The Australian Aged Care Market

Australia | Focus on

The vulnerability of asset rich but cash poor operators

Adrian Arundell
Joint Managing Partner
Azure Capital

The Australian aged care industry is a +A$20 billion per annum revenue generator, employing over 224,000 staff across more than 1,800 businesses who care for over 270,000 elderly and disabled residents[1]. Despite significant consolidation of recent years and the emergence of leading ASX listed players, the market is still defined by a significant number of small-to-medium sized businesses operating under an increasingly burdensome regulatory framework. 

 

The market is largely funded by government contributions primarily through the Aged Care Funding Instrument (ACFI) which are aimed at funding operational costs of operators, complemented by private payments (being a combination of lump sum payments and/or daily fees) which are aimed at funding capital costs of providers.

 

The major listed players are Regis (market capitalisation of ~A$385m), Estia (market capitalisation of ~A$390m) and Japara (market capitalisation of ~A$130m). Given the trend towards an ageing population, a generally historically ‘under bedded’ environment and the attractive counterparty exposure to government funding, the industry has also attracted significant private equity interest – with the most high profile players being Allity Care (Archer Capital) and Opal (AMP/G.K. Goh).

 

The Australian aged care market has experienced an unprecedented level of volatility in the past 12-24 months. A Royal Commission, COVID-19 and ongoing reforms to government funding (including an increasing government preferencing of home care models) have created enormous uncertainty in the industry. As a result, the listed players have generally experienced a 50-75% fall in their share prices over the last 12 months. These share price falls are reflective of both an expected reduction in future earnings through reduced revenue and increased costs, but also the higher cost of funding due to the increase in assessed risk of investment in the sector.

"The Australian aged care market has experienced an unprecedented level of volatility in the past 12-24 months.  A Royal Commission, COVID-19 and ongoing reforms to government funding (including an increasing government preferencing of home care models) have created enormous uncertainty in the industry. "

The final report from the Royal Commission is due in February 2021. The federal government has committed to a regulatory response to this report when it is released, however, there remains uncertainty regarding what structural reforms it intends to pursue.   

 

In addition to these issues, there has been an underlying large and more immediate change to individual funding preferences which are likely to further exacerbate the industry-wide issues referred to above. This change in ‘funding preference’ outlined below is likely to lead to significant distress for some players in the Australian market and therefore interesting buying opportunities for patient acquirers who are willing to take a view on likely regulatory outcomes and have sufficient capital buffers to manage through any periods of funding dislocation.

 

The individual funding preference issues arise from a transition away from residents traditionally paying a ‘lump sum’ Residential Accommodation Deposits (RADs), to a preference instead for a higher monthly Daily Accommodation Payment (DAP) as an alternative to a RAD. Many operators hold only a portion of the RADs they have received from existing residents in cash (i.e. a ‘prudential cash buffer’), relying on incoming resident RADs to fund the outgoing RAD liability of departing residents. Where incoming residents choose not to pay RADs, many operators will quickly deplete their prudential cash buffer – leaving them with significant unfunded cash outflow requirements. In effect, the change in RAD/DAP preferences is shifting a capital funding burden from residents to age care operators – many of whom are ill-equipped to procure funding from alternative sources, especially when traditional funding providers are increasingly nervous about investment in the sector.

 

This DAP preference trend is being observed industry wide:

"For example, the proportion of people choosing DAP/DACs has risen from 33 per cent in 2014-15 to 41 per cent in 2018-19. A sustained move away from RAD/RACs will have significant financial implications for many residential care providers, depending on how they have structured their business. However, a significant potential risk for providers is a sizeable and quick cash outflow in repaying RADs in response to the spread of COVID-19 in a facility. In such a situation, new residents may not be replacing departing residents. In addition, a downturn in the housing market as a consequence of COVID-19 would flow through to lower use and lower value of RADs."[2]

 

The pace of this change, and hence escalation in net cash outflow for operators, is causing significant anxiety in the industry with predicated debt levels (for those that have accommodation facilities) expected to increase significantly.

 

For those that haven’t secured appropriate financing arrangements their vulnerability is about to be exposed – with many asset rich, but cash poor operators needing to urgently find solutions. At 30 June 2019, total of A$30.2 billion of RADs was held by providers[3]. A net outflow of as little as 10% of this balance would create a funding hole of circa A$3 billion.

"For those that haven’t secured appropriate financing arrangements their vulnerability is about to be exposed – with many asset rich, but cash poor operators needing to urgently find solutions."

In this context the trends we believe are likely to emerge include:

  • Emergence of non-bank lenders to bridge finance the transition from RADs to DAPs: We believe a significant opportunity exists for new entrants to the market to approach operators facing net cashflows to offer financing (largely backed by land and buildings) to assist with the transition to DAPs;
  • Increased sale and leaseback of facilities: Yields for healthcare assets are at all time lows and the ability to essentially derive long term fixed price lending through sale and leaseback will be attractive.  We believe there is an opportunity for large scale property investors to secure significant exposure to this asset class; and
  • Distressed sales and opportunistic buying: The natural limitations of the Australian lenders, the time it will take new financiers to enter the market and unfortunately the lack of the perceived need by some operators to move fast (and now) will mean M&A opportunities will likely arise.

 

Azure Capital has advised on several significant transactions in the aged care industry, including advising Bethanie on the acquisition of Berrington (a 211 bed business), Craigcare on its sale to Bain Capital (a 900 bed business) and Mercycare’s acquisition of Belrose Care (a 254 bed business).  We are actively involved with participants in the industry and working to develop solutions to these emerging issues.

[1] https://japara.com.au/news/future-trends-in-australian-aged-care/

[2] Australian Government - Eighth report on the Funding and Financing of the Aged Care Industry July 2020

[3] Australian Government - Eighth report on the Funding and Financing of the Aged Care Industry July 2020

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