Private equity in the care sector is thriving on growing demand and dwindling state provision. Vivek Kotecha asks whether its sweet tooth for debt might not bode well for its future health.

The UK’s care sector has been under a lot of media scrutiny this year following the government’s proposals to implement a cap on fees, the ongoing impact of the pandemic, and recent coverage of opportunistic profiteering by investors in the industry’s largest companies. How care-crisis homes made Saudis millions; Families forced to sell homes; The unacceptable face of capitalism; and so on – the headlines yelled.

Yet for decades now, the state has retreated from funding for adults and from providing care for both adults and children. From 2011 to 2019 the total government spend on adult social care was less, in real terms,  than its expenditure in 2010, despite a rise in the number of people needing care. Now only 43% of requests for support are approved by local authorities. By 2018 the number of state-owned adult care beds had dwindled to 17,000, a fall of 88% since 1980.

Children’s social care is still fully funded by local government, but the number of local authority-owned homes is falling and is greatly outnumbered by privately-owned homes.

In its place a variety of for-profit and not-for-profit organisations have stepped in to provide care. There is a wide diversity in size: 80% of adult care home providers operate just one care home, while the top ten children’s home providers amount to only 19% of the total market.

And a recent and growing wave of Private Equity (PE) investors is attracting a lot of attention and controversy. PE ownership is already dominant across the largest adult care groups, with some accused of profiting from a failing system at the expense of those in their care. Their ownership is implicated in the collapse of the Southern Cross care group and the ongoing financial difficulties at Four Seasons.

PE investors are now increasing their presence in the children’s care sector and are, to their supporters, bringing in investment and harnessing economies of scale. So should we be concerned about this new wave of owners?

The PE industry emerged in the 1980s, and is infamous for administering “shock therapy” to its earliest acquisitions.

PE funds invest in a range of private companies with the aim of selling them later for a profit. The funds raise money from investors – usually pension funds, insurance companies, and foundations – which is then returned after about ten years. The funds buy businesses using investors’ money and loans, and aim to own them for four to six years. The main profit comes when the company is sold or listed as a public company, although some funds also focus on income and dividends.

The PE industry emerged in the 1980s, and is infamous for administering “shock therapy” to its earliest acquisitions. This involves asset sales, outsourcing, cost reductions, and reorganisations to achieve rapid improvements in efficiency. Many of PE’s earliest investments were financially very successful and attracted more investors.

However, PE funds also use other short- and long-term strategies to increase the value of their businesses. This can include a longer-term form of shock therapy where a business cuts back and invests in products that offer the most promising profits. There are also growth strategies such as:

  • catch-up investment when the business hasn’t had enough funding to do so in the past; acquisitions of competitors or complementary businesses; and
  • new products, customers, or channels.

These strategies are not unusual, but PE investors are different from others in that they are willing to borrow a lot more money when buying companies. And PE funds use high-powered incentives to ensure that the business’ management meets ambitious financial and operational targets. Some have described the PE approach as “capitalism on steroids”.

So what attracts PE to the labour-intensive and intrinsically low-innovation care sector? The adult care home sector, which PE entered in the late 1990s, and, more recently, the children’s home sector, both offer opportunities for high returns from growth strategies. Those opportunities are being fuelled by several developments:

  • the sectors are mostly made up of small businesses so there are economies of scale to be had from merging;
  • the ageing population is growing the number of customers, and more children are being placed in care each year;
  • fees for children are state-backed which curbs the risk of non-payment;
  • the sectors’ large property portfolios can be split for increased returns; and
  • the growing need for additional services such as dementia care and fostering.

Early investors have done very well. Allianz Capital Partners sold its stake in the Four Seasons care home group for almost double what they paid for it after only two years. Bestport Private Equity reportedly generated a 330% return on their sale of a children’s care business last year.

PE ownership of care businesses does bring benefits. PE-owned operations are investing in new capacity, and acting as a counterweight to the loss of homes as family-run businesses close upon retirement. Their focus on profit from growth means that they can afford to make critical changes and focus on investment, instead of yearly profits. Their increased standardisation of processes, administration, recruitment, and training and size makes them easier for commissioners to do business with.

Ambitious management targets focus on what is quantifiable but good quality care is hard to measure.

Their strong focus on financial management offers the possibility of better value for money for state payers. Interim findings from the Competition and Markets Authority stated that the largest private children’s care home providers have operating costs that are on average 26% lower than the equivalent local authority homes.

There are concerns with PE-owned firms becoming a bigger part of the care sector. A chief cause for concern is that ambitious management targets focus on what is quantifiable but good quality care is hard to measure and so may decline. International studies have found a link between for-profit ownership, including PE, and indicators of a poor quality of care and deteriorating working conditions. The focus on achieving a high financial return at the expense of residents’ care was covered in a recent BBC Panorama programme.

Another major concern is over the amount of debt that PE funds take on to buy businesses. PE funds expect more from their businesses and so are happy to borrow more, allowing them to out-bid rivals. A number of care businesses have a history of multiple sales between different PE owners. Each sale adds more debt to the business and an expectation of higher growth to pay off that debt. In this way, over time a business can become over-exposed to the risk its debts will become unaffordable, particularly if there is a sustained period of little to no growth in fees as has happened to state fees for adult social care. Indeed business failure and collapse in the care sector is often due unaffordable debts. In many cases the underlying business is profitable enough, but unable to bear the debt burden and growth expectations placed upon it.

One PE chief likened the industry’s use of debt to how a child would approach a box of chocolates: “It’s tempting to eat them all at once . . . but it wouldn’t be the right thing to do”. A review of the largest companies in the children’s care industry found PE-owned companies would take an average of 11 years to pay down their external debts, versus under two years for non-PE owned firms.

The wave of PE funds entering the care sector brings the promise of much-needed investment, cost control, and standardisation of services. However, the high debt levels leave a large part of an essential sector vulnerable to severe disruption if the economic tide pulls out.

Vivek Kotecha

Vivek is an accountant and public policy consultant with a background in health policy and tax management consulting. He trained as a chartered accountant at Deloitte before moving into health …

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