Private equity funds in the Middle East and North Africa are focusing on defensive sectors like healthcare, education and fast moving consumer goods. As the second in a series of three articles discussing the rationale and strategies behind such defensive strategies, this article focuses on the case for investing in the regional healthcare sector.
On a growth trajectory
There is no question that healthcare is booming despite the financial crisis — not only in the Middle East and other emerging markets, but also in many parts of the developed world. Healthcare is now a consumer priority, and it is setting the political agenda. Despite the individual and governmental focus, the current system for delivering healthcare is believed, by most experts, to be archaic. In the United States (US), the cost of maintaining the current system is consuming around 15 percent of gross domestic product (GDP), and many believe it is heading towards 20 percent of GDP. In the Gulf Cooperation Council (GCC), quality healthcare is simply not delivered by the current system to most of the population despite the fact that GCC governments have elevated healthcare to a policy priority.
The rate of growth in the sector exceeds that of GDP, and such a rate is proving to be sustainable despite the economic slowdown. In Saudi Arabia, the healthcare sector is expected to grow at 10 percent annually over the period 2005 to 2010. There is a strong emphasis among GCC governments to improve healthcare services and related infrastructure, which is translating into large government spending. With large budget commitments, young and growing populations, and the rise of a number of lifestyle illnesses like diabetes, the region’s healthcare and the underlying sub-sectors are bound to grow in the years to come.
Where to invest
Yet the healthcare sector is tricky to invest in. Market forces do not necessarily translate into revenue or profits — look at how hospital profits have been squeezed in many markets by insurance companies. Regulatory intervention for example, in setting the price of pharmaceuticals, is the norm rather than the exception, and significantly skews the sector’s economics. The misalignment of interest between the patient, the payer (usually government or insurance), and the service provider creates mistrust and sub-par service delivery to the ultimate consumer of the service. In the GCC, the public sector controls 75 percent of the sector, and public operators are resisting change and protecting their turf. The physician-centric model for delivering healthcare is under pressure due to escalating costs and physician shortages, yet physicians, through their professional associations, are resisting initiatives to improve the system.
Many healthcare investment opportunities are also capital intensive. Hospital’s costs reach tens of millions of dollars, and pharmaceutical companies invest billions in research and development. For investors, such capital intensive business models do not yield good returns because a significant part of the operating cash flow has to be reinvested in the business to sustain its growth.
The lucrative investment opportunities in the Middle East are in specialized healthcare delivery and supporting services. Services like dialysis centers, ophthalmology clinics and labs have coherent business models. They have controlled and well understood cost structure, need limited real estate investment, can be quickly replicated across geographies and sustain better margin pressures. Consequently, the bottom line can grow at much healthier and faster rates than a general hospital chain.
The macro fundamentals for healthcare may be very attractive, but the healthcare system churns out many losers. This is a sector where you may be best rewarded by staying on the sidelines or behind the scenes.
Imad Ghandour is executive director at Gulf Capital
