Social Care Crisis Turns Spotlight on PE

When Southern Cross, the UK’s largest social care company, announced that it could not afford the rent on its 750 properties, housing more than 31,000 elderly residents, there was understandable alarm.

Press, politicians and the residents and their families grew concerned about the future prospects for the business.

What was less predictable was the firestorm of negative commentary on private equity that this crisis provoked. US private equity firm The Blackstone Group, which paid £164 million ($267 million) for Southern Cross in 2004, listed it on the stock market in 2006 and exited the business in 2007, made an estimated profit of £500 million ($814 million) in three years.

Since then, Southern Cross’ share price has tumbled, valuing the business at £12 million ($19 million) where once it was £1.2 billion ($1.9 billion), and it has come close to collapse thanks to rent liabilities of £180 million ($193 million) per year.

Critics argue that the financial model under which Southern Cross worked, where it sold its real estate to reduce debts. But, they argue, it was left with a high rental burden, created by private equity investors to pay dividends, while leaving the U.K. taxpayer liable to pick up the pieces when the company failed.

Blackstone countered that the great majority (95%) of Southern Cross’ property leases were in place before it acquired the business and that it cannot be held responsible for the economic conditions that have prevailed since it sold its stake in 2007.

Also, public sector cuts have affected local government spending (a major source of funding for social care homes), and more elderly people are staying in their own homes, which reduces demand for social care properties. Meanwhile, running costs and rents have risen, forcing Southern Cross into a loss-making position.

But these facts seem to have evaporated from the public consciousness. “Sharks!” was the headline in one newspaper.

“There is anger and outrage that so many lives have been thrown into turmoil through the actions of City venture capitalists,” wrote a journalist in The Daily Mail.

Left wing politician John Healey was quoted in the same paper stating: “People need to know they won’t be left high and dry by the decisions of City hedge fund managers.”

Even the most respectable of financial commentators, Robert Peston of the BBC, had some sharp words to say about private equity. Looking back to the early years of the 21st century, he remembered what he called the “fashion” for private equity firms to replace equity with debt.

“They would take a business, and then borrow huge sums against the assets in that business, to release the equity in that business for the benefit of the private equity firms’ partners and backers,” he said.

Southern Cross should serve as a warning of what happens when we forget our basic approach to economic policy and the role of the state.”

Justin BowdenUnion spokesman

The Southern Cross situation, according to Peston, is an example of private equity firms selling out of companies when the going is good, having received significant tax incentives from the U.K. government—in the form of tax deductible interest payments, low capital gains on carry for example—and then disappearing.

“For all the cleverness of private equity firms at selling out at the top of the market, it is the perception that they bank the profits, but aren’t around to clear up a mess they’ve in part created, which is doing serious damage to their image,” he said.

British politicians now question whether there should be new restrictions on how much businesses can borrow and if they can deduct interest payments from tax, as many private equity firms do. There are also questions over the tax burden on private equity partners and their backers who are not domiciled in the United Kingdom, both on their carry and on their general affairs.

Health care analyst William Laing at Laing & Buisson argues that no such regulatory changes are sensible or likely.

“Why should you regulate, when there’s no significant danger to the social care residents?” he asks. “There is a nasty taste in people’s mouths because of the financial wheeler-dealing, but it’s a non-issue as far as I’m concerned.”

Laing concedes that residents’ conditions have deteriorated because there has been a shortage of funds to invest on the properties, but he believes the split structure of operations and property companies in health care will survive, despite the bad press it has received over Southern Cross.

Shadow health secretary Emily Thornbury believes that the structure created by its private equity owners contributed to Southern Cross’ problems.

“We have to make sure that long-term care businesses are not treated in the same way as widget factories,” she says. “We have seen old people being treated as commodities. So we’re looking at the regulations and at whether social care providers are financially viable. Southern Cross had an unsustainable business model: when private equity was in charge, they thought the only way was up.”

One reason that the Southern Cross issue has assumed such symbolic importance for investors is that the UK’s Coalition Government, made up of right wing Conservatives and middle of the road Liberal Democrats, has proposed introducing more private sector involvement in the health sector.

The opposition Labour Party and its supporters among the unions have grave concerns about these plans and point to Southern Cross as an example of what they fear will happen if health provision is privatized.

Such a debate may sound quaint to American ears, given the recent furor over President Obama’s health care reforms, but British taxpayers are deeply fond of their National Health Service and believe that it distinguishes them from less civilized, less evolved nations.

A country that provides free health care to all its citizens regardless of status is a happier place to live, they argue. The apparent ability of private equity firms to turn a quick buck from the provision of care to elderly people strikes to the heart of this debate.

For over a decade, private equity funds have been significant and responsible investors in health and social care, providing not only necessary capital investment but also introducing modern working practices and efficiencies.”

Mark FlormanCEO BVCA

Whereas Tony Blair and Gordon Brown encouraged private equity on the grounds that it fostered efficient businesses and created a valuable new industry for the City of London, the unions take a very different view.

“The British labour movement [was] founded…to deal with the perennial flaws of capitalism,” says Justin Bowden, spokesman for the GMB (General, Municipal and Boilermakers) union, which has 600,000 members. “The most obvious of these flaws are the tendencies towards excess and monopoly exhibited by private equity and banking. Southern Cross should serve as a warning of what happens when we forget our basic approach to economic policy and the role of the state.”

Private equity firms clearly disagree with this analysis.

At the British Venture Capital and Private Equity Association (BVCA), a spokesman pointed out that Southern Cross was in fact only modestly leveraged, that sale and leaseback is a very common structure in all kinds of business sectors and that very many social health care companies, whether private-equity owned or not, are struggling in the current economic climate.

Nevertheless, other leading social care companies, such as Four Seasons Health Care and Care Principles, have been private equity owned and have had major financial problems after being loaded with debt. Both Four Seasons and Care Principles are now majority-owned by their lending banks after private equity firms sold them to Qatari investment fund Three Delta at generous valuations.

Mark Florman, CEO of BVCA, argues that U.K. citizens should be grateful for private equity investment rather than critical.

“For over a decade, private equity funds have been significant and responsible investors in health and social care, providing not only necessary capital investment but also introducing modern working practices and efficiencies,” he says.

“With a growing need and constrained public funding, it is imperative that private sector investment continues to flow into the sector.”

One health care analyst agrees, noting that the unions’ agenda is “to say that the private sector cannot be trusted to run health care facilities.”

Even so, the barrage of criticism of the private equity owners of Southern Cross has certainly stung the BVCA.

“It is completely false to state that Blackstone has stripped the property assets out of Southern Cross,” wrote the association in a detailed reply to press coverage. “The Southern Cross saga has certainly shed light on the extraordinary challenge that we all face in funding an ageing population. It has not, though, demonstrated that either Blackstone in particular, or private equity as a whole, is a force operating against the public interest.”