Ramsay Health Care, Virgin Care, Harmoni, The Practice, Circle and Care UK cannot be treated as going concerns without the financial support of their parent companies
Analysis of the accounts of a number of NHS service providers reveals some disturbing trends.
It is estimated that 37 private healthcare companies bid for almost 400 NHS service contracts worth £262m earlier in the year. The Guardian’s analysis looked at six of the biggest companies with a particular emphasis on patient care: Ramsay Health Care, Virgin Care, Harmoni, The Practice, Circle and Care UK.
Without exception, these six customer-facing operating companies admitted they could not be treated as going concerns without the financial support of their parent companies.
This creates a disassociation of interests between the managers and owners of the companies that are providing crucial NHS services. In essence, those who provide the care for patients are not the ones who decide whether that care can continue to be provided.
The financial position of the operating companies is, at best, weak. Only one of the six, Ramsay, reported a profit in its most recent accounts and even it regards the trading environment as “challenging”.
It is perhaps significant that Ramsay is the only “pure” healthcare company. It is owned by its Australian-based and listed namesake parent, which began trading in 1964 and first ventured overseas when it bought Capio in the UK, which now trades as Ramsay Health Care.
Virgin Care represents Sir Richard Branson’s Virgin Group’s entry into the healthcare market. It took a majority stake in the loss-making GP practices business formerly owned by Assura Group in 2010. But the British Virgin Islands-based Virgin Group has an extensive portfolio of interests.
The remaining four companies are essentially backed by private equity investors. This brings with it a heady mix of complex corporate structures, offshore financing and curious share ownership profiles. Private equity also imposes a financial framework that is traditionally incompatible with a long-term commitment to an industry.
The private equity model tends to adopt an approach that sees investors exiting their investment after three to five years. However, a successful exit is dependent on the operating company demonstrating it can deliver value for the new owners. There is little in the accounts of the four companies under private equity ownership to suggest they are in a position to make a compelling argument for long-term value delivery.
Indeed, the owners of Harmoni have already accepted that it is time to withdraw from the sector. They sold the company to rival Care UK last month in a deal worth £48m to create a business that could serve up to 15 million patients.
The sale was foretold in the accounts for the year to March 2011, which warned the business might have to be sold at a price that would not be sufficient to repay all the preference shareholder debt. Investors were told then that further repayments to preference shareholders were dependent on Harmoni being sold. One reason why the holding company could be treated as a going concern was because the preference shareholders had waived their right to any shortfall if a disposal failed to raise sufficient funds to repay their debt in full.
Given the poor profitability profile of the operating companies, it is no surprise that the private-equity-owned businesses have not always needed to adopt the high leverage model to secure a tax advantage. Interest payments to service high levels of debt have often been used by private equity finance companies to protect profits from tax.
But when the operating companies are inherently unprofitable, there is no need to borrow heavily to deliver a tax advantage. High finance charges cannot be blamed for a poor financial outcome at the healthcare providers.
The Practice has admitted it will be 2013 at the earliest before it can make any profit and it was relying on its private equity backers to provide the funds to meet its cash flow demands, which were expected to peak this year.
Circle has not made a profit since its inception in 2004. In the past four years, it has run up accumulated operating losses of £130m. Despite its own admission that it may never make a profit, the group has still managed to raise nearly £100m in new equity in the past two years.
Circle was the first private company to run an NHS hospital at Hinchingbrooke in Huntingdon. But, in the first six months of operation, the losses at the hospital were £4m, double those which had been forecast. Those losses have to be funded somehow.
Ali Parsa, the former Goldman Sachs banker who founded Circle, stepped down as its chief executive earlier this month. He remains on the board as a non-executive director and will spend more time “fulfilling his passion for social entrepreneurship”.
All the companies have shown that they can grow revenue, sometimes at quite dramatic rates, but without translating that into sustainable profits growth.
The only way to achieve sustainable profits growth is to increase income at a higher rate than costs.
It is no surprise, then, that a common theme across the six operating companies is an ambition to grow revenue. It is possible to infer from the way the various managements talk about their businesses and their strategy that they see the operating companies as high-volume, low-margin businesses.
Some of the NHS contracts on offer are enticingly substantial, with the prospect of £100m-a-year-plus of revenues. But competition for those revenues is intense, putting a downward pressure on prices. At the same time, the NHS is also under pressure to reduce its own costs. The upshot is that the contracts may be sizeable but not necessarily as inherently profitable as the service providers would like.
The worrying consequence is that the operating companies may find themselves the victims of an uncomfortable pincer movement. Below them is a challenging and competitive trading environment adding constant pressure to squeeze out cost. Above them are the parent companies with financial imperatives that demand a return on their investment.
Already Bridgepoint, the private equity group which financed the management buyout at Care UK in 2010, has restructured the way the company deals with its property requirements. Bridgepoint created a parallel property business called Silver Sea Holdings. Silver Sea has exactly the same ownership structure as Care UK, so is related to, but not part of, the wider group. Silver Sea will buy and develop the residential properties that Care UK needs, which it will then lease to Care UK. As a consequence Bridgepoint will own a portfolio of freehold properties while Care UK will have a portfolio of operating leases.
This may not be the sale and leaseback structure that was at the root of Southern Cross’ downfall, but it is a stark example of how owners and managers must coexist with different financial agendas.
So far the owners have maintained a united front in support of the managers of their operating companies. But that support brings with it a pressure to perform. There is a danger that this will in turn put pressure on managers to take a more aggressive stance on the costs that could threaten to undermine the pursuit of revenue. If the managers cannot deliver the improvement in performance which is anticipated then the owners’ support will be tested.