April 2008

Investment and Financing in Healthcare Sector : Dilip Khanna, Associate Director, Healthsciences Practice, Ernst & Young

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The Indian healthcare sector is on a high-growth trajectory propelled by unparalleled domestic growth, increasing public awareness and growing global interest in India’s delivery capabilities. The government’s focus on making healthcare a priority sector, increasing penetration of health insurance, rising per capita income and increased incidence of lifestyle related diseases is resulting in an increase in the patient base. The sector is currently estimated at about US$ 30 billion and is expected to grow at a CAGR of 12-15% out for the next 10-15 years.

According to industry estimates, over next 6 years about US$ 78 billion worth of investment would be required in the Indian healthcare sector.  However, the government spending in the healthcare sector still lags behind other developing nations. According to WHO, government spending on healthcare in 2004 amounted to 24.8% of the total health expenditure in India, as compared to 45.3% in Brazil and 49.4% in South Korea. As a result, private sector participation in this sector is crucial to meet the shortage of quality healthcare facilities it is expected that of the US$ 78 billion investment, up to US$ 70 billion may come from the private sector.

Historically, participation of private sector players has been extensive in the primary and secondary healthcare segment. Corporate hospitals were set up in the late 1980s, but the emergence of chains (other than Apollo to some extent) was not forthcoming. The focus at the time was on availability of medical care rather than providing comprehensive quality healthcare. However, the last 5-7 years have witnessed the emergence of organised healthcare with a number of players such as Fortis, Apollo, Wockhardt, Max Healthcare etc. setting up multiple hospitals and creating a comprehensive healthcare delivery platform. In addition, even players like Apollo Tyres and Reliance, who have traditionally concentrated on other industrial segments, are making a foray into this sector. Due to such private sector participation, revenues from private sector hospitals are estimated to reach around US$ 35.9 billion by 2012.3

Investment Considerations
The healthcare delivery industry (particularly the hospitals) is characterised by the following:

  • Capital Intensive: The hospital business is extremely capital intensive and involves long gestation periods. The initial costs per bed are in the range of INR 5-10 million for tertiary care hospitals in large cities.
  • Manpower Shortage: Doctors and nurses are critical to the success of any hospital. Due to shortage of these skilled professionals, attracting and retaining medical talent is a key concern area.  By 2012, the country will be short by an estimated 4.5 lakh doctors and 12 lakh nurses.
  • Brand Building: Long term success of a hospital is dependent on the brand image it enjoys in the market.  Building a brand requires significant commitment of time and monetary resources which a lot of players are not able to afford. Success of hospitals such as Gangaram  and Escorts to a large extent is attributable to the brand and the niche they have carved out for themselves.
  • Obsolescence Costs: The healthcare industry is characterised by frequent product innovations and evolving technology. This leads to redundancy of expensive medical equipments every 5-7 years, thus requiring regular reinvestment in the facility, and thereby, serving as an impediment to the hospitals growth plans.
  • Complex Business Model: This mainly results from two factors – the high risk environment involving human lives and managing the doctor & corporate management interface, with doctors still continuing to be prime agents for filling up hospital beds.

The increased presence of corporate players has resulted in a transformation of the sector with various operating models emerging to achieve twin objectives of geographical presence as well as profitability.  Some of the modes of entry/expansion deployed by the corporate players are described below:

  • Greenfield Expansions: In a Greenfield set up, the owner is responsible for construction of the facility and all other operating costs including equipment, staff, liability insurance, maintenance supplies and capital expenditures. Such a set up can cost anywhere between INR 2.5 to 10 million per bed, depending on factors such as hospital specialty, location of the facility, target consumer segment etc.  Some of the recent hospital projects announced and the associated cost per bed are as under.It can take 2 to 3 years from the time of conceptualisation of a project and its completion. The construction of the facility alone takes 18 to 30 months.4 The capital commitments and associated gestation period for Greenfield hospitals impact the ability of players to create new facilities in a short period of time.
  • Brownfield/Management Contracts: Due to problems associated with Greenfield projects, companies have started showing an inclination towards Brownfield  facilities or ‘operate and manage’ arrangements. Brownfield facilities require the company to refurbish, equip and operate hospitals that are owned by another player/company.(Graph:1)

Typically, these arrangements do not require significant capital expenditure and have a much shorter gestation period of about 6 months. Some of the organised players are entering into these ‘operate and manage’ arrangements with smaller hospital owners as a market consolidation/low-cost market entry strategy. These arrangements are structured as a revenue & profit share or as fixed lease contracts with varying durations (dependent mostly on the level of investment being made by the new entrant).

These Brownfield expansions are also vital to the ‘hub and spoke’ strategy being increasingly followed by leading healthcare chains to expand their network. The ‘hub and spoke’ model enables patients to transit smoothly from primary to tertiary care.  The tertiary care hospital is the hub where as the primary and secondary healthcare facilities, diagnostic centers and pathology labs act as spokes. This ‘hub and spoke’ model allows hospitals to further expand their reach, build their brand and effectively utilise the available resources.

  • Acquisitions: The Indian healthcare delivery market is extremely fragmented. Consolidation through acquisitions is one of the key steps being taken by existing players to expand their networks and healthcare delivery capabilities. Fortis’ acquisition of Escorts Heart business was a marquee transaction to acquire capability in the cardiac care  segment and to establish a strong market presence in the national capital. Private equity players such as ICICI Venture are also playing a proactive role in acquiring hospitals to create an integrated delivery system.

Performance uation
Key financial milestones for a tertiary hospital in India are presented in the below table:

Leading healthcare players are leveraging their size, experience and capabilities to shorten this time line and achieve higher profitability and financial viability. Even though the Indian healthcare sector is still in its infancy, private healthcare players in India are faring better than their overseas counterparts with respect to various key financial parameters.

Some of the critical financial parameters of a hospital’s profitability and financial efficiency are as under:

  • EBITDA Margin – The Indian healthcare industry’s average EBITDA margin of 17.7% compares favorably to its US counterpart (15.7 %).  The EBITDA margin depends on various factors including location, target market, price sensitivity and hospital specialty.
  • Return on Capital Employed (ROCE) – Even in this performance measure, the Indian healthcare sector’s leading players have an average ROCE of about 13% which is significantly higher compared to their US counterpart’s average of 7.3%. (Graph: 2)

As the Indian Industry matures and improves its operating efficiency (in terms of ALOS, BOR etc1)7  these financial performance measures are expected to improve further.

Even though the above parameters are average performance measure of the players in Indian healthcare industry, it is important to note that there exists significant variation in their individual performance depending on different factors including hospital specialty, size etc. An Ernst & Young Healthcare Survey conducted in October 2007 made some interesting observations:

  • Multi-specialty hospitals tend to show the maximum average EBITDA margins (20.7%), followed by single-specialty (14%) and cardiology (13%)

  • Cardiac speciality hospitals generate the maximum revenue per occupied bed per day (INR 13,413) followed by single-specialty hospitals (INR 11,141) and multi-specialty hospitals (INR 10,620) (Graph: 3)


Also, the Multi-speciality showed maximum profitability per occupied bed per day (INR 2200 per occupied bed per day); (Graph: 4)


  • An analysis of the EBITDA margins revealed that hospitals of medium size (141-220 beds) have the maximum profitability; (Graph: 5)

Financing Options
As significant variations exist in the financial and operating parameters among different players, even the lenders and investors pay significant attention to these parameters in their uation. Equity investors are attracted by proposals to invest in hospitals that are a part of a larger business model or several such stand-alone hospital projects are being financed through a holding company format. Such a strategy leads to value accretion at the holding company level and risk mitigation across the hospital projects. The promoter’s track record of establishing such projects is another key factor in the uation process. Hospital configuration i.e a general hospital v/s a tertiary/multi-specialty format is important in determining the commercial viability based on the hospital’s location, other competitors, characteristics of the target market etc. Investors/Lenders uate the business case and the operating assumptions very closely. For Greenfield hospitals, the debt to equity ratio of 1:1 is considered optimum.8 Despite the above mentioned stringent criterions being used by investors for uating project financing, there is an increased appetite amongst the private equity players to invest in the healthcare sector. Some of the marquee transactions in the healthcare delivery space include Apax Partners’ US$ 104 million fund infusion in Apollo Hospitals, Warburg Pincus’ investment of US$ 32 million in Max Healthcare and Trinity Capital’s funding of US$ 31.4 million to Fortis. ICICI Ventures has launched a US$ 250 million fund for acquiring hospitals and investing in the healthcare sector.

On the debt side, hospital projects need access to long term funds. Multilateral institutions such as IFC, World Bank, Asian Development Bank etc have lent to this sector. Indian banks and financial Institutions are also increasing their exposure to this sector. The recent budget announcements would also improve the viability of new Greenfield hospitals being set up in Tier II & III cities, thereby encouraging debt and equity investments in this sector.

Given the urgent need for developing quality healthcare infrastructure in India, the Government  may also consider according Infrastructure status to this sector, thereby, enabling a better fund allocation and longer tenure to this important industry.

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