Southern Cross Healthcare plc’s recent £96.5 million acquisition of rival Avery cemented its place as the UK’s largest care homes operator and gave yet another fillip to its share price.
The Darlington-based company, which provides care for the elderly, now operates 667 homes and has some 33,800 beds across the UK. Since announcing the acquisition on June 7, its share price has climbed to 582p at the time of writing from 539p. It is now a FTSE 250-listed company with a market cap in excess of £1 billion.
Southern Cross is one of the more successful examples of how the industry has developed during the past 15 years following the decision by the NHS started to outsource its health and domiciliary care services.
Since 1997, the company has grown rapidly through acquisitions, especially after being acquired by US private equity firm Blackstone in 2003. When Southern Cross was floated in June last year, investors flocked to the company and its share price has more than doubled since. It has also posted healthy results; in its interims for the six months to April 1, 2007, its ebitda rose by 42% to £21.8 million.
“[Healthcare is] more of a mature industry now; Blackstone came in and developed Southern Cross into the largest operator by far and floated the company,” said Richard Lunn from corporate adviser Christie + Co. “That was an important milestone in [the healthcare] industry because that was the eventual exit for the private equity player at a high level.”
With high-profile successes such as that, it is unsurprising that investors, private equity firms and ambitious businesses are attracted to the sector.
“The whole gamut of care is seen as an opportunity,” Lunn said. “There is a massive diversification of care. There is obviously the elderly market, but then you have people under pensionable age with mental health or learning disabilities, eating disorders, physical disability, drugs and alcohol rehabilitation, psychiatric rehabilitation. There is also a whole gamut of children’s services; children’s homes, educational services, it is a massive field.”
Indeed, there is now “huge interest” in the sector from private equity, according to Mark Hales, chief executive of Claimar Care, an AIM-listed domiciliary care services provider.
But despite this, many private equity firms are frustrated by the way the sector is fragmented – according to Hales, 3,500 care operators exist in the UK. “The issue the private equity market has is finding a large enough platform that has the management team in place,” he said. “That’s where they’ve been struggling; those providers aren’t out there generally – there are probably only 20 companies in the UK that aren’t quoted which operate more than 10 branches.”
“The challenge for the private equity boys is to find sufficient mass in one go that they can use as a platform to build. Certainly the feedback I get is that they’re seriously struggling to do that.”
While private equity firms may be struggling to find businesses of a sufficient scale to invest in, trade buyers and buy-out teams have had no such problems and continue to be active consolidators in the sector.
In April, for example, health and social care provider Care UK plc acquired Mercury Health Holdings from Tribal Group plc for £31.5 million in a cash and shares deal. The deal is expected to be earnings enhancing within the next year.
Another significant deal was the £175 million management buy-out of elderly care services provider Orchard Care Homes in June.
The deal, which saw Paul Mancey take control of the business from founder Lawrence Tomlinson, was funded with debt by Royal Bank of Scotland. The company has plans to grow from its current 26 homes to 56 through an ongoing expansion plan.
But these deals are in the minority. Most in the sector are very small, reflecting how the majority of businesses operate from single branches.
Nevertheless, Hales believes these businesses are steadily consolidating, although the competition to acquire these businesses is minimal – due to the sheer numbers – which ensures considerations are not spiralling and such businesses can be bought for about four to six times earnings. “There are probably only five or six serious consolidators in the market, so there is enough for us all to be going at without having to pay premiums for those smaller providers,” Hales added.
But for larger deals, such as Claimar’s recent acquisition of Acorn Care Homes for £8 million, competition increases. “Where you’ve got a provider like Acorn, the multiples do go up because obviously you’re buying a different proposition, you’ve got infrastructure savings and economies of scale,” Hales said. “Those are fiercely fought over and very attractive for all the right reasons.”
Acquisitions are also attractive because they come with a degree of security and are often immediately earnings enhancing. “We’re buying businesses with contracts with local authorities that typically are three to five years in length, so we can say with a fair degree of certainty what our revenues will be for quite some time,” Hales added.
Moreover, consolidation is set to rise, with increasing regulation and a shift in policy by local authorities influencing the market. Local authorities, which have traditionally outsourced services to up to 30-40 providers, have in the past 18 months sought to rationalise that numbers and are increasingly offering contracts to larger players that can meet their needs. Also, increasing regulation is affecting smaller operations’ margins, forcing some to sell out.
“It’s a very infantile market – there wasn’t a market until the late ‘90s in any real shape or form,” Hales continued. “There’ll still continue to be consolidation over the next five or so years and in 10 years there will perhaps be 10 providers across the UK, but there is a long way to go before we get there.”
Hales added that Claimar is about the fifth largest provider in the UK, yet only has roughly a 1% share of the market. “We’ve still got masses to go at,” he said.
Meanwhile, healthcare related properties, such as GP surgeries, have become an investor class of their own. While historically investors shied away from healthcare properties, they are now capitalising on the value in them.
In recent years, investment firms created to invest in primary health property have emerged, such as MedicX Fund, Primary Health Properties and Assura Group.
Keith Maddin, chairman of MedicX Fund, said investors are drawn to the primary health property sector for several reasons, including yields of around 5.25.
The stable income stream – occupants of primary health properties are often subsidised by the government – also brings investors to the sector. “You’ve got three-yearly rent reviews [whereas] general commercial property tends to be five years and the current market experience is those rent reviews are going up, at least if not better than RPI [which] the increase in land price and build cost is driving,” Maddin said.
“[Also] you tend to invest in properties that are fully let, they tend to be 20-25 year leases with no breaks. So you’ve got a very secure income stream, but you’ve got some quite attractive growth to that income stream.”
Inevitably, this ensures the market is highly competitive, with more funds seeking to move into the sector. “There is lots of market talk that pure property investors, that are not what I’d call sector specialists, showing interest in buying into the asset class,” Maddin said.
There is also a flow of new properties coming onto the market, with many existing properties deemed not fit for purpose and being replaced by purpose-built facilities.