Master Thesis
Do Private Equity Investments in
Healthcare create Value?
Research on the European private healthcare market
Name: H.M. Oomens
Adress: de Leeuw van Vlaanderenstraat 2e 1061 CS Amsterdam The Netherlands Student number: 1537342 Telephone number: +31622289078 Email: Hielke.Oomens@gmail.com Rijksuniversiteit Groningen
Master Organizational and Management Control 1st Lecturer: dr. C.A. Huijgen
2nd Lecturer: dr. B. Crom
Proem
In 2005 I started my business studies at the University of Groningen. As a young student I did not have the slightest idea in mind how my years in college would unveil. After two years I noticed my interests in applied courses and going abroad. These interests have been satisfied and deployed, learning a lot. Being active in student life and doing the things that had my interest have stood central in my education. I wanted to finish my last year with an interesting internship. I found this internship at Plainvanilla investments, a private equity firm based in Amsterdam. Applied work and responsibility were the things that attracted me. I can look back on a successful year, finishing my education and attaining firsthand experience in the private equity field. The field in which my upcoming job will be situated.
First I would like to thank my attendant Roy van der Geest at Plainvanilla investments for helping me find a good subject and assisting me in the research process with ideas and comments.
Secondly I would like to thank my lecturer Christiaan Huijgen for his share in the research process, steering my ideas and results in the right direction. Creating a scientific based research.
Last but not least I would like to thank my parents for making it possible for me to go to college, experiencing the most valuable years of my life so far.
I hope this research will arouse your interest as much as it did mine.
H.M. Oomens
Abstract
The amount of private healthcare initiatives in Europe is rising. This trend will most likely continue in the upcoming years because of two interdependent reasons; (1) healthcare costs are rising (2) public and political opinions are shifting from hostility to acceptance of private care. The main investors in private healthcare are private equity firms. This research tries to provide insight into whether private equity investments in healthcare have created value. The main research question is:
“Do private equity investments in European healthcare create value?”
Table of content
Chapter 1: Introduction……….………...….6
1.1 Problem statement………....…...6
1.2 Objective and research question………...8
1.3 Motivation………...9
1.4 Relevance………....10
1.5 Structure………...……...11
Chapter 2: What is healthcare? ………...12
2.1 Introduction………...…………...12 2.2 Healthcare systems………...………...12 2.2.1 Healthcare providers………..………...14 2.2.2 Healthcare funding……….…...14 2.2.3 Healthcare payment………...14 2.2.4 Health insurance……….………...15
2.3 Public healthcare dominance……….………...………...15
2.4 Structural factors influencing healthcare………...………17
2.5 Dynamics of the European healthcare market……….………18
2.6 Regulations influencing private care………...………20
Chapter 3: What is private equity?...22
3.1 Introduction………...………...…...22
3.2 Private equity investments………...22
3.3 Private equity fund structures………...………...24
3.4 Private equity providers………...25
3.5 Why are private equity investments in healthcare growing? ………..……25
Chapter 4: Financial analysis of private equity investments in healthcare………...….……...…….27
4.1 Introduction………...………...………...27
4.2 Research variables………...…….………...27
4.3 Research methodology………...…….………….……...28
4.3.1 Value creation………...29
4.3.2 Handling the net debt issue………...30
4.3.3 Outperforming the market? ………...………...35
4.3.4 Handling the dividend issue………..36
4.4 Establishing a research population………...………...36
4.5 Extracting the data………...……….……...36
4.6 Data management………...………..…...37
4.7 Structuring the datasheet………...………..38
Chapter 5: Results………...……….44
5.1 Introduction………..………...44
5.3 Value creation………..……….……...46
5.4 Value creation by MBO’s………..………...………...48
5.5 Branch related companies or private equity funds as buyer………..………..………50
5.6 Value creation in the U.K. ………..……….………...52
5.7 Care & cure versus other healthcare companies………..………54
5.8 Longer holding periods and value creation……….………56
5.9 Intermediate purchases by target companies………..…….………58
5.10 Correlation………..……….……...60
5.11 Regression analysis……….………...61
5.12 Robustness test 1……….………...63
5.13 Robustness test 2……….………...64
5.14 Recap Results……….………….………...65
Chapter 6: Conclusion and further research……….………68
6.1 Conclusion………...……….………...68
6.2 Limitations……….…………...……...70
6.3 Further research…...………....……….…...71
Chapter 1: Introduction
1.1 Problem Statement
Investing in healthcare has raised discussion in Europe. Is it ethical, profitable and desirable? In the past, healthcare was seen as a governmental and national issue and in some countries profits were not allowed. “How can one put a price on care?” was, and still is a widespread belief.
In recent decades changes have taken place in the healthcare market. Costs are rising, waiting lists are prolonging, the population is aging and there is more demand for efficient and transparent healthcare (EIU, 2009). These dynamics have contributed to changing public and governmental opinions on private healthcare. There is reason to believe that private healthcare could solve some of the major problems that arise with a public healthcare system (Relman, 1980).
Private and public healthcare systems differ in the way of funding and distributing care. They vary from systems in which healthcare is fully controlled and provided through the government to private systems. However, most countries have adopted a hybrid system. (WHO, 2006).
Private and public healthcare have both their disadvantages. The main reason for unwillingness to change to private healthcare is that certain parties assume unaffordable healthcare for the disadvantaged and less necessity of complex healthcare because it is not cost effective. The main argument against public healthcare is that it nurtures inefficiency (Relman, 1980).
this topic is significant and opinions vary. Nonetheless, a shift towards more private healthcare is observed throughout Europe (Relman, 1980, Jeurissen 2010, WHO 2004, EIU 2009, Wagstaff et al. 1999).
In recent years there have been several private healthcare initiatives in the Netherlands as well, such as the Slotervaart hospital, the IJsselmeer hospitals and the HSK group. Also smaller initiatives are more common, such as ambulatory surgery centers (ASC’s). These centers are small separate clinics ran and funded by physicians. Also the new Dutch government seems to prefer a shift in the private direction. Taking these factors into account the shift towards more private funded healthcare is a fact.
From an international perspective, private healthcare tends to be less of a discussion. In certain countries these type of organizations have existed for years and are still gaining share in the healthcare market (Jeurissen, 2010). Taking the existing private healthcare systems and the shift towards more private funded healthcare systems into account, it seems that private healthcare is gaining importance and is an interesting topic to examine.
Private healthcare implies that investments are made by non-governmental parties. One precondition for private parties to invest is profitability. Investors have to believe that healthcare investments are indeed profitable and create value. Are these healthcare investments as profitable as believed? Are they profitable at all, and to what extent?
The focus in this research will be on the investors and not on the patient. This research is not about quality of care or finding out which type of healthcare system is optimal. It will try to provide insight into whether private healthcare investments are desirable for the investor.
in healthcare are examined to find out whether they have created value for the investor. This insight can be used by private equity companies that doubt the desirability of healthcare investments.
1.2 Objective and research question
There is a general shift towards more private funded healthcare in Europe. The goal of this research is to find out whether private equity investments in healthcare create value. Private investors expect opportunities in this market. Are these opportunities based on evidence? If the Netherlands is shifting towards a similar system, the knowledge attained in this research from the rest of Europe can possibly apply to the Dutch healthcare market. The main research question of this thesis is:
“Do private equity investments in European healthcare create value?”
1.3
Motivation1.4 Relevance
Numerous articles have been written on whether private healthcare delivers care quality and affordable care compared to public healthcare. Different studies show different results. One OECD study (Colombo & Tapay, 2004) indicates there is no optimal system and that private as well as public systems can deliver qualitative care and be efficient. There have not been widespread studies on the investors’ perspective. The entity that provides private equity to healthcare companies and who expects positive future cash flows. How profitable and valuable were these investments? Did they create more value for the investor in comparison to an alternative investments?
This research tries to provide insight into these matters. The results of this research indicate that investments in healthcare are indeed profitable and create value. This could mean that these companies have performed well. If these companies perform well then the care, service or products they supplied could have been fair as well.
1.5 Structure
Chapter 2 will elaborate on defining healthcare. Details are provided on what healthcare entails, which entities are important and how they work. Public healthcare dominance and dynamics of the market are explained.
Chapter 3 provides insight into what private equity entails. The types of investments and important entities are set forth. The reasons for private healthcare growth are also provided.
Chapter 4 deals with the financial analysis of private equity investments in healthcare. In this chapter the methodology and the creation of the dataset and research variables are set forth.
Chapter 5 contains the statistical methods and results used to analyze the research variables. The main research question and sub-questions are answered in this chapter. The chapter will finish with several robustness tests.
Chapter 2: What is healthcare?
2.1 Introduction
“Healthcare is the prevention, treatment, and management of illness and the preservation of mental and physical well-being through the services offered by the medical and allied health professions” (WHO, 2006).
To provide healthcare a healthcare system must be established. Health care systems are designed to meet the health care needs of target populations. There are a wide variety of health care systems around the world. In some countries, health care system planning is distributed among profit organizations, whereas in others planning is made more centrally by governments, trade unions, charities, religious, or other types of organizations to deliver planned health care services targeted to the populations they serve.
In January 2011 the Dutch minister of healthcare declared that new policy will be introduced that allows private healthcare initiatives for the first time. Private healthcare initiatives were already present in the Netherlands but on small scale with many restrictions. Many other countries in Europe such as the U.K., France, Germany and Switzerland have already a more mature private healthcare market. The arguments in this chapter will underpin the fact that the trend towards private care will continue in Europe.
2.2 Healthcare systems
2.2.1 Healthcare Providers
Health care providers are trained professional people working self-employed or as an employee in an organization, which may be a for-profit company, or a not-for profit organization. Organizations employing people providing health care are also known as health care providers.
2.2.2 Healthcare funding
From figure 1 one can observe six different types of healthcare funding. They are:
1. Direct and indirect taxes
2. Compulsory or social health insurance 3. Voluntary or private health insurance 4. Medical savings
5. Out of pocket payments 6. Loans, grants and donations
Most national healthcare systems feature a mix of all six models. In Europe this system is referred to as the public-private mix (Maarse, 2006). One study based on data from the OECD (Colombo & Tapay, 2004) concluded that all types of health care finance are compatible with an efficient health care system. However because of path-dependencies some systems perform better than others (Carr-Hill 1994).
2.2.3 Healthcare Payment
- Fee for service
Fee set by individual practitioners.
Central negotiations where practitioners agree on standardized patient reimbursement rates.
- Capitation payment systems
Practitioners are paid for each patient on their list, with adjustments for different types of patient aspects such as age and gender.
2.2.4 Health insurance
Health insurance is a mechanism for people (1) to protect themselves from the potentially extreme financial costs of medical care if they become severely ill, and (2) to ensure that they have access to health care when they need it (Claxton, 2002). Health insurance can take on different forms per, but also within countries. Some countries have social health insurance, which implies that every citizen is obligated to be insured at a governmental or private insurance institution. A health insurance policy is a contract between an insurance company and an individual or his sponsor (e.g. an employer). The contract can be renewable annually, monthly or exist lifelong. The type and amount of health care costs that will be covered by the health insurance company are specified in advance. The individual insured person's obligations may take several forms (AHRQ, 2007).
2.3 Public healthcare dominance
large funds necessary for a private healthcare investment. The entry barriers for healthcare are considered high.
When comparing continental Europe to the United States, the difference in public healthcare dominance in Europe could be explained by the fact that European countries have more sociological opinions regarding healthcare. ‘Healthcare should be free and available to anyone’, was and still is a widespread belief throughout Europe.
A complicating factor in healthcare is the complexity of ensuring quality and quantity of healthcare products and services in an objective way that is understandable to the clients (patients). This implies a public opinion that shifts towards preferring public healthcare, since it has no opportunistic investor interest. At non-profit healthcare institutions the investor is the government. The interest of public healthcare organization is to satisfy their stakeholders which are the government, employees and patients. Governments can support public healthcare institutions in lack of resources, focus on special care and cure, paternalism, universal access and setting quality benchmarks. To ensure non-opportunistic behavior in the for-profit sector, governments can impede regulations. An example is limiting profitability of healthcare institutions.
The rise in healthcare costs and inefficiency problems are perceived to be mainly responsible for the change in public and political opinions on private healthcare. If healthcare systems work on efficiency and if there would be increased competition the costs of healthcare would be reduced. The Netherlands are a good example. It had a very publicly orientated healthcare system, but that has changed in the past decade. Not only have they shifted to a private healthcare plan, the government has also passed a law that entitles healthcare organizations to (limited) profit.
stakeholders have no opportunistic incentives have to be weighed against the disadvantages. In a public system here is limited access to funding and there are fewer incentives for efficiency. On the other hand the higher the monitoring costs of private healthcare and the stronger the incentive for moral hazard, the higher the costs of ‘contracting’ will be. Contracting meaning the amount of work, effort and regulations necessary to ensure appropriate healthcare.
2.4 Structural factors influencing healthcare
Apart from the fact that healthcare systems are subject to change, the healthcare itself and the demand for healthcare changes as well. The healthcare system is influenced by healthcare demand. The demand for care changes because structural factors in countries develop throughout the years. Structural factors include factors such as economic growth, new technologies and demographics.
There is one main problem in healthcare. This problem applies to all healthcare markets throughout the developed world. The problem is that healthcare costs are rising rapidly. In a recent report, PriceWaterhouseCoopers (2008) has signaled two drivers of increasing healthcare costs in western countries. The first factor is substantial general inflation. It accounts for a large part of the rising healthcare costs. In 2007 it accounted for 2,5% of the 6,1% worldwide growth in healthcare costs. In 2010 the average growth in European healthcare costs was 3,3% in 2010, with inflation rather low (1,2%) because of the financial crisis (Mercer, 2008).
The second factor is the rise in healthcare costs in excess of inflation. Since inflation is a factor that is not possible to influence directly through healthcare policy and regulation, the costs in excess of inflation are more important to this research. The main reasons for the rise of healthcare costs are listed below:
for large scale healthcare institutions and companies, these networks tend to reduce competition.
2. Higher priced technologies: New technologies increase prices because they are frequently more expensive than existing technologies. New prescription drugs, imaging technologies and medical products are the largest drivers.
3. New treatments: These treatments consume large amount of capacity from specialists.
4. Aging: Because of the baby boom after the second world war the population in most western countries is aging fast. This requires more utilization of healthcare. 5. Lifestyle: Lifestyle challenges including obesity, smoking, drug abuse, poor
nutrition and lack of physical activity contribute to an increase in the utilization of health services.
6. More intensive diagnostic testing: In recent times the demand for diagnostic testing have increased. The growth has slowed down but it still contributes to rising costs.
2.5 Dynamics of the European healthcare market
The European healthcare market is diversified. In this research only member states of the European Union and Switzerland were included because their healthcare markets are developed and therefore suitable for comparison. However examining only member states of the European Union does not imply a unified healthcare market. On the contrary, all countries have a variety of different healthcare systems. Some systems are government orientated and some are market based.
Switzerland has around 59% public healthcare expenditures, the remaining 41% is held by both social health insurance and private healthcare (Maarse 2006, Jeurissen 2010).
Literature on long term healthcare market data indicates that the expenditure on public healthcare has decreased in certain countries over the last few decades (Maarse, 2006). Social health insurance and private healthcare are gaining market share. In social health insurance systems the payments for care are made through public or private health insurance institutions instead of the government. The Netherlands and Belgium have adopted a private social health insurance system in 2003. This is observed in Table 1 by the absence of Dutch and Belgian public expenditures on healthcare. This does not imply private care. Healthcare institutions in the Netherlands were not allowed to be profitable by law until 2006.
In the recent decade the number of private healthcare initiatives has been growing, although it has not been on a large scale. Europe in general still has, especially when compared to the United States, a publicly orientated healthcare system. Europe only accounts for twelve large hospital and long-term care holdings, but they are witnessing robust growth (Wagley, 2000). Most of the European initiatives are on a small and mid
2004 2005 2006 2007 2008 Austria 75,7 76,1 76,0 76,4 76,9 Belgium .. .. .. .. .. Czech Republic 89,2 87,3 86,7 85,2 82,5 Denmark 83,8 83,7 84,1 84,5 .. Finland 73,0 73,5 74,6 74,5 74,2 France 79,3 79,3 78,4 78,3 77,8 Germany 76,9 76,8 76,7 76,7 76,8 Greece 59,1 60,1 62,0 60,3 .. Hungary 72,4 72,3 72,6 70,4 71,0 Ireland 77,0 76,6 76,3 76,8 76,9 Italy 76,0 76,2 76,6 76,4 77,2 Luxembourg 84,8 84,9 85,1 84,1 84,1 Netherlands .. .. .. .. .. Poland 68,6 69,3 69,9 70,8 72,2 Portugal 72,0 71,8 71,5 .. .. Slovak Republic 73,8 74,4 68,3 66,8 67,8 Slovenia 72,9 71,9 72,4 72,0 72,3 Spain 70,6 70,6 71,3 71,8 72,5 Sweden 81,8 81,6 81,6 81,7 81,9 Switzerland 58,4 59,5 59,1 59,1 59,1 (e) United Kingdom 81,4 81,9 81,9 82,0 82,6
scale basis (Jeurissen, 2010). This presumption is reflected by the market size of the companies in the dataset used for analysis in chapter 4 and 5.
Public opinions on private healthcare have been shifting as well. In most European countries private healthcare was not an issue 20 years ago because it was simply not even considered. Now it is a widely discussed issue that has growing political support. Because this research focuses on healthcare investments, no further details will be provided on political issues.
2.6 Regulations influencing private care
According to Mossialos (2002), the influence of national healthcare regulation on a country’s healthcare sector can be divided into two different aspects:
1. Policy objectives include regulations concerned with nationwide strategies for healthcare. For example, providing accessible healthcare for the entire population, guarantee the healthcare safety, stimulate innovation and to educate citizens about clinical services, pharmaceuticals and a healthy lifestyle.
2. Management mechanisms have a more practical and operational character and target specific regulations that are needed to reach the goals as described in the policy objectives. Management policies can be focused on factors such as greater operating efficiency and effectiveness of both human and material resources. Healthcare institutions receive a negotiated budget, with a total budget limit for all hospitals, established by the government. Healthcare professionals receive fees based on the negotiation between the government and medical societies.
regulations. These regulations can influence the existence of private care in two ways. First it can prohibit profitable care (e.g. Sweden) and second, it can limit the profitability of these companies when profitable care is allowed (e.g. the Netherlands). This is done so that the private healthcare companies are controlled and affordable and qualitative care is guaranteed.
Chapter 3 What is private equity?
3.1 IntroductionPrivate equity is a class of equity securities in operating companies that are not publicly traded on a stock exchange (Bartlett, 2010). Private equity can be used to finance new developments, products and technologies, expand working capital, to make acquisitions or to strengthen a company’s balance sheet. It can also resolve ownership and management issues. A succession in family-owned companies, or the buyout and buy-in of a business by experienced managers, may be achieved by private equity funding. (EVCA, 2009)
3.2 Private equity investments
Among the most common investment strategies in private equity are leveraged buy outs and venture capital. In a leveraged buyout, a company is acquired by a specialized investment firm using a relatively small portion of equity and a relatively large portion of outside debt financing. The leveraged buyout investment firms today are generally referred to as private equity firms. In a typical leveraged buyout transaction, the private equity firm buys a majority control of an existing or mature firm. This is distinct from venture capitalists (VC) firms that typically invest in young or emerging companies, and typically do not obtain majority control. The difference between private equity and
venture capital is illustrated in Figure 2. In this paper, we focus specifically on private equity firms and the leveraged buyouts in which they invest. This is because venture capital investments are small which makes them difficult to study.
A common non-venture private equity strategies is a leveraged buy-out (LBO). An LBO is an acquisition of an existing publicly listed or private company by a private equity firm in which the acquisition is funded by debt, typically provided by a bank. Equity or shareholder loans provided by a private equity investor and, sometimes, also the management of the target company. A newly incorporated special purpose vehicle (“SPV”) is typically used as the acquisition vehicle. Payments by the SPV of principal and interest on the bank debt are serviced by cash flows of the target. Security for the bank debt is provided with the shares in the target held by the SPV and with the target’s assets (HM Treasury, 2001).
Different types of LBO’s are:
Management buy-out (MBO): A type of LBO where funds are provided to enable the current management to acquire an existing product line or business. Management buy-in (MBI): Funds provided to enable an external manager or
group of managers to buy into an established company.
Public to Private: Purchase of equity of publicly listed companies, which are delisted subsequently to become private companies again. Private equity capital is provided to finance the development of the private company, with the aim to a relisting or sale.
3.3 Private equity fund structures
Private equity funds are usually organized as limited partnerships as seen in figure 4 with the limited partners providing most of the capital and the general partners making investment decisions and receiving a substantial share of the profits, most often around 20% (Axelson, 2009). Limited partners can include any type of person and organization with the necessary funds for investment.
Figure 3. Typical LBO structure (source www.altassets.com)
Equity &
3.4 Private equity providers
There are different types of private equity from different types of providers. There are classic private equity firms but also funds, persons, banks, corporate investors and insurance companies. All types of European equity investors are depicted in figure 5. Because of the financial crisis in 2008, a drop in private equity investments by banks and a rise in public equity investments is observed. In this research the focus will be on the private equity firms as described in section 3.2. These private equity firms can operate as a single entity (e.g. August Equity, Waterland Investments), operate for institutional investors such as pension funds or insurance companies (e.g. Alpinvest, Allianz Capital partners) and operate for banks (e.g. ABN structured capital markets, Barclays private equity). An overview of all private equity investors incorporated in this research is provided in appendix II.
3.5 Why are private equity investments in healthcare growing?
When defining the size of the healthcare sector, different types of organizations are included. In this research healthcare is used in a broad sense because there are more types of companies related to healthcare than just hospitals. If a country has a public healthcare system, related companies can profit from the public market. Public healthcare organizations operate inefficient and suppliers can charge high prices. Insurance and pharmaceutical companies are excluded from the research because they represent a large specific healthcare sector themselves.
The growth of the for-profit healthcare sector is based, at least partly, on expected cash flows and profitability. The next question is whether investments in healthcare are more profitable than investing in other sectors. This research tries to shed light on this issue. To find out how interesting the healthcare sector is for investors the return on private healthcare investments has to be calculated. Private healthcare companies can be allowed by the government to charge higher prices than public healthcare companies and make more direct and strict cost cutting decisions. High market power by these companies assures the excitability of these strategies. A few factors are typical for the healthcare market; a concentrated market because of high entry barriers and high levels of information asymmetry between clients and providers.
A private healthcare market implies for-profit healthcare companies and institutions. A for-profit hospital can be defined by the existence of proprietary rights that represents formal control of the firm (Furubotn and Pejovich, 1972). These proprietary rights include:
1) The right to receive the residual, after all other obligated payments have been made 2) The right to terminate or revise the ownership of the company
3) The right to sell the rights specified under 1) and 2)
Chapter 4: Financial Analysis of Private Equity Investments in
Healthcare
4.1 Introduction
In the recent decade interest in healthcare investments has increased throughout Europe (Wagley 2000, Jeurissen 2010). Why has this occurred? Aside the fact that regulations on private healthcare are less strict than before, a return on investment and an increase in value is expected by investors. Is this a correct assumption? In this chapter the value creation of private equity investments in healthcare is studied. Value creation is defined as the difference in acquisition and selling price of healthcare companies. This difference is considered as value for the investor. Did the private equity investments in healthcare companies create value? If they did, was there more value created compared to an average market investment? This chapter tries to answer these questions for the European private healthcare market by extensive financial research.
4.2 Research variables
An investor invests because he expects a return on investment. The return on investment can be measured with the following equation (1):
, = ,+ ,
=0
− ,0
, = Return on investment of company i, at moment t , = Sum of dividends of company i, at moment t , = Offered selling price for company i, at moment t
- , = Net debt + equity received for company i, at moment t ,0 = Acquisition price of company i, at moment 0
In an ideal research situation the return on investment would be measured by deducting the acquisition price ( ,0) from the selling price ( ,) and the sum of received dividends ( , ) produced by the investment. The period from acquisition to selling point of the investments is considered the holding period. This base equation is simple but when trying to provide a more realistic image of private equity deals, more comprehensive variables need to be taken into account. Financing structure, net debt position at acquisition and selling point, investments and divestments during the holding period, market expectations, economic growth, exchange rates and type of debt provided by type of institution are only the beginning of a long list of variables that influence private equity investments.
Before the research methodology is described, we start with some important definitions:
Target company: the healthcare company subject to be bought and sold by a private equity firm
Private equity firm: the private equity investor that buys, or partially buys a healthcare company
Holding period: the period that the private equity firm keeps the healthcare company in its portfolio
4.3 Research methodology
To find out whether private equity investments in healthcare have created value a dataset of deals had to be established. After comparing different financial databases on quality and accessibility, MergerMarket was chosen. This website offers in depth information on all types of investments throughout the world.
4.3.1 Value Creation
The main research variable in this research is value created by healthcare companies for private equity investors. The dataset consists of European healthcare companies that have been bought and sold from 01-01-2000 until 31-12-2010. After data management and research it seemed that the return on investment equation (NUMMER!!!) shown in section 4.2 could not be used. There was no information available on the net debt positions of the target companies. Net debt is necessary to calculate the amount of equity invested. With the available information at hand, the best method for research was measuring value creation. In the section below the rationale and the thorough basis for using value creation instead of the return on investments is explained.
For most of the deals incorporated in the dataset, Mergermarket could only provide the enterprise value and not the equity value nor net debt incorporated in the deals. The enterprise value equation (2) is provided below:
= +
= Enterprise Value of company i = Net Debt Value of company i = Equity Value of company i
Hence the choice was made to analyze the change in enterprise value of the target companies. Another complicating factor are the dividends received by the investor (y). These are mostly undisclosed. There are two reasons for the lack of information on this variable:
1. Private equity firms are not publicly traded and are not obligated to provide information on their investments.
A solution to the problem of lacking information on net debt and dividends is to gather all annual reports from the target companies incorporated in the dataset. These annual reports have to be from before, after and during the holding period. Unfortunately annual reports during the holding period are generally not available because of the two reasons mentioned above. Furthermore the annual reports from before and after the holding period proved hard to find, incomplete or non-existent. MergerMarket nor any other kind of information database would be possible to give further insight into this matter. Therefore the decision was made to continue the research with value creation as main research variable.
Value creation entails the difference in enterprise value at the moment of buying and selling the target company. We assume that growth or decline in enterprise value reflects the same fluctuation in equity value and thus value created for the investor. The reasons for choosing value creation are explained in the following section. The value creation equation (3) reads as follows:
, =
,0− , ,0
, = Value creation of company i, at moment t ,0= Acquisition price of company i, at moment 0
- ,0 = ( + ) invested in company i, at moment 0 , = Received selling price for company i, at moment t
4.3.2 Handling the Net Debt issue
The problem with lack of information on net debt of a target company is a possible change in debt structure during the holding period. This distorts the outcome of the return on investment. An example is provided below:
Company i is bought by investor A at moment 0 with an enterprise value of 1 million euro and 100.000 euro net debt. Company i has a 900.000 euro equity value.
Company i is sold by investor A at moment t with an enterprise value of 1.5 million euro and 600.000 euro net debt. Company X has a 900.000 euro equity value.
While the enterprise value of the company has risen, the equity value has remained unchanged. This would imply that there is no return on the investment during the holding period.
The same problem occurs when the target company invests in another company during the holding period by the investor. This may change the net debt structure. Information on the financing structure of these interim deals are undisclosed. The only information available is the occurrence of an interim purchase by the target.
Thus, equity value and net debt are excluded from the research. This could influence the quality of the research. However, in this research the focus will be on creation of ‘value’. This means enterprise value will be used as the basis for the analysis. However, accepting enterprise value as the basis for value creation has actually advantages over equity value.
2. Criticism on private equity firms often entails extracting most of their investment directly after the deal has been closed. This usually happens by attracting more net debt and using these funds for paying out dividend to itself. This creates equity value for the investor but does not create enterprise value for the target company.
3. Enterprise value is less arbitrary than equity value. The different ways of financing investments is excluded. The financing structure is more important to the investor than to the target company’s growth and success. Rather it is used for growth of the equity value and therefore the private equity firms’ profit, when selling the company.
Also from a theoretic point of view, it is defendable that changes in enterprise value corresponds with changes in equity value. The idea that leverage does not influence the market value is based on the Modigliani and Miller theorem (Modigliani and Miller, 1958) that states: “The market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of the way it chooses to finance its investments or distribute dividends.” This theorem has been widely discussed (Giesecke & Goldberg 2004, Becker 1978, ). Nonetheless its validity is still supported in contemporary literature (Bradley et. al 1984, Lally 2004). A first leverage pricing model that emerged from the Modigliani and Miller theorem is the Merton model (Merton, 1977) which tries to find a fair price for corporate debt. A problem with these models is that they only hold in a perfect economy. According to Rubinstein (2003) a perfect economy entails:
1. No riskless arbitrage opportunities.
2. Operating income (from assets) is not affected by capital structure.
3. The proportion of operating income that is jointly allocated to stocks and bonds is not affected by the firm’s capital structure.
4. The present value function is not affected by capital structure
experience on capital structures. For this research it is assumed that all target companies have an appropriate leverage ratio, which does not harm the equity value.
4.3.3 Outperforming the market?
Suppose that the findings of this research indicate that private equity investments in healthcare create value. This means that there is a positive difference in deducting the selling price from the acquisition price. This is valuable information. However, more important is; how much value is created? We want to find out whether private equity investments in healthcare have created more value than other types of investments and thus outperform the market. The growth or decline in value will be compared with a suitable market index (e.g. LSE, DAX or AEX) depending on the size and country of origin of the target company.
4.3.4 Handling the dividend issue
Because of the lack of information on received dividends by the investor we assume that no dividends are paid out from the target companies to the investors. Instead cash flows are assumed to be used for paying off the investors’ bank loan, or reinvested in the company. This means that when comparing the value creation of the healthcare companies against market indices, reinvestment indices have to be used for appropriate comparison.
4.4 Establishing a research population
4.5 Gathering the data
The amount and the quality of the data from mergermarket.com were the base and simultaneously the bottleneck of this research. MergerMarket allows to create datasets based on different variables. For this research all deals and investments made by private equity funds in European healthcare from 01-01-2000 until 31-12-2010 were selected. The choice for 10 years was made in anticipation of the amount of data the search would generate. The Mergermarket database search generated a dataset consisting of around 2500 deals in the European healthcare market.
4.6 Data management
Equation (3) as shown before in section 4.3.1 requires an acquisition deal and a selling deal. This means that the healthcare companies in the dataset had to be bought and sold by a private equity firm, within the ten year timeframe. All 2500 deals were scanned and about 100 companies that had been bought and sold by an investor in the past 10 years remained. For this research it is assumed that 100 random selected healthcare companies, spread throughout Europe provides an unbiased sample. Data reports from Mergermarket show an array of information on every deal. MergerMarket provides two types of reports: financial reports and deal reports. The first provides financial and brief background information on every deal, the latter provides more qualitative information. For this research the use of financial reports was necessary. Mergermarket financial reports contain the following variables:
MergerMarket is not able to provide a consistent amount of information on every deal. Especially information about the EBITDA and EBIT Multiples appeared to be infrequent. The first step was to analyze the information provided by Mergermarket, on every deal and create a list of research variables.
4.7 Structuring the datasheet
Since the final research variables of the research were dependent on the quality and availability of data, the raw data had to be filtered and restructured. This section will explain how the data was restructured and the choice for final research variables. Reducing and enhancing the raw data was necessary. Some variables were removed, some were kept, some needed more information and some were added after further research.
The final variables in the dataset, their rationale and how they were established are set forth below:
Acquisition date
The completion date of the acquisition deal was chosen because it measures the actual date of acquisition of the target company. This is the start of the holding period.
Selling date
The completion date of the sale of the target company was chosen, to correspond with the actual acquisition date and define the duration of the holding period.
Holding period
This is the period in which the target company was held in an investment portfolio by a private equity company. The holding period is denoted in years. The holding period is also used to compare the value creation of the target company and the growth in a market index during the same timeframe.
Target company
Private Equity Fund
The private equity fund is the investor that has bought and sold the company in the ten year timeframe. Different situations occur. Sometimes a private equity funds backs up the management of the target company for a management buy-out. In some cases the target company is bought by only one private equity fund, and in other cases by a consortium of private investors or funds.
Stake bought
The stake bought represents the stake percentage of shares that the investor has bought in the target company.
Stake sold
This variable entails the percentage of shares in a target company that is being sold. For example, a private equity firm buys 75% of stock in a target company. When it sells the entire 75% at the end of the holding period, the ‘stake sold’ is 100%. When the investor sells 50% of the 75%, the stake sold is 37,5%. The stake sold is incorporated in the dataset so it can be multiplied by the selling price in order to calculate the value of the stake sold.
Acquisition price
In the Mergermarket datasheets there are two important variables regarding the acquisition price; enterprise value and deal value. The enterprise value is the total value of equity and net debt of the target company. The deal value is equal to the enterprise value when a 100% stake bought in the company. When the deal value is less than 100%, the percentage is multiplied by the enterprise value.
However, there was one problem with the Mergermarket deal variables. Not all enterprise and deal values were comparable because Mergermarket provided three different types of acquisition values:
2. 50-99% deals: The enterprise value and deal value represent the stake in equity value and 100% in net debt. Mergermarket states that the investor is responsible for the entire company if it owns a majority stake.
3. 0-49% deals: In these deals the enterprise value and the deal value only represent the equity value.
Most of the deals in the datasheet are 100% deals. The 50%-99% stake deals include 100% net debt. Since the amount of net debt is unknown we assume 100% net debt as well. The 0-49% stake deals however, create a problem. They only represent the equity value and exclude net debt. This means that 50-100% stake deals represent enterprise value while the 0-49% only represent equity value. A total of 10 deals had a 0-49% stake. Because all deals are compared on enterprise value, net debt had to be calculated for these cases. By investigating the annual reports for the target companies, before or after closing the deal these value were found. For 5 deals the annual reports were found and the net debt and enterprise value was calculated. The other 5 deals were removed from the dataset.
The value ( ,) of the stake is calculated as follows: The first step is to calculate the net debt ( ) of the target company from the balance sheet. To do so we have to calculate the excess cash by deducting 20% of the turnover1 from the total cash position of the target company. Second, we calculate the net debt ( ) by deducting the excess cash from the total debt. After that we multiply the stake percentage times the net debt ( ) and add it to the stake of the equity stake ( ).
1. Excess Cash = Total Cash – (0,2 * Turnover) 2. Total Net debt ( ) = Total Debt – Excess Cash 3. Stake of Net debt ( ) = Stake *
4. (Stake * ) + Equity value ( ) = Stake value ( ,)
Selling price
This is the enterprise value, or stake in enterprise value that is sold by the private equity fund at the end of the holding period.
Management buy-out
To find out whether the deal was a management buy-out (MBO), all ‘deal descriptions’ had to be read. The ‘deal description’ gives a summary of 100-400 words about the background and context of the deal. This summary also provides information on whether the deal is an MBO or not. In the datasheet this variable denotes a 1 for an MBO, and a 0 for an investment without management participation.
Type of buyer
This variable denotes whether the target company has been sold to another private equity fund or to branch related (healthcare) company. In the Mergermarket data sheets it is denoted as ‘buyer company’.
Capitalization
The capitalization (CAP) variable classifies the size of the deal and the enterprise value of the target company. The classification is based on definitions from investopedia.com and includes nano, micro, small, mid and large. This classification helps to find a suitable market index for comparison.
Country of origin
To determine the country of origin of the target company, background information was necessary. Occasionally the ‘deal description’ provided information on this variable. If information was not available, internet search engines were consulted. The country of origin variable helps to classify the target companies by country and choosing a suitable market index for comparison.
Target company category
The healthcare sector contains different subsectors. Because we want to study the healthcare sector in a broad sense, different types of healthcare companies are included in the dataset. The healthcare companies were classified in four categories2:
- LAB: Laboratories and diagnostic laboratories
- DEV: Producers of medical devices and medical equipment
- DIV: Diversified companies mainly have operations in healthcare but in other business fields as well.
Value creation (Gross value creation)
Value creation is the main research variable as discussed earlier in this chapter. The value creation equation (3) is shown in section 4.3.1. From now on value creation is referred to as ‘gross value creation’.
Market index
A market index was used to measure the growth in a comparable reinvestment index over an equal period as the holding period of a company. The index values extracted from Datastream v4.2. The specific index depended on three factors; the country of origin of the target company, the size (CAP) of the target company and the availability of data. Data from the national reinvestment indexes were used, unless data was missing. In that case data from global stock market indices was used. The FTSE3 as first choice and when FTSE data was also missing the MSCI4 was chosen.
Index growth rate during period
The index growth rate is calculated by dividing the index value at the date of the sale of a target company by the index value at the date of acquisition of the target company. Difference value created & Index growth (Net value creation)
Each deal has a ‘gross value creation’ variable and a ‘index growth rate’ variable. To calculate the outperformance of value creation, the ‘gross value created’ is divided by the ‘index growth rate’. This way, the difference in value growth of the investment can be compared to the index growth during the same period, per deal. We call this outperformance ‘Net value creation’.
Intermediate purchases
MergerMarket does not provide information on deal sizes and financial structures of acquisitions made by target companies during the holding period of an investor. The only
information available is the occurrence of an acquisition. In the datasheet this is denoted as a 1, if the target company has not executed intermediate purchases this is denoted as 0.
Chapter 5: Results
5.1 IntroductionIn this chapter the dataset is statistically analyzed. In the first section a description of the dataset is provided. After that the first research question discusses whether European healthcare investments have created value and if they have outperformed the market. The remainder of the research questions follow. The results are provided by means of statistical analysis with SPSS.
The two main research variables ´value creation´ and ´index growth´ are considered ´string variables’ by SPSS. String variables are considered nominal and had to be transformed into numeric variables for analysis. We will determine the value of both variables and test on significance in difference of means. Therefore a paired sample t-test is used. This test computes the difference between the two variables for each case and tests whether the average difference between them is significantly different to zero. The remaining sub-questions test the significance of difference in mean values of two groups and are analyzed with independent sample t-tests. After that we apply a multivariate regression analysis for testing the joint influence of the different factors on value creation. The results are checked on robustness by testing two different sub-groups of the dataset. In the last section an overview and conclusion of the results is provided.
5.2 Descriptive statistics
Table 3 indicates that the value of acquisition deals varies within a range of 3,4 billion euro. The selling deals have a range of 3,16 billion euro. The mean value of the acquisition deals is 288,79 million euro, the mean value of the selling deals 495,51 million euro. This would indicate that healthcare investments by private equity firms have created value. Because there are more aspects that complicate this assumption, and to prove significance, the dataset will be analyzed with more statistical tools in the next sections.
The period in which all deals took place was from the 1st of January 2000 until 31th of December 2010. The holding period has a range of 8,45 years with a maximum holding period of 8,62 years and the minimum holding period of 65 days. The average holding period is 3,55 years.
The maximum gross value created was 12,69 times initial investment, or a gross value creation of 1169%. The minimum value creation is negative with 0,16 times the initial investment (-84%). Net value created is the gross value created divided by the market indices growth during the same period, also referred to as the market outperformance. The maximum net value creation is 13,81 times initial investment or 1281% market outperformance. The minimum net value creation is negative with a loss of 0,04 (-96%). The average market outperformance being 1,95 or 95%.
Table 3. Descriptive statistics
N Range Minimum Maximum Mean Std.
Deviation Acquisition Price 92 3423,00 5,00 3428,00 288,76 523,88
Selling Price 92 3156,00 10,00 3166,00 495,51 681,13
Holding Period 92 8,45 0,17 8,62 3,55 1,77
Gross Value Creation 92 12,53 0,16 12,69 2,32 1,84
Net Value Creation 92 13,77 0,04 13,81 1,95 1,91
5.3 Value creation
This section tries to answer the main research question by providing results on value creation. The gross value creation is compared to the growth of the market indices in order to calculate the outperformance. The main research question is:
- Did private equity investments in European healthcare create value?
The results from the dataset indicate that European private equity investments in healthcare have indeed created value. However, at the same time European economies experienced growth. This means that the selected market indices have created value as well. The real percentages are provided below:
Average gross value created by European private equity investments: 132,45% Average growth of the specific market indices during the same timeframe: 40,9% Net value creation or market outperformance: 91,55%
The next step is to statistically prove that the investments in European healthcare have created significantly more value compared to the European market indices. To statistically prove this, we want to eliminate coincidence. This coincidence will be represented by alpha (Sigma). The chance that the market outperformance is based on coincidence will have to be below 5% (Sigma = 0,05) to ensure significance.
Hypotheses:
H0: Private equity investments in healthcare have not created significantly more net value than average market reinvestment indices
Table 4 shows the mean of 2,32 for gross value creation. This means the average value of the private equity investments has been multiplied by 2,32 (132%) from 2000 until 2001. The mean of 1,41 shows that the average market indices value in Europe has been multiplied by 1,41 (41%).
N# Mean St. Dev. Sig.
Gross Value Creation 92 2,32 1,84
Market Indices Growth 92 1,41 0,59
Value creation Paired 0,92 2,02 0,00
Table 4. Value creation
The results indicate that private equity investments in the European healthcare market, from 2000 until 2010, have created significantly more value compared to the average European reinvestment indices. This is shown by the 0,92 (91,55%) difference in means and a Sig. of 0,00. H0 is rejected and H1 is considered.
In the upcoming sections, the sub-questions are set forth. They are answered by analyzing the research variables that were established in section 4.7.
5.4 Value creation by MBOs
There are several types of private equity investments as mentioned in section 3.2. One specific type of investment is the management buy-out. When a private equity firm acquires the target company it can involve the management of the company. This sub-question provides insight into management buy-outs (MBO) and their influence on the creation of value. The sub-question is:
- Did management outs create more value compared to non-management buy-outs?
MBOs also align the managers’ and financiers’ strategies for realizing a return on investment. This has a positive effect on the value of the company (Wright et al. 1994).
The MBOs and non-MBOs in the dataset were transformed into 0 = non-MBO and 1 = MBO. Because two independent groups are tested on significance of difference in means, the independent sample t-test is used. We want to know the difference in net value creation between the two groups. The net value creation is used for analysis to eliminate error: What if a MBO has created more value compared to a non-MBO, but the MBO was performed during a time of greater economic prosperity? This means the increase in value would be explained by economic growth. To guarantee a fair basis for comparison, the net value creation is used as a test variable in all upcoming sub-questions.
Hypotheses:
H0: Management buy-out have not significantly created more net value than non non-management buy-outs
H1: Management buy-out have significantly created more net value than non non-management buy-outs
Table 5. Group statistics MBO
Test Variable MBO N# Mean St. Dev.
MBO vs Non-MBO
No 35 1,89 1,42
Yes 57 2,59 2,02
Table 6. Independent sample t-test MBO
Test Variable Equality Variances Assumed? (Levene) Mean Diff. Sig.
Difference in Value creation Yes -0,7 0,06
The Sig. of 0,06 in table 6 indicates that the difference in value creation for both groups is not significant. This would mean H1 is rejected and H0 is adopted. However, because the Sig. shows a value close to Sig. = 0,05 we assume ‘marginal’ significance of H1.
We now know that MBOs have create more value compared to non-MBOs. In the next section the difference in net value creation depending on the type of buyer is analyzed.
5.5 Type of buyer
Why would there be any difference in value between different buyers? The answer lies within the selling price of the target company. In this research it is assumed that two situations can occur when selling a target company:
- Did target companies sold to a branch related buyer create more value than companies that were sold to private equity firms?
The theory behind this is that when a target company is sold to branch related company, it will have certain synergies with the target company. The branch related buyer might already have an experienced administration in office, knowledge, experts in the field, etc. A private equity company would not have these advantages. The expected cash flows of the target company go up when it is sold to a branch related buyer. When expected cash flows rise, the selling price increases. The net value is used as test variable.
Hypotheses:
H0: Selling the company to a branch related company does not imply significantly more net value than selling it to a private equity fund
H1: Selling the company to a branch related company implies significantly more net value than selling it to a private equity fund
Table 7 indicates 42 branch related buyers and 50 private equity firm buyers. Target companies that were sold to a branch related buyer had a higher net value creation with 2,4 times initial investment (140%) compared to companies that were sold to another private equity firm with 1,57 (57%) times initial investment.
Table 7. Group statistics branch related buyer
Test Variable Branch Buyer N# Mean St. Dev.
Type of buyer Yes 42 2,4 0,39
Table 8. Independent sample t-test Branch related buyer
Test Variable Equality of Variances Assumed? (Levene) Mean Diff. Sig. Difference in Value
creation No 0,84 0,02
Levene’s test for equality of variances indicated 0,006 which is below Sig. = 0,05. No equality of variances was assumed. Table 8 reflects that by selling the target company to a branch related company the value creation was significantly higher (84%). This means H0 is rejected and H1 is adopted.
We now know that management buy-outs and selling the target firm to a branch related buyer increases the net value creation. In the next section U.K. healthcare investments are compared to continental healthcare investments on net value creation.
5.6 Value creation in the U.K.
There is reason to believe that healthcare investments in the U.K. have created more value for private equity firms compared to those in continental Europe. The U.K. private healthcare market evolved earlier and has had more time to develop into a mature market. It is more open to private care compared to any other country included in the dataset. The sub-question is:
- Did healthcare investments in the U.K. create more value than in the rest of Europe?
Hypotheses:
H0: Healthcare investments in the U.K. have not created significantly more net value compared to healthcare investments in the rest of Europe
H1: Healthcare investments in the U.K. have created significantly more net value compared to healthcare investments in the rest of Europe
Table 9 indicates a net value creation of 1,86 (86%) times initial investment for non-U.K. investments and a 2,06 (106%) times initial investment for U.K. investments. The actual growth numbers of the U.K. firms in the dataset are slightly higher than the non-U.K. investments. Next step is to find out if this difference in net value creation is significant.
Table 9 Group statistics U.K.
Table 10. Independent sample t-test U.K.
Test Variable Equality of Variances Assumed? (Levene) Mean Diff. Sig. Difference in Value
creation Yes -0,2 0,31
The Levene test showed 0,95. This means equality of variances is assumed. Table 10 shows the mean difference is -0,2 (-20%) and the Sig. of 0,31 is far above 0,05. This implies that H1 is rejected and H0 is adopted. The difference in value creation is most likely to be explained by coincidence. This implies that U.K. healthcare investments are not perceived to be more profitable than continental healthcare investments.
We now know that management buy-outs and selling the target firm to a branch related buyer have a positive effect on net value creation. U.K. healthcare investments have not
Test Variable U.K. investments N# Mean St. Dev. U.K. investments
No 48 1,86 0,32
created significantly more net value. In the next section care and cure related companies are compared to other types of healthcare companies on net value creation.
5.7 Care & cure versus other healthcare companies
To make assumptions about a large part of the healthcare sector not only hospitals were included in the dataset. As mentioned in 4.7, different types of healthcare were also incorporated. The four subgroups that these were divided into were:
- Care & Cure - Laboratories - Medical Devices - Diversified
There is reason to believe that private hospitals and care homes are very profitable (Jeurissen, 2010). They operate in a monopolistic environment with high information asymmetry between patients and specialists. Private hospitals and care homes can also demand high prices for their services. Profit margins can be raised significantly because there is opportunity for cutting out the slack in these organizations by means of strict efficiency strategies. The previous factors would translate into higher positive future cash flows, raising both the buying and selling prices. The sub-question is:
- Did investments in care & cure related companies create more value than others?
Hypotheses:
H0: Care & Cure related companies did not create significantly more net value than other types of healthcare companies
Table 11 indicates that 40 target companies turned out to operate in the care & cure sector. The rest of the companies were compiled of the latter three subgroups. The means in table 11 indeed show that care and cure related companies delivered higher value compared to laboratories, medical devices producers and diversified healthcare companies. Care and cure companies delivered 2,23 (123%) times initial investment compared to 1,74 (74%) times initial investment for the rest.
Table 11. Group statistics C&C
Test Variable C&C N# Mean St. Dev.
Care & Cure
No 52 1,74 2,03
Yes 40 2,23 1,72
Table 12. Independent sample t-test C&C
Test Variable Equality of Variances Assumed? (Levene) Mean Diff. Sig.
Difference in Value creation Yes -0,49 0,1
The Levene test proved that equality of variances is assumed. From table 12 the mean difference of -0,49 shows a significance of 0,1, surpassing Sig. = 0,05. This means that H1 is accepted and H0 is rejected. However, because the Sig. shows a value close to 0,05 we assume ‘marginal’ significance of H1.
