Why don’t great whites ever bite private equity managers? Professional courtesy.


In the main, private equity (PE) is feared, maligned and misunderstood by most outside of finance circles. It’s misunderstood in part because the poster child of PE, Gordon Gekko of the iconic 80s movie Wall Street, isn’t actually that realistic. If you are going to improve company value significantly within five years, stripping everything to the bone, selling it in pieces and bragging about it is very rarely the straightest path to better value. Much more often, the straightest path is alignment of people, values and a new strategy, with a good dose of strategic investment thrown in, something that a prior owner wasn’t able to do.

The other sometimes frustrating reality of PE is that they often actually are “the smartest people in the room”. Sociopathic too of course, but for a dollar they will usually do their best to keep that in check until either pay day, or the day that things start going belly up and they need to beat a hasty retreat.

PE can work out, and not just for senior management buying in, especially when the PE firm you’ve been acquired by is a good one.

In the case of Healius’s GP clinics, they have been, in Australian terms, acquired by a PE dream-team. BGH is a recently formed collective of some of the best Australian PE managers of the last 10 years. It’s a group with a big track record of success, a lot of experience and clout, and a self declared determination to be the biggest and best PE firm in Australia within a few more years.

That’s a plus, certainly for any GP wondering what life is going to be like under the new ownership.

You are moving to an owner with managers who are smart with money, management, people and strategy, and the intent to make the company you work much much better in the shortest possible time.

If that all works out, it’s very unlikely that part of their plan will ever be to make your working life worse than it already is. As counterintuitive as it may seem to our image of PE, people management and alignment are most often a big component of any new strategy to improve the value of a business.

Having said that, a statement by Healius CEO Dr Malcolm Parmenter to the effect that the terms and conditions of existing doctors aren’t expected to change, and that the medical management of the business will remain the same, should be taken with the appropriate grains of salt.

Sure, a lot of employees and managers will have contracts with terms and conditions which can’t legally be changed much, at least in the short term. But that doesn’t amount to much over time if the company is to expedite its path to becoming more valuable. PE bought the company to improve it, and that means change, no matter what level of employment you are at.

There are a few other pros of being bought out by a smart, well capitalised and determined PE firm that are worth mentioning.

Private ownership

Healius was constrained in all sorts of ways with its GP centre business, not the least of which was its structure as a public company, with a primary revenue stream and growth profile coming from its pathology business. That meant the GP centre business was always going to be second priority in investment. It also meant that there was continual share price pressure for a certain level of return, and that pressure, especially in the short term, would have created some restrictions in the amount that the core group was prepared to spend on the GP centres and how much management focus it got. In the end, Dr Parmenter as much as admits all this in the sale statement, saying that GP centres were dragging down the overall performance and value of the larger pathology centred entity.

In private ownership, with a singular focus on the GP centre model, and with capital to make changes, you can do a lot more to make a business better. You don’t have the distraction of public reporting and shareholders to please. You can also make changes faster and more or less in private.

Management focus, motivation and expertise

During due diligence BGH would have put a lot of effort into understanding the expertise of the management they were bringing over.

A PE strategy, and one BGH is known for, is installing the best management teams, but also teams which are more than happy to risk their own money in the venture. In other words, if Scott Beattie, the current head of GP centres is going to continue in that role, he likely would have been assessed as the most capable person to continue, and asked to buy shares in the new venture.

The management has a vested interest in the success or failure of the venture. The formula for that varies, but at its base, a PE firm asks the manager to back its plan and themselves by putting up their own money for a certain class of shares and bet on the plan to deliver the upside in the shares.

This can have a good and bad effect on management, and it certainly clarifies the relationship between senior management and employees a lot more in the sense that there is big upside and downside for the management, whereas for employees that isn’t anywhere near as much in play.

The other common theme for PE and the starting management team is that they give that team a lot of rope and investment, but don’t tolerate much failure. If things aren’t going well a year or two in, expect senior management to get turned over quickly. This can be a good thing as well, so we will call it another positive.

In any PE acquisition it is important that the initial management team is on board, motivated and focussed. But rarely does PE retain all existing management with a view that they just need better focus, capital and management. Another advantage that PE can bring is to put new expertise and skill in to help existing management. That might be actual new senior management in support, or a lot of support in the way of expert consultants, and so on.

Experience

Another pro can be what experience PE can bring to an existing or newly forming management team. In the case of BGH, there is some good experience in the healthcare market, specifically with one partner, Ben Gray, having been a principal player in the firm TPG when it acquired private health provider Healthscope.

TPG ended up selling Healthscope for a good return, which is a strong sign. Part of the Healthscope turnaround was TPG selling the GP centre business out of Healthscope while under management. That isn’t necessarily a bad omen. It means at least that BGH understand well what its getting into, and that a GP centre business combined with a private hospital business was, like Healius, not an ideal portfolio for optimal performance of both businesses.

The other “experience” stat we should throw in is the track record of the BGH group. Generally, a really good and big PE firm might make 10 acquisitions for one of their big funds, fail miserably on one, succeed spectacularly on another, and the rest will be on a spectrum in between. That’s makes for not bad odds for the Healius GP group under BGH if the performance record of its partners stays intact.

IT and digital capability

As much as Healius wanted us to believe that big was better and it was at the forefront of enabling GPs through IT, it wasn’t. The heritage of the group was bulk billing and Healius installed simple infrastructure to manage a simple model, and didn’t update it much at all when that model started changing to add mixed billing. If you visited 30 Healius clinics as a patient in the space of a few months, no-one would likely notice, in each of the centres, nor in head office. That’s how connected the group really is in terms of operations and data smarts.

The IT systems of the group, and its approach to connectivity – between clinics, to external providers, and to patients – are seriously in the realm of legacy. If someone smart enough can fix this part of the group up in a couple of years there will be upside for everyone – the owners, the GPs, the patients, and the healthcare system in general.

There is opportunity here and BGH is unlikely to ignore it, especially since the incoming boss from Healius, Scott Beattie, was in charge of Technology and Innovation at Healius prior to to heading up the GP centres. He is likely to have a good idea of the potential for digital transformation of the group and now he likely has a new boss who wants to go there with some investment.

The cons

So there’s most of the upside. The summary might be, just because it’s PE doesn’t mean it’s going to bad. It can turn out to be quite the opposite, even if you are ‘#justaGP’ employee.

As stated above, the BGH team is smarter in assessing these deals than nearly everyone else. But PE does get things wrong occasionally, and when that happens it can be tortuous.

The PE acquisition of patient management system (PMS) provider MedicalDirector (MD) by Affinity might be a good example. Affinity bought MD for about $150 million, persisted with the existing management, and although the revenue and profitability of the venture appear to be a robust improvement in its five years of ownership, it has only been enough for Affinity to sell the venture for around the same price five years later.

In the meantime, the brand has lost significant market share and, it could be argued, a lot brand reputation after launching a cloud version of its PMS, called Helix, which seems to have not gained any traction with its core market. MD, which arguably five years ago was the market share leader and most likely to succeed as a the largest and most powerful platform network information business, is now under serious threat from its main competitor Best Practice, and from a bevy of startup, cloud-based competitors.

So what could go wrong?

Price

My first dry-witted lesson in PE from a new PE boss went like this: “It’s not rocket science, mate. You buy low, fix it up and sell high.”

The problem for BGH might conceivably be, it didn’t really buy that low.

If you look at the problem with the Affinity acquisition of MD, that was almost certainly the single most important factor in failure to improve the business. If you buy too high, you create all sorts of problems, the key ones being you don’t have as much leeway to invest, you put your management team under extreme ongoing pressure up front, and obviously, the exit price you always planned is going to be that much harder.

Did BGH buy high or low?

As stated, the BGH team are the “smartest folks in the room”, so they probably have a plan no one knows about. A subtle shift in business model profile which no-one else is seeing, or something else as simple as that.

But from the outside looking in, BGH bought too high. Not the sort of near-fatal too high that Affinity seems to have done for MD, but higher than it might have needed to.

The price for the GP centres business was $500 million, nearly all of it in cash.

Market analysts had estimated that the GP clinic division might be worth $400 million when it went up for sale a few months back. The market put virtually no value on the division from a share price perspective. This is the icon of healthcare asset market valuation, much watched by the finance sector. The Medical Republic wrote an article recently valuing the business at just $70m. In fairness that was done without a clear understanding of what the GP centres actually contributed in profit after overheads as that number wasn’t reported at the time. We had made that valuation based on the business generating no profit at all after overheads.

Other pointers to value are:

  • The percentage of revenue generated by the GP centre division, applied to the offer for all of Healius earlier in the year by Chinese suitor Jangho. That is 18% of $2.1 billion, or $378 million. But given everyone knew the value was mostly in the pathology business, you’d have to discount this figure substantially.
  • The actual declared EBITA of the GP centres business which is reported in the AFR as $32 million moving to $50 million and makes the multiple of EBITA on the sale price ( a common valuation technique) at 10 to 16 times. For some comparison, that is half the multiple paid for the Healthscope private hospitals business last year – but it’s not really a good comparison as they are fairly different businesses and business models.

The last indicator that the price could have been lower, Dr Parmenter said the sale price was a great result for Healius, and it was.

All external indicators suggest BGH didn’t pay “low”.

If this is the case, then what prompted BGH to pay a premium?

All GP centre businesses have been struggling to maintain their profitability ever since the federal government started tightening the screws on the MBS more than five years ago. Although GPs are clearly a secret to the efficient management of a healthcare system which is increasingly going to be stretched by an inbound chronic care tsunami, it doesn’t feel like the government is going to back away from this stance any time soon.

There are any number of theories:

  • Healius’s GP centres were always underperforming and Healius didn’t have the room or capital to fix that, something Healius admitted in the sale process.
  • Healius was hamstrung by a corporate history of being a bully to GPs and that has been lifting over time.
  • Healius’s revenue profile was nearly 100% bulk billing and in moving that profile there is an opportunity for margin enhancement.
  • Healius’s infrastructure is so old and inefficient – particularly around data and IT – that a comprehensive plan to modernise it will introduce considerable ongoing efficiencies.
  • The new telehealth regime is going to be mostly all upside for a well-capitalised and organised GP centre group with a good national footprint.

All of these factors are in play. It’s just to what degree BGH and its new management team might really be able to shift the dial on each of them.

The only other major con that seems obvious is that healthcare businesses where the primary employees are doctors are notoriously difficult to manage for change. That might be a factor that is even more heightened where GPs are concerned.

This isn’t necessarily that GPs are an obstinate bunch who don’t like change. Doctors are coalface life-savers and managers. That means a tonne of scrutiny and risk averse regulation, which makes healthcare company transformation a much trickier prospect than in many other markets.

But the same issues mean that the cult of the doctor is also a very important factor in any management of a company where they are your main asset. Doctors are often perceived by analysts outside of healthcare as having a culture that needs to be broken or transformed to meet the demands of a new digital and connected world.

That is entirely missing the point of the cult of the doctor and would be a fatal mistake of any new owner to make, not just because doctors are very open to change and technology, but because they are also a very smart bunch, who if you get offside you are going to find very hard to get back onside.

Understanding culture and bringing the GP team with them will I suspect be the number one factor in ultimately determining the success of the BGH venture – not business models, revenue mix, government policy or a legacy brand problem.

If you weigh the buyout up on all the pros and cons above, there are a lot more pros for the existing Healius GPs than cons.

Sure, BGH are sharks out to make money quickly and employees will need to overcome a natural distaste for this world. But all the elements are there for things to get better, not worse, over time.

The major stumbling block is likely to be meaningful engagement of the GP workforce in any plan so the new management can take them on a change journey.

Like PE or not, BGH is largely right time, right place, right level of smarts for the next stage of the GP centre business.

And the group isn’t going to be there forever. It might work out for everyone.