Guest post by Jonathan Farrer (partner), Paul Burns (partner), David Ellenby (partner), Rhys Jewell (partner) and Rachael King (partner) at Corrs Chambers Westgarth.
Despite the COVID-19 pandemic, 2021 ended up being a record year for M&A activity in the Australian aged care sector, culminating in of the two largest aged care transactions ever announced in the Australian market. [1]
Riding on the tailwinds of these transactions, a number of themes are emerging and playing out across the sector.
We expect many of these to be pertinent for the pipeline of aged care M&A transactions – which is already building up for 2022.
1. NOT FOR PROFITS LEAD THE M&A CHARGE
It’s no coincidence that two not-for-profit entities were the successful buyers of Allity and Japara – the two largest aged care M&A transactions ever announced in the Australian market.
The majority of operators in the aged care sector are not-for-profits and they have some significant advantages compared to their for-profit peers, which can provide an edge in competitive M&A processes. Some examples include income tax, payroll tax, fringe benefit tax and stamp duty concessions and exemptions.
In addition, not-for-profits are able to re-invest profits back into their business rather than facing pressure to distribute profits back to shareholders. This can result in strong balance sheets to help support funding for M&A transactions (including cash and debt funding).
2. SCALE BENEFITS
A number of leading operators in the sector have built scale through M&A and, in doing so, have generated significant financial benefits. The country’s top aged care providers are generally more profitable (on an EBITDA per bed basis) than smaller operators as a result of factors such as higher occupancy rates, investments in technology, efficient administration systems, lower procurement costs and more flexible staffing rosters.
This creates an environment where facilities are typically worth more in the hands of larger operators than small operators, thereby supporting business cases to grow through M&A activity. The highly fragmented and highly regulated nature of the aged care market accentuates the need for consolidation, as smaller operators look to exit.
3. REGULATORY REFORM DRIVING EXITS
Many operators continue to look for exit options as the regulatory burden for aged care providers continues to increase.
Following the findings of the Royal Commission into Aged Care Quality and Safety, the Commonwealth Government announced reforms across five ‘key pillars’ to be delivered within a five year period. The changes will put further cost pressures on operators and in many cases will change the way they run their businesses.
A number of changes will come into effect from 1 July 2022, with a new Aged Care Act proposed to come into effect from 1 July 2023 in order to ‘underpin the necessary and generational change required to reform aged care in Australia’. A summary of some of the key changes can be found here.
4. COVID-19 IMPACTS
The COVID-19 pandemic significantly changed the operating environment for aged care facilities. In many cases COVID-19 has forced changes to operating policies, created additional regulatory burdens and increased costs – often making it difficult to continue operations.
Buyers of aged care businesses will typically ensure their due diligence investigations cover the target’s response to COVID-19. This can include the extent to which the staff and residents have been vaccinated for COVID-19, how they have dealt with outbreaks at specific homes, whether any staff or former staff (including casuals and contractors) contracted COVID-19 while working and how they are positioned to deal with any future outbreaks. Funding received under the Government’s COVID-19 assistance schemes will also usually be scrutinised.
COVID-19 is also typically a focus during sale agreement negotiations, in particular for ‘material adverse change’ and ‘ordinary course of business’ clauses (noting that there can be specific carve outs in such clauses relating to pandemics). Warranty and indemnity regimes should also be considered through a COVID-19 lens.
5. STAFF UNDERPAYMENT RISK
As a sector where wages represent a significant portion of total costs, staff underpayments loom as a major risk. Buyers will want to make sure they don’t inherit a hidden liability where they subsequently become responsible for years of staff underpayments or other non-compliant workplace practices by the former owners of the business.
There are a number of ways this risk can be dealt with through due diligence, protections in the sale agreement and warranty and indemnity insurance. In most cases, a detailed review by an independent accounting firm will help to ensure this risk is properly assessed and appropriately allocated.
6. PROPERTY DILIGENCE
Property is commonly another key asset of aged care businesses, so any restrictions on the use of properties should be considered in due diligence. It’s not uncommon for properties that contain aged care facilities to have the ability to be used for other purposes, such as retail uses, retirement village uses and potential development.
It is important to diligence these uses as different regulatory regimes apply to each aspect of the property (e.g. the Aged Care Act, the Retirement Villages Act). Planning regimes and compliance can also differ depending on use or proposed use, and various uses may be prohibited by a restrictive covenants or other dealings registered on title.
Property title review is an important weapon in a client’s due diligence arsenal. It can assist with determining the actual or historical use of a property containing an aged care facility (e.g. there may be a statutory notice which is registered on title stating that the Retirement Villages Act applies to the property). It should also flush out certain statutory charges which in some cases may secure significant amounts that could affect the deal value.
7. SPIN-OFFS, RESTRUCTURES AND CONSORTIUM DEALS
As more capital looks for a home in the aged care sector, we expect to see examples of structured deals similar to those witnessed in adjacent health care sectors such as hospitals and medical centres.
This might include foreign capital teaming up with local operators, sale and leaseback arrangements and refinancings. We expect operators will also continue to assess their portfolios with a view to selling non-core assets, such as retirement villages and underperforming sites.
[1] Corrs advised Bolton Clarke on its proposal for Japara Healthcare and its acquisition of Allity. The issues identified in this note do not necessarily reflect the issues in those transactions.
