(Bloomberg Gadfly) -- Once upon a time, doctors believed most diseases could be cured by drawing out excess “bad blood.” In practice, the treatment was as likely to weaken the patient as improve her condition.
There’s a lesson in that for the investors who plan to restore ailing Australian hospital operator Healthscope Ltd. to strength by giving it a second spell in private equity’s sanatorium. Many of Healthscope’s problems date back to the period after TPG Capital and Carlyle Group LP spent $2.3 billion taking it over in 2010. Why would a repeat prescription do any better?
You can get a sense of this by comparing Healthscope’s performance to that of Ramsay Health Care Ltd., its larger and only serious rival in Australia’s private-hospital market. Over the eight years up to the acquisition in 2010, Healthscope’s revenue and net income rose about ninefold, increasing at around twice the pace of the same measures at Ramsay.
Since then, the boom years have ended at both companies – but while Ramsay has used its clean balance sheet to expand into new markets and drive net income from A$148 million ($112 million) in its 2010 fiscal year to A$480 million over the most recent 12 months, the debt loaded onto Healthscope has weighed on profits. Its A$99.5 million of net income for 2017 is just A$218,000 more than the year before the takeover.
There are some obvious things that a private-equity owner might do with a second crack at Healthscope. A spin-off of its medical testing businesses, which tend to command slightly higher multiples than core hospital operations, could help reduce that A$1.67 billion debt pile – although existing management is already considering doing that with the company’s Asian labs.
The previous period under private-equity ownership also focused heavily on restructuring procurement and improving labor productivity. As a result, personnel costs have been held steady at about 46 percent of sales for a decade, whereas Ramsay’s have edged up to 53 percent.
All of this, though, ignores the main thing a hospital operator needs to do to compete: build hospitals.
Ramsay’s capital expenditures have surged in recent years as it added more beds, operating theaters and health centers. While Healthscope’s capex-sales ratio ran ahead of Ramsay’s as it was struggling to catch up before the 2010 takeover, that situation has reversed since – driven no doubt by the fact that its increased debt load leaves scant room for further investment.
It may not be easy for Healthscope to resist the approach. Before the proposal was announced its shares had fallen 26 percent over the past two years, to less than the A$2.10 issue price in its 2014 IPO. What’s more, retirement fund AustralianSuper Pty. -- which already holds 14 percent of the company -- is a member of the bidding consortium alongside former TPG and Macquarie Group Ltd. dealmakers.
Australia’s private hospital market is also going through tough times, with growth in the insured population stalling. The temptation to sell out and let someone else take those risks away from shareholders will be strong.
Still, executives with an eye to the long-term health of the group might reflect on what private equity would like to do to the business in terms of capital efficiency and selling off non-core businesses, and go about the same procedures on their own. Physician, heal thyself.
David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.
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