India hospitals: Capital cure

Advent International has been investing in India for 12 years, the last three of which have been spent looking for a way into the hospital sector. Country Director Avnish Mehra and his team began by mapping out the key hospital chains that had achieved critical mass, reducing the target list from dozens of brands to just eight. This was followed by a systematic cold-calling process, reaching out to each of the companies' management and operating partners, and exhaustive due diligence.

In April, Advent finally committed $105 million to CARE Hospital, which Mehra considers an attractive combination of reasonable scale, strong market position, experienced management and a need for capital. As the protracted search suggests, few other assets in India's hospital market fit the bill.

"There are now 1 million beds available in the India market - only half are private beds and, of those, just 50,000 are run by corporate chains that we can actually target," Mehra tells AVCJ. "When you look into large hospital chains run by good institutions with quality healthcare services, the number of opportunities shrinks quickly."

Massive market

India's healthcare sector as a whole is worth $40 billion and seeing compound annual growth of 15%. It is expected to reach about $120 billion by 2015 and continue to double twice in the coming 10 years. Rising incomes are a key factor. The number of households earning more than INR200,000 ($3,765) grew 14% year-on-year in 2009-2010 and expansion is on course to accelerate to 26% by 2014-2015. According to KPMG, health insurance penetration is also rising at a double-digit rate, with less than 15% of India's 1.2 billion population currently covered.

"Rising disposable incomes are drawing attention to the private healthcare sector because many of the so-called ‘rich-man diseases' such as cancer and diabetes are emerging and these patients want the best healthcare services." says Sanjay Kumar Sehgal, managing partner and CEO at East West Capital Partners. "I don't see why making 3x your money or a 25% IRR isn't possible for an Indian healthcare investment."

According to AVCJ Research, private equity firms have committed $448 million to Indian healthcare companies across 12 deals so far in 2012, surpassing last year's total of $333 million. Hospitals and healthcare centers have accounted for five transactions, but more than 80% of capital deployed.

Apart from Advent's deal, Government of Singapore Investment Corp (GIC) paid $100 million for a minority stake in Vasan Healthcare, which runs eye-care hospitals nationwide. The company was already a favorite of private equity, having received $40 million from Sequoia Capital and Westbridge Capital in 2008. GIC's investment came barely two months after Olympus Capital Asia committed a similar amount to DM Healthcare, a chain of hospitals, medical centers and pharmacies in India and the Middle East. It was Olympus' first foray in the Indian healthcare sector after 10 years in the country.

"The India hospital market is just starting to happen, there opportunities are huge," says Vishal Vasishth, former managing director of Song Investment Advisors India "It is still in a very early phrase of growth and we expect a lot to happen in the near future."

This nascent stage of development contrasts favorably with the relative maturity of two other healthcare segments, pharmaceuticals and medical devices, both of which are growing rapidly and frequently linked to private equity. A significant amount of money has been pumped into pharmaceuticals over the last two decades, to the point that the industry is already cash-flow positive and can fund its own growth. The arrival of multinationals such as Abbott Laboratories and Japan's Daiichi Sankyo has also driven up valuations.

Medical devices, meanwhile, is not considered to be of sufficient size to facilitate private equity exits. More importantly, imports account for over 70% of the market, which leaves little space for local companies to scale up.

"On the contrary, the hospitals segment has traditionally been a public sector play but it has undergone rapid change in the last five years, with significant investment from the private sector and the emergence of 4-5 national hospital chains," says Nitin Deshmukh, CEO of Kotak Private Equity, which backed Manipal Hospitals two years ago. Manipal is reportedly seeking a further injection of up to INR1.5 billion from private equity sources to fund further expansion.

There is no doubt that private health services in India have ample room for growth. On a global level, average healthcare spending is equal to 9% of GDP, but in India the ratio is barely 4%. Yet the private sector's role is more significant in India than almost anywhere else in the world, receiving $3 out of every $4 spent. Investors are flocking to the country to help address the massive imbalance between demand and supply.

Hospitals are a particularly attractive target because the market is so fragmented and in dire need of infrastructure investment. An estimated 85% of hospitals have fewer than 30 beds and are run by individuals or just a couple of doctors. The number of beds available per 1,000 people in India was only 1.27 in 2009, less than half the global average of 2.6.

Limited availability

The problem for private equity investors is identifying viable targets that can be used as platforms for industry consolidation. There is a handful of large hospital chains - led by the likes of Apollo Hospital Group, Fortis Healthcare and Max Healthcare - that dominate the tier-one cities. These are operators either publicly listed or already have private equity backers, and therefore not interested in receiving fresh capital from mid-market PE firms. At the same time, investment opportunities in second-tier players like CARE Hospitals or DM Healthcare are not readily available.

"I don't think there will be many $100 million transactions in the Indian market," says Amit Mookim, head of healthcare of KPMG India. "Deal size will be smaller and will focus on either standalone assets with a growth story or new formats in healthcare delivery - most of the large chains are already well-funded."

In order to absorb an investment of $100 million, a hospital chain must already have multiple projects underway as well as the management bandwidth to support such scale. This is a challenge in India where there is an average of 0.6 doctors per 1,000 people, against a global average of 1.23. It is questionable whether the existing manpower can embrace a sudden influx of large hospital chains, regardless of consumer demand.

"A major challenge is how to build a good quality work force," Song's former managing director Vasishth adds. "Right now India is very fragmented and there is a shortage of high quality doctors and nurses. This transition requires better trainings and it takes time."

Some private equity players have responded to this situation by targeting single-specialty hospitals because the administrative burden is lighter and recruitment is more focused. Eye-care specialist Vasan Healthcare, for example, can apply its homogenous set of skills nationwide, which means it is easier to scale up the business. In this context, GIC's investment makes sense.

According to KMPG, the Indian eye-care market is currently close to $3 billion in size and some practitioners are achieving year-on-year growth of 30-40%. Song and Helion Ventures also invested in eye-care hospital Eye-Q, a decision driven largely by stronger revenues and higher growth rates compared to multi-specialty chains. A host of other specialty segments, including oncology, dialysis care, infertility clinics, diabetic clinics and ambulatory care, are expected to require investment in the next 10 years as they seek to expand nationwide.

"The big difference between the 1990s and now is that recent investments have been moving towards more specialist hospitals such as eye-care, cancer and diagnostic," says East West Capital Partners' Sehgal, who backed Apollo Hospital Group in the mid-1990s when he was with Schroder Capital Partners. "The first wave of hospital investment arrived in the 1990s in leading cities. The second wave is going to focus on specialists and smaller cities."

Bet small, grow big

The emergence of investment opportunities in smaller cities is driven by evolving consumer trends. Ten years ago, people living in India's major cities typically went overseas for treatment. Now, residents of smaller cities are also traveling to where they expect to receive the best quality care - Mumbai, Delhi, Bangalore and Hyderabad. Close to one quarter of patients in these conurbations are not locals, with a large portion coming from tier-two and tier-three locations.

An established pattern in developing markets is that consumer demand in top-tier cities begins to saturate while emerging areas continue to exhibit rapid growth from a lower base. There is a clear opportunity for healthcare investment in cities of 1-2 million people - effectively taking good quality general and multi-specialty hospital chains nearer to the source of demand.

Be Well Hospital is a good example. The company, which operates a chain of secondary care hospitals that target tier-two and tier-three cities, as well as the suburbs of top-tier locations, recently received a capital injection from Song.

"The quality health infrastructure is strong in metros but non-existent in smaller towns," says Vasishth. "The opportunity is get into the smaller capital efficient companies and helps them grow very rapidly to become a regional market leader. The sweet-spot size to start with is $10-25 million."

Kotak Private Equity's investment in Manipal Healthcare is a case in point. In addition to its hospital in Bangalore, Manipal is currently a dominant player in South India, with 11 hospitals and 1,500 beds across eight cities or towns, including Mangalore, Vijaywada, Goa and Vizag. CARE Hospitals, which has hospitals with 800 beds in Hyderabad, also operates another 800 beds in tier-two cities.

Another reason for going into less developed cities is lower real estate prices. While hospital chains have ambitions to scale-up, achieving critical mass is a challenge: many have yet to reach the profit margins they were originally targeting. Steering clear of top-tier cities where speculation has pushed property prices to record highs or operating capital-light hospitals - which do not own the buildings and land - may be a better option.

"Real estate is expensive in tier 1 cities, and there is a fair amount of capacity putting pressure on new hospitals in achieving return and profitability metrics," says Gaurav Malik, managing director Olympus Capital Asia. "DM Healthcare is focused on undersupplied tier 2 and tier 3 markets, setting up smaller hospitals with 150 to 200 beds that will be quality leaders in their local markets; the cost of setting up is lower and the local demand is strong enough to fully utilize their capacity."

While Advent and Olympus are among those make their first investments in hospital chains, others have already exited. Olympus' investment in DM Healthcare enabled early backer India Value Fund to cash out of the company.

ICICI Venture exited Sahyadri Hospitals via a secondary transaction in February, as IDFC Project Equity, a subsidiary of Infrastructure Development Finance Company (IDFC), committed around $37 million to Pune-based specialty hospital chain. Of that sum, around $20 million was used to buy ICICI Ventures' holding, presenting the PE player with a decent return, sources familiar with the transaction tell AVCJ.

"Our philosophy of investment is buying into operating hospital chains that already have good reputations, steady cash flow and patient traffic," says M.K. Sinha, CEO of IDFC Project Equity. "This will be a trend that private equity firms will continue to seek new hospitals for growth opportunities, while infrastructure funds like IDFC Project Equity will facilitate their exit."

Trade sales to local and international hospital groups offer another potential exit route. Apollo is said to have acquired hospitals and set up different brand names in smaller cities, while in 2009 Fortis bought 10 hospitals from Wockhardt, an Indian pharmaceutical company that was forced to divest non-core assets following underperformance in its wider business.

Government incentives

In order to further facilitate private sector involvement in healthcare, the Indian government also offers incentives for foreign direct investment. These include allowing offshore entities to take 100% ownership in most types of local service providers. Columbia Asia, Singapore-based Pacific Healthcare and Parkway Group are among the multinationals that have established a presence in the market. South African hospital chain Life Healthcare also acquired a 26% stake in Max Healthcare for some INR5 billion, marking one of the largest ever foreign investments in India's healthcare sector.

"Whether multinationals will emerge as potential acquirers depends on their competitiveness over local players, including the likes of Max and Apollo," Sinha adds. "We have not seen many of multinationals being successful because the cost structure is generally lower for local players."

For this reason there is some skepticism over the likelihood of widespread multinational-driven M&A in the pharmaceutical market being replicated in the hospital space. Even if this exit channel doesn't gather momentum, private equity investors can always rely on IPOs, with hospitals still underrepresented in the capital markets. According to Olympus Capital, the total capitalization of listed hospitals in India is only $2.5 billion, compared to $58 billion for pharmaceuticals. This ratio of 4% is well below the global average of 20% plus.

"There are only a couple of listed companies in India, and they have received very attractive valuations," says Olympus Capital's Malik. "However, we will focus on building the company to become a billion company before pursuing a public listing."

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• Topics
• Healthcare
• South Asia
• Expansion
• Investments
• healthcare
• India
• Growth capital
• Advent International
• Olympus Capital Holdings Asia
• KPMG
• East West Capital Partners
• GIC Private