India's growing healthcare funding crisis

The issue of leverage is haunting many players in the healthcare sector in India. Leverage to hospitals has rapidly increased and is at an all-time high of around 4.5 times of EBITDA (earnings before interest, tax, depreciation and amortisation). Right from Fortis, Seven Hills Hospitals to Care Hospitals' investee Abraaj Capital and Max Healthcare, the issue is plaguing a lot of players. In fact, the credit rating by some of the leading credit rating agencies to the hospitals, over the last year, has deteriorated from stable to negative. So why has the positive outlook towards healthcare sector in India, in the backdrop of programmes such as Ayushman Bharat, suddenly changed?

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• Liquidity in the system is stretched with delays in disbursements of capital expenditure committed to newer hospitals by banks and NBFCs;
• Rising interest rate regime coupled with rupee depreciation, has shot up the cost of the capital;
• Increased costs of operations by 100-150 basis points due to project and regulatory delays, gestational losses due to delays in starting operations;
• After demonetisation, during which the cash transaction was limited to up to Rs 2 lakhs in healthcare, there has been a decline in cash payments and therefore inpatient utilisation;
• Limited opportunities to raise equity fund as investors have become discreet on platforms given after market corrections valuation are at all-time high.
• Mismatch of tenures between short, medium and long-term fund raises;
• Strategies focused on EBITDA improvement and creative accounting to manage EBITDA growth and trading off long-term value creation in healthcare delivery business; and
• Delayed buy-back/exits and IPOs for investors.

Unlike past, the current healthcare asset bubble is about to burst due to unprecedented leverage pile up and needs correction. Many operators facing the liquidity desperately need capital infusion, to tide over the current situation, created due to the leverage-backed EBITDA expansion strategies of the past.

What can be done to set this right?

• Breaking the cycle between incremental leverage and asset-creation cycles with short and medium-term leverage;
• Evaluating asset-light business models, with focus on EBITDAR (earnings before interest, taxes, depreciation, amortisation, and restructuring) value creation;
• Focusing on operational efficiency, with newer business models to expand into tier II and III towns for demand aggregation at their hubs with asset-light strategies;
• Manage clinical talent supply-chain to reduce operating costs and improve efficiencies;
• Redesigning the expansion strategies from asset-heavy campus to community-based asset-light chains, offering full suite of clinical services (mother & child, day-care surgery, ophthalmology, etc);
• Innovative healthcare financing models that cut out the intermediaries such as re-insurer, distributors, TPAs, etc. that eat into insurance pool available for healthcare services; thereby offering bang for the buck to the insured and higher reimbursements to the care providers;
• Transforming into a consumer-friendly provider for the healthcare consumerism biased customer; and
• Moving closer to the funder (payers and capital providers such as REITs)

In my various articles, I have highlighted the financial and operational expansion strategies that operators need to adopt. Our fund's internal analysis on funding required to break-even for asset-light operators, ranges from 0.72-1.11 times of funding, versus over 2.0-11.0 times for heavy business models in healthcare. This validates the current crisis, due to the asset bubbles being built up. The current market analysts are rewarding asset-heavy, over-leveraged operators by valuing them on EBITDA multiples, while penalising the asset-light players. With the few asset-heavy players going belly up through tumultuous times, reality is sinking in that EBITDA multiples is not the right metrics for comparing asset-heavy and asset-light business models. EBITDAR is now being looked at to compare the two different business models. At this point, I would like to highlight that strategies for investment in different specialties of healthcare also vary and is depicted in the chart below:

The right approach would be to aggregate demand in the top-18 cities of India through multi-specialty hospitals and centres of excellence in a certain specialty, while single-specialty chains, day-care surgery centres in the tier II and III cities, which become a feeder. This would optimise the financial returns trading off with issue of fast scalability and maturing of inpatient bed capacity.

Moving out of the current crisis

A recent CRISIL report states that private sector healthcare networks require Rs 4,700 crores to build their referral networks in 2018-19 alone. With the leverage levels in healthcare at an all-time high and asset bubbles being created, the options for funding long-term are very limited. To mitigate the stress at PBT and PAT levels, the interest outgo and serving of leverage have to be petered down to a conservative 3.0X EBITDA levels. There are very few financial strategies that are available for healthcare operators to get out of the current situation. They can only move ahead by monetising the assets and moving towards asset-light models, for funding the growth and EBITDA stabilisation in the medium term as inpatient occupancy stabilises on their mature beds. Some of the options are compared in the table below:

It's time for them to shift out of high-interest leverage-backed asset-growth to a benevolent capital source. Else the last vice of leverage will not only haunt the healthcare operators in India but also push up healthcare costs, given the demand-supply gap for healthcare led by the current investment gap.

(Kapil Khandelwal is Managing Partner of Toro Finserve LLP, India's First Healthcare Infrastructure Fund and Director EquNev Capital Pvt Ltd.)