Change of heart

Private equity investments into hospitals and diagnostic chains have nearly quadrupled from 2011 to 2013, according to a FICCI-KPMG report. Overall, the sector has attracted close to $1 billion from both domestic and foreign financing companies. But there have been 24 PE exits worth $720 million in 2015, the highest since 2011, according to Venture Intelligence. Many of the exits have been via IPOs. Is this prudent cashing in or a loss in appetite? 

IPOs galore
“Healthcare, especially the hospital sector, is a very capital-intensive sector, with a return profile that does not necessarily fit all private equity investors, who typically have a 4-5 year horizon. As there are very few listed healthcare assets and given that several investors had reached the end of their fund life, IPOs were a good solution for all stakeholders,” says Vikram Hosangady, partner and head, deal advisory, KPMG. 

For perspective, PE exits through IPOs have yielded returns as high as 4.53x — when Ridgeback Capital sold its stake in Granules India in 2015.Thyrocare Technologies, whose IPO in May this year yielded a return of 3.5x for CX Partners, seems like it was a matter of good timing. A person familiar with the development says, “There were significant strategic interests, but given the good IPO market, the company decided to go for it.” CX Partners had identified underpenetrated sectors such as diagnostics and medical consumable products in 2011-12, and consequently bought stakes in Thyrocare in the diagnostics space and Sutures India in the medical consumables space. 

Even within the exits, ones via private transactions have fared much better than IPOs. The private sale of Intas Pharmaceuticals by ChrysCapital to Temasek Holdings got returns of 17.6x, much higher than the public exit of Baring India from Indoco Remedies at 5.2x, according Venture Intelligence. 

Regulatory hang-up
While Hosangady’s theory resonates, some flag regulatory hurdles for the multiple exits last year. “The last 2-3 years have seen valuations go through the roof and 2016 is witnessing regulatory bumps, resulting in the underperformance. Thus, it was prudent for PE investors to book (profit) when the going was good,” says Ambareesh Baliga, independent market expert. 

Gulpreet Kohli, former managing director, ChrysCapital, too feels the sector has taken a beating in the last 12-18 months. “Historically, growth has been good because this is a defensive sector. In the last couple of years, there have been successful exits in the diagnostics space, with Dr Lal PathLabs and Thyrocare, and in domestic generics space with Mankind. In most of the successful exits, people have held it for 6-7 years, so returns have compounded over time. But if you look at the past 12-18 months, pharma has been one of the worst performing sectors.”

Kohli, especially flags companies that export products. Because of FDA warnings and growth issues, he says, the whole sector has de-rated. “Companies reliant on domestic growth and diagnostics though have fared better,” he adds.

Shomik Mukherjee, head, South Asia, Actis, though is not too worried about the sector’s outlook. “Our sense is that regulatory challenges can be viewed both ways — on the one hand, investors do have reason to get nervous. But the flip side is that if you’re good at identifying companies that have good systems and processes in place, the regulatory risk creates yet another barrier to entry. It filters the not-so-good players. As far as valuations are concerned, the FDA scrutiny will only impact valuations of players who haven’t had years of experience in the space.” Actis in 2013 invested $48 million in Active Pharmaceutical Ingredient (API)-manufacturer Symbiotec Pharmalab, which reportedly operates the highest number of US FDA-approved API plants in the world.

Good till it lasts
Regulatory issues aside, India, as one of the most privatised healthcare industries in the world, still offers a lot of potential. 70% urban households and 63% rural households in the country are primarily dependent on the private sector for their healthcare needs, according to the National Family Health Survey 3. This is mainly because of the poor quality of government healthcare services and due to the fact that India has one of the lowest public spending on healthcare in the world (1.2% of GDP compared to a global average of 5.4%). Moreover, according to FICCI-KPMG report, healthcare industry in India is expected to grow at 16% CAGR from $83 billion in 2014 to $280 billion by 2020.

But despite these numbers, Hosangady says the high valuations aren’t likely to continue. “We expect valuations to moderate, especially in hospitals, as strategic investors, who have been increasing their footprint, start to focus on integrating their recent acquisitions,” he says. 

In spite of these reservations, deal activity in the hospital space has picked up, with Abraaj Group buying 72% stake in CARE Hospitals for $221 million from PE firm Advent International in January 2016. The IPO of Narayana Hrudayalaya, a multi-specialty hospital chain, also generated significant interest and was eventually oversubscribed around 8x.

But it appears future investments  will vary according to PEs’ risk appetite. Some say PE investment is likely to flow into sub-sectors such as diagnostics, which have high RoI potential, and not hospitals. A senior partner in a leading PE firm says, “Generally, PE investors tend to stay away from businesses that have long-term gestation and depressed RoC and RoE. In the healthcare space, those are typically hospitals.” 

However, Mukherjee says, “There are two ways of expanding a hospital chain: greenfield and brownfield. While greenfield has challenges of high real estate costs and long gestation period, brownfield expansion involves acquiring secondary care or nursing hospitals, and roping in real estate developers to do a custom build, in which case some of the risk in budget overruns gets passed on to the developers.” 

Treaty bind 
Baliga points to another factor that could affect investment in hospitals. “Nearly 55% and 29% of FDI flows to the hospital sector have come via Mauritius and Singapore routes respectively in the last 15 years. Investments are less attractive in the near future as Mauritius has reviewed DTAA and there is a possibility of similar move with Singapore,” he says.

Meanwhile, the IPO pipeline in the healthcare sector looks promising. The IPOs of VLCC, New Delhi Centre for Sight & Aster DM Healthcare are expected to hit the market in the near future. 

Amit Chander, partner, Baring Private Equity Partners though says the slowdown in IPO exits after 2015 is not because there aren’t enough PE-backed portfolio companies but a tempering in Indian market valuations after the global and emerging market correction in early 2016. 

But given India’s increasing population and rising awareness of preventive healthcare, it remains one of the most attractive sectors for private equity capital. As Chander says, “The ‘risk-off’ view (of PE investors) could change in the later part of the year. One could argue if it is already changing, with expectations of a good monsoon and broader economic recovery. ”