Investment and Finance in Aged Care – The Second Wave
Investing and Finance in Aged Care – The Second Wave
Introduction
This is an exciting time for an industry on the cusp of major change. As the Living Longer, Living Better reforms are being introduced later in the year, major transactions have surfaced, providing an insight into the expectations of investors for the future.
In an otherwise subdued investment market, the residential aged care sector has been stimulated through escalating demand and improving margins. The Government projects that a 40% increase in aged care homes will be required over the next ten years at a cost of around $25 billion.
Acquisitions, both large and small are on the increase and business values are rising. If the new Government gets an early handle on fixing the accommodation payment policy, this could be the beginning of the biggest period of aged care infrastructure investment in this country’s history.
In this paper, we present insights from those involved in the major residential aged care transactions – owners and investors, as well as drawing on our own experience in facilitating these transactions across Australia.
Industry Evolution
Government funding of aged care was only formally established in Australia in 1964. Subsidisation became necessary when the cost of providing aged care outgrew the Age Pension. The current system reflects the evolution of provider service models and the introduction of government reforms in the mid-1980’s and later through the Aged Care Act 1997. The aged care industry is now one of the fastest-growing industries in the country generating over $15 billion in revenues.
The ‘new world’ of aged care will likely see a greater prevalence of larger players, creating tangible, current opportunities for those contemplating sale.
Historically, the limited access to subsidies and heavy Government regulation had restricted new private sector investment in residential aged care. However, investment is becoming more attractive as consumers are required to contribute more toward the cost of services and subsidies have increased to meet higher levels of need.
The most notable change in investment appetite took place in the 2000’s as groups such as Macquarie Bank, AMP Capital, Japara and BUPA started to secure market share by acquiring thousands of beds across Australia. The first wave was driven by sound demographic fundamentals and these groups saw opportunities to consolidate an industry with a high level of revenue certainty.
As the consolidator momentum appeared to be gaining steam, the Global Financial Crisis (GFC) hit and activity quickly dwindled.
In recent years, these same characteristics have brought renewed interest into the market. Industry activity is now increasing faster than the pre-GFC period, characterised by the re-entry of Private Equity firms, new foreign investors, and the continued expansion of incumbent portfolio operators. Further, non-traditional players in aged care are showing considerable interest in the sector, waiting for the right opportunity to invest, including superannuation funds and property Real Estate Investment Trusts (REIT’s).
These large investors have substantial amounts of capital and have been attracted to the aged care sector, in part, by its cottage nature and the potential to introduce scale efficiencies. Further government reforms scheduled for July 2014, and confidence in the new Government, is also fuelling their appetite for the sector.
What’s Changing?
A review of aged care facility ownership shows that around 17,000 beds have either changed hands or are currently changing hands since 2010, representing almost 10% of a very thinly spread sector.
In the current financial year alone, Ansell Strategic has facilitated over $450 million in new transactions. While individual buyer priorities vary, the following characteristics reflect the most common buyer specifications in these acquisitions:
- Reasonably modern stock in metropolitan regions
- A high proportion of single bedrooms
- Good facility scale and/or development potential
- Portfolios with strong bond uplift potential
- Solid financial performance with potential for subsidy improvement and greater roster efficiency
- Stable workforce and manageable Enterprise Bargaining Agreements
- Sound care standards and accreditation standings
Larger portfolio’s buyers also place a high value on the experience and expertise of the management team and their desire to continue in their roles post-acquisition.
The departure of smaller providers is most notable over recent years. Around 30 single home or small portfolio, operators have been assumed by the remaining private for-profit operators.
While longer term forecasts of reduced regulation on service price and supply are seen as positive, the level and cost of regulatory compliance in aged care remain very high. Many departing family- owned enterprises have had substantial wealth locked away in capital intensive aged care assets; many were unable to keep up with regulatory demands and generate returns sufficient to offset the risks and chose to realise the asset value rather than dealing with further regulatory demands.
Changes in the charitable space have also been gaining momentum, although the motivations for departures are often more complicated.
ECH Inc has been a successful and highly respected residential aged care operator for almost 50 years. However, the group made a strategic decision to focus on their retirement living and community care business.
Late in 2013, ECH Inc approached Ansell Strategic to identify buyers for their aged care business comprising 11 homes across South Australia comprising around 1,200 beds.
ECH’s homes were acquired in March 2014 by Allity, one of Australia’s fastest growing operators owned by Archer Capital.
ECH is an organisation that was established to care for the most disadvantages people in society. Through the realisation of our residential aged care assets, we saw the opportunity to provide a greater benefit to more older people wishing to age in their own home.
While the private sector has been growing, government-run operators are busy implementing their exit strategies.
For Government operators, the decision to exit is often financially driven – the vast majority operate at significant operating losses – outweighing what has been very strong community backlash to home closures. Both the NSW and Queensland state governments have run sale processes, with only marginal success. The Victorian state government has tendered for advice on the sale of a portion of its 5,000-bed portfolio.
Several local councils have successfully sold their aged care assets to the private sector, including Whitehorse and Knox councils in Victoria (and Monash council is currently in the final stages of transfer to Royal Freemasons Vic), Broken Hill and Greater Hume in NSW, and Kwinana in Western Australia.
The classes of investors being actively observed include Private Equity, foreign investors (private organisations and sovereign wealth funds), and institutional investors (property REIT’s and superannuation funds).
Each investor class has a distinct risk appetite, return expectations, and investment approach.
Investment Strategies
Private Equity
2013 saw the arrival of two new Private Equity investors in aged care
– Archer Capital and Quadrant. These are not the first Private Equity investors in aged care in Australia. In the 2000’s, CVC Asia Pacific owned DCA (since sold to BUPA) and Macquarie Capital acquired the aged care assets of the Salvation Army and Moran group. Other local and foreign firms including KKR, Blackstone are also known to have shown strong interest, albeit without success to date.
Typically, Private Equity organisations invest where they identify quick wins – either in improved asset values or margins. In aged care, this can be seen through rapid expansion via acquisition, producing scale benefits and resulting margin improvements.
“After the purchase of LendLease Primelife’s 30 homes, Archer Capital and Allity have progressed strongly with our growth program. The acquisition of ECh’s high quality aged care homes reflects our ambition to deliver the best servides we possibly can.”
David Armstrong, CEO, Allity
It can be further implied by the pre-reform rush of Private Equity activity that they are seeing the potential for windfall gains. This demonstrates a somewhat contrarian view to some industry incumbents; that is, Private Equity investors believe that the Living Longer, Living Better Legislation represents substantial opportunity rather than the negative views commonly expressed by some in the industry.
“Following our experience wih Summerset NZ, Quadrant sees good potential in aged care investment in Estia Health. With an improved regulatory environment under LLLB and the predictability of cash flows in the sector, operators who focus on clinical outcomes are well positioned to provide services to the increasing care demand”
Marcus Darville, Director, Quadrant Private Equity
The key to realising this future potential may depend on how the new Government will implement the Living Longer, Living Better legislation. While market activity for the established homes is on the increase, investment in new infrastructure will remain stagnant unless anomalies in accommodation payment options are addressed. We consider this further below.
Existing Operators
Although stalled by the GFC, the consolidation strategies employed by Australian providers has generally proven to have been a winning formula. Buoyed by higher subsidy levels and better access to resident capital contributions (accommodation bonds), large Australian operators have leveraged their scale to improve efficiencies, purchasing power and shared resources across multiple homes.
Major groups like Regis, Sapphire, Blue Cross and McKenzie Aged Care have been actively acquiring new facilities while continuing to expand organically through green and brownfield projects. Private sector operators have dominated acquisitions over the past two years despite the not-for-profit sector representing over 60% ownership of residential aged care facilities.
During 2013, the founding Regis shareholders bought back Macquarie Bank’s 44% interest in the national aged care provider in a deal thought to be worth over $150 million.
“Our decision to buy out Macquarie demonstrates our confidence in the increasing demand for the Australian aged care industry. However meeting this demand is dependent on Government policy promoting continued access to the necessary capital. If this occurs our growth targets will be achieved through a balanced mix of acquisitions and new developments.”
Bryan Dorman, Chairman, Regis
Expect further growth from Australian providers as they compete for market share in an increasingly competitive environment.
Foreign Investors
Large sovereign wealth and international superannuation funds who have actively invested in Australian assets are yet to appear in aged care. This is likely due to the shortage of sufficiently large investment opportunities, typically having a minimum $250 million investment target. Less than ten private operators would meet this investment target, few of which are known to be available.
As industry consolidation in aged care further evolves, and more opportunities arise, it could be expected to see the emergence of large foreign super funds as investors in aged care.
In the meantime, foreign Private Equity investment activity is emerging. Last year, major Singapore investment house GK Goh acquired 48% of AMP Capital’s Domain Principal for around $138 million. The investment will allow the group to redevelop and expand one of the largest aged care portfolios in Australia.
For us, the business fundamentals around Australian aged care are sound. We see the potential fo rachieving scale through consolidation as a significant upside and our corporate structrue allows us to take a long term views as the industry matures”
Thomas Teo, CFO, GK Goh & Director Domain Principal
Asian investors are also looking for opportunities to learn from Australia’s very high quality aged care service offering. The recent partnership, involving Melbourne based Royal District Nursing Service (RDNS), to develop and operate over 1,500 aged care beds in China could be seen as a sign of things to come.
“RDNS saw China as a logical opportunity to leverage our experts and extend our mission inot an area of great need. The exportation of our development, operational and training skills into Asia is fundamental to our future growth strategy”
Stephen Muggleton, CEO, RDNS
Institutional Investors – Property REIT’s
Domain Principal started its life as a pure-play property investor in aged care. Similar to a traditional property REIT, the initial AMP Capital investment owned the physical property and simply collected rent. This has since evolved to a more traditional owner- operator of aged care, however, the REIT-style investors are re- emerging.
An extension of the REIT model can be observed in Japara Holdings, which has currently split ownership of the majority of physical assets from the operating business. Third party investors own the Property Trust (or REIT) which receives rent for the provision of the special purpose aged care property. This allowed Japara to quickly grow, as the majority of capital investment to acquire aged care facilities was provided by the investors in the Property Trust, leaving the operating business to focus on generating returns from the provision of care.
Not without its complexities, the REIT model has potential to become more prevalent as aged care operators seek new sources of capital, and investors seek new asset classes to generate returns.
This is all magnifed by the fact that superannuation fund investors – the members – are the same people who will be demanding more aged care beds, as the effects of ageing population increase stress on a sector already nearing capacity.
Institutional Investors – Superannuation Funds
Investment from domestic superannuation funds in aged care has been negligible to date. Some indirect investments have occurred as well as secondary investments via interests in Private Equity.
Like large foreign investors, domestic superannuation funds are unlikely to have yet identified any sizeable or sufficiently sophisticated investment targets in aged care. They are also likely to have been deferred by poor experiences with retirement living investments and have typically avoided more complex operating businesses such as aged care.
However, superannuation funds are starting to widen their investment horizons away from more traditional sectors (property, infrastructure) in search of greater value in non-traditional sectors. Late in 2013 the $5 billion Catholic Superannuation Fund announced its planned investment in up to $40 million in the Japara Property Trust, further demonstrating the likely investment activity to arise from institutional investors.
Aged care is likely to become an increasingly attractive investment target for superannuation funds. Perceptions of low sophistication – typified by the “cottage industry” label – are being eroded by consolidation and emergence of corporatised operations. Observations of financial stability – enhanced by the sectors’ overall solid performance throughout the GFC – will align with their risk appetite and desire for certainty.
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