Beyond the horizon
The healthcare investment market is arguably at its busiest in a decade. Not since the financial crash have so many of the major assets in the sector been involved in active sales processes – but is this a sign of over-heating, or merely a reflection of the enduring popularity of healthcare as an investment opportunity?
One major factor to consider is the increasing influence of institutional money, REITs and other forms of ‘long-hold’ investors. Attracted to healthcare for its characteristic ‘defensive’ qualities, long-term investors are often able to pay higher multiples for assets on day one due to lower cost of capital and longer investment horizons. However, long-term capital often takes a different approach to both trade and private equity – and this has consequences for how owners approach management teams, capital expenditure and market consolidation.
To explore these issues and further consider the impact of long-term investors on the market, HealthInvestor UK magazine and sector specialist law firm Druces held a round table discussion on 31 January in central London involving leading investors, operators and advisers to the sector. The following is an abridged version of that conversation.
Vernon Baxter: Andrew, how has the profile of investors changed in recent years? Who are you seeing around the table?
Andrew Surgenor: There has been a lot of change in terms of what the capital is, where it comes from and what it’s looking to invest into. There are investors that just want long-term secure income, then others that are prepared to take a bit more of an opportunistic approach. We’re seeing capital from all around the world looking at the market – UK pension funds are very active in the sector, and we’re seeing the infrastructure funds coming in. We’re also now seeing money looking at the middle part of the market, where there is value to be added by improving assets. It’s a very encouraging time.
Vernon Baxter: Ben – Octopus is one of the most established names in the market, but is the sector getting tougher to compete in?
Ben Penaliggon: When we launched Octopus Healthcare Fund as an open-ended fund back in August 2017, one of the biggest questions we got from investors, was, ‘Can you actually deploy the capital?’ Since then we’ve raised over £300 million and we have managed to deploy it. It can be done – clearly how we do it is crucial. The vast majority of our transactions have been off market and directly with developers and operators – that is very important, being able to access the market. It will be an ongoing thing but, I think we all know around the table, there is a structural under supply of quality product. There is going to be a need, on an ongoing basis, to raise capital to meet that need.
Vernon Baxter: Clare, we’ve known about the supply and demand issues for some time – why is there still such an imbalance?
Clare Connell: One of the issues with meeting the demand is you’re competing against residential developers and they can afford to spend more on land acquisition. I also think it would be great for the sector if there were an example of an older people’s care group that would sell without owning properties – because we haven’t had that, despite numerous unsuccessful processes. It’s holding back the sector and to see the first of these deals would be quite transformational in the sector.
Vernon Baxter: As a relatively new entrant to the market, Paul, what are your initial impressions of the social care space? Paul Bridge: Well, my background is social housing, where there’s been massive under supply but also concerns about private capital’s involvement in that market. So, one of the aims of Civitas was to make investing in equity acceptable within the social housing sector. When we looked at care, it was clear there are a number of people investing in it – but we wanted to bring an institutional feel to it, we wanted to make it better. There is clearly an enormous need for responsible capital… [but] I don’t think people realise how many interesting entrepreneurial companies there are in this space, and we just want to be a longer-term partner for them. Tom Smith: I totally agree with Paul – there is little awareness generally about how social care works as a market and the role of private capital. When you look back at the 2017 election, the Tories tripped up by trying to put forward a social care policy – by trying to solve a problem that didn’t exist in the public view. That is what the government’s grappling with and why the Green Paper is so delayed. They’re very uneasy with the politics of private capital being involved, but it’s going to be up to industry and financial institutions to come forward with new products.
Vernon Baxter: David, as the operator around the table, what impact does different types of capital have on an organisation on a day to day basis?
David Petrie: Fundamentally, where we differ from any other sector is it’s all about caring and all about looking after people. We are backed by a company called Montreux, who sold Regard Group recently. They believe that by investing in care, they can help it become better. What it means from my point of view is when I’m sitting in a board meeting, we talk about quality first and foremost. The belief is always if you get the quality right and you get the care right, the profits will follow onwards. If you’re investing in the sector, you need people on the ground who think like that. You can’t walk in and start telling people who are, let’s face it, not on a massive amount of money, ‘Work harder’. You’re not going to be able to offer six-figure bonuses to people, so you’ve really got to focus on quality if you want that asset to grow.
Vernon Baxter: Iain, as a representative of some of the ‘long-term capital’ that has entered the market – to what extent does health and social care fit your investment criteria?
Iain MacLeod: The reality is that there are only small sub-segments of the market that can fit in an infrastructure portfolio. When one looks at the specialist care, learning disabilities and mental health markets here in the UK, for the right assets I think it does fit in with the portfolio. It’s not straight down the middle of infrastructure, but it is within our mandate. The focus on quality of care is absolutely essential but I do think that the introduction of long-term capital into the market is a good thing. At Choice, the average length of stay of our residential learning disability service users is nine years. Now, when you’re in the business of caring for vulnerable people, who are there in your care for a long period of time, you need to be thinking long-term about their health. The market has historically been funded by private equity. We’ve had lots of success cases of that, but some less successful cases. I entirely echo David’s thoughts – quality of care is where it all starts. For us, when we were evaluating opportunities, that’s the first question to ask. These are businesses that are for profit, but there is also a social responsibility in terms of caring for vulnerable people.
Mark Gross: Even within long-term capital, it’s important to understand not all investors are the same. Actually, I’d argue no investor is the same. It all depends on the make-up of the team, the strategy of the fund, people’s approach and their experience. Our view as a growth and development investor is to think about long-term investing – because, ultimately, where Downing’s model has worked well is when it works as an aggregator of smaller businesses into something that becomes more meaningful. It’s about understanding the management team, what their business plan is, what their goal is, where they want to get to. It is then about, well, what’s the right capital structure to put in place? Can we get an appropriate risk and return for our investors? Quite often when you’re dealing with the more entrepreneurial teams, they’re typically more focused on cost but actually that could undermine value in the long-term. Part of what we do is actually help them think longer-term. It may cost us a bit more, it may take a bit more time… but our approach isn’t to think about short-term. We’re not trying to cut costs to boost EBITDA immediately before a sale; people see through that and it’s not right.
Ben Penaliggon: We like to stylise ourselves as a very engaged landlord. We’re very conscious we’re not the operator, we’re the investor – but we do see ourselves as completely aligned with the operator. First of all we take a real interest in the physical wellbeing of the building – we all know what a brand-new building looks like and we all know what the building looks like five years later if it hasn’t been invested in. On the governance side, we’ve built a clinical team up in-house and it’s their job to liaise with our operators to make sure that we know what’s going on to the best of our ability – but, most importantly, we’re helping everybody navigate what’s become an increasingly challenging regulatory environment and helping them get the best operational outcomes for the business in that regard.
Vernon Baxter: Chris, how does the presence of longer-term capital materially impact the clients you advise? Are operators changing their behaviours?
Chris Axford: I’ve been doing this for 19 years and I have to say the longer-term funds coming in over the last few years has been really positive. When I first started, everyone was talking about three-to-five-year horizons. They never thought longer-term about what they were doing with the real estate, training the team, etc. Many investors and operators are still focused on exit and how they’re going to do that in the longer-term, but this type of capital coming into the market has changed strategies and people are more attuned to what they need to deliver in order to be able to manage an exit. There has been more of a focus on the underlying business. It’s changed the way they deliver things and that’s a real positive.
Vernon Baxter: Andrew, many of the deals involving long-term capital have involved punchy multiples. Is this pushing up vendor expectations?
Andrew Surgenor: It’s actually creating something of a two-tier system because there are some portfolios that have the quality infrastructure funds and the long-term investors are interested in, and they’re going for premium prices. But equally any advisor will tell you that some portfolios have really struggled to sell. That’s because they perhaps had made acquisitions very quickly, without integrating them – and in that situation you’re looking at a very different buyer; it has to be much more experienced turnaround purchaser and those assets are going for much more reasonable prices.
Iain Macleod: If you look at the specialist care market the investments made by infrastructure funds have all been for businesses that sit at the very top of the rankings when it comes to quality. For us, we don’t try and invest in a business and turn it round. That’s not the business that we’re in; we’re into investing in businesses of quality, with management teams for whom quality is the number one focus, and then helping them grow the business and develop their business. We’re not interested and do not have the capability to do a turnaround of a business where half of its homes are going to require some improvement.
Vernon Baxter: We’ve been discussing long-term capital so, I want to finish by asking the table for their own long-term view of the market. If you each look ahead a decade, how do you see the sector evolving?
David Petrie: There’s a huge opportunity in this sector because, quite simply, if we can put more investment in bigger companies, with more attention to the governance, we’re going to get better care. But I also hope the world changes. I think we do need to bring in people with an outside perspective. I do not believe that the way the funding gets through to the sector is going to be the same. I think we’re going to see disruptors in the market but mainly I hope in 10 years’ time we’re doing things better and it leads to better quality for everyone we look after.
Jeremy Huband: One of the most interesting things will be the role of overseas investors. Those guys have seen an opportunity in the UK market and they’re here to stay – and I think we’ll see investors who are very interested in the dynamics of the UK market and who will seek to export specialist management out from the UK into the global market. I also believe technology will be a huge driver of change. Technology gives us huge potential to remotely monitor people and carers and this – done correctly – could lead to huge improvements in care and how it is delivered.
Tom Smith: I’m slightly less optimistic on the tech side – there’s plenty going on in primary care, but when it comes to social care and specialist care, we are met with a bit of a cultural barrier from both commissioners and users.
Claire Rigby: I’d like to see tech a bit more at the forefront – we have to move forward with the times. But more generally there’s going to be a lot more investment opportunity coming into the market – especially from overseas – and it will be an interesting time for the sector. I believe it will also come to the fore politically and socially, and I don’t think the government has really recognised that yet.
Andrew Surgenor: I think we’ll see consolidation but not consolidated. There’ll be an increase in quality both in terms of physical environment and quality of care – but my big hope for the sector is that it stops being a slightly embarrassing building on the edge of town and becomes upfront and in your face with integrated care facility in town. The current elderly coming through aren’t going to get old quietly and they’re going to want to be in town centre environments, getting their care and still living life.
Iain Macleod: There will be more consolidation but, personally, I don’t believe in consolidation just for scale’s sake. I don’t think bigger in this industry means better. You can get to a size where the board room lose touch with what’s going on in the care home. Then that can lead to quality issues so there’s a balance to be struck. I think there is a role for all types of funding providers going forward and I hope that will drive more entrants of long-term capital.
Chris Axford: I was asked something very similar about ten years ago at one of these events and at the time people said that the major changes would be care homes were going to be dying out because everyone was going to be kept at home. That was because there were huge advances in technology which could keep people at home and monitor what they were doing and the way the care was delivered. Retirement villages were going to be the new thing. We’re in a very similar situation today, which is that people think things are going to change dramatically but I’m not sure the sector is as dramatic as that. That said, I do think that consolidation will carry on. It’s been carrying on for years and years and there’s still a huge amount to be consolidated.
Paul Bridge: Care companies will continue to grow because the demand is there at all stages – from elderly to people at the start of their lives. The estimated growth in young people with disabilities that require care that is well beyond just part-time is 5-10% a year currently. So more and more people will require others to care for them, and that can’t be done within the home, within their family. We will have to manage our real estate really carefully and respond quickly to care needs.
Ben Penaliggon: I’d like to see capital do more than simply invest in the sector but very much to be part of the narrative around its evolution – by being a reliable source of repeat capital to support operators, but also to engage and actually support the businesses and support with innovation.
Clare Connell: I think we’ll continue to see infrastructure funds being interested in healthcare for some time – there is a lot of fear of a potential Labour government and this actually means infrastructure funds are afraid of the nationalisation of airports, rail, etc. They’re actually allocating more funds towards health and social care as the cost of taking that back in-house is just too prohibitive for government.
Mark Gross: What I do think is that there has been a structural change in the market – long-term capital is here and it will increase over the next decade. We want to try and create as much alignment as possible and allow people to aggregate in a way where we can all help each other.
The above is an edited transcript and is not reported verbatim. The panel met in central London on 31 January 2019.
There is no doubt that the healthcare investment market continues to grow and evolve, and this has increased investment appetite. Longer term capital investment in the sector, aligned with sound management and strategic advice presents real investment opportunities.
The last 20 years have seen increased consolidation in the sector and rising competition for the best quality of care provision. This change started with a focus on the underlying fabric of buildings and ‘future proofing’ but what has been encouraging, with the relatively recent change of investor profile, is the increased focus across the board on the quality of care being delivered.
Innovation in technology and management systems has become a key factor in gaining advantages in the sector and the focus by investors in care quality bodes well for the underlying service users.
Producing the best returns available is an inevitable and positive by-product of the increased focus on quality of care. Our view is that this strategic approach continues to be sustainable and is encouraging for ongoing healthcare investment.
The uncertainty of the current political climate has caused other asset classes to suffer, comparative to the health and social care sector, but the underlying metrics for healthcare investment remain solid and should continue to do so over the next two decades.
There will be challenges arising from those political and economic issues, but the better prepared organisations and investors will find that there are great opportunities as a result.
Partner | Corporate department
For and on behalf of Druces LLP
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Managing director, Investor Publishing
Chief executive, Civitas Housing Advisers
Managing director, Connell Consulting
Partner, Downing Capital
Head of healthcare, HSBC
Managing partner, iCON Infrastructure Fund
Director, Octopus Healthcare
Chief executive, Active Assistance
Practice lead, public services, Global Counsel
Senior director, healthcare valuation, CBRE
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