Healthscope owners contributed to its corporate heart attack

To say the collapse of private hospital giant Healthscope was an accident waiting to happen feels like a statement of the bleeding obvious. For Canadian private equity player Brookfield, which paid $4.4 billion for the company in 2019, it was an embarrassing and costly commercial misjudgment.

With Healthscope placed in administration this week, the process of selling individual hospitals or groups of them has begun. Up to 10 buyers, including Macquarie Group, St Vincent’s and Calvary and a slew of non-profit operators, are reportedly looking to cherry-pick from the portfolio of 37 hospitals and treatment centres.

Bank funding has been put in place to keep the hospitals open for a period. But the long-term survival of all of them is not assured.

State of emergency: Healthscope hospitals will be sold after the company’s collapse.Credit: Eamon Gallagher

To be sure, there was an element of bad luck for Brookfield with the black swan event of COVID, which delivered a major commercial disruption to all in the private hospital sector.

But for private equity firms, whose strategy largely hinges on buying sick companies, applying their own brand of cost-cutting treatments, amputating their untreatable parts and streamlining their operations, the choice of Healthscope as an acquisition was a head-scratcher.

There was no simple quick fix and a dearth of profit or revenue levers to push.

Brookfield appears to have underestimated the structural challenges facing the industry.

To begin with, there are well-documented and long-running commercial tensions between private hospital operators and the private health insurers that pay their bills.

Private hospitals are very costly to run, and with a range of expenses such as staff, rents and equipment, which have been further rising in the post-COVID era of high inflation, they are in a constant battle to extract more from the health insurance giants.

A government review into the private hospital sector released in November last year found their profit margins had been halved over five years as costs rose faster than revenue.

Needless to say, health insurers, whose customer premiums are government regulated, don’t want to squeeze their own returns. It explains why many private hospitals are run on a not-for-profit basis – often owned by religious organisations.

But Brookfield appears to have underestimated the structural challenges facing the industry.

In the first instance, it funded part of the big purchase price with $1.7 billion debt (as is often the case with private equity deals). Thus interest costs chewed up much of Healthscope’s cash flows. A second funding source was to raise $1.7 billion from the sale and leaseback of hospitals within the portfolio – and as a consequence high rents wiped out its cash flows even more.

Then it miscalculated a pivotal assumption. It figured that the demographic trend of Australia’s ageing population would work in its favour, given the rising proportion of older people who would require hospital services.

But it didn’t count on younger people opting out of private health insurance – particularly during a cost-of-living crisis. In other words, there was decreased demand.

Unlike with regional airlines or dilapidated South Australian steelworks, the government is not about to step in and ensure private hospitals stay open. It wants the warring hospital operators and insurance companies to slug it out between themselves.

What many in the industry describe as an industry crisis is a situation that the government treats as kryptonite. It doesn’t want to upset voters by green-lighting a rise in insurance premiums. Nor does it want to be seen bailing out a large Canadian private equity firm – even one that is the alma mater of Canada’s Prime Minister Mark Carney.

Health Minister Mark Butler would prefer not to characterise the private hospital sector as one in crisis rather suggesting that Healthscope is something of a unique case.

But while the Healthscope case has its own peculiarities, the financial issues surrounding the industry have been well documented.

There is a case to suggest this company is the canary in the coalmine.

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