Care services: sustaining value

Private equity houses continue to make the most of opportunities in the care services sector, in particular outsourced services for the elderly, disabled and those with special needs being subsidised by the public sector via contract agreements. Valuations appear to be soaring, but how long will private equity houses be able to extract value from these deals? Angela Sormani reports.

Private equity looks like it is gearing up for another bumper year in healthcare, with around £15bn of private equity investment circling healthcare assets, according to Deloitte. Key healthcare drivers in 2006 include property fund interest in healthcare assets, Government investment and changing regulations, demographic trends pushing demand for long-term healthcare and awareness in the cosmetic industry.

Another interesting new development in the market is private equity seeking to identify other growth areas outside mainstream care such as cosmetic surgery, childcare and dentistry. Also of note, there have been more private equity firms acquiring healthcare businesses and splitting the operating model and the assets: so called ‘propco/opco’ deals. This split is driving the biggest healthcare multiples as property funds look to acquire the assets and this is an opportunity being explored by many private equity firms in the sector.

Tim Murphy, co-head of debt advisory at Deloitte, says: “We are seeing frenetic activity in the private equity industry as it looks to make returns on the inherent earnings potential and underlying property value of healthcare. We have seen private equity fund healthcare deals with an array of debt models including sale and leaseback, hybrid securitisation, not to mention standard leveraged structures such as second lien notes and PIK (payment in kind).”

Bowmark Capital, Electra Partners, Granville Baird, Graphite Capital, HgCapital and Sovereign Capital are among a handful of mid-market private equity firms that have been taking advantage of opportunities spinning out of the healthcare space and are continuing to do so.

Dr Victor Chua, healthcare practice leader and partner of Candesic, says: “Valuations for healthcare businesses have been high in the last two years. Sale prices for the Priory Group, Partnerships in Care, Westminster Health Care, and Four Seasons have taken industry commentators by surprise and set new price/earnings multiple reference points.” And these high valuations have not been confined to just one segment; elderly/nursing care homes, acute and secure psychiatric hospitals, acute medical/surgical hospitals, and even schools for the autistic and emotionally disturbed have all enjoyed record multiples.

Last year and the beginning of this year has seen a wealth of private equity-backed deals in the space including most recently Granville Baird Capital Partners management buyout of Choices Holdings Limited, a provider of supported living and residential care services to people with learning disabilities, and Sovereign Capital’s £22m acquisition of Alkare, a specialist provider of residential care for adults with mental health needs. Last October Bowmark Capital made a further investment in The Regard Partnership, a provider of care and residential services to people with a learning disability, to fund its acquisition of Adapt Care. Also in October, Graphite Capital backed a care homes management team to build a new nursing home group, Avery Healthcare, with a £29m development capital package.

These investments are already bearing fruit. Electra Partners Europe is one of the latest private equity firms to benefit from stellar returns in the sector. Through its sale of Ashbourne Healthcare in February 2006, Electra achieved one of its best ever exits, generating a multiple of 7x capital invested.

Jim Flaherty led the management buy-in team, alongside partners Chee Jap, John Storey and Mark Gosling. Electra had previously backed Flaherty and his team through a minority investment in Principal Healthcare Finance. Principal was put up for sale in 2001; Electra entered into early negotiations, but decided not to proceed. After the sale of Principal, Electra and the team looked at several targets in the care home sector. Ashbourne, which was headquartered in Glasgow at that time, numbered among these original targets and was a clear front-runner, despite being loss-making at that time. The business was well known to Electra and the management team: Electra had backed an earlier buyout in 1995, while the buy-in team had supplied the business with sale and leaseback facilities in the mid-1990s, during their time at Principal Finance.

Ashbourne had been floated by Electra in 1996 and was subsequently acquired by a US healthcare provider towards the end of the 1990s. It was later sold to its management in 2000. The company had suffered during a difficult period for the care home sector in the UK during the 1990s, with rising costs, falling fees and tighter government standards. Many small operators exited the market and the number of available places in elderly care homes fell considerably, against the demographic backdrop of an ageing population. These factors meant by 2002 the outlook was improving, prompting Electra’s interest in the sector. Fee income for care homes was increasing above the rate of inflation, while operating costs remained stable and Ashbourne’s underlying business was showing the first signs of improvement on the back of these influences when Electra and the team started to look at it.

The £22m buy-in of Ashbourne was completed in April 2003. Over the next 18 months the business made a total of 13 acquisitions, including the buy-back of a number of leasehold properties. This acquisitive strategy enabled the business to grow from an annual turnover of £123m to £180m, with annual EBITDA of over £23m.

In 2004, Ashbourne received an unsolicited offer for the business, which prompted Electra and the team to explore the potential for an exit. Four potential buyers were approached and all four entered into negotiations. The winning £280m bid came from Bank of Scotland Corporate, which bought the business in a joint venture with the existing management team. By February 2006, after a further significant acquisition, the £88m purchase of Ridgmont Care Homes from Graphite Capital bringing in more private equity investors into the mix, the team had fashioned a full exit from Ashbourne. This was achieved through the sale and leaseback of the majority of its freehold properties to London & Regional Properties for £365m and the subsequent divestment of the leasehold interests to Southern Cross, a care homes operator backed by Blackstone Capital, for around £77m.

But whether these types of valuations can be sustained remains to be seen. Chris Collins of Electra Partners Europe says: “Most of the elderly care homes have been privately owned for some time. But local authorities fund most people who are in care homes. The public sector doesn’t own the care homes, but it does fund the residents. Local authorities fund 70% of residents at Ashbourne. The other 30% are funded by private money. But the percentage of private pay is creeping up and these fees can be significantly higher than local authority rates and there is therefore scope to improve overall profitability.”

There are currently some big-ticket deals on the sales block in terms of both exits and also acquisition opportunities for private equity firms. At the time of going to press, BC Partners-owned General Healthcare was up for sale with a £2bn price tag and Four Seasons, which used to be owned by Alchemy and then acquired by Allianz, is also on the market with a £1.3bn enterprise value. West Private Equity’s Clinovia is also coming up for sale.

Chua says: “For a private equity firm to acquire these businesses it only ever makes sense if a company is still growing. Leveraged buyout firms make money on growth. You have to believe you can grow these companies. The question on many people’s minds is how much further can these businesses go?”

Demand for nursing homes soared in the late 1990s due to many operators exiting the market in the early to mid-1990s, some taking advantage of booming property prices to convert their Victorian-style nursing homes into flats. This led to a loss of approximately 50,000 elderly care beds in the UK since 1997 and in 2004-2005 the supply/demand balance is still in the favour of the care provider and therefore there is further opportunity for growth in this sector, says Chua.

He says: “Ten years ago the nursing care industry was at a slump. Now prices have been going up because people have been exiting the market and there is now a shortage of care home places. The clinical demand with the elderly will remain as we are an ageing population, but the key question is whether the funding for people with learning disabilities and the elderly will continue. There is a push towards more home-based services as opposed to institutional care. We have modelled supply and demand for a number of companies in nursing/residential care, including in our model local wage rates, local authority policy on care of the elderly, trends in private pay and in most regions the outlook is strong. In areas such as the North East with low private pay and excess supply of beds, the winners will be those groups who are able to reposition beds into other areas of care.”

Chua mentions his clients showing interest in other forms of care such as primary care (GP surgeries), which the NHS is opening up to commercial businesses. “That may well be an attractive place for private equity firms who are willing to take a bit more risk,” he says. “If you talk to anyone in the NHS all they want to talk about is primary care.”

Chris Collins is still optimistic: “A lot of value has already been taken from this sector, but I think there are still attractive businesses out there for the long term due to the demographics of the business and also because they are predictable businesses to manage and very cash generative.”

But Chua warns: “I think the number of deals will continue this year, but I do think that increasingly people are having to focus on other areas and as the competition for these deals is so intense, people are paying very high prices, leaving no room for mistakes in execution.”