Business Money – Finance and Banking for Business

The long-term future of long-term care

December 2005

Richard Smith, chief operating officer, Taylors Business Surveyors & Valuers

Can it be sustained? After more than two years of increasingly frantic activity in the care sector, that is the question once again exercising the minds of those with an interest in reading the market. There are inevitably political, economic and social factors which could affect the sector. Coupled with that is the assumption that a predominantly asset-backed industry must be cyclical. And finally, there are those “once bitten” the last time the long-term care bubble burst – and most in the industry have been around long enough to remember – who are shy of getting caught a second time.

I venture however, that this time things are different. The long-term care industry saw its last significant slump around the early 1990s. At that time, there had been around 10 years of sustained growth, to the extent that we had effectively witnessed the birth of a new business sector in the UK. The first wave of entrepreneurs and operators had seen the opportunity that provision of long-term care appeared to offer and for a while it seemed that every failing seaside hotel or former vicarage was being converted to a care home.

Then, around the turn of the decade, came the care sector’s double whammy. Interest rates were sustained at more than 13% for over two years, inevitably impacting on the property-backed market. The Care in the Community Act 1990 put paid to plans of those who viewed long-term care as an easy way to make profit from government money. The impact of these two factors, particularly the latter, served to influence values over the next 10 years. This was exacerbated latterly by uncertainty around what was to become the Care Standards Act 2000.

Looking at 2005 however, the base rate is presently at 4.75%, with some commentators confident that this is set to fall. The whole supply and demand profile of the sector has changed. Fifteen years ago, the industry was coming off the back of a period of sustained growth. Today, in spite of recent new investment, we are in a period of sustained contraction as net bed numbers decline on an annual basis. Make no mistake; this will continue to happen.

Regulatory issues around the environment in existing homes will not go away and will continue to impact on the viability of many converted properties. Some of these homes will already be trading at artificially high levels, buoyed by current supply and demand imbalance. After so many difficult trading years, the operators of these homes will continue to extract profit until such time as they wish an exit from the business. At that point, many are likely to opt for the path of least resistance by selling the property for development, rather than becoming embroiled in the tangle of onerous legislation they would have to deal with to sell as a going concern.

What of the political influences affecting today’s market? In 1990, the Care in the Community Act had a significant and sustained effect on values in the sector. Could something similar happen now? There is no accounting for the policies of political parties, but whatever the politics of the government of the time these will not alter the core demographic figures. After all, it doesn’t matter what you call dementia; the condition still exists. It doesn’t matter how you refer to the frail elderly; the dependency is still the same.

Those investing in new care facilities have recognised this. Unconvinced? Then consider this – the unparalleled level of investment in care homes we have seen over the last two years on the part of banks, private equity and venture capital funds, has taken place against a backdrop of a government sworn to replace traditional long-term care beds with extra care facilities. Yet these investors have chosen to disregard the political message in favour of what they see with their own eyes, which is an increasingly ageing population whose needs are not being met as a consequence of a falling supply of adequate care provision.

The sector is also less exposed to other external influencing factors than many others. Contrast the effect 11 September had on the hotel sector with occupancy rates in care homes in late 2001 and the point is made. An extreme example perhaps, but it illustrates that this market is subject to a very different set of drivers than many other sectors. Old age, after all, is not a matter of choice.

It may be that there is an inherent expectation amongst some that values have to fall again, a view predicated on an almost inbuilt pessimism that at times seems to blight the sector. This in itself is no reason for them to do so. It is likely that such a sustained period of depressed values as we saw during the 1990s has influenced some in the sector to accept this as a kind of normality, or a benchmark against which to measure the industry. The reality is we have moved on. Rather than hitting record levels, the UK healthcare market has merely found parity at last with the returns which are available from other business sectors.

There will, of course, continue to be something of a two-tier market, reflecting a disparity in values available through economies of scale to corporate operators against those achievable by private care homes. Whilst we are also likely to see a reduction in mergers and acquisition activity in the corporate sector – there is only so much consolidating one sector can do – this does not imply that values or multiples will fall. Nor are the prices being paid unrealistic, as has been mooted in some corners.

The multiples discussed relating to any deal will always fluctuate, simply because there are three different numbers to consider; historical EBITDA, run-rate and sustainable EBITDA. Investors are increasingly reflecting the latter in prices paid. If these same bids are assessed against historical EBITDA the multiples may appear fanciful, but they are relatively meaningless in an industry where the revenue and costs going forward are so predictable. Those who choose to ignore this will increasingly find themselves losing market share.

There is nothing spectacular or unusual about values in today’s long-term care market, other than in the context of the UK healthcare sector itself. Values currently being paid reflect a fair return in comparison with other industries, in a market where forecasting your future customer base is as predictable as any. The future, as far as I can see it, holds no unpleasant surprises for today’s investor.

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The long-term future of long-term care