Are buyout firms well placed for healthcare reforms?

This year alone, there have been five healthcare buyouts in the UK. One of them, Four Seasons Healthcare by Terra Firma, was worth almost £1bn.

Healthcare distinguishes itself from other industries with its predictable flow of demand and its public visibility. Providing every person of the country with free care, it is also expensive and its business structure is feared unsustainable, not least in these troubled economic times. Over the years the National Health Service (NHS) left funding gaps in its wake that the private sector has gradually moved in to fill. "The private sector has a role to play in the UK health service," says Kevin Grassby, managing partner at Bowmark Capital, owner of Care Fertility Group and Glenside. "Its role is to service the capital needs of the sector." Indeed, the private sector may soon be dealt its strongest card yet: a fully open market offering the whole range of NHS services to "any qualified provider" under the Health and Social Care Act's "right to provide" initiative.

No government fire sale
However, General Partners are unsure of whether the part-privatisation of some NHS functions will indeed trigger a boom in private equity takeovers of hospital services, which is what many critics fear the government is hoping for. David Porter, managing partner at Apposite Capital, a firm that specialises in investing in health care, says: "The hope is that the change in commissioning – to have more involvement from doctors – will lead to a more radical change in the way healthcare is provided. If that happens, that would be for the benefit of the private sector. But people don't realise quite how much there is already going on."

Are buyout firms well placed to benefit from ground-breaking healthcare reforms in the UK?

Grassby is more cautious in his prediction: "It's difficult to evaluate and understand what will happen as the political objectives and the practical outcomes can often be two very different things. In the face of such uncertainty, as an investor you have to rely on the fundamentals of investing in businesses that do a better job at a lower cost and avoid areas where the upheaval is greatest or least predictable." But he adds: "Healthcare reform usually has one of two objectives: to deliver cost savings or to improve the quality of care. Hopefully it will do both, but it might end up doing neither."

If put into practice the way the bill is currently written, doctors will form commissioning groups that will buy services with a pool of allocated government money. Hospitals and providers will get paid by the government for their services while being allowed to keep the profits they make. Critics fear that this could impinge on the quality of service and even create a downward spiral as profit-driven providers seek to undercut their competitors. Porter fends off such criticism: "I don't think people are right to be so critical about private equity running healthcare services. I think in general private equity has been extremely good in social care and healthcare. It has built some quite efficient businesses and has provided capital when there was none available."

Bad apple
Private equity investments in the healthcare sector have, of course, gone wrong in the past. When Blackstone's former residential care group Southern Cross collapsed in 2011 it left thousands of elderly people in limbo over their future and drew significant negative media and political attention. The collapse was largely blamed on Blackstone's failure to plan for the long-term need of the business, its over-leveraged structure and stripping of the company's assets.

Grassby warns of risky tactics in the health sector: "It becomes scary when there is a breakdown in care. We try to mitigate the investment risk by making sure when we invest that the quality of care is best in class. And during our period of ownership, we continually prioritise quality of care as we have learnt that everything else flows from getting that right. Quality has to be at the forefront of the business plan. Our experience has been that you don't want to aggressively leverage healthcare businesses. You need to build in headroom for those unforeseen bumps in the road."

Bowmark Capital's value realisation strategy does not rest on leveraging and the GP still expects mainstream returns. The GP sticks to two investment strategies: the private model and the niche model. In the private care service, like residential care, services are charged to the individual. This model, facilitated by the introduction of means-tested elderly care, does not rely on government funding and can price its services according to value. In this sense, competition tends to drive value upwards rather than downwards as individuals can decide which home they want to go to and are likely to pick the better one.

The other business model, which is government-funded, relies on adding value through specialisation of services. On Bowmark's portfolio company Glenside, Grassby explains: "We like businesses where their competitive position is based on providing quality outcomes and a cost benefit versus alternative forms of provision. If you can satisfy both of these criteria you are in a very good place. In particular, we like niches in healthcare where only few providers can deal with the acuity of the customers' needs. Increased specialisation enhances the ability to add real value."

Grassby maintains that Glenside has been run cheaper and more efficiently since being in private hands, despite being free at point of use, but he admits that the universial free-for-all healthcare model may be at risk under the reforms. Commenting on critics' fears of a tiered system where all healthcare may not be available to everyone, he adds: "There has always been informal rationing. Under the new system rationing will have to become more explicit."

"The private sector and private equity definitely has a role to play in the UK health service. Not only in terms of providing capital to a notoriously capital intensive sector, but also in terms of enhancing and developing long-term businesses that will provide the sector with some of the financial and commercial disciplines it needs," says Grassby.

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• Topics
• Buyouts
• Healthcare
• UK / Ireland
• Bowmark Capital LLP
• Apposite Capital