FRESENIUS MEDICAL CARE AG

Description Europe is cheap. Healthcare is cheap. Here’s a German healthcare company at 7x EBITDA and 8x FCF with 70% of sales in the U.S., a scale-derived moat in a duopolized industry with nearly 40% market share, up from 25% market share 25 years ago, and a classic spin-off playbook in progress, albeit with an unusual start (this spun-off company has traded separately from the parent since 1996, but only legally deconsolidated and self-directed since 2023). Also has good liquidity at a $13.5B market cap. ($9B float). Fresenius Medical Care ADR (FMS $23.09) represents 0.50 shares of the Germany-listed common shares (FME GR, €44.34), which on 12/27/24 regained membership in the DAX Index (40 stocks). It is the largest provider globally of kidney dialysis services for patients with end-stage renal disease (ESRD) which requires 3 treatments per week (3 to 4 hours each session) for the rest of a patient’s life (except for the few who can get a kidney transplant), and is roughly the same size in that business line (which FMS calls their “Care Delivery” segment at 80% of sales) as DaVita (DVA $170, ATH) in the U.S., where each company has roughly 40% market share. DVA hit an all-time high today, while FMS is 60% off its $57.94 ATH of Mar. 2018. That’s not just symptomatic of a U.S vs. Europe valuation disparity; DVA has crushed FMS in business performance and capital allocation over the past 25 years. Partially because… best stock websites AI Stock Screener how to invest in SpaceX how to invest in OpenAI warren buffett indicator current yield curve … FMS also has a lower margin, more capital-intense med-tech manufacturing business which they call their “Care Enablement” segment (20% of sales). A major new product is set to launch in the U.S. in 2026. As home dialysis (currently 14% of patient population) is increasing more rapidly, FMS should benefit from increased sales of the equipment and consumables. DaVita is the market leader in providing home dialysis services (with FMS at #2 in home service), but they buy equipment from FMS and others like Baxter. https://www.freseniusmedicalcare.com/en-us/company/our-company/news-releases/davita-kidney-care-expands-use-nxstage-home-hemodialysis-machine/ This long-term drag is turning up now. Fresenius Medical is at EV of 7x TTM EBITDA (€3.5B) (18% EBITDA margin), and 8x TTM FCF (€1.6B) (46% of EBITDA), with net debt/EBITDA of 2.8x (below their stated target leverage range of 3.0x to 3.5x). I estimate fair value for FMS of $35 (+52%), which would be 9x EBITDA, and 12x FCF. DaVita is currently valued at EV of 10x TTM EBITDA ($2.7B) (21% EBITDA margin), and mkt. cap 10x TTM FCF ($1.4B) (52% of EBITDA), with net debt/EBITDA of 3.2x. The recent (Nov. 30, 2023) legal separation / deconsolidation of Fresenius Medical from its parent company, Fresenius SE (FRE GR, €36.03), which retains a 32% stake in FMS, offers a textbook post spin-off playbook: new management, improving profitability, divesting low margin ops, and improved capital allocation, which should ultimately result in a sale that maximizes value for the parent company’s retained stake in FMS. In 2023 FMS established their “FME25” transformation program with a goal of €650M in cost savings, of which they’ve already achieved €519M as of Q3 2024. Demand growth is driven by an ageing population. There are 36M Americans living with Chronic Kidney Disease (CKD), of which 808,000 have progressed to End-stage Renal Disease (ESRD), of which 68% are on dialysis (550,000). Roughly 135,000 Americans are newly diagnosed and start dialysis each year, which usually more than offsets the number of dialysis patients who die or get a transplant. https://www.niddk.nih.gov/health-information/health-statistics/kidney-disease#:~:text=Chronic%20kidney%20disease%20%28CKD%29%20affects%20more%20than%201,disease%20%E2%80%94the%20risk%20for%20CKD%20is%20even%20greater. Covid-19 killed many dialysis patients, which caused an unusual decline in revenues, but patient numbers have been rebounding, although above average mortality among dialysis patients lingers on. The average ESRD patient lives about 7 years (84 months) on dialysis, but that average includes many who die within their first year on dialysis (very roughly around 15% to 20%), and many who live more than 15 years. Commercial payor insurance covers 30 to 33 months of dialysis (at 3x the reimbursement rate of Medicare) while Medicare kicks in after 30 to 33 months, regardless of age (usually Medicare available only for 65-year-olds and older, except for dialysis (as of 1972) and ALS). In the U.S., dialysis providers lose money on Medicare patients, with commercial pay producing all of their profit, a very unusual situation. Despite the fact that Medicare reimbursement rates don’t cover the cost of care, dialysis still represents a very large 7% of Medicare’s budget. Study data showing that new anti-obesity drugs might reduce demand for kidney dialysis has occasionally (on 10/11/23 and 10/30/24) slammed the stock prices of DVA and FMS. But those drugs are deemed by many to be a net neutral factor, as Patrick Wood, Morgan Stanley’s medical technology analyst states, “The outlook for the kidney dialysis sector is less clearcut: Reducing obesity levels may mean there are fewer patients requiring dialysis, but increasing longevity could have a paradoxical effect of extending dialysis time for those patients that still require the treatment.” So, while there is a risk that those new drugs do result in a secular decline in demand for dialysis, my guess is that partially because of that countervailing effect it would take a number of years for that to become apparent. Also, some recent studies show a very high rate of discontinuance with these drugs, apparently due to the side effects: https://news.northwestern.edu/stories/2024/11/why-do-50-75-of-people-stop-taking-glp-1-drugs-within-a-year/ FMS has not been written up on VIC before, although roojoo wrote up the parent company, Fresenius SE on 1/11/19, which touched on FMS briefly. DVA (now $170) has been written up multiple times on VIC (10/28/01 by ecf191 at $18, 2/14/03 by ecf191 at $20, 7/29/16 by BJG at $77.00, and 9/7/18 by Poms at $67.83). Clearly the VIC community was right to focus on DVA and shun FMS. As was Ted Weschler, who bought DVA somewhere between $1 and $2 in early 2000, and got Berkshire into it right after he joined in 2012. Berkshire now owns 44% of DVA, with a cost basis likely under $50. Jim Chanos was vocally short DVA around $60 from 2017 and recommended as a short again in Sept. 2019 but covered in 2020, presumably at a loss. DaVita has vastly outperformed Fresenius Medical in stock price and business performance over the past 25 years, partially due to Fresenius Medical being weighed down by a low margin and more capital-intense products manufacturing (med-tech), their “Care Enablement” business (21% of sales), and low margin non-U.S. exposure (30% of sales), and poor capital allocation (overpaying for acquisitions, not buying back shares). That all is beginning to change now. I think on or before their June 17 Capital Markets Day in London, FMS will announce a significant share buyback, as CEO Helen Giza seemed to be hinting at that during QA after their presentation at the J.P. Morgan Healthcare Conference on 1/13/25. Fresenius Medical was created in 1996 when WR Grace merged their scandal-ridden National Medical Care (NMC) dialysis business with the dialysis business of Fresenius SE, which was mainly renal products manufacturing. The pitch that being uniquely vertically integrated would be a benefit proved false in this case. Davita is the biggest external customer of FMS med-tech products, but DVA understandably seeks alternative suppliers and sometimes funds such competition as an investor. One small example: https://www.prnewswire.com/news-releases/rockwell-medical-expands-partnership-with-davita-301522722.html I think FMS would be better off selling their med-tech manufacturing business, which should be entering into a period of higher growth from a new product line and higher margins, making it easier to obtain a good exit valuation, but they have not indicated any such consideration. sp500 pe ratio vti vs itot schd vs dgro ixj vs xlv vwo vs iemg tip vs schp While DVA was buying back its own stock in huge amounts at less than 7x EBITDA in the early 2000s, and smaller regional players at 5x to 6x EBITDA, FMS bought back none of its own stock and paid 11.8x EBITDA for Renal Care Group (RCGI) in 2005, a $3.9B deal. FMS overpaid for NxStage (NXTM) in deal announced 2017 to expand in home dialysis products, paying $1.95B, 5x sales of $394M in 2017, 98x EBITDA of $20M, although NxStage revenue now $913M in 2024 (12.8% CAGR over 7 years) and home dialysis is growing fast so maybe that investment will pay off now. https://finance.yahoo.com/news/fresenius-medical-care-grows-number-120000740.html Still, FMS has been barely profitable in their med-tech (Care Enablement) manufacturing overall, but with operating profit margin improving from less than 2% over the past couple of years to just under 6% in Q3 2024, and targeting 8% to 12% near-term and 15%+ in the long term. I think that business would do better if owned by a strategic buyer like Baxter that wouldn’t be selling products to a competitor, but again, it’s not been discussed as non-core or up for sale so for now that’s just my sense of what should happen. Perhaps a good reason for not selling that division just yet is that they’ve invested hundreds of milliions in a new product which will roll out in the U.S. in 2026. Here’s the CEO discussing it at the JP Morgan Healthcare Conference on 1/13/25: “…to talk about high-volume hemodiafiltration or HDF. It has grown substantially over the last 10 years and has become the standard of care in our clinics in Europe. The findings of the European Union's CONVINCE study as well as our real-world experience in EMEA demonstrate a 23% reduction in mortality for patients treated with HDF versus standard hemodialysis. This could equate to an additional statistical average of 18 months of life. However, HDF has not been available in the U.S. before now. And as I mentioned earlier, our 5008X machine was the first HDF-capable machine to receive FDA approval. And in June, the first U.S. patients were treated with the 5008X system in our clinics. To our knowledge, there is no further FDA approval for an HDF machine in progress. We believe that this modality, which is fundamentally different than standard highflux hemodialysis, is an opportunity to take a leap forward in providing more innovative therapy in the United States. And as you can imagine, we saw strong interest at the American Society of Nephrology Congress at the end of October. As a vertically integrated business with considerable market share, we are uniquely positioned to bring this innovation to the U.S. market and set a new standard of care, like we have done in the past with single-use dialyzers. We are currently detailing a holistic plan for the United States rollout, optimizing the potential returns across Care Delivery and Care Enablement. And beyond HDF capabilities, the 5008X is a much more modern, more efficient, user-friendly machine that can also be used for regular dialysis treatments. It will not need bags with IV solutions for priming of the machine, and the machine performs self-cleaning during treatments, and so does not require a 45-minute break between treatments. Also, training time is expected to be significantly lower than with the current 2008 system. We are fully on track with our preparations for the launch of the 5008X machine in the U.S. at the end of this year, with a broad, full-scale commercial launch being planned for 2026.” So maybe FMS will hold on to their med-tech business, at least until next year, but overall it’s pretty clear that the former parent company doesn’t want to keep so much capital (€4.4B at current price, nearly 14% of FRE’s enterprise value) tied up in a passive 32% stake in FMS, so maybe they’ll sell the whole thing to private equity and then the PE firm can sell the med-tech business later. I should have been an investment banker. When Ted Weschler bought DaVita in early 2000, the stock had vastly under-performed FMS over the prior 18 months, with DVA’s stock down from $12 in June 1998 to $2 on 12/31/99, while FMS was up from $10 to $14 over the same time frame. As of 12/31/99, DVA was over-leveraged with net debt to EBITDA of 7.2x, and trading at 10x a depressed EBITDA (13% margin, down from 25% in 1998). FMS had only 2.8x net debt to EBITDA and was trading at 11.5x EBITDA (22% margin) on 12/31/99. It clearly wasn’t just about getting into the cheaper of the two, it was mostly about the subsequent business performance and the massive buyback of shares that DVA completed. DVA’s shares outstanding on 12/31/99 were 243.1M, and today it’s 82M. FMS ADRs (using the underlying FME GR shares) outstanding on 12/31/99 were 237.1M, and today it’s 293.4M. I think it’s likely that FMS will improve margins and capital allocation and ultimately valuation, maybe not enough to replicate DVA’s performance from 12/31/99 to now (18.9% CAGR vs. 7.8% SP500 and 3.6% from FMS), but enough to significantly outperform DVA and the market averages over the next 1 to 3 years. Risks: anti-obesity drugs materially reduce demand for dialysis. Adverse reimbursement rates. Shift in payor mix from private insurance pay to Medicare. Billing fraud or other misdeeds that both FMS and DVA have engaged in a few times before. Or the stock may wallow for all eternity simply because I have observed it and discussed it here. Catalyst Catalysts: Feb. 25, 2025 Q4 earnings report. June 17, 2025 CMD (Capital Markets Day) - potential share buy back 2026: U.S. launch of HDF / 5008X system Sale of med-tech “Care Enablement” division Sale of Fresenius SE’s 32% stake in FMS Sale of FMS entire company