17 October 2013
In consideration of consolidation
Consolidation is likely to halve the number of Australian residential aged care operators in the next decade, as the sector works to increase efficiencies, attract infrastructure investment and safeguard its ability to care for an ageing population.
This prediction reflects two major shifts occurring in Australian aged care. Firstly, the move from being a society covering the majority of costs for aged care, to one with a higher population of elderly residents and less taxpayers. Secondly, the welcoming of baby boomer generation residents accustomed to higher standards in services and accommodation.
Set against these shifts, a key financial challenge for aged care over the next 10 years will be funding the estimated 90,000 new residential aged care places it requires. With each new place costing on average between $200-$250,000 to build, that’s a total bill of about $20.25 billion in today’s dollars.
With future government subsidies likely to be directed into care rather than capital for accommodation and hotel style service provision expansion, smart providers are defining their strategic focus. Will they be a consolidator, or will they be consolidated? Will they focus on consumer funding, or government funding for the provision of care (as well as accommodation and hotel services) for financial and socially disadvantaged residents?
Current costs in aged care
The Bentleys National Aged Care Survey has analysed the general purpose financial reports and the profit and loss and other operational data of close to 250 residential aged care facilities around Australia.
in 2012, it found low levels of profitability in the sector, with expenses increasing at higher rates than income and the average net profit standing at 7.8 per cent (down from 9.95 per cent in 2005-06).
With greater focus on the decoupling of care, services and accommodation, the survey broke down costs across those categories to identify that care costs now represent 67 per cent of the average provider’s expenses (up from 65.3 per cent in 2011), accommodation at 15 per cent and (hotel style) services at 18 per cent.
It also found that care costs (where subsidies are generally first directed and include items like nursing and chemist supplies), jumped 11.58 per cent between 2011 and 2012.
This is opposed to average income - including subsidies, consumer and other funding combined – which grew at only 7.97 per cent in the past year.
Average services costs (such as cleaning and catering) grew 9.07 per cent since 2011 while accommodation costs (such as rates and other property running costs) decreased slightly, down 1.19 per cent on last year.
Accommodation bonds, a necessary source of consumer capital funding, now account for almost a third of total capital financing (31.17 per cent, up from 16.83 per cent in 2005-06), and government subsidies contribute about 70 per cent of revenue. The average metropolitan provider has around $6.4 million held in accommodation bonds, effectively funds under management, whilst the average non-metropolitan provider holds 25 per cent less at $5.1 million.
Moving forward, subsidies are likely to reduce substantially as the state is forced to care for more people with fewer resources, with funds expected to be funneled towards rural and remote residences as well as those that care for the financially or socially disadvantaged. Significant financial differences exist between metropolitan and non-metropolitan providers, such as the differences in bond levels held, and overall profitability ($11.77 for metro providers versus $6.57 per resident per day on average for non-metro areas).
Consumer funding will increase, particularly as consumers’ abilities to contribute increases through superannuation (which the sector should be watching very closely) and personal wealth. However, new federal government financing arrangements could limit the level of consumer funding providers can access.
Meanwhile, investment as a funding source will rely on the types of returns the sector can offer investors. The 2012 survey reported average return on equity in aged care at 6.57 per cent, which is relatively low compared to the returns in excess of 10 to 12 per cent efficient providers would look for as a return on their equity.
Another area of real growth to support investment into aged care is funds under management (FUM), with refundable accommodation deposits (RADs) paid by residents to aged care providers. The current amount of bonds held by providers is in excess of $11 billion and projected to significantly increase.
This will necessarily however bring a whole new regime of treasury management requirements for residential aged care providers to proactively manage, such as how to use these monies effectively to get the best returns on investment, how long to lock away money for, and what type of investments to make.
With aged care providers less able to control the external impacts of consumer funding and investment, the sector’s focus shifts to how internal factors can help raise funds for capital expansion.
The cause for consolidation
Sector consolidation has been recommended as a way to facilitate efficient use of resources by various sources, most notably by the late Professor Warren Hogan in his 2004 Review of Pricing Arrangements in Residential Aged Care report for the Australian Government.
Otherwise known as ‘economically enforced efficiency’, consolidation of services is inevitable in the future, as taxpayer funding subsides and the sector seeks to further efficiency by cutting down on administration and other costs.
This year’s survey supports this stance, finding that facilities with 60 or more beds performed better, as administration costs were able to be spread out over more residents.
In fact, the top quarter of respondents spent $1.95 less in administration costs per resident per day compared to the bottom three quarters. Doing some high level analysis, if three quarters of today’s 180,000 residential aged care places could save $1.95 in admin costs per day, there would be a resulting $96.086 million of sector-wide savings per year.
Results also indicated a direct correlation between a higher number of beds and higher returns on equity, given they are more efficient. Thus, external investors are more likely to inject capital into larger providers.
Not only do bigger, more consolidated providers have better access to debt and equity, further efficiencies can be gained through group purchasing arrangements for clusters of smaller aged care providers.
The shape of consolidation
In considering consolidation, sector comparisons can be worthwhile. With approximately 1,200 approved residential aged care providers in Australia, aged care is a widely fragmented sector, similar to childcare in the late 1990s.
At the other end of the spectrum, the supermarket and banking sectors (with four key market leaders) represent ultra consolidation.
While residential aged care service provision is unlikely to ever become ultra consolidated, we predict consolidation to around 600 providers is likely over the next decade. Of course, aged care consolidation will be closely scrutinized for provider risk due to its many similarities to the childcare sector, which suffered greatly with the collapse of ABC Learning.
Just as residential aged care providers and facilities are many and varied, aged care consolidation will mean different things throughout the sector.
Consolidation is already happening, for example Bupa's acquisition of Innovative Care, making it the biggest commercial provider in Australia alongside other top-tier players including Domain Principal (owned by AMP) and Regis (owned by Macquarie). Bupa’s involvement in residential aged care is strategically aligned with its primary role as a health insurance funder; it wants to keep people healthy and in home for longer, to reduce health expenses claimed on health insurance such as hospital visits.
At the next level down, there are several mid-tier groups with around four services each that will be looking to consolidate over the next few years.
The next waves of consolidation will likely focus on another one or two mid-tier groups (backed by private equity) acquiring groups of four to eight services to form organisations of around the same size as Bupa is now. This is because these types of funds prefer to make larger acquisitions to maximise use of their time.
In regional and rural communities in particular, consolidation is likely to take the form of community services coming together to share back office functions such as shared purchasing to increase buying power.
These types of organisations will also need to consider what they do with their assets and how they merge them into a new consolidated structure. Often these assets are land and buildings left to them from the community at some time in the past, for example if a wealthy benefactor left some land then the community did fundraising to construct the buildings. These will likely be difficult discussions for proud regional communities, and boards led by local leaders who have fought hard to build a sense of community and see consolidation as deterioration.
Of course, there will always be a role for smaller residential aged care providers, particularly those that provide niche or home-style services or cater to specific care needs, such as respite, transitory care (out of hospital) or condition-specific specialisations such as Dementia care.
It is likely however standalone services of less than 60 places will generally not be viable into the longer term future due to the necessary quality and regulatory frameworks required to support the provision of quality care and safeguard the elderly.
Even if not in the immediate plans, smaller aged care providers should give consideration to whether being a consolidator or becoming consolidated would be a viable option for the future. A practical checklist of matters to consider may include:
- How does each asset and liability on the balance sheet get dealt with? Any legacy issues?
- What is the long term Business as Usual (BAU) position if things don’t change?
- What are the alternatives? E.g. forming a buying group? Sharing a CFO / back of house processing?
- What are key advantages/disadvantages of the proposed arrangement?
- What are proposed synergies of the consolidation activity?
- What new management and governance structures are required?
- What people, systems and processes are necessary?
- What are the cultural/local community sensitivities?
- What is a proposed timing for the arrangement? Any urgency required?
- What legal arrangements are required e.g. Asset/land owning trusts, service companies?