Who says money doesn't care?

Britain is getting older and private equity firms are cashing in, buying and selling nursing homes whose income seems assured for years to come. But do finance and vulnerable people make easy bedfellows?

Buyout firms and nursing homes. It's a pairing that can lend itself to morbid humour. Like the quip doing the rounds now on the eight-month £1.4bn auction of Four Seasons Health Care, the nation's number two nursing homes group. It has gone on for so long, the jibe goes, that the prospective bidders are dying of old age.

Poor taste perhaps, but Four Seasons is a prime example of the extent to which private equity has transformed the nursing home sector in just a few years, and what the growth of companies like it means for the UK's elderly and other patients in need of constant care.

The top two nursing-home groups - Southern Cross, owned by private equity group Blackstone, and Four Seasons, owned by rival Allianz Capital Partners - have nearly 50,000 beds between them out of a total, says researcher Laing Buisson, of 530,000 places in the UK. Both are the products of a string of acquisitions in recent years that has shrunk the number of players in the industry. "Ten years ago there were 20 publicly quoted companies," says Mike Parsons, the chief executive of nursing-home group Barchester Healthcare. "Now there is one."

It is easy to see why private equity firms love to invest in nursing homes: the UK is getting older. Today, one in six Britons are of pensionable age, and 1.1 million people are aged 85 or older, says Age Concern. As healthcare improves and birth rates fall, the ratio is expected to increase.

Nursing homes also come with sprawling property portfolios, which can be used as collateral to raise huge amounts of debt. This in turn means that buyout investors have to put up relatively little of their own money to buy them.

And in the Government, the owners of nursing homes have a reliable customer. The state has been moving away from caring for the elderly in large, long-stay hospitals to paying for smaller-scale, community-based care, such as private nursing homes. All this means that buyout firms have made billions selling companies to each other or floating them on the Stock Exchange.

The Four Seasons auction may be dragging on but its owners have made an enormous return in the past seven years. In 1999, buyout firm Alchemy Partners paid £133m for two companies to form Four Seasons. Five years and several acquisitions later, Alchemy sold it for £775m to Allianz. Today, Allianz is shooting for a price of £1.4bn.

But industry executives acknowledge that the consolidation mania has now largely run its course. While the largest groups, such as Southern Cross, Four Seasons, Bupa and Barchester, together control less than 20 per cent of the 20,000-plus homes in England, most of the rest are modest family-run operations that would require too much effort to consolidate for buyout players. "The earnings growth in elderly care came to maturity two years back," says Alan MacKay, the head of healthcare at private equity firm 3i.

That, along with the high asking price, is why the Four Seasons auction has taken so long, say sources.

Indeed, many buyout firms are now eager to take the "buy, build and flip" template that worked so well for nursing homes and apply it to the next area: specialist care homes. These sites cater for patients with a range of learning disabilities, mental health issues, and intellectual and physical impairments that need intensive, sometimes round-the-clock care. The sector is at least as fragmented as nursing homes were five years ago and is attractive to investors because of the higher fees they can charge. "Things are going to move very quickly," says a banker. For example, Independent Living Group (ILG), a specialist-care company which operates around 40 homes with 282 beds, is being auctioned at the moment.

Yet amid revelations of poor care - and in some cases abuse - at specialist homes, critics fear that private equity will be unable to help, especially if the sector transfers some of the alleged shortcomings it has demonstrated in nursing homes.

"With so many private equity beds in the sector, it has become short-termist and less concentrated on improving standards," says Mr Parsons at Barchester, which looks after private patients at the high end of the market.

Private equity investors say such criticism is misplaced, as the state, which foots around 75 per cent of the bills for these services, will only pay for quality.

Age Concern is less convinced. "The Government agenda is all about choice, and yet at the same time, we are finding that in some areas this choice is being restricted by an increasing consolidation of the care-home market," says the charity's director- general, Gordon Lishman. "When people move into a care home, they look for different things, and we must remember that one size does not fit all."

For specialist homes, it is still early days, but already buyout firms and trade buyers are making their moves. Private equity group HgCapital paid £322m last month for Paragon Healthcare, just after selling the smaller Castlebeck for £255m to a group linked with Barchester. Care- Tech, which listed last year, has seen its shares soar 40 per cent in 2006 as interest in the sector intensifies, and ILG is being hotly contested in an auction that could push its price to £100m.

Cinven paid €800m (£541m) last year for Partnerships in Care, the largest specialist homes group, and 3i hopes to build Care Principles into a group that can provide a "pathway" of services for the least needy all the way through to the most severely disabled patients.

"There are so many problems that can be fixed. There is a lot of scope to make a good business and help fragmented local governments make their budgets work better and get better quality of care. It will be a pretty exciting five years," says Mr MacKay.

Specialist care fees are higher because these homes have to pay their staff more, but scrutiny is increasing. Every year, the Government negotiates rate increases for care homes, and historically fees have risen a couple of percentage points above inflation. But as private equity firms get rich on these businesses, the Government's willingness to raise prices has dwindled. "The last round of negotiations was stickier than the last two or three years," says a sector banker.

One tactic is to sell high-margin specialist care businesses to larger nursing home groups, where the profits can be obfuscated in the sea of the parent company's numbers.

"People are a bit nervous about the high margins you can make in this business. It's one thing to sort of know what they are, it's another to publicly list them in an annual report," says the banker. "It would be stuffing it in the face of the NHS."

Care has come a long way from the days of Victorian asylums, and private equity has played a leading role in driving improvement.

Even so, the alignment of the priorities of buyout firms, which operate on three- to five-year investment horizons, with the long-term care of society's most vulnerable members makes some uneasy.

"There is an increasing view in the sector that private equity-backed managers are becoming more financially driven," says Stewart Wallace, the development director of CareTech. "There is a huge row to be had about this."