Healthcare as an infrastructure investment?

Global private equity investments into healthcare soared to a new record high of US$151 billion in 2021, across 515 deals – a huge jump up from US$66 billion across 380 deals in 2020.  And for those tempted to think that 2020 was a pandemic-induced blip, the previous recorded high for PE investment in healthcare was US$77 billion in 2006, less than half the 2021 deal value ^[1]. 

Healthcare also proved its economic stability with transaction internal rates of return outperforming the broader private equity market by ~6% over the past decade and healthcare deals with multiples on invested capital of less than 1,0x only forming 17% of deals, compared to ~26% for all other industries ^[2].

Growth private equity funds have long invested into healthcare, attracted by the potential high returns generated by leverage of digital technology and fragmented sub-sectors. 

Now, however, the healthcare industry is seeing infrastructure funds compete for more mature assets. 

• The Australian market recently saw EQT acquire the Icon cancer care group and Infratil and Morrison acquired Qscan followed by New Zealand’s Pacific Radiology Group.
• This trend is consistent with other mature markets, for example, Goldman Sachs, OMERS Infrastructure and AXA’s recently purchased Amedes Holding, a German-based operator which offers interdisciplinary and medical-diagnostic services for patients, resident doctors and clinics in Germany, Belgium, Austria and Dubai.

The resilience and non-cyclical nature of healthcare in these markets is evident, supporting the view that certain healthcare assets are rightly viewed as infrastructure.

So why does healthcare present opportunities for infrastructure funds?

Is healthcare an infrastructure asset?

At its most fundamental, ‘infrastructure’ is investment into tangible assets that provide services essential to meeting society’s needs.  Looked at through this lens, healthcare sits squarely within ‘core-plus’ infrastructure, specifically social infrastructure.

With the lens of private capital investments, an infrastructure investment is an investment in a sector which customarily offers a stable, non-cyclical returns with strong long-term visibility on the returns profile.  In other words, infrastructure is generally a defensive asset with significant downside protection and low correlation to macro conditions.

Mature healthcare businesses in Australia and other developed countries fall within infrastructure using either of those lenses.  Let’s break that down.

Essential services in a mixed public/private system

With healthcare essential in keeping people alive and healthy, the question becomes do you need private healthcare, or is the public system sufficient?  In Australia, like many developed countries, private healthcare operates alongside the free or subsidised public healthcare system.  Whilst there is an elemental of discretion for at least some consumers in choosing to utilise the private system in lieu of the public system, the Australian Government actually heavily relies on the private system to service a stable proportion of the overall healthcare demands because the public system has insufficient capacity to meet the healthcare requirements of all Australians. This was evidenced during COVID-19 when the Australian Government immediately provided cost coverage for all Australian private hospitals to ensure their ongoing viability and ability to also prioritise COVID-19 patients.

Inelastic demand

There is limited scope for individuals and governments to reduce or deprioritise healthcare spend, even in challenging economic circumstances.  Most healthcare expenditure can, at its highest, only be delayed not avoided.  In addition to jeopardising health outcomes, the required expenditure may  increase if healthcare is delayed, for example cancer screening compared to cancer treatment.  The experience of the pandemic has also result in many patients becoming more proactive in seeking healthcare with an increase in diagnostic services and preventative care.

In Australia, where government subsidisation and high private insurance penetration is high, there is secure and resilient funding for most healthcare services. The result is that the demand for many healthcare services is not proportionate to macroeconomic consumer confidence or discretionary income levels.  Given its nature, healthcare demand can also be irrational in the strictly economic sense, with both individuals and governments paying for treatments which have an objectively low success rate.

Barriers to entry

Significant barriers to entry are another characteristic of infrastructure assets. Because they confer an advantage on incumbents, barriers to entry de-risk investments in existing businesses.

1. Doctors are finite and in very short demand

Viewed as a business asset, doctors, and relationships with them, act as a barrier to entry because doctors are finite in the market.  Doctors take a long time to fully qualify (with the period from undergraduate degree to specialist qualification usually 10+ years) and even longer to develop a reputation and consequential sustainable practice.  The specialist colleges may only release a limited numbers of training positions each year and the exams fail rate can be high, sometimes as a deliberate strategy to moderate supply.  Medicare billing restrictions also mean that foreign qualified medical recruits who are not permanent residents of Australia are generally restricted to working in remote and rural locations.  Once established in their careers, doctors tend to have mixed financial and career motivations, seeking to balance financial outcomes with professional satisfaction and lifestyle.

This means that strong relationships with doctors, and systems and incentive structures to both support their practices and align them to a particular private healthcare group, offer a significant advantage over new market entrants by making doctors ‘sticky’ and difficult to poach.

2. Lack of scale can equal lack of economic viability  

Healthcare businesses need to meet accreditation standards, have the capacity to service patients (often including highly expensive equipment) and get quality right from day one, regardless of whether there is sufficient initial demand to result in profitable operations. Often, healthcare facilities will need to have the staff and infrastructure capacity to also handle contingencies and complications, regardless of patient numbers.  In short, lower initial demand does not generally correlate to lower costs.

Scaled operators with multiple facilities and/or proximate acute care services are better able to manage a staged ramp-up, achieve sufficient occupancy levels quickly and manage fixed costs in establishing healthcare facilities. Efficiencies can be gained by sharing resources and referring patients from other facilities, as well as by leveraging high acuity services which will have a multiplier effect on their capacity to provide other services.  Existing reputation and relationships also often mean that demand grows faster, compared to new entrants.

3. Licensing

Most healthcare services require a form of licence or similar accreditation from a Government Agency. Whilst in some cases anyone who can meet the applicable standards can obtain the relevant licence, in other cases licencing and accreditation and the associated ability to obtain government funding operates as a barrier to entry and limits competition. Direct barriers to entry can also arise as a result of government seeking to control  spend on healthcare services – for example, where there is a finite number of funded ‘beds’ in a city or region at any one time.

4. Data

Data held by healthcare businesses is increasingly viewed as a valuable asset in its own right. Patients are likely to return to providers who already hold their health information (or can quickly obtain it). Bulk data and data analytics are essential to enable providers to translate population demographics into demand profiles to inform their investment decisions and to price services for contracts with funders. New entrants are therefore disadvantaged by their lack of healthcare data.

Why infrastructure investors need healthcare

The drive of infrastructure funds to look beyond traditional core infrastructure to healthcare assets is being driven by a combination of factors:

1. Infrastructure funds have very significant, and ever increasing, capital to invest. In short, the capital has to be spent and there are only so many core infrastructure assets.
2. Infrastructure fund investors such as pension funds (themselves trying to meet the demands of an ageing population) are seeking investments with higher returns which are still relatively safe.
3. Healthcare assets give infrastructure funds the opportunity to diversify their portfolios from a narrow mix of core infrastructure assets.
4. Increasing competition for core infrastructure assets has led to higher price expectations and reduced opportunities for bilateral transactions. Even in the current uncertain market, seller expectations may not have fallen.
5. In the face of high inflationary pressures and cost of living challenges, governments are placing downward pressure on permissible rates of return on monopolistic assets and other core infrastructure.

Benefitted by long-term positive tailwinds, larger and more mature healthcare assets have come to be viewed as defensive and stable in the current macroeconomic environment.

Please note that we have used external resources to contribute to the article.