Is private equity's British care home model ageing badly?

Private equity investment in care homes, or nursing homes as they’re known Stateside, has never been without complications. Just ask the Carlyle or Blackstone groups, both of whom have been targeted repeatedly by pundits and protesters suggesting such assets shouldn’t be in private hands.

“They may not have sold their own grandmothers to make a fast-buck, but they certainly sold yours,” was the soundbite lobbed by a UK politician back in 2011 with the collapse of Southern Cross, a UK care-home chain previously owned by Blackstone.

The latest headache is a warning from ratings agency Fitch that the UK sector in particular will not be able to maintain its margins.

“Private operators are squeezed because their revenue is capped by local authorities, and their costs are increasing,” says Fitch analyst Victoria Ghannage. “It is a classic squeeze of margins.”

Since 2011, local authorities have tried to balance the books in the face of government funding cuts. All care homes with publicly funded residents have endured a 5 percent drop in fees, according to care sector data and analysis specialist LaingBuisson.

Meanwhile, the national living wage is about to exacerbate margin pressures in a sector where staffing is the most significant cost, accounting for around 60 percent of turnover, and up to 80 percent where more complex care is required.

That suggests that a business model based on structural growth, propelled by an ageing population, and steady, recurring revenues in a primarily government-funded sector has become increasingly challenged. Which is concerning, given Fitch reckons 90 percent of the UK’s care homes are private equity-owned. The largest operator is Terra Firma, which acquired Four Seasons Health Care in an £825 million ($1.1 billion; €1 billion) deal that included £500 million of debt in 2012.

In its latest report on leveraged finance in the sector, Fitch gave a ‘CCC’ debt rating to Four Seasons partly because, like smaller peer Care UK (owned by fellow private equity firm Bridgepoint), it has more exposure to lower margin publicly funded residents with less specialised needs, more likely to be affected by funding cuts.

In the face of such pressures, Terra Firma’s injected a fresh £50 million and split the business into three, diversifying revenue streams: Four Seasons Health Care, comprising 350 homes providing personalised nursing care alongside residential care; Brighterkind, with 70 homes targeting higher-end customers looking to self-fund; and The Huntercombe Group, which has 40 hospitals and provides treatment for mental health and brain injury treatment outsourced from the NHS.

An industry source said it was slowly increasing the amount of privately funded patients in the largest and most financially pressured division, with it ultimately targeting 70 percent self-funded for the division’s 20,000 residents. The split of public and private residents is currently around 50/50, but latest admissions have taken it to 54 percent self-funded residents.

There is some relief ahead – from April, local authorities can allocate an extra 2 percent to social care budgets – but it’s by no means smooth sailing. Expect GPs to take some significant actions to support their investments in a sector squarely under pressure.