China hospitals: Long-term cure?

Hony Capital, Trustbridge Partners, Eight Roads Ventures, FountainVest Partners, Ascendent Capital Partners, TPG Capital, CDH Investments, Hillhouse Capital and Morgan Stanley Private Equity Asia. Nearly everyone, it seems, owns a Chinese hospital - and this is unlikely to be a complete list. Last week, Bain Capital joined their ranks with the $150 million acquisition of Asia Pacific Medical Group (APMG).

The appeal of the hospital space is clear. It represents an opportunity to leverage not only rising demand from an aging and increasingly affluent population but also government reforms intended to bring in more private capital. There are, however, three questions for PE investors. One, can they monetize these hospital ventures? Two, can they get the top local doctors to come and work for them? And three, can these goals be achieved within the time confines of a traditional private equity structure?

The door was fully opened to overseas investors in 2014 when the government permitted 100% foreign director ownership of hospitals in several major cities. Private participation in the industry was already on the rise: As of June 2014, there were 11,737 private hospitals, according to Deloitte, or 47% of the national total, up from 27% in 2008. However, they account for just 10% of overall visits and the total number of discharged patients, well below the government target of 20%.

This is likely to change as healthcare spending rises and initiatives such as universal healthcare insurance take hold. Expenditure is projected to grow at an annual average rate of 11.8% in 2014-2018, to reach $892 billion. There is scope for continued expansion well beyond that, given China's healthcare spending came to an estimated 5.4% of GDP in 2013, much lower than most developed countries.

Until two years ago, annual private equity investment in China's hospital and healthcare services space had surpassed $100 million on just one occasion. Then in 2014, $675 million was deployed, followed by $371 million last year.

Strategies vary greatly and so do the ways in which PE investors answer the three questions. Indeed, a couple of groups have addressed the last question first by actually or hypothetically removing their deals from a traditional PE context. Eight Roads has spent more than seven years bringing its brand new hospital group, Delta Health, online. It claims to have the capital and the patients to participate in healthcare reform over the next two decades. Trustbridge is also working on a greenfield development and the GP is said to be open to buying the asset out of the fund if that is the best course of action.

However, the most common private equity strategies are acquiring a string of hospitals and consolidating them within a dedicated platform (Hony and Morgan Stanley Private Equity Asia) and developing existing facilities (Bain's plan for APMG). Neither is straightforward. While M&A is challenging when the number of would-be buyers far outweighs the available assets - pushing up valuations - brownfield expansion can be complicated by government restrictions or lofty land prices.

Even if PE investors succeed in building or buying hospital assets, they need doctors to perform surgeries and patients capable of paying for them. China has insufficient properly-trained doctors and the elite gravitate to large public hospitals where they are better paid and have a clearer path to promotion. The government has introduced initiatives encouraging these professionals to spend time in the private sector as well but it is a gradual process.

As for payment, it is very difficult for private hospitals to qualify for coverage under the schemes that comprise China's universal health insurance program, so most currently miss out. This places the burden of payment on the patient, narrowing the potential demand base.

It is not an impossible situation for investors. Some private hospitals are profitable - so GPs must be careful what assets they target and perhaps aim for specialist providers - and then there is potential opportunity in buying franchises from public hospitals, which would address some of the staffing and payment roadblocks. Nevertheless, patience appears to be a virtue for PE firms targeting healthcare.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• Greater China
• Healthcare
• Buyouts
• Hony Capital
• Bain Capital Asia
• Morgan Stanley Private Equity Asia
• Trustbridge
• TPG Capital
• Fountainvest Partners