Excerpts from an interview:

It’s been almost 10 years since the UK care home chain Southern Cross collapsed. And another giant in the sector, Four Seasons, has recently gone into administration. Both were private equity-owned. Why did this happen?

Most of the care home business is state-funded, not all of it by any means, but the majority. It’s expensive. And the demand is going up steadily as people age, and families become less and less keen to look after the elderly.

The state continually tries to pull the price down. And at the same time, there’s no constraint on the demand for services. You start off with the very basics of getting people a clean, warm place with some food in it, but then you start adding everything else that you need to make it really an attractive place. And the costs start to rise to hotel levels. So, there’s a continuous tension between cost and service provision. The principal costs of running nursing homes are human beings, many of whom are actually on minimum wages of one form or another. So, you know, it’s a tough game, this.

If you then put on top of that a capital structure, which has got a massive debt in it, and that needs servicing, you’ve got another big problem — of your cash flows. Now, it’s not been so severe in the last years because interest rates have been very low, but when interest rates are high, then the pressures become very extreme.

This is something where you’ve got some obvious economic issues and some moral issues: How well do you want to treat the section of the population that wants to be in a care home or needs to be in a care home?

And that’s pretty well irresolvable. Because clearly, people would like everything to be done nicely and make it easy. But the hard facts are it’s a difficult business, made harder if you take a stressful capital structure. But the alternative, which is to leave it to the state, purely and simply, has on average been worse.

People find that without the controls of cost that you get in the private sector, they often run up to potential losses. There is grave difficulty in actually managing a state-owned workforce as opposed to a private [one].

Nobody’s found a magic bullet for this — there are as many failures in the public world as are in the private. And the victims tend to be the elderly. But luckily, because of the obvious distress involved, mostly when things fail, it gets sorted out one way or another quite quickly, usually with serious state intervention.

Regarding private equity in general, a lot of the people that we’ve been speaking to are highly critical of private equity’s involvement in the care sector, and say there is no place for it. That there should be different models.

I can imagine that, but…you’ve got a big definitional problem. If you went back 20years, private equity was a nice clear, tidy concept. You’ve got people like Blackstone, who’ve got massive property funds, massive private equity funds, both involved in the deal. They’re listed companies as well. So, the definition of what they are is getting quite hard. You’ve got groups like Partners Group in Switzerland; they invest in these things — they would regard themselves as an institutional investor, but you might very well regard them as a private equity firm.

So, it’s not particularly easy to pick out the difference. The issue is really how stressful the capital structure is. That’s where the risks start to come in and where the unpleasantness comes in. You’re going to get more failure, and more failures of highly leveraged groups than unleveraged groups — you don’t need to be that much of a genius to spot that. And it’s the use of debt that’s more of a problem than the nature of the shareholder. Some of the deals that have gone badly wrong [for example] were owned by Irish individuals. They failed spectacularly and they were geared up to the armpits by some of the more adventurous Irish banks.

We read, 10 years ago, when you said the best way would be to regulate the sector, like any other public utility…

And I think that’s still the best answer. It’s not perfect.

In practice [it means] that people get regular and good quality inspections, but there’s quite a lot of money required to do that. It may only be half a per cent of the revenues of the care home sector, but it deserves that kind of quality control expenditure. So that people don’t suffer because people are running things without adequate staff; that you haven’t got care homes with 200 people, in the middle of the night, having a staff of precisely one. That kind of thing, which does happen, is obviously bad.

Proper regulation gives you the best chance, and you give the regulator strong powers. If the companies aren’t performing, then they can move in, hard; takeover, put it into a protective receivership, that kind of thing.

I’m not aware of anyone that’s actually gone that far. But the powers the regulators’ got, and certainly in the UK, are already quite strong. They can close things very quickly.

But on the other hand, if it is regulated in a way that allows for sufficient staff, well-paid and available for all old people in care homes, wouldn’t it automatically be considered to be no longer attractive for private equity investors?

It could be that that would be not attractive for them. But somebody has to take the capital risk. And you know that there’s not that much difference between it being an Irish billionaire, a small public company, or a private equity firm. They’ve all got the same motives; they may have different appetites for risk. In that grouping, the Irish billionaire would probably take the biggest risk. And he would probably rely on limited liability to cover him against the losses.

The public company would probably be the least risky. But the reality is, care homes are a real political issue about how much resource you put in them. I think if you’ve been around any of these homes, nobody wants to see people working very long and antisocial hours on minimum wages.

But the alternative is, there’s nobody doing the care and that’s really terrible. And those are the kind of things that this subject matter just keeps running into all the time.