% stake.

North America has the lion’s share in the group’s EBIT thanks to FMC and Kabi. FMC has a 15.4% EBIT margin and derives 66% of its revenues from NA while Kabi’s NA sales accounts for 30% of the division’s turnover with an average operating margin which tends to normalise at around 30% in the country, negatively impacted by the gradual recovery of some competitors which had experienced drug shortages (cf. Chapter4).

Fig. 3: Fresenius SE & Co KGaA Guidance as of Q3 2014 results


54%

24%

17%

5%

FRE Sales by Division

55%30%

13%2%

FRE EBIT by Division

21%

48%

27%

4%

FRE Net Income by Division

FMC

Kabi

Helios

Vamed

40%

42%

10%

8%

FRE Sales Geographic Split

27%

56%

10%

7%

FRE Net Income by Division

Europe

North America

APAC

LatAm & Africa

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2. Kabi: Transitional year now behind it but headwinds still ahead

Fresenius’s Kabi brings together four businesses aiming to provide: 1) sterile injectable IV drugs (US exposure mainly), 2) Clinical nutrition, both parenteral and enteral, 3) infusion therapy packages (blood substitutes), and 4) Medical devices as well as Transfusion technologies. As mentioned earlier, the division accounts for 25% of Fresenius SE’s revenues (EUR5.2bn 2014 BGe) and is the group’s main margin contributor with EUR916m EBIT (17.5% of revenues; 2014 BGe) representing 28% of Fresenius SE’s EBIT margin.

Fig. 4: Kabi in a nutshell


After a transitional period in 2013-2014 characterised by the gradual recovery of IV competitors in the US market implying a return to a less favourable momentum in the country, we view the division’s pace of growth as slowing in the coming years to normalise at around 7%.

19%

35%27%

19%

Kabi Sales by Division

Infusion Therapy

IV drugs

Clinical Nutrition

Medical Devices

41%

30%

19%

10%

Kabi Sales Geographical Split

Europe

NA

APAC

LatAm & Africa

31%

48%

14%

7%

Kabi EBIT Geographical Split

Europe

NA

APAC

LatAm & Africa

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2.1. IV business, still strong but not as it used to be

Fig. 5: Kabi’s IV drug business pace of growth estimates

EURm 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e 2018e CAGR 14-18e

IV drugs 1 027 1 328 1 438 1 701 1 733 1 776 1 847 1 940 2 046 2 169 5,1%

Organic 9,0% 23,0% 12,0% 12,0% 6,0% 2,5% 4,0% 5,0% 5,5% 6,0%

Reported 29,3% 8,3% 18,0% 1,9% 2,5% 4,0% 5,0% 5,5% 6,0%

as % of KABI sales 36,2% 36,3% 37,5% 34,7% 33,9% 33,3% 32,8% 32,4% 32,0%

as % of FRE sales 8,3% 8,7% 8,8% 8,5% 7,4% 7,1% 6,9% 6,7% 6,7%


Kabi’s IV business (35% of Kabi’s sales) offers more than 148 IV drugs mainly to hospitals (~80% of IV drug sales).

Since the acquisition of APP Pharmaceuticals (US injectable IV drug pharmaceutical company) in 2008 for USD3.7bn, the business derives roughly two-thirds of its sales from the country of which 40% relies on the sales of just six drugs. This has been made possible by high barriers to enter the market.

Propofol (~15% of IV sales) is a short-acting anaesthetic used in induction and maintenance of general anaesthesia, sedation for mechanically-ventilated adults, procedural sedation and veterinary medicine.

Naropin/Ropivacaine (>5% of IV sales) is a local anaesthetic mainly used in pregnant women during labour and for after pregnancy surgery.

Heparin (~5% of IV sales) is an injectable anti-coagulant.

Levothyroxine (~5% of IV sales) treats thyroid hormone deficiency in patients with nodular disease or thyroid cancer to suppress thyroid stimulating hormone secretion.

Aztreonam (~5% of IV sales) is an antibiotic used to treat bacterial infections in patients who are allergic to penicillin.

Haloperidol (<5% of IV sales) is an anti-psychotic used to treat mental illness (schizophrenia among others).

2.1.1. The euphoria has cooled down around the US margin In 2010, Fresenius Kabi’s main competitors in the country, i.e. Hospira, Novartis Sandoz, Teva and Mylan (14%, 10%, 4% and 4% market shares respectively) experienced shortages in sterile IV drugs. The FDA had halted production due to manufacturing problems, calling into question the stability of the products. This situation allowed Kabi to significantly increase prices of its IV drug products leading to margin levels in the country of up to 40% (40.7% in 2012) with a 42.9% EBIT margin peak in North America in Q2 2012.

APP Pharma acquisition strengthens Kabi’s IV portfolio and US exposure

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Since then, the shortages have been gradually resolved and Kabi’s margins in the country are now expected to stabilise at 30% to reflect the re-integration of competitors’ products on the market. To note is that a slower than expected recovery from key competitors such as Hospira could lead to higher margins than anticipated.

From approximately 120 IV drug shortages in 2012, this number has now dropped to the 60-70 range, of which only 20 to 30 shortages benefit Kabi (the main product being Propofol).

2.1.2. But the region will remain key Nonetheless, we are still expecting the IV business to significantly contribute to the division’s revenues (at least 30% in 2018, BGe) and to drive the division’s EBIT margin (>50% Kabi’s EBIT).

The main reason is that the company guided for a launch pace range of six to ten new products per year as IV drugs are going off-patent in the US. We highlight Kabi has currently more than 110 injectable IV development projects of which 40% are targeting the US market with 15 ANDA pending.

Fig. 6: Kabi’s injectable IV drugs development projects and the potential generic US IV drug patent expiration market


In the US alone, more than 170 small molecule injectable products with over USD20bn in branded sales will go off-patent over the next decade. An early market entry strategy is the one followed by Fresenius SE.

Product launches have to be closely monitored

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Fig. 7: US generic injectable IV market competition at market formation

Source: Company Data; Scrip; Datamonitor; IMS MAT Dec 2011; IV Generics.

Whilst IV launch pace guidance at Kabi should be monitored closely, as any delay could have an impact on revenue growth, we believe the company could keep to it but we have doubts on its capacity to overstep it. Indeed, Kabi’s Grand Island (NY) facility, although it has seen its number of warning letters issued by the FDA decreasing from 16 in 2011 to eight in January 2013, four of them were repeat observations. Since then, Kabi has asked the FDA to re-inspect the facility and we await an update on this. Upon any FDA upgrade of the facility to the Voluntary Action Indicated (VAI) status, Fresenius would have two plants (Grand Island, NY, and Melrose, IL) able to produce new IV drugs which could trigger an increase in the launch pace guidance.

2.2. “Old Kabi” portfolio allowing cross selling in the US

Defined as the “Old Kabi” portfolio, the Medical devices and Perfusion businesses accounts for 40% of the division’s sales. Considering Fresenius’s strong presence in the IV business, the group estimates that synergies from its sales in the US could reach EUR60-70m annually in a couple of years after launch (BGe EUR60m in 2017). Nonetheless cross selling will not totally offset margin pressure in the country.

2.2.1. Medical devices The division accounts for 19% of Fresenius SE’s sales and we estimate it will grow at a 5.5% CAGR over the next four years, resulting in market share gains compared to a EUR3bn relevant medical device market only growing at ~3% per annum.

Fenwal, which was acquired in 2012 for USD1.1bn, fits with the group’s strategy to increase its exposure outside IV drugs in the US and reach a EUR1.5bn 2017 sales guidance which, at the time it was set (2012 CMD), implied acquisitions. Fresenius Kabi’s medical business only had a limited presence in the region before the deal with few products sold, none of which were its main product lines. Excluding Fenwal, Kabi’s EBIT margin was 19.8% in 2013 (vs. 18.6% after integration). Despite a significant homogeneity in customers’ profiles (i.e. hospitals mainly), we believe that Kabi is not likely to return to these levels in the coming years.

2.2.2. Perfusion business Through this business, Fresenius sells basic solutions that help compensate loss of fluids as well as colloids which are blood volume substitutes used to maintain blood volume, haemodynamic

VAI status upgrade for the Grand Island plant still uncertain

EUR60-70m synergies from cross selling by 2017

Innovative products and homogeneity in customers’ profiles

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circulation and tissue oxygenation (HES). Supply chain optimisation is key to being competitive and to gain access easily to new markets while ensuring quality remains important to provide worldwide standards to customers and increase loyalty (e.g. closed systems versus open systems).

European HES restrictions implemented in October 2013 by the EMEA in patients with sepsis (bacterial infections), burn injuries or critically ill patients (increased risk of kidney injury and mortality), alongside a 10% price cut in China which started in February 2014, had a one-off impact on sales at the beginning of the year (-8% in Q1 2014 over Q1 2013). However, cross-selling in the US and strong sales growth in emerging markets will not enable the company to totally offset the margin decline due to the gradual recovery of Kabi’s IV drug competitors.

2.3. Clinical Nutrition Business to gain momentum

2.3.1. First cross selling to further offset margin decrease Fresenius’s Clinical Nutrition business is structured around the two principal routes of clinical nutrition, i.e. parenteral and enteral nutrition. Parenteral nutrition consists of feeding someone intravenously, bypassing the usual process of the eating system, while enteral nutrition refers to the delivery of complete feed directly into the stomach. Parenteral nutrition products are much harder to bring to the market as they need to be approved by health authorities. The worldwide clinical nutrition market is estimated worth EUR6.2bn.

Fig. 8: Clinical nutrition market worldwide


The US is a “new territory” for Kabi’s clinical nutrition business, as described by management. Fresenius will focus on enteral nutrition which accounts for 92% of the clinical nutrition market and would benefit from a market structure which is more wholesale-oriented like the European one.

However, in late August 2014, Fresenius SE gained FDA approval of its three-chamber parenteral nutrition bags Kabiven and Perikabiven. These are the first bags delivering intravenously infused solutions of lipids, dextrose and amino acids with electrolytes to be approved and sold in the US while they are already selling in more than 85 countries and have been used to treat nine million patients. As the three components are not mixed together, these bags have a two-year shelf-life compared to 12 hours for competitors’ products. Although parenteral nutrition in the US only accounts for 8% of the US clinical nutrition business and consists in a more retail-oriented market, approval in the country could trigger cross selling with perfusion and injectable IV drugs.

Structured around parenteral and enteral nutrition

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2.3.2. Danone: a free option which flew away Fresenius has often been cited as a potential bidder for Danone’s Medical Nutrition business, specialised in enteral nutrition and benefiting from a more limited portfolio than Kabi’s. Although this division is the smallest of Danone’s four businesses, behind yoghurt (Activia and Actimel brands), water (Evian and Badoit) and baby food, the company has a 20% market share in this EUR6.5bn market.

Danone’s Medical Nutrition’s 2013 sales accounted for EUR1.3bn, and its EBIT margin at 17.8% is slightly lower than Kabi’s, which stands at 19.5%, helped by injectable generics (vs. Fresenius SE’s margin is 15%). Operating profit was EUR244m.

We believe that this deal would have make sense from a strategic standpoint. Kabi would have been able to emphasise its diversification beyond injectable IV generics as highlighted by the Fenwal acquisition in medical devices in 2012 (cf. Section 2.2.1) and commercial cross selling would have immediately led to synergies which we estimate at around EUR50m per year. Considering the price of such a transaction with the latest rumours in October 2014 relaying a EUR4bn price, it is likely that the main source of concern would have been financing and possibly an anti-trust authorities issue as the resulting company would have had a 40% market share in the medical nutrition business (20% from Danone aside from the existing 20% market share Kabi already has). Nonetheless, a joint bid with a PE fund (Permira?) as has been speculated by press articles would have been a good solution.

On 12th December 2014, Danone announced that its four divisions are key to sustain growth, putting to an end to months of speculation surrounding a potential divestment of is clinical nutrition business, said to be on sale since March 2014. Looking to expand outside the IV business, we view this announcement as a setback for Fresenius SE.

2.4. Emerging markets

2.4.1. Asia-Pacific Fresenius Kabi first entered the APAC market in the early 1980s (1982 in China), progressively leveraging on its know-how and today is fully benefiting from a market leader position in numerous countries (cf. Figure 9). In 2013, the region accounted for 18.6% of Kabi’s sales and we estimate its contribution rising to be above 25% in 2017 sales, showing a 14% growth rate per annum over the period. Kabi has developed its footprint in APAC by producing locally (IV drugs and clinical nutrition bags) and opening R&D centres answering the needs of both highly fragmented markets and local quality standards. In one year, its Infusion therapy and IV drugs divisions strengthened thanks to product roll-outs. As of today, the Chinese price cut implemented at the beginning of the year does not affect performance in the country as this one-off item is now fully integrated by management. As shown in Figure 9, the Infusion therapy and IV drugs businesses have gained market share on the back of the medical devices business which was affected by the enlargement of the addressable market with the acquisition of Fenwal and therefore impacted medical devices’ sales in the region. New products had to be integrated in Kabi’s offer and diluted its leading position.

Danone’s enteral nutrition business would have been a strong fit

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Fig. 9: APAC roll-out product portfolio 2012 (top) – 2013 (bottom)


Figure 10 highlights the growth opportunities in APAC. Clinical nutrition accounted for slightly more than 75% of the region’s sales in 2012 while only representing 29% of group’s total sales. We believe that the strong penetration of IV drugs in the US is a performance that Fresenius could reproduce in the APAC region despite competition in light of both governments’ preference for generics as they implement healthcare reforms aiming at covering a large part of the population and the growing number of IV manufacturers in developing countries (mainly India). Regulators are favouring locally-produced drugs as well as domestic corporations which could benefit Fresenius even more through its many manufacturing and R&D facilities in the region.

IV drugs sales opportunity in APAC

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Fig. 10: Clinical Nutrition to gain momentum in APAC


With the Danone “free option” having flown away, we highlight that Kabi’s leading position in the clinical nutrition segment will be harder to maintain. Indeed, 33% of the 2013 EUR1.3bn sales of Danone’s clinical nutrition division were derived from Emerging countries with China being the main contributor to growth and the fourth contributor to sales.

2.4.2. Latin America Latin America represents 10% of the division’s turnover. We expect the region to post strong sales upto 2017 with an estimated 14% CAGR.

Fig. 11: LatAm roll-out product portfolio (2012)


As in Asia Pacific, Kabi produces IV drugs and clinical nutrition bags locally. The group has identified growth areas such as Uruguay, Ecuador and Costa Rica in which regulatory requirements tend to align with international standards and range of treatments covered and quality of care are continuously improving.

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3. Helios & Rhön Klinikum...1+1=3

3.1. Expanding geographical coverage Fresenius SE’s Helios business is focused on providing acute and post-acute hospital care to patients. The division operates only in Germany where it has a comfortable 40% market share in the private hospital sector, half of it coming from Rhön Klinikum’s acquisition (RHK). Fresenius competes with Asklepios (20% market share) and Sana (>10% market share).

In 2013, the division contributed to 17%, 13% and 27% of Fresenius SE’s sales, EBIT and net income respectively. Its business model based on raising newly-acquired public hospitals’ margins to the group’s level (12-15%) perfectly fits with the German hospital market trend. Before acquiring RHK, the division had grown its market share to 20% of the private hospital segment (17% of the German hospital market) on the back of the public hospital segment (49% of German hospitals) undergoing a privatisation wave as roughly a third were not profitable enough and public funding was being squeezed. The remaining 34% share belongs to the non-profit private hospital segment in which the market share is flat.

Fig. 12: Strong geographical coverage with 110 hospitals

Source: Company Data

Having struggled to acquire Rhön Klinikum in 2012, Helios and RHK finally came to an agreement in September 2013. In this agreement, Fresenius SE acquired 43 facilities from RHK for EUR3.1bn, expanded its geographic coverage and became the leader in Germany. Out of those 43 hospitals, three had to be excluded from the transaction after an anti-trust authority review due to their proximity with existing Helios hospitals. The committee review also required the sale of two of Helios’s hospitals.

Make geographical coverage denser with the acquisition of Rhön Klinikum

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Fresenius expects the acquisition to be margin accretive (ex-integration costs) as soon as 2014 and accretive including acquisition costs in 2015. Whilst we estimate that synergies on operating profit could reach EUR85m in 2016 (EUR20m in 2014 and EUR50m in 2015), the group is expecting EUR85m of synergies as soon as 2015. Previously expected at around EUR80m, integration costs have been reduced to the EUR60-80m range and will be spread over 2014 and 2015.

Considering Helios’s 40% market share, it is likely that we will observe a slowdown in public hospital acquisitions and believe it likely that any further acquisitions will be given increased scrutiny by the authorities.

Fig. 13: Fresenius Helios and Rhön Klinikum’s reconciliated P&L (EURk)

Helios-RHK hospitals 2013 2014e 2015e 2016e 2017e 2018e

Sales 3 393 5 349 5 713 6 091 6 485 6 894

Organic 3,0% 4,0% 4,0% 4,0% 4,0% 4,0%

Reported 6,5% 4,0% 6,8% 6,6% 6,5% 6,3%

Acquisition volume 118 150 150 150 150

Acquisition growth 3,5% - 2,8% 2,6% 2,5% 2,3%

EBITDA before synergies 508 742 858 942 1 032 1 139

14,2% 13,9% 15,0% 15,5% 15,9% 16,5%

Integration costs (35) (35)

Synergies 20 85 85 85 85

EBITDA after synergies 508 727 908 1 027 1 117 1 224

% of sales 15,0% 13,6% 15,9% 16,9% 17,2% 17,8%

D&A 118 204 231 244 247 261

% of sales 3,5% 3,5% 3,5% 3,5% 3,5% 3,5%

EBIT 390 522 677 783 870 964

EBIT Margin 11,5% 9,8% 11,9% 12,8% 13,4% 14,0%

Helios 2013 2014e 2015e 2016e 2017e 2018e

Sales 3 393 3 649 3 915 4 191 4 479 4 778

Organic 3,0% 4,0% 4,0% 4,0% 4,0% 4,0%

Reported 6,0% 7,5% 7,3% 7,1% 6,9% 6,7%

Acquisition volume 118 120 120 120 120 120

Acquisition growth 3,5% 3,5% 3,3% 3,1% 2,9% 2,7%

EBITDA 508 529 587 650 717 788

% of sales 15,0% 14,5% 15,0% 15,5% 16,0% 16,5%

D&A 118 128 137 147 157 167

% of sales 3,5% 3,5% 3,5% 3,5% 3,5% 3,5%

EBIT 390 401 450 503 560 621

EBIT Margin 11,5% 11,0% 11,5% 12,0% 12,5% 13,0%

Fresenius SE

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RHK hospitals 2013 2014e 2015e 2016e 2017e 2018e

Sales 1 700 2 080 2 163 2 250 2 340

Organic 4,0% 4,0% 4,0% 4,0%

EBITDA 213 270 292 315 351

% of sales 12,5% 13,0% 13,5% 14,0% 15,0%

D&A 77 94 97 90 94

% of sales 4,5% 4,5% 4,5% 4,0% 4,0%

EBIT 136 177 195 225 257

EBIT Margin 8,0% 8,5% 9,0% 10,0% 11,0%

Net profit assumptions 77 104 114 135 152

% of sales 4,5% 5,0% 5,3% 6,0% 6,5%


3.2. Key indicators heading in the right direction in 2015

Two main indicators are key to the healthy growth of the German hospital sector and need to be watched closely.

On a quarterly basis, Fresenius gives an update on admission rates. Whilst the inpatients admission rate has increased by 3% in 2013 compared to 2012, this indicator has been a source of concern in Q2 and but showed a slight recovery in Q3 with a 2% increase compared to the previous quarter.

Fig. 14: Admission rate showing signs of recovery

2013 Q1 2013 Q2 2013 Q3 2013 Q4 2014 Q1 2014 Q2 2014 Q3

Acute care inpatients 196107 186943 185257 186396 276600 281220 292955

Acute care beds 18907 18903 18912 18885 27900 28905 27170

Acute care Inpatients/beds ratio 10,4 9,9 9,8 9,9 9,9 9,7 10,8

QoQ growth -4,7% -0,9% 0,8% 0,4% -1,9% 10,8%


The second indicator is the G-DRG (German Diagnosis Related Group) inflator updated on an annual basis in October by the Institute for the Hospital Remuneration System. This rate indicates the revaluation of reimbursements received by hospitals for each medical or surgical act performed on patients. It is the same for all diagnosis-related groups. Gradually introduced over a ten-year period following legislation in 2000, a significant number of German states have already adopted this system. Set at 2.53% for 2015, this is the second highest increase for the inflator rate since its implementation. This is positive news for Fresenius as the expected CPI inflation rate for 2015 is 1.60% and to Helios’s contribution to the group’s net income (32% in 2015e), thus highlighting Fresenius SE’s good defensive play in a tightened environment on healthcare expenditure (cf. Hospital privatisation trend discussed above).

Admissions rates and DRG inflator rate are key indicators

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Fig. 15: G-DRG inflator historical prices


Steady sales growth at Helios from Rhön would benefit the group, strengthening its diversification by increasing exposure to other areas than dialysis (Fresenius Medical Care) as well as medical supply and devices (Kabi). Moreover, we estimate that the division’s EPS will grow at a 16% CAGR over the 2014-2018 period, driving Fresenius SE’s EPS growth.

1,48%

2,00%

2,81%

2,53%

2,01%

1,51%

1,04%

1,60%

0%

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3%

2012 2013 2014 2015

G-DRG inflator

Inflation CPI

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4. Fresenius Medical Care

Fresenius Medical Care is a global leader in the dialysis market, providing daily care to endstage renal disease patients (ESRD) in its own clinics as well as in a patient’s home. The latter is a growing niche market, which could in our view show a strong sales ramp up in the coming years especially for peritoneal dialysis. As a reminder, in January 2014, Fresenius MC and NxStage Medical (ESRD medical devices supplier) extended their Chronic Outpatient Therapy agreement until December 2016. Under this the term of this agreement Fresenius purchases the NxStage System One and related supplies for home haemodialysis therapy in the US to NxStage.

Fresenius Medical Care also sells dialysis products to hospitals. Revenues amounted to USD14.6bn in 2013 of which 73% from Services, 24% from Products and only 3% for the newly-created Care Coordination business (cf. Chapter 4.3).

For the period 2015-020, FMC expects the Services division (76% of sales in 2013; 62% in 2020) to grow in the 6-8% range (BGe 6.6%), with 5-6% volume/patient growth, ~1% in price/mix and 1-2% from market share expansion and/or M&A acquisitions. The Product division (24% of sales in 2013; 20% in 2020) should contribute to growth to a lesser degree as the company expects it to grow in the 4-7% range (BGe 6.8%) with 3-4% volume/patient growth, ~2% price/mix and 1-2% in market share expansion and/or M&A acquisitions. While we remain cautious on the USD5bn sales target set for Coordinated Care in 2020 (implying a >10% 2015-20 CAGR), the group targets a ~10% growth for FMC p.a. until 2020.

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Fig. 16: FMC in a nutshell


4.1. Strong underlying market trends FMC is benefiting from strong market dynamics with an addressable population base in need of dialysis growing at a roughly 6% CAGR. Diabetes and hypertension, responsible for roughly 75% of chronic kidney disease (CKD) largely contribute to increasing the patient base. In the US, 10% of the population is suffering from diabetes (more than 29m people, of which 8m is undiagnosed), 1.7m new people are diagnosed each year and one in three is suffering from high blood pressure.

ESRD or late stage CKD population (stage 5, complete and irreversible kidney failure) in need of chronic dialysis (kidney working at 10 to 15% or less of its capacity) or renal transplant represent more than 3 010 000 patients worldwide. We believe the 6% growth is sustainable given that: i) the reservoir of stage 3 and 4 CKD patients is constantly increasing and represents approximately 3x or 4x the stage 5 population currently being treated and ii) the CDC estimates that, in the US, the number of people with diabetes will double or triple by 2050.

76%

24%

Sales Split Services/Products

Dialysis Services

Dialysis Products

0%

20%

40%

60%

80%

100%

2012 2013 2014 2015 2016 2017 2018 2019 2020

Sales Split by Product/Services and Geography

Ex NA Dialysis Products

Ex NA Dialysis Services

NA Dialysis Products

NA Dialysis Services

30%

30%

6%

34%

Sales Split by Geography (type of payors in NA)

NA Sales (Medicare)

NA Sales (Private Insurers)

NA Product (direct payment)

International Sales

Population in need of dialysis growing at a >6% CAGR

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Fig. 17: Number of dialysed patients worldwide (top) / Prevalence of ESRD patients (bottom)

Source: Company Data; US Renal Service Data.

Fig. 18: New case of kidney failure by primary diagnosis


4.2. Leader in the US dialysis market...

44%

28%

23%

5%Diabetes

High Blood Pressure

Other

Unknown

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The division derives 66% (USD9.6bn in 2013) of its sales from the US where it competes head to head with DaVita, both having a ~33% market share. The remaining ~33% is split between independent dialysis service providers. FMC derives 90% of its US sales from clinic services and 10% from the sale of dialysis machines.

4.2.1. 2011 Bundle reform ESRD patients are split into two categories depending on whether they are in their first 30 months of dialysis which determines whether Medicare is a secondary payer or not.

25% of US ESRD patients are under dialysis for less than 30 months. For this period, private insurers cover full reimbursement of the dialysis procedure. The other 75% of US ESRD patients is eligible for Medicare reimbursement as they are under dialysis for more than 30 months. As private insurers’ reimbursement rates are higher than Medicare’s, both groups whether they are private or public contribute equally to FMC’s revenues from dialysis procedures in the country (i.e. 66%).

With a treatment cost of about USD90 000/patient/year (of which 1/3rd for the dialysis procedure stricto sensu) representing more than 6% of Medicare’s annual budget but less than 1% of the covered population, the US federal government decided to streamline its reimbursement procedures, which was voted by the American Congress and implemented in 2011.

Fig. 19: Medicare spending related to dialysis – split by procedure


Until 2011, each product used for a dialysis treatment was individually reimbursed with only a limited bundle gathering together the dialysis procedure and supplies (haemodialysis and peritoneal dialysis being paid the same) with monthly routine laboratory tests.

As of January 2011, the new Centre for Medicare Services (CMS) system pays one amount of money per patient per treatment for all dialysis, bringing together the “old bundle” (mentioned above) with all injections (EPO, antibiotics, iron) as well as the labour of nephrologists. Three to four dialysis per months where set as a treatment base while the reimbursement per procedure was set at USD229 and this will be adjusted each year by a number of factors linked both to the patient (age, weight, co-morbidities) and the dialysis centre (quality of care).

Dialysis costs represent 6% of Medicare’s budget but less than 1% of covered patients

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The key take away from this reform is that each year in July, the CMS issues draft guidance for the next year composed of two adjustors giving the final reimbursement rate for the year to come. This rate is further confirmed in the final guidance document issued by the American Congress in November. These two adjustors composing the final bundle rate are the following:

The inflation rate (adjusted base rate),

ESRD facility network reduction or productivity rate adjustment factor (patient and facility adjustor).

Fig. 20: ESRD treatment algorithm


This method is aimed to favour cost reductions by implementing a productivity factor. Medicare concomitantly recommended to reduce EPO (erythropoietin) use, the latest representing 20% to 25% of the reimbursement received per procedure.

4.2.2. 2013 draft guidance revaluation was quite a fright Until 2013, dialysis providers had reduced EPO administration more than Medicare had previously recommended, raising their margins as the reimbursement rate was pre-determined each year and providers could pocket any gain.

In July 2013, acknowledging that the decrease in EPO use in dialysis patients was significantly higher than expected by the CMS, the American Congress issued a draft guidance recommending a 12% rebasing in the bundle rate. This would have implied a drop in 30% of FMC’s total turnover which is derived from Medicare reimbursement.

Issued in November 2013, CMS final rule recommended staging the revaluation over a three-year period. This was further softened by a progressive rebasing extended until 2018, the goal being to flatten the bundle rate for 2014 and 2015 until oral medications were supposed to be included in the Bundle.

In March 2014, the House of Representatives and the Senate redefined the way the bundle will be updated by CMS and the following recommendations have been adopted:

Inclusion of oral medications has been delayed to 2024 versus 2016.

Draft guidance issued each July and further confirmed in the Final guidance document in November

12% rebasing proposition in 2013 draft guidance finally softened by a progressive rebasing extended until 2018.

Flat bundle rate in 2014 and 2015

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2015 Rebasing will lead to a flat bundle rate. Issued on October 31st 2014, the 2015 Bundle base rate has been set at USD239.43 with a 2.1% market basket update and a -0.5% productivity adjustment implying a -1.4% rebasing rate leading to a 0.2% increase in the base rate.

For 2016 and 2017, the rebasing rate will be reduced to 1.25%.

For 2018, the rebasing rate will be reduced to 1%.

Fig. 21: Bundle rebasing since first 2011 reform implementation

2011 2012 2013 2014e 2015e 2016e 2017e 2018e 2019e 2020e

Bundle rate (USD) 229,63 234,81 240,88 239,02 239,43 241,22 243,03 245,46 250,37 255,38

Market basket 3,0% 2,9% 3,2% 2,1% 2,5% 2,5% 2,5% 2,5% 2,5%

Productivity (0,9%) (0,6%) (0,4%) (0,5%) (0,5%) (0,5%) (0,5%) (0,5%) (0,5%)

Rebasing (3,3%) (1,4%) (1,25%) (1,25%) (1,00%)

In USD (7,9) (3,4) (3,0) (3,0) (2,4) - -

Base rate change 2,1% 2,3% (0,5%) 0,2% 0,8% 0,8% 1,0% 2,0% 2,0%

Source: HR4302, Bryan Garnier & Co estimates.

Assuming a 2.5% market basket increase and a -0.5% productivity adjustment factor over the period 2016-2020, we estimate that the bundle rate will growth by roughly 1% in 201, 2017 and 2018, then increasing by 2% until 2020.

4.3. Aiming to cover the entire dialysis spectrum

4.3.1. 70% of the dialysis market not addressed by FMC As discussed in section 4.2., FMC currently covers only USD30 000 out of the USD90 000/patient/year cost incurred by dialysis treatment. During its April 2014 Capital Markets Day held in New York, FMC’s management team introduced to investors its ambition to cover the entire dialysis spectrum beyond just the dialysis, i.e. the remaining 70%, through its newly-created Coordinated Care division.

Fig. 22: Medicare’s dialysis reimbursement split

Source: Company Data, United States Renal Data Service.

Coordinated care aims to cover the entire dialysis spectrum

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Fig. 23: Coordinated Care to represent 18% of revenues by 2020


Expanding its base business to cover the whole scope of dialysis implies consolidation. FMC has already made significant acquisitions outside dialysis for a total amount of USD1.14bn (BG estimates), the goal being now to increase synergies or create new synergies by strengthening its activity in weaker areas.

Fig. 24: Fresenius Medical Care acquisitions (1996-2013)


In July 2014, FMC acquired a majority stake in Sound Inpatient Physicians (SIP). SIP groups together more than 1 000 physicians in both acute and post acute centres (100 centres) and aims to reduce inefficiencies by improving clinical process methodologies, preparing physicians better and working closely with hospital administrations. This USD600m investment is expected to be accretive in 2015 earnings was part of a recapitalisation process alongside historical partners, i.e. TowerBrook (a PE fund) and senior management. Moreover, in November, FMC announced another acquisition in this area, Cogent Healthcare, carried out by SIP which had been acquired earlier in the year. Cogent Healthcare also has a hospitalist network present in more than 80 hospitals.

USD3bn to be allocated to Care Coordination until 2020

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We view these two main acquisitions as good news for Fresenius, which should enable the company to anticipate the Quality Incentive Programs (QIPs) recently introduced by the US government and which will be effective as of January 2015. These QIPs will focus on reducing both re-admission rates and length of stay.

When it acquired SIP, FMC also announced, for an undisclosed amount, the acquisition of MedSpring Urgent Care Centres, adding 14 care centres in Illinois and Texas. This acquisition further reinforces FMC’s strong presence in the North-East and South US.

In October 2014, FMC acquired National Cardiovascular partners, a US leading operator of endovascular, vascular and cardiovascular services operating in 21 outpatient vascular centres in six states with over 200 physicians. The company indicated that NPC is expected to generate more than a USD200m turnover in 2015 and will be margin accretive (+1%) on EPS in 2015.

We expect FMC to continue to deploy its strategy in Care Coordination; these three acquisitions being part of a USD3bn M&A and capital allocation plan set to spread out until 2020. Nonetheless, with USD1.14bn spent in M&A this year, we believe that the external growth pace will be put on hold in 2015 to better integrate the three new businesses (restructuring…). Looking at 2016, when we expect M&A operations to re-accelerate at FMC as part of its Care Coordination strategy, we believe that FMC will focus on cardiovascular hospitals as more than 70% of dialysed patients have cardiovascular diseases. This should expand FMC’s reach in patients having CKD while having a better control of its patient base.

4.3.2. Potential upside on margins By the end of the third year of a pilot study conducted between 2006 and 2008, patient outcomes were significantly improved with mortality and hospitalisation rates reduced by up to 20%, as shown in the table below. Moreover, it was able to achieve total cost savings of 5.1%, highlighting the significant margin gain dialysis providers could reach by integrating nephrology centres, laboratories, etc. to their existing offer.

Fig. 25: Care Coordination cost savings potential

Source: Company Data; Arbor Research: ESRD Disease Management Demonstration Evaluation 2006-2008.

While we see margins relatively flat over the years to come at FMC (15-16% range), we believe that once the integration of Care Coordination related acquisition will be effective, this could trigger margin expansion for the company, benefiting from efficiency gains.

Addressing the full scope of dialysis care could trigger margin expansion over the long run

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4.4. Emerging markets to boost FMC growth FMC has an historical presence in emerging markets (LatAm and APAC) where it has the widest geographical coverage among its main competitors (Baxter, DaVita, B. Braun and Diaverum).

Fig. 26: Fresenius’s strong historical presence in emerging markets


Depending on whether the country is at a more or less advanced development stage, FMC will either look for efficiency gains (Korea, Taiwan, Hong Kong, Singapore, Australia and New Zealand) or significant sales growth (China, India, Thailand, Malaysia and Indonesia).

4.4.1. Significant sales growth in less advanced mature countries Asian countries, whatever their development phases will be a key growth reservoir for FMC to expand its patient base. Countries such as China, Thailand, Indonesia, Malaysia or the Philippines are the ones where the number of patients under dialysis grew by 13% on average in 2013. Moreover, governments are progressively expanding healthcare coverage while lessening the constraint for dialysis service providers to open nephrology care centres. In these countries, FMC aims to invest heavily to answer the increasing demand for dialysis.

Fig. 27: Dialysis patient growth by country (in % 2013 vs. 2012)


FMC could be a major player in China where the government is slowly shifting towards some privatisations while significantly expanding the contribution to healthcare expenses. The company has

9,3%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

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two ongoing pilot projects in the city of Qingdao (500 miles from Beijing in the Shandong Province) where it operates private dialysis care clinics. FMC also aims to have built another 35 Metrocare Cooperative Dialysis Centres (MCDC) by 2014 year-end which will be added to the 100 already built (each 100 beds clinic costs about USD200k to USD400k to build). Once approvals are given, the company’s leadership position will be boosted in the haemodialysis market as it will benefit from 7 to 15 years management and a product supply exclusivity period for MCDCs. In the country, FMC is positioning itself as a key player in three main areas: 1) products, where it continues to be a market leader, 2) MCDCs in partnership with China, and 3) private clinic projects which could materialise in the next couple of years.

4.4.2. Japan: an emerging country…in dialysis In countries at a more advanced stage, investment will be the necessary minimum to sustain growth as part of FMC’s Global Efficiency Programme discussed in section 4.5 and the strategy will be close to that followed in EMEA and NA.

In Japan, FMC has a different business model as it sells its products via Nikkiso (10 years distribution agreement inked in 2010), a leading player in haemodialysis products, which enables FMC to be the only non-Japanese company to hold a 5.4% market share in a USD15bn market and to have an increasing presence in the second largest patient population in APAC. The company expects to sell 3 million dialysers in 2014 supported by the launch of CorDiax in Q1.

Moreover, some medical corporations can now be owned by foreign companies and Fresenius has made it clear that it will participate in this so-called market deregulation but it did not plug any revenue from potential acquisitions or ownership interests in its guidance. Even if it is just the beginning of a difficult to estimate source of revenue for FMC, we believe the company is poised to gain market shares in the country. As Figure 17 and 29 shows, Japan has a significant number of patients suffering from chronic kidney diseases as well as a high reimbursement fare. Whilst FMC has not yet communicated on its strategy in the country and broadly in APAC for strategic reasons, we expect it to give more details on it during its full-year publication in February 2015.

Fig. 28: Differences across APAC countries in dialysis reimbursement

Country Reimbursement (USD)

Avg Reimbursement Price (USD)

Nb of patients HC Spend as % of GDP

Japan Full 243 323 646 10,1%

Australia Full 317 - 9,1%

Korea Full 147 - 7,5%

New Zealand Full 205 - 10,3%

China Partial 59 410 230 5,4%

India Partial 18 98 727 4,0%

ASEAN None to Partial 0 to 140 155 994 3,6%

Source: Company Data; World Data Bank.

We view Japan as a significant opportunity for FMC

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4.5. Global Efficiency Programme and capital allocation

4.5.1. USD300m efficiency run rate by 2017 Alongside the presentation on its Coordinated Care division to capture growth beyond dialysis strict-sensu, FMC at its CMD detailed its Global Efficiency Programme (GEP) initiated in 2013 and which has the target of reaching a USD300m run-rate by 2017.

Whilst the company aims to derive 70% of its GEP target from developed markets, only 30% will come from developing countries, where the steady growth rate of the population in need of dialysis leads to significant CapEx which cannot be associated with efficiency gains yet.

Fig. 29: FMC’s investment strategy in APAC


70% of efficiencies (USD210m) will reach their run rate by 2015 while the remaining 30% should be completed in 2016-17. FMC has targeted 18 projects in five business areas and we are pleased to see that the company is willing to streamline its procurement business from which 30% of total savings will be derived. This global programme requires USD100m spread out over three years starting in 2013. In terms of location, 60% of savings will be made in North America, 25% in the International region while the additional 10% and 5% will be made in Global Manufacturing Operations and Global R&D respectively.

Fig. 30: Where to find efficiencies at FMC?


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We would stress the gap between the expected 10% top-line growth and the company’s bottom-line guidance, i.e. “high single-digit” net income and EPS growth which we believe should come from margin dilution and increasing minority shareholders from potential acquisitions (cf. section 4.3.1) alongside a conservative approach which does not include acquisitions’ relative effects on EPS. Moreover, an underestimated impact of lower than expected reimbursements would also explain why these cost savings are not translating into as much as they could in the EPS guidance.

4.5.2. USD2bn non-allocated cash flows between 2017 and 2020 USD8bn of cash flow should be generated by the end of the decade. USD3bn has already been allocated to Care Coordination, of which roughly USD850m (USD600m majority stake in SIP; USD240m in NCP acquisition based on 1.2x 2015 sales) have already been used. FMC aims to allocate an estimated USD3bn to sustain its dividend policy (payout ratio over 25% since 2010).

This leaves us with roughly USD2bn of non-allocated cash flows which could be used for deleveraging. Indeed, we do not see the company to opt for a share buyback program considering its manageable but high Net Debt/EBITDA ratio (x2.7 in 2013) which is likely to be put under pressure with further M&A operations in the upcoming years (cf. Chapter 4.3.1)

Fig. 31: FMC Cash flow development


4.6. Fresenius Medical Care poised to outperform DaVita HCP

4.6.1. Care Coordination strategy Earlier announcement of its intention to diversify into integrated care has been associated with a rerating for DaVita Healthcare Partners, leading to a significant outperformance of the company’s share price versus FMC (Figure 33). On May 21st, 2012, DaVita announced a merger agreement with Healthcare partners in a USD4.42bn deal (83% in cash, 17% in DaVita shares). The combination of the two companies aims to offer comprehensive solutions for ESRD patients whereas FMC has a more holistic approach which tends more to vertical integration.

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Fig. 32: FMC vs DaVita share price (local currency; rebased 100 as of 05/21/2012)


Nonetheless, since FMC held its Capital Market Day in April 2014 and presented in details its strategy to diversify into integrated care and engage into M&A operations, we would highlight the outperformance of FMC’s share price over DaVita Healthcare Partners, further strengthened when the company announced its first acquisition in July 2014. To note is that a 1:3 share split in August might have reinforced investor’s interest in the company.

Fig. 33: FMC vs DaVita share price (local currency; rebased 100 as of 07/07/2012)


4.6.2. Contract with payers During its third quarter conference call, DaVita’s management lowered the high end of its EBIT guidance for its dialysis/kidney care business i.e. Healthcare Partners, from USD240m to USD240m mentioning pressure from Medicare and commercial payers

Whilst patients covered by Medicare and Medicaid comprise nearly 90% of treatments at DaVita, it accounts for 66% of its revenues derived from dialysis services in the US i.e. the remaining being derived from private payers. Figure 16 highlights the split at FMC which is roughly similar.

80

100

120

140

160

180

200

FRESENIUS MED.CARE (XET) DAVITA HEALTHCARE PTNS. (~U$)

90

95

100

105

110

115

120

125

30/06/2014 31/07/2014 31/08/2014 30/09/2014 31/10/2014 30/11/2014

FRESENIUS MED.CARE (XET) DAVITA HEALTHCARE PTNS. (~U$)

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As mentioned above, DaVita starts to diversify into integrated care as well as to bundle its private patients earlier leading the company to ink contracts with commercial payers earlier than FMC i.e. in 2010 and late 2012 for the two companies respectively. These contracts usually have three to five years duration and include discounts in the first year, putting pressure on the average revenue per treatments. Negotiated in 2010, we are expecting DaVita to renegotiate these contracts in 2015 or 2016 which could put at risk its organic growth.

Fig. 34: Revenue per treatment (in USD) for DVA (left) and FMC (right)


4.6.3. EPO price set to decline for FMC Following the 2011 bundle reform, we believe that the decreasing demand for Amgen’s erythropoietin, Epogen, should accelerate in 2015. Two main reasons support our thesis.

Our understanding from discussions with Roche is that first sales of Mircera, whilst having been approved by the FDA in 2007, will occur by the end of 2014.

Alongside the end of a non-exclusive contract with Amgen for EPO supply by the end of 2014, FMC is conducting a pilot study with Mircera, which we believe, should strongly benefit the group. It is likely that the company will launch a tender offer to decrease prices thereafter and may have inked in a supply contract with Roche in H2 2014 when the pilot study results will be available. To note is that DaVita’s exclusive contract with Amgen ends in 2017, which keeps FMC ahead of its main competitor on EPO pricing. DaVita has the right to go elsewhere for 10% maximum of its EPO supply.

Fig. 35: Epogen (Amgen) vs. Mircera (Roche) sales (in USDbn); Average EPO price evolution over the course of treatment

320

325

330

335

340

345

350

355

Q4

2009

Q1

2010

Q2

2010

Q3

2010

Q4

2010

Q1

2011

Q2

2011

Q3

2011

330

335

340

345

350

355

Q4

2011

Q1

2012

Q2

2012

Q3

2012

Q4

2012

Q1

2013

Q2

2013

Q3

2013

0

0,5

1

1,5

2

2,5

Epogen vs. Mircera Sales (USDbn)

EPOGEN sales

MIRCERA sales

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Source: Company Data; Evaluate Pharma.

Moreover, a vast majority of FMC’s clinics in the US are CRIT-line clinics. Crit-line is a device used to monitor hematocrit and oxygen concentration in blood i.e. red blood cell and oxygen volume in blood respectively, helping physicians and nurses to better dose EPO and thus reducing its use.

4.7. Valuation Our DCF-based model points toward a EUR71 fair value to reflect the acquisition of three businesses expanding FMC’s presence into Care Coordination. Our WACC is 7.3% (Equity risk premium of 6%, Beta=1, rf=2.8%). We have rolled-out our DCF to 2015.

We assume a 10% EBIT margin for newly acquired Care Coordination businesses and also plug in our estimates EUR50m one off costs in 2014 and 2015 to reflect restructuring in the latter.

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Fig. 36: DCF valuation

USDm 2014e 2015e 2016e 2017e 2018e 2019e 2020e

Sales 15 403 - 16 774 17 817 19 013 20 301 21 727 23 257

Growth 4,3% 5,4% 6,0% 6,6% 6,7% 7,0% 7,0%

Recurring EBIT 2 259 - 2 486 2 761 3 002 3 237 3 441 3 661

%sales 14,7% 14,8% 15,5% 15,8% 15,8% 15,8% 15,8%

Taxes (602) - (679) (761) (844) (913) (983) (1 047)

(33,8%) (33,8%) (33,8%) (33,8%) (33,8%) (33,8%) (33,8%)

D&A 670 707 749 799 853 913 977

%sales 4,4% 4,2% 4,2% 4,2% 4,2% 4,2% 4,2%

Change in working capital (97) (197) (218) (272) (290) (310) (332)

(0,6%) (1,2%) (1,2%) (1,4%) (1,4%) (1,4%) (1,4%)

Operationnal Cash-flows 2 230 2 316 2 531 2 685 2 887 3 061 3 259

Capex (838) (883) (937) (998) (1 015) (1 086) (1 163)

%sales 5,4% 5,3% 5,3% 5,3% 5,0% 5,0% 5,0%

Free cash-flows 1 392 1 433 1 594 1 687 1 872 1 974 2 096

% croissance 2,9% 11,2% 5,8% 10,9% 5,5% 6,2%

DCF calculation 1 2 3 4 5 6

Year 1,5% 2015e 2016e 2017e 2018e 2019e 2020e

FCF 1 433 1 594 1 687 1 872 1 974 2 096

discount rate 1,00 0,93 0,87 0,81 0,76 0,70

Discounted rate 1 433 1 486 1 466 1 517 1 492 1 476

Cumulated FCF discounted 8 870

Terminal value 36 947

Discounted terminal value 26 028

Entreprise value 34 898

- Net debt 7 195

= Book value 27 703

- Minorities 788

Equity value 26 915

Number of shares 301

Share price (USD) 89

1,25

Share price (EUR) 71


Whilst FMC has traded at 15% premium on a P/E basis over the last five years, it is currently trading at a 5% discount versus DaVita.

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Fig. 37: Peers comparison (P/E 1Y Fwd)


Considering FMC strong fundamentals and its Care Coordination strategy which could unveiled strong value creation, we see FMC discount versus peers unwarranted.

Fig. 38: Peers comparison

Au Capi Capi PE VE/CA VE/EBITDA VE/EBIT EPS CAGR PEG

08/04/14 (M local Ccy) (M€) 15e 16e 17e 15e 16e 17e 15e 16e 17e 15e 16e 17e 2014-17 15e /CAGR

COLOPLAST 'B' 95 194 12 749 26,2 23,5 22,4 7,1 6,7 6,5 18,8 17,2 16,9 20,9 19,0 18,0 9,3% 2,8

ESSILOR INTL. 15 890 15 890 21,3 19,5 18,0 2,8 2,6 2,4 12,2 11,3 10,6 15,4 14,3 13,2 9,6% 2,2

FRESENIUS MED CARE 8 596 7 047 17,9 16,2 14,8 1,7 1,6 1,4 8,7 7,9 7,3 11,3 10,3 9,4 10,2% 1,8

GETINGE 42 946 4 793 13,2 11,6 9,3 2,1 1,9 1,8 8,8 7,6 6,7 12,3 10,4 8,9 20,2% 0,7

GN STORE NORD 23 313 3 122 19,0 16,5 13,7 3,1 2,9 - 13,6 12,5 - 16,0 14,7 - 18,3% 1,0

SMITH & NEPHEW 8 044 9 766 16,4 14,8 12,7 2,8 2,6 2,6 9,1 8,4 8,5 12,4 11,3 14,6 12,3% 1,3

SONOVA N 8 596 7 047 21,6 19,5 18,0 4,1 3,8 3,8 15,5 14,2 13,9 18,4 16,8 16,0 10,2% 2,1

Sector Average 8 630 19,4 17,4 15,5 3,4 3,2 3,1 12,4 11,3 10,6 15,2 13,8 13,4 13% 1,7

Weighted Average 20,4 18,4 16,8 3,7 3,5 3,3 12,9 11,8 11,3 15,7 14,3 14,0 11% 2,0


9

11

13

15

17

19

14/12/2009 14/12/2010 14/12/2011 14/12/2012 14/12/2013 14/12/2014

FRESENIUS MED.CARE DAVITA HEALTHCARE PTNS.

-15%

-5%

5%

15%

25%

35%

45%

55%

65%

14/12/2009 14/12/2010 14/12/2011 14/12/2012 14/12/2013 14/12/2014

PER : FME vs. Davita Average

Fresenius SE

34

5. Vamed

Vamed is Fresenius’s division which is focused on hospital projects and services. The division accounts for 5% of the group’s turnover (EUR1.02bn in 2013), 2% of the EBIT margin and 4% of the total net income. In 2013, the project business represented 57% of the division’s sales while the remainder was derived from services’ revenues. In October 2014, Fresenius won a EUR520m restructuring contract for a German hospital as well as an attached technical management contract valued at approximately EUR1.2bn and lasting until 2044.

We believe that the hospital project division has a strong footprint in emerging countries where there is a strong focus on building primary healthcare facilities. Vamed’s sales in Africa, APAC and Latin America were EUR112m (11%), EUR82m (8%) and EUR51m (5%) respectively. Conversely, we believe that established markets have a greater contribution to the services division (EUR775m, i.e. 76% of sales derived from Europe) where emphasis is put on improving operational management to bring efficiencies.

Fig. 39: Fresenius Vamed prospective P&L

EURm 2013 2014e 2015e 2016e 2017e 2018e

Sales 1 020 1 102 1 190 1 285 1 388 1 499

Organic 13.0% 8.0% 8.0% 8.0% 8.0% 8.0%

Reported 20.6% 8.0% 8.0% 8.0% 8.0% 8.0%

EBITDA 65 86 96 109 118 127

% of sales 6.4% 7.8% 8.1% 8.5% 8.5% 8.5%

D&A 10 17 18 19 21 22

% of sales 1.5% 1.5% 1.5% 1.5% 1.5% 1.5%

EBIT 55 69 79 90 97 105

EBIT margin 6.0% 6.3% 6.6% 7.0% 7.0% 7.0%

Financial result -3 -3 -3 -3 -3 -3

Pre-tax income 52 66 76 87 94 102

Income taxes -14 -18 -21 -24 -26 -28

tax rate -27% -28% -28% -28% -28% -28%

Others -1 -1 -2 -2 -2 -2

Other % -2% -2% -2% -2% -2% -2%

Net income 37 47 53 61 66 72

Net income margin 3.6% 4.2% 4.5% 4.8% 4.8% 4.8%


Fresenius SE

35

6. Valuation

6.1. Fresenius Se & Co KGaA valuation We derive our Fair Value from an equally-weighted average of both a multiple-based and a DCF-based model. Our Fair Value works out at EUR42 of which 50% comes from our EUR39 multiple-based method and 50% from our EUR45 DCF-based method.

We value Kabi, Helios and Vamed through an EV/EBITDA multiples method. Kabi’s EV/EBITDA multiple is an average of peer basket multiples (Hospira, Baxter and Hikma) while multiples used for Fresenius Medical Care are derived from our DCF-based model of the division.

Fig. 40: SotP model

2015e EBITDA

EV/EBITDA Multiple

EV Comments

FMC 2 524 10,8 27 225 Based on our fair value of EUR71

Fresenius Kabi 1 226 12,9 15 848 Peers basket with Hospira, Baxter, Hikma

Fresenius Helios 908 11,0 9 984 10% discount to 12x Rhoen multiples

Fresenius Vamed 96 7,0 675

Total Entreprise Value 53 732

FSE net debt 13 460

FMC minorities (31.4%

ownership)

18 676

FSE minorities 701 19 377,1

Equity Value 20 895

Nb of shares 540

Per share 39

Current share price 42

Upside (6,8%)

EUR/USD 1,26

Peers EV /EBITDA

2015 Current

HOSPIRA 14,2

BAXTER 10,8

HIKMA 13,9

Average 12,9

Valuation Summary Equity value Weight

DCF 45 50,0%

SOTP 39 50,0%

Fair Value 42


Fresenius SE

36

Our DCF-based Fair Value for Fresenius SE works out at EUR45. We assume the same WACC rate as the one we use for our FME DCF-based model.

Fig. 41: Fresenius SE DCF model

M $ 2013 2014e 2015e 2016e 2017e 2018e 2019e 2020e 2020e

Sales 20 331 24 006 25 866 27 535 29 396 31 293 33 312 35 461 37 749

Growth 5% 18% 8% 6% 6% 6% 6% 6% 6%

Recurring EBIT 2 991 3 325 3 748 4 156 4 532 4 824 5 136 5 467 5 820

%sales 15% 14% 14% 15% 15% 15% 15% 15% 15%

Taxes (669) (781) (889) (995) (1 090) (1 399) (1 489) (1 585) (1 688)

28% 29% 29% 29% 29% 29% 29% 29% 29%

D&A 843 927 936 971 1 037 1 104 1 175 1 251 1 332

%sales 4% 4% 4% 4% 4% 4% 4% 4% 4%

Change in working capital (288) (96) (103) (110) (118) (125) (133) (142) (151)

-1,4% -0,4% -0,4% -0,4% -0,4% -0,4% -0,4% -0,4% -0,4%

Operationnal Cash-flows 2 877 3 375 3 692 4 023 4 362 4 404 4 688 4 991 5 313

%growth 17% 9% 9% 8% 1% 6% 6% 6%

Capex (1 047) (1 176) (1 267) (1 349) (1 440) (1 533) (1 632) (1 738) (1 850)

%sales 5% 5% 5% 5% 5% 5% 5% 5% 5%

FMC (567) (587) (645) (705) (782) (852) (929) (1 012) (1 103)

Growth 9% 11% 9% 9% 9% 9%

Free cash-flows 1 263 1 612 1 779 1 968 2 140 2 019 2 127 2 241 2 360

% croissance 27,7% 10,4% 10,6% 8,7% (5,7%) 5,4% 5,3% 5,3%

DCF calculation 1 2 3 4 5 6

Year 2014e 2015e 2016e 2017e 2018e 2019e 2020e

FCF 1 263 1 779 1 968 2 140 2 019 2 127 2 241

discount rate 1,00 0,93 0,87 0,81 0,76 0,71

Discounted rate - 1 779 1 836 1 861 1 638 1 609 1 581

Cumulated FCF discounted 10 304

Terminal value 39 730

Discounted terminal value 28 031

Entreprise value 38 335

- Net debt 13 460

= Book value 24 876

- Minorities 831

Equity value 24 044

Number of shares 540

Share price (EUR) 45


Fresenius SE

37

Price Chart and Rating History

Fresenius SE

Ratings

Date Ratings Price

15/05/12 BUY EUR29.37

Target Price

Date Target price

26/02/14 EUR40

07/01/14 EUR41.25

26/11/13 EUR39.27

17/09/13 EUR36.96

27/02/13 EUR33.99

17/01/13 EUR31.68

02/08/12 EUR30.69

15/05/12 EUR29.37

27.6

29.6

31.6

33.6

35.6

37.6

39.6

41.6

43.6

14/06/13 14/09/13 14/12/13 14/03/14 14/06/14 14/09/14 14/12/14

FRESENIUS (XET) Fair Value Achat Neutre Vente

Fresenius SE

38

Fresenius Med. Care

Ratings

Date Ratings Price

12/06/11 BUY EUR50.96

Target Price

Date Target price

10/04/14 EUR58

26/02/14 EUR56

07/01/14 EUR63.5

26/11/13 EUR60

03/07/13 EUR53.5

17/01/13 EUR65.5

02/08/12 EUR64

06/12/11 EUR61

44.6

49.6

54.6

59.6

64.6

14/06/13 14/09/13 14/12/13 14/03/14 14/06/14 14/09/14 14/12/14

FRESENIUS MED.CARE (XET) Fair Value Achat Neutre Vente

Fresenius SE

39

Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating

BUY Positive opinion for a stock where we expect a favourable performance in absolute terms over a period of 6 months from the publication of a recommendation. This opinion is based not only on the FV (the potential upside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion.

NEUTRAL Opinion recommending not to trade in a stock short-term, neither as a BUYER or a SELLER, due to a specific set of factors. This view is intended to be temporary. It may reflect different situations, but in particular those where a fair value shows no significant potential or where an upcoming binary event constitutes a high-risk that is difficult to quantify. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion.

SELL Negative opinion for a stock where we expect an unfavourable performance in absolute terms over a period of 6 months from the publication of a recommendation. This opinion is based not only on the FV (the potential downside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion.

Distribution of stock ratings

BUY ratings 57,4% NEUTRAL ratings 37% SELL ratings 5,6%

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Bryan Garnier & Co Limited or another company in its group (together, the “Bryan Garnier Group”) has a shareholding that, individually or combined, exceeds 5% of the paid up and issued share capital of a company that is the subject of this Report (the “Issuer”).

No

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The Issuer has a shareholding that exceeds 5% of the paid up and issued share capital of one or more members of the Bryan Garnier Group.

No

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No

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No

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No

11 Analyst has short position The investment analyst or another person involved in the preparation of this Report has a short position in the securities or derivatives of the Issuer.

No

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No

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A partner, director, officer, employee or agent of the Bryan Garnier Group, or a member of such person’s household, is a partner, director, officer or an employee of, or adviser to, the Issuer or one of its parents or subsidiaries. The name of such person or persons is disclosed above.

No

14 Analyst disclosure The analyst hereby certifies that neither the views expressed in the research, nor the timing of the publication of the research has been influenced by any knowledge of clients positions and that the views expressed in the report accurately reflect his/her personal views about the investment and issuer to which the report relates and that no part of his/her remuneration was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in the report.

Yes

15 Other disclosures Other specific disclosures: Report sent to Issuer to verify factual accuracy (with the recommendation/rating, price target/spread and summary of conclusions removed).

No

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