Expert View: Health equals wealth in private equity's master plan

Global, 'mega' funds are making audacious plays and raising record sums

The world of private equity started last week with an incredible coup: the US hospital chain HCA was acquired by a consortium of private equity houses for a record-breaking $33bn (£18bn).

These global, "mega" private equity funds are now making audacious plays and raising record sums. Investors all over the world, from pension funds to super-wealthy families, are knocking down the doors of the top-performing houses to get a piece of the action.

Much of the cash is coming from US state pensions and endowments. A rule of thumb is that the big pension funds will make up around 20 per cent of a private equity fund's clients, but will invest around 80 per cent of the capital. A lot of speculative money is in the market, much of it coming from high-net-worth investors. Much of this is cyclical: when the markets are healthy, more money is available to invest in non-core, alternative investment vehicles. The flow is likely to slow down, however, if the market turns.

The same is not the case for the pension funds. Even if the market does turn, private equity will continue to be a growing industry, probably for a long period. But in such a competitive market, where will they find the opportunities?

They invest across all industry sectors, but healthcare has become the hot one recently. HCA is the landmark private equity deal to date, but it is in analysing the type of businesses private equity firms want to buy that we get a window into their master plans.

What is so exciting about the healthcare sector? The drivers across the developed world are ageing demographics and a heightened awareness of healthcare. In the US, an additional prize could come from the raft of health reforms that have been predicted. The private equity houses are keen to seize upon these opportunities.

It is not all milk and honey, however. In the UK, changes in policy on the NHS have turned the volume down on this particular party, and a curtailment in spending by the Government is expected to mute the more traditional investment opportunities. So what's the next angle?

One huge opportunity for private equity houses is to develop business models that bridge the gap between primary and secondary care. For example, acute hospital care is an expensive and not especially effective way of looking after people with long-term illnesses. But the next available level of care, provided by local authorities, is not intense enough. This gap between primary and secondary care is a result of the lack of synergy between the NHS, which runs hospitals, and the social care from local authorities. The opportunity for the private sector lies in developing a new kind of business model, such as high-end home care, to capture the shifts in service delivery emphasised by recent government policies. At the current time there are few entry points into this market for private equity, but it is an area that could develop significantly.

As markets mature and consolidation opportunities diminish, private equity houses will always be busy tracking down the next big thing. So far, the best have delivered impressive returns for investors, and one can only conclude that the institutions and individuals that continue to queue up to invest in private equity funds are confident they will carry on working their magic. Perhaps, however, it is less a matter of "more of the same" and more "pulling another rabbit out of the hat".

David Jones is a corporate finance partner at Deloitte