Private equity and venture capital have carved a small but significant niche in the finances of Australia’s health care industry. How are these private funders influencing practice?
The Australian financial press is agog. Healthscope, Australia’s second largest private hospital operator, is being spruiked for a mid year sale or stock market listing by its co-owners, private equity investors The Carlyle Group and TPG Capital.1
The figures are immense. The 44-hospital, 650-bed operator, with a large property portfolio and medical and veterinary pathology services, is being valued at between $4 and $5 billion. Such a sale price would be a 50% to 80% increase over the purchase price paid by Carlyle and TPG, who purchased the group for $2.7 billion in 2010.
Under their private equity owners, Healthscope says it has managed to push for higher payments from the private health insurers, improve management, and establish ongoing beneficial agreements with suppliers and purchasers.
On the balance sheet, the most recent results show an interim net profit of $21 million for the 2013–14 financial year, up from a $109 million loss the previous year.
Healthscope is the most prominent private equity health care investment in Australia right now, but it is only one of many and the latest in a history of headline-grabbing deals. Last year, the $338.7 million initial public offering (IPO) of in-vitro fertilisation services provider Virtus Health by Quadrant Private Equity was the largest deal of its kind for 2013. The year before that, heads were turned by the acquisition of a controlling share of cancer, cardiology and sleep medicine services provider Genesis Care by large United States-based private equity group KKR.
Australia’s ageing population, the increasing amount of money spent on health and our proximity to Asia have made our health care industry an attractive target for local and international investors, private equity groups with deep pockets and the ability to identify and amend operational inefficiencies and pursue opportunities for expansion.
Typically, private equity investors try to improve management or improve the operation of the business, potentially providing additional capital if it is required for innovation or expansion.
Dr Mark Humphery-Jenner, senior lecturer in finance at the Australian School of Business at the University of New South Wales, says the relatively recent establishment of larger non-government operators in the Australian health care sector — many created by medicos — makes it an ideal time for private equity to be involved.
“Essentially there is an inbuilt increase in the clientele in that the population overall is ageing. So there is an increase in the amount of revenue you can extract because the market is going to increase.
“Also, it is essentially an inelastic good in that all people are going to need aged care when they get older. They don’t have much choice.”
“Thirdly, there is still scope to purchase an asset at a relatively low value, because it is poorly run, and then significantly improve it. The main reason for that is that in some countries such as Australia there has been a historic lack of business involvement in some of these sectors.”
However Dr Humphery-Jenner says that there is likely to always be a brake on investment due to the significant government intervention in the industry. The risk for investors remains that the fortunes of a company could be turned around overnight — Budget night in particular — by a shift in government policy and regulation.
Starch, discipline and results
American private equity giant KKR’s involvement has brought more resources and a little more “starch” to the operations of Genesis Care since the original 2012 investment, says the company’s medical director, cardiologist Dr Geoff Holt.
“KKR provide tremendous discipline to the way you do things and their processes cause you to question, ‘Is there a better way to do what I’ve always done?’.”
For example, KKR, which recently had as much as US$9 billion invested in the health care sector, required the company’s medical specialists to reconsider their approach to referrals.
“They looked at our referral management and asked why doctors referred to us, and what the turnover of those doctors was, what keeps them and what loses them”, Dr Holt said.
“Doctors think they intuitively have the answers, but we don’t really.”
It has meant changes that bring more discipline to how referrals are managed. And while the changes haven’t been easy for everybody — “being asked to contemplate change is a challenge” — Dr Holt says he appreciates the extra scrutiny.
“We now run a pretty sophisticated organisation where we track things, and we have a Sydney office that provides human resources and payroll and legal, while the local practices do the local management, the logistics of medicine.
“There’s more rigour about understanding the business, with an acknowledgement that happy doctors who are practising high-quality care are going to remain engaged.”
The recognition at Genesis of the link between happy doctors, good medicine and patient outcomes has seen clinical independence remain central to the group’s ethos throughout its expansion and it has been written into the company’s charter.
Nevertheless, Dr Holt is well aware that there is a lot of scepticism and suspicion regarding the mixing of medicine and profit. Competitive pressures have changed the medical landscape, he says, and looking ahead, those changes are going to continue putting pressure on small-scale private practice.
And against the background of the excitement surrounding the mooted Healthscope sale or IPO, Genesis is not ruling out having its own IPO sometime in the future.
“It would be an option we would look at,” says Dr Holt. “Would we go to market? I have no idea. Those things can actually just happen.”
1. Carter B. Lend Lease likely to play for Healthscope property portfolio. The Australian 2014; 20 Mar. http://www.theaustralian.com.au/business/latest/lend-lease-likely-to-play-for-healthscope-property-portfolio/story-e6frg90f-1226859690486 (accessed Mar 2014).
While they are often grouped together, private equity and venture capital operate at different ends of the business spectrum.
Private equity will take an established business and help to improve or restructure it in order to increase its value. Venture capital provides smaller investments for very early stage developments, start-ups and medical device or drug commercialisation.
Australia has long had a healthy medicine-oriented venture capital sector. It operates alongside government grants and on the fringes of university research groups, fostering innovation.
Some of Australia’s greatest recent health innovation success stories, such as Cochlear and ResMed, had their start in this way.
GBS Venture Partners is one of the country’s leading life sciences venture capital groups and last year two of the drugs it supported in development were among just 20 innovative products (not variations on already existing drugs) given the stamp of approval by the notoriously difficult United States Food and Drug Administration (FDA).
“We were really excited about getting two produced within one year”, says GBS Ventures managing director Brigitte Smith. The company’s two FDA successes were Peplin’s Picato for treating basal cell carcinoma and Chemgenex’s Omapro for chronic myeloid leukaemia.
Ms Smith says that, in many cases, venture capital is one of the key factors in getting Australian innovations commercialised and to the market in order to treat patients and to help clinicians do their jobs.
The importance of this funding source for innovation by drug and device creators was recognised in last year’s McKeon Review — the long-awaited strategic review of health and medical research.
The panel, which included one of Australia’s most celebrated private equity veterans, Bill Ferris AC, recommended the establishment of a $250 million fund comprising money from both government and corporate investors that could be used to support new health care products through their early stages of development.
In theory, the returns from the investments would ensure that the fund could keep supporting new drug and device development indefinitely.
Ms Smith hopes that this will occur and will be watching Budget night closely.
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