The next steps in the care homes market

The origins of the sellers’ market that has dominated the UK care homes sector for the last three years began in the late 1990s. Many smaller operators were exiting the sector during that period, while long-term demographic trends have meant firm and growing demand for elderly care.

The residential property boom only added to these factors. That tempted many care home owners to sell up and escape the rigid fee structure imposed by local authorities and the growing regulation of the government.

For the private equity houses that saw those signs and got in early, the care home industry has been a major earner. 3i, for example, earned more than four times its original investment when it sold Westminster Healthcare last year and Alchemy made a similar return on its exit from Four Seasons.

Graphite Capital’s sale of care home business Ridgmont to Ashbourne Healthcare, meanwhile, made a 6.5 times return on equity. Graphite backed a secondary buyout of the business in 2001 from Cinven and built up the company from 19 to 29 homes with more than 1,300 beds.

The care homes industry has not always been as healthy as it appears today, however. In the early 1990s there was an oversupply of capacity, which meant local authorities were able to hold down fees.

“For a long period in the 1990s, fee rates paid by the public sector were frozen,” says Mark Hudson, an investment manager at Graphite. “Then, in recent years, the government realised that was unsustainable if it wanted a healthy privately run industry.”

The background macro factors to the industry suggest it is a good long-term bet. The ageing population suggests demand will continue to be strong, while the public sector is keen to get elderly patients out of expensive hospital beds and into cheaper care home or nursing home facilities. Care home beds, largely staffed by low-paid carers, cost £500 to £600 a week, while an NHS bed costs some £350 a day.

This cost ratio means a healthy care homes sector is important to the government in order to ensure that local authorities and NHS trusts pay realistic fees.

But there are risks. One danger is that, with prices and profitability recovering, there will be new entrants coming into the industry. Victor Chua, a partner at management consultancy Candesic, argued that there are some barriers to slow such a trend, however. These include strict planning controls over new care homes, and expensive property prices in much of the UK. Chua believes the industry has a good few years of high profitability before the cycle changes due to the expansion of supply.

That suggests that consolidation will continue apace. Despite the increase in the number of mergers and takeovers in the last few years, the UK care home industry is still fragmented. No player has more than 5% of the market and the vast majority of businesses are very small.

Currently, the main players by number of beds are US house Blackstone, which acquired Southern Cross last September; Barchester, which acquired Westminster from 3i; Allianz, which acquired Four Seasons from Alchemy; and Ashbourne, backed by management and Bank of Scotland. Other significant players are Cinven, which bought mental health business Partnerships in Care in March; and 3i, which has recently sold BetterCare Group but acquired a Nordic business, Carema, and UK specialist care provider Care Principles.

Bupa is also a leading player, but is not thought to be interested in acquisitions. Barchester, along with Partnerships in Care and Allianz, is thought to be among the potential bidders for mental healthcare business The Priory.

The fact that there is so much interest in The Priory, which is being sold by Doughty Hanson, and could go for up to £650m, is an indication that opportunities in the more traditional managed care home sector are limited.

Graphite’s Hudson said most of the larger deals in the elderly care sector had been done, although there were still a few medium-sized businesses and lots of smaller operators. “We may also see some of the larger businesses consolidate with each other, perhaps in order to float,” he said.

David Jones, a partner at Deloitte Corporate Finance, said that the problem in elderly care was the dominance of a large numbers of small homes. “If you’ve got 14,000 beds and you want to grow by 20%, it is very hard because there aren’t many companies with 2,000–3,000 beds that are available to acquire. It is not that practical to buy lots and lots of 60-bed homes.”

Medium-sized care home business ANS is being sold via Rothschild. It is likely to fall to one of the existing players in the market for an expected £300m. Of the remaining significantly sized operators, Craegmoor is the most likely to come up for sale. Legal and General Ventures has held the asset for several years and is likely to be thinking about exit options.

Portfolio games

So, which private equity houses are building the best portfolios in residential care? Different firms have different strategies, but, when it comes to elderly care, Blackstone is regarded as one of the top players. “They have made several acquisitions at very good prices, so they’re obviously good deal-makers,” says Chua.

Allianz is regarded as having good cost control and is keen to expand, as is Ashbourne. All these companies are likely to make money buying up more elderly care homes, according to industry analysts.

Cinven’s investment in Partnerships in Care, which provides medium-secure psychiatric accommodation, was regarded as expensive. Fees for that kind of work are much higher, however, because of the greater staffing requirements. Fees for medium secure psychiatric places are around £200,000 a year, compared with £25,000 for standard elderly care home places.

“Demand for secure psychiatric places currently outstrips supply, so Cinven must think it has made a good investment,” said Chua.

Whatever happens in terms of further consolidation of elderly care, it is clear that private equity owners cannot rely only on favourable macro conditions to create value.

There are limits to the ways that value can be created, nevertheless. The vast majority of costs go on local labour and there are strict regulations governing staffing ratios. Despite this, larger groups can muscle up the fees paid by the public sector and negotiate block contracts. There are also economies of scale to be achieved.

Alchemy built up Four Seasons by acquiring Cresta Care. “Cresta itself was created through the merger of four separate companies and each had its own separate regional administration, which we were able to amalgamate into a single, national headquarters,” said Martin Bolland, a partner at Alchemy.

Others believe that real value is not really in “plain vanilla” elderly care homes any more. Rather, it can be found in more sophisticated care packages and in expansion into related areas such as residential services for people with learning difficulties, mental health services and children or adolescent residential services.

“A lot of the value in the UK care home sector has come from property rather than care. It is the add-on services that provide the opportunity to create value, such as care for people who are elderly and frail but also have diabetes, or who are blind. The fees for that kind of specialist care are quite high,” said Alan Mackay, a partner at 3i.

3i has made a strategic decision to get out of standard care homes and to focus instead on higher-value services. This was seen in its buyout of Care Principles, a leading specialist care provider for adults with learning difficulties.

“We want to create a ‘care pathway’, which means offering multiple levels of care to public sector purchasers. That means that when an individual’s needs change, we can move them up or down the scale,” said Mackay.

3i is also turning its sights to Continental Europe, much of which it sees as following the UK experience in strengthening private sector provision of residential care. It acquired Swedish care home operator Carema in April, which it claimed was the Nordic region’s premium business in this sector, with 4,500 beds.

Although the region has a high public sector involvement in the economy, countries such as Sweden are happy for private operators to provide residential care and be paid from the public purse, Mackay said.

But some observers are less convinced by the merits of European expansion. Chua of Candesic argued that synergies between countries are hard to achieve because of the different ways residential care is regulated and paid for in various countries. He added that profit margins were also significantly lower than in the UK.

Mackay agreed that profitability was currently highest in the UK, but said that there was significant variation between European markets. “In France, profits are quite high; while in Germany, companies are struggling because of a change in the funding regime,” he said.

Countries such as France, which has a highly fragmented market, are likely to consolidate in the coming years and this offers major opportunities for private equity players with healthcare experience, Mackay said. “For example, in France much of the psychiatric care is run by the prisons service, which the authorities recognise doesn’t make much sense, and they’re open to private sector provision,” he said.

Whether Continental Europe delivers on these expectations remains to be seen. Nevertheless, groups such as 3i are confident that other markets will follow the UK model. Whatever happens in mainland Europe, there is also the prospect of significant activity going forward in the UK. This involves both further consolidation in elderly care and new opportunities in other forms of residential healthcare.