Private medicine is – discreetly – an enormous industry in Ireland.

Private hospitals in Ireland are owned by American hospital groups, global private equity funds, billionaires and private investors. We, customers, interact with it at arm’s length, usually through our insurance policies if we have private health cover.

We occasionally get a glimpse of the size of it. Like in 2018, when the French Private Equity group Infravia bought the Mater Private for €495 million. The industry is so low-key that in 2019 Ireland’s second-biggest hospital group, Bon Secours, merged with a giant American hospital group called Mercy Health, and the final deal wasn’t reported much in the Irish press. At the same sales multiple of the Mater Private deal, Bon Secours would have been worth over a billion euro at the time.

The big seven hospital companies had revenues of more than €2.4 billion between them in 2017 and 2018. And when the government took over the private hospitals for three months at the beginning of the Covid crisis, it had to shell out €330 million. 

Private hospitals pulled out of that contract with the government mainly because the medical consultants weren’t happy with it. The consultants wanted to keep the ability to treat private clients, alongside Covid patients.

Now that Covid is back, there’s a new need for hospital beds, and the government is trying to make another deal with the private hospitals. But there’s no chance of the government striking a deal with the whole private hospital system, as it did in March. There’s too much opposition from within the hospitals. The best it can hope for is to strike deals with individual hospitals.

Making those deals won’t be easy. The consultants don’t want to be press-ganged into public work. And some of the hospitals don’t have much room for manoeuvre. The Beacon Clinic’s debt, for example, is almost eight times its earnings. The Beacon deputy chief executive has said his board is “not minded” to sign back on.

In the last two year period, only one of the big seven hospitals paid a dividend, of €3.7 million. And 2018, the most recent year for which we have records, they collectively lost money. 

Where does the money go? And what deals are coming next?

The big seven

There are seven big hospital companies in Ireland: St Vincents, Bon Secours, the Beacon, the Hermitage, the Blackrock Clinic, the Mater Private and the Galway Clinic. In 2018 they brought in in €1.15 billion between them. Over the previous five years, the big seven’s collective turnover increased by 27 per cent. The following chart shows how their revenue has grown over time (omitted from the chart is the Mater Private).

By revenue, St Vincents is by far the biggest. It made €448 million in 2018. Bon Secours, the second-biggest, made €286 million. 

The following chart shows the big seven hospitals’ revenue as a percentage of overall revenue in that year. It’s striking how stable their market share is. Each one finishes 2018 with the same share of overall revenue it had in 2013. 

Why is market share so stable? Maybe because health care is somewhat insulated from market forces by the health insurance system. In this system, patients don’t choose their hospital based on price. Instead, the hospitals cut deals with the insurers, which guarantee them a steady stream of patients and revenue. 

The hospitals are home to consultant doctors, who charge the health insurers for their time. Prices differ greatly among specialisms. In the US, where more data is available, we see that surgery is the most lucrative business for private hospitals. And in the US, Kaiser Health News, hospitals make most of their money from elective admissions, rather than emergency treatments.

Missing earnings

Collectively the hospitals made €1.2 billion of revenue in 2018. But collectively, they lost €5.7 million. What’s going on?

The following chart shows net margins for the big seven hospital companies in 2018. As you can see, the Mater Private sticks out a mile. The Mater Private lost €23 million in 2018, the year before it was bought. But even excluding the Mater, the hospitals’ net margin was 2.5 per cent. 

As is often the case with scantly-profitable companies, the hospitals prefer not to focus on net income. Their preferred profit measure is operating profit — a number that excludes things like interest payments and tax. 

Well, they might prefer to exclude interest because many of these hospitals are laden with debt. Before it was bought out, the Mater Private’s debts were greater than its book assets (though the €495 million paid for it would suggest its book assets didn’t fully value the firm). I’ve compared the other six hospitals’ debt/equity ratio to the average debt/equity ratio for US-listed hospital companies — that’s the horizontal line. By that measure, you can see St Vincent’s and especially the Beacon, owned by the businessman Denis O’Brien, are heavily indebted. 

Heavy debts are only a problem in as much as the underlying business isn’t profitable enough to service them. How do the hospitals stack up in this respect? The net debt to ebitda ratio compares a company’s debt burden to its earnings before interest payments. It shows the debt burden relative to the earnings that service it. The following chart shows the hospitals’ net debt to Ebitda; again, the Beacon stands out. But this time the Blackrock Clinic looks less healthy. For most industries, a net debt to ebitda ratio above 4 would be considered hefty. The Blackrock Clinic’s is 7.5. 

Bon Secours’ 2018 net debt to ebitda ratio was high, at 8.5. But it doesn’t have to worry about such things any more, after its merger with Bon Secours Mercy Health, an Ohio-headquartered US Hospital group that runs 50 US hospitals. The debt is BSMC’s problem now.

So the first answer to the question of why the private hospitals aren’t more profitable, is that they have a lot of debt to service. After the Beacon for example paid €5.4 million in interest, its net profit was €2.3 million. Vincents paid €6.6 million in interest, leaving it with €1.4 million in net profit in 2018. The Hermitage paid €2 million in interest, leaving it with €700,000 profit. The following chart shows interest payments relative to net income.

Why all the debt?

Why all the debt? There are a few reasons why it might make sense for the hospitals. The first is the standard point that funding a business with debt can increase returns for shareholders. That’s because debt investors expect a lower return than equity investors. The shareholders of a company can increase the amount of money left over for themselves if they use borrowings to fund the business. 

This strategy can go wrong if a company’s earnings take a hit, and there’s nothing left over for the equity investors. But private hospitals are an industry with stable revenues, as we’ve seen. St Vincents isn’t going to get competed out of business any time soon. Of the 94 industries catalogued by NYU finance professors, hospitals had the fourth-most debt behind only banks, restaurants and tobacco companies.

Besides squeezing extra returns out for shareholders, there’s another reason hospitals carry a lot of debt: because running hospitals is expensive. Hospitals require lots of money to operate and build. 

This brings us to the second big drag on hospital profits. The hospitals invest millions each year on new buildings and fit-outs. All this investment shows up on the income statement every year in the form of a massive depreciation charge. The following chart shows the effect of depreciation charges on the hospitals’ earnings.

This is significant because depreciation is a non-cash charge. It’s there to represent the income statement the money that was previously invested in new buildings and the like. But it doesn’t reduce the amount of cash generated by the hospital year in year out.

So a hospital with a heavy annual depreciation charge might actually generate lots of cash every year for their owners. And that’s what we see with a lot of these hospital companies. The core business of treating sick people for money generates plenty of cash every year. It’s the capital expenditure/depreciation, and the associated interest bills, that make the hospitals only thinly profitable.

What follows is a comparison of net income to operating cash flow for the hospitals. As you can see, they generate a lot more in cash than they do profit. 

The fight over Covid

All these reams of charts refer to 2018 and before, which is the period for which we have figures. But hanging over all this is the private hospitals’ response to Covid this year. 

The private hospital association agreed a deal with the government in March, during the panicked early response to the virus, whereby the government would take over the full capacity of the private system. The deal was agreed without the consent of the consultants, who were reportedly furious when they heard about it.

The consultants were handed a “type A” contract – one that doesn’t permit them to take on private work – for the duration of the deal. They weren’t happy with it. They were expected to maintain their private rooms at the hospital, which can cost up to €20,000 per month, without state support. The state expected the consultants to work out a deal with the hospitals over private rooms.

The contract ran from the end of March through to mid-June, and it cost the state €350 million. 

The deal wasn’t popular from the outset. And as time went on, it turned out that the private hospital capacity wouldn’t be required. The consultants’ fury was directed at Irish Hospital Consultants Association Vice President Dr Laura Durcan. She resigned in April because of “abuse” and “harassment” by private consultants.

Following uproar from consultants, the private hospitals’ contract with the government was terminated in June. It’s been reported the government is now seeking contracts with individual hospitals as we face into the second wave.

What they’re worth

The private hospitals are a strange beast. As we’ve seen, their profits are tiny. And they rarely pay dividends. 

But they’re clearly valuable. They have book values — ie, what they own minus what they owe — of around €100 million each, as the following chart shows.

If anything, the hospitals’ book value may understate their true value. €495 million for the Mater Private – a company with net liabilities of €30 million before it was bought in 2018 – would suggest as much.

Clearly, the value is down to the hospitals’ free cash flows. Private equity, billionaire investors and overseas hospital groups are of the view that a steady flow of customers from the insurance companies, and the steady cash flows they generate, are worth paying for.

But the hospitals to a greater or lesser extent all have the same issue -– low return on equity. Their profits, in other words, are small relative to assets. If profits don’t rise, shareholders might consider flogging some of their hospital assets to grab value out of the businesses.

Ownership and next moves

For private hospital owners looking to boost skimpy returns on equity, there’s another option: merging with other hospitals. Merging hospitals boosts profit margins for the usual reasons: economies of scale, economies of scope. Plus there’s a health-industry specific benefit: it helps them in negotiations with the insurers. According to McKinsey, a consultancy, increasing leverage over insurers was the main reason for the flurry of hospital M&A in the years leading up to 2012.

There’s a lot of evidence showing bigger hospital groups are more efficient. This happens partially at the level of individual hospitals (optimal hospital size is around 250 beds), and partially at the level of hospital groups. The following chart shows bigger hospital groups make more money. It shows operating margins at hospital groups of different size. The bigger the hospital group, the bigger the margin.

Mergers are not new to Irish healthcare. Bon Secours, having acquired Barrington’s Hospital in Limerick in 2017, was swallowed up by Ohio-based Bon Secours Mercy Health (BSMC) last year. There’s every sign BSMC isn’t done yet: BSMC CEO John Starcher has said he sees Ireland as “a platform to Europe”.

Billionaire Larry Goodman has spent years in court squeezing some of the original Blackrock Clinic founders out of the business. He now owns 84 per cent of that business; two-thirds of the Hermitage Clinic; and last year he bought the final 25 per cent of the Galway Clinic in a deal valuing it at €127 million.

The Goodman hospitals don’t operate as a unified entity – yet. Goodman hired Gordon Dunne, former chief of the Mater Private, in 2019, to help unify these businesses. The Goodman group made about €300 million revenue as a group in 2018. That’s a lot in Irish terms, but still not at a point where it would generate huge economies of scale. Goodman could conceivably grow his group further, or sell it on to a bigger fish.

There are at least three big fish. BSMC, which operates 50 hospitals in the US, is one. The University of Pittsburgh Medical Centre (UPMC) formerly owned the Beacon Clinic before Denis O’Brien elbowed it out. UPMC, which has revenues of $21 billion, is the owner of the Whitfield hospital in Waterford, Clane hospital in Kildare, and a radiotherapy centre in Cork in partnership with BSMC. Either or both of these two large private sector players could act as a consolidator in the sector.

Finally, the state will always be the biggest player in Irish health. Covid-19 has highlighted the capacity problems in the public hospitals. The politics aren’t currently in favour of buying the private hospitals, but that may yet change under a left-wing, Sinn Féin-led government. And Labour leader Alan Kelly has called for the government to step in and buy them.

What’s clear enough is that the current setup isn’t a stable equilibrium. The assets are too valuable to be generating so little income. And there are too many potential buyers out there. Expect more deals.