Hugo de Savary's – living with learning disabilities.

Here is a my tuppence worth blog post on Southern  Cross which has been hitting the financial pages because of the financial crisis. It is also starting to creep on to the main pages due to its sheer size as it is the largest provider in the sector and carries some impressive stats… In the UK it has over 750 homes, 38,000 beds, 31,000 residents and over 40,000 employees,predominantly it specialise in eldercare but also learning disabilities.

Why then, you might ask, is this company hitting the news for all the wrong reasons? Many pundits will say that this is because Southern Cross’s rents are too high or that government cuts are having a serious impact, and yes these all maybe true, but in my opinion the fundamental answer is a more general one that can be indirectly attributed to events that occurred over 30 years ago. Rewind to the 1980s, the government at the time went for a plurastic approach making it possible for people on income support to access private homes starting with the Supplementary Benefit Regulations. This coincided with changing user’s aspirations demanding better environments than the ones typically offered by local authorities that were constructed predominantly from the post-war era. The net result of this was that care homes became market commodities that attracted large amounts of investment from the private sector, piling into supply an insatiable demand for services. Amongst the players bringing in investment were private equity firms and investment funds who typically had a 3-5 year exposure to this new market, where they would initially invest by buying and existing care operator, grow the care business mainly through acquiring other providers and then sell the portfolio of homes, with their income generating residents, for a profit thanks to economies of scales and rationalisation to another firm with the same sort of timeline – this process happened many times over. The model is no different for these funds that enter other sectors, all with varying degrees of success. Is this perhaps where the problem lies; should the health and social care sector which has no financial protection or regulatory control, be treated in an identical way to other sectors in light of what it provides?

With cheap money plentiful from the banks and the closure of local authority services fuelling the growth of the marketplace, it all looked rosy, but then the bubble burst…with the credit crunch. With the crunch came expensive and scarce bank finance, government cuts for fees and rising costs all resulting in a sector that was losing its shine. The Southern Cross story is one that may tarnish private equity’s reputation operating within the sector and could have far reaching consequences to the way the market operates and is regulated if market failure is deemed to have occurred in the near future.

From 2004-2007, Blackstone the largest global private equity firm engineered 3 big deals evidencing its general sophistication at making money. It initially bought 2 care providers; Southern Cross for £162m and  Ashbourne Grp for £85m. The 3^rd deal was NHP, bought for £560m, a property company providing the premises where the likes of Southern Cross operated from. In crude terms, half of the leases of the newly enlarged Southern Cross were owned by NHP. Whilst in Blackstone’s ownership, these leases were renegotiated at more favourable rates in NHP’s favour, usually on 25 year terms with a yearly built-in upward escalator of at least 2.5% but in some cases the more onerous RPI was used. In 2007 Blackstone sold NHP for £1billion and floated the enlarged Southern Cross Healthcare Holdings. The FT estimated that Blackstone quadrupled its original investment, netting it at least £1billon profit from both selling NHP and the floatation. Not bad for 3 years worth of deal making, but the accolades of succesful genius business wheeling and dealing are starting to change, when the genetically modified organisation is fighting for survival – that has potential social and political implications which could adversely affect not just its stakeholders but also a much wider audience.

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