Issue - Australia’s Crime Rate is a National Disaster
Private Equity, Subsidies and the Care Sector
Author: Marie dela Rama
Date: 31 October 2007
We are hearing more and more about private equity nowadays. But while it is growing in importance and influence, the nature and purposes of private equity appear little understood. In this article, Marie dela Rama shines a light on recent private equity activity in the aged care sector in Australia and around the world.
In the September 18th issue of The Bulletin this year, Eddy Groves - CEO of childcare group ABC Learning - was declared as the 45th most influential businessperson in Australia. The publication noted that Groves saw: "the opportunities offered by consolidating the fragmented [childcare] sector, dominated by community groups and mum-and-dad operators, but underwritten by a river of government childcare subsidies."
Similarly, the aged care group Retirement Care Australia (RCA) - part of Macquarie Bank's private equity arm, Macquarie Capital Alliance Group (MCAG) - pointed out on its website the predictable revenues and strong growth prospects of this sector: "The aged care industry provides stable underlying revenue streams and predictable cash flows, primarily from government funding and subsidies." RCA entered the sector after buying aged care homes in 2005 from the non-for-profit entity, the Salvation Army. RCA will soon be known as Regis Group after its recent merger. The merged entity aims to have over 4,000 beds in the near future.
The similarities in these two sectors have not gone unnoticed. Matt Wade, a Sydney Morning Herald columnist, wrote on the increasing financial awareness of "the care industry - which includes child rearing, aged care, disability services, social work, health care and even education". Caring is personal. In Wade's words, "it affects loved vulnerable loved ones such as young children, aged parents and sick relatives. So it's fair to assume most people would like to see the care industry operating well." It's also very costly: "It's an industry with a 'cost disease'... For companies in the care business, high relative costs will mean lower relative returns for shareholders compared with firms in other industries."
In recent years, the aged care sector has seen a notable influx of private equity firms. These firms have entered, bought and have begun to consolidate a still largely, fragmented arena dominated by non-for-profits. The sector is now a fast-moving, exciting place to be if you're a fund manager. The investment opportunities are available and extend beyond bed licences. Some older nursing homes are sitting on lucrative prime real estate land as in the case of a private equity owned nursing home in Perth's Nedlands.
Other private equity firms joining RCA into the aged care sector are ANZ Capital (Ibis Care), Babcock and Brown (Primelife), AMP Capital (Principal Care), Ironbridge Capital (which bought New Zealand's Qualcare due to "strong demographic trends...and significant level of government backed revenues"), Hastings Funds Management (Craigcare) and CVC Citigroup (DCA Group). Hastings (now part of Westpac) bought Craigcare in 2003 and sold its interests in 2006, achieving an internal rate of return of 27 per cent. The American-European private equity consortium CVC Citigroup bought DCA last year. CVC is one of the largest private equity groups in the world. In October this year, the consortium announced it had sold DCA's interests of 96 homes and 7000 beds to UK healthcare group, BUPA, for around $1.225 billion dollars.
So, what is private equity?
According to David Hall, from the UK's University of Greenwich:
Private equity (PE) consists of the shares of companies which are privately owned, i.e. not publicly quoted on the stock exchange and so not subject to the disclosure rules of the stock exchange. PE funds are created as partnerships by financial services firms, by inviting investors like pension funds or rich people to commit a certain amount. The funds are then used to invest either in companies which are not quoted on the stock exchange - 'private' companies - or in companies which are listed, following which they are usually turned into private companies and so 'de-listed'. Each firm may have a number of different funds. The firms make money by charging commission fees on the money invested, and by getting a return on their own investment in the deal. The other investors get their return through cash payments made by the fund out of the profits from the investments, and from their share of the sale price of the company, or parts of the company, when they are sold on.
Private equity investments have proliferated, especially in the wake of stricter disclosure regimes imposed after the spectacular corporate collapses earlier this century. They have a deliberately limited life span. Hastings exited after three years while CVC Citigroup exited after only a year. The ability to manage, to package and to on-sell assets is standard.
The orientation of private equity, therefore, is purely financial. It is not necessarily in the sector because of a concern with caring for the aged. Due to the nature of private equity investing, aged care facilities are seen as part of a portfolio of assets. The performance of this portfolio depends on the other assets in that same portfolio. Generally, the investors in private equity are institutions and wealthy individuals. For example, AMP Capital's Principal Healthcare forms part of its investment portfolio (which includes Brisbane Airport, Lane Cove Tunnel, Sydney University Village, NZ Hospital Car Parks) and is sold as part of an "infrastructure equity fund". To enter this fund, the minimum investment required is $500,000.
What is happening in our aged care sector is part of a worldwide phenomenon. Private equity firms have invested heavily in the health and social care sectors in the USA and Europe. In July 2006, three private equity funds led by Kohlberg Kravis Roberts (of RJR Nabisco fame) bought HCA, the largest private hospital company in the USA, for $33 billion US dollars.
With my colleagues Melissa Edwards and Jenny Onyx, our concerns about private equity entering the aged care sector - and the care sector in general - can be whittled down to two issues: the subsidies and the quality of care.
Firstly, the amount of subsidies available in the care sector can be seen as profiteering by private equity from public funds. Government subsidies in the aged care sector create attractive investment opportunities for investment funds looking for a low risk venture. For ABC Learning, 40 per cent of its Australian sales come from government subsidies (The Age/Bloomberg, 28th August 2007). For Macquarie's RCA, around 70% of its operating income comes from the Commonwealth Government (RCA/Regis Merger Announcement, May 2007). In 2005-2006, the Government spent $7.1 billion on aged care of which $5.3 billion was for residential aged care subsidies. The average subsidy per utilised place is $34,000. Multiply that figure by the number of beds owned by an aged care service provider and the amount comes to hundreds of millions of dollars in subsidies to the bigger players.
Subsidies are a form of incentive which support and encourage industries and sectors that are necessary for the effective functioning of society but which have been largely overlooked by the market. However, with the entrance of these highly profitable businesses into the sector, surely the time has come to reassess the government subsidies that are available to them. Subsidies - without consideration of the profit status of the entity - are transforming the aged care sector into an uneven playing field where charitable and for-profit players are competing for the same pool of subsidies. The subsidies are becoming what Oxford academics Norman Myers and Jennifer Kent term "perverse subsidies" which "undermine market decisions about investment, and reduce pressure on businesses to become more efficient".
Secondly, there is the issue of the quality of service provision. Private equity firms have to make a return on their investment. Market segmentation will increase between the wealthier and not so-wealthy pockets of the population.
Currently, there is no empirical research available on the quick transfer and turnover of ownership and its effect on staff, the end-users (the residents) and families and friends of the end-users. Management may remain constant despite the ownership changes. RCA brought in Tricare, which has a history of managing aged care facilities. RCA also reported that they have introduced a single national wage agreement at seven sites, consolidating 14 previous agreements.
In the absence of Australian data, research overseas has been more forthcoming. On September 23rd 2007, The New York Times published a report which analysed more than 1,200 nursing homes owned by large private investment groups since 2000 against the US national average. Some of the homes had their budgets reduced, staffing stagnated or declined, resident activities and services were cut, and inevitably, complaints increased. The newspaper report noted that, in light of accounts that a poorly run home was owned by Warburg Pincus, one nursing home advocate stated: "Private equity is buying up this industry and then hiding assets. And now residents are dying and there is little the courts or regulators can do."
The political (and bipartisan) response has been immediate with Democrat Senator and Presidential Candidate Hillary Clinton and Republican Senator Charles Grassley requesting the US Government Accountability Office to examine the quality of care of private equity owned homes.
Will this be a portent of things to come in the Australian aged care sector?
Earlier this year, I made a submission to the Senate Committee on Private Equity. I recommended that short-term private equity investors lengthen their investment horizon to discourage flipping and create less uncertainty and reduce distress for residents; there be a reassessment of the structure of subsidies in the sector; and that there ought to be more monitoring in place on private equity activity in the sector. The aged care sector is not highly competitive. It is also not devoid of subsidies like private equity's success stories in the retail sector (e.g. Coles Myer and Pacific Brands). More importantly, the aged care sector deals with people at their sunset and most vulnerable stage of life.
Let light shine on private equity. Perhaps they can make a positive contribution to the welfare and wellbeing of older Australians as corporate social responsibility trumps short-term shareholder value maximisation.
The alternative scenario is simply unconscionable and morally irresponsible.
