Two announced hospital deals — Fosun Pharma’s (复星医药) announced acquisition of Chindex International, Ltd., and a partnership between Evergrande Real Estate Group (恆大集團) and Harvard’s Brigham and Women’s Hospital– have generated much discussion in niche investors and analyst communities about how much, or how little, investors should be excited about the possibility that China’s healthcare service sector is open to investment.
In point of fact, these two deals are not cause for optimism. Rather, they are the story of the inability of healthcare services in China to make a profit writ large.
With few very minor exceptions, and the reputations of Chindex and Harvard notwithstanding, no single institution in China has yet figured out how to make hospitals, and more generally, healthcare services, profitable in China in the long term; not the Chinese government, not private Chinese firms, not the semi-foreign companies from Taiwan-Macao-Hong-Kong, and certainly not truly foreign firms from other Western countries.
Moreover, it is very unlikely that a sustainable profit model is a real possibility in the short to mid-term. China’s mix of government policies and ministry regulations disadvantage private health service institutions in the marketplace through discriminatory tax treatment relative to public hospitals, market entry limitations that force private hospitals into underdeveloped population zones and stall expansion projects, as well as various other acts that make it difficult for private health providers to compete with public hospitals in the recruitment of capital and medical staff.
Until last week at least, despite these challenges, the United States could claim one successful and prominent entry in China’s private healthcare arena – the United Family Care family of hospitals and clinics, run by Chindex International, Inc. Chindex opened Beijing United Family Hospital in 1994, and since then opened up several more clinic branches across China, including the United Hospital in Shanghai .
However, when Shanghai Fosun Pharmaceautical Group Co Ltd (from here on out “Fosun Pharma”) announced that it was partnering with equity house TPG Capital to acquire Chindex in a deal valued at $369 million, the United States lost this single claim to success in China’s healthcare services market.
The deal, when finalized, will give Fosun Pharma majority ownership of Chindex, result in Chindex becoming a private company, and will turn the beacon of American success in the Chinese healthcare industry into a subsidiary of a Chinese conglomerate.
For reasons I have addressed in detail elsewhere, it is very unlikely that Chindex’ innate profitability was the catalyst for Fosun’s acquisition. In fact, Chindex’s hospitals have always been a very low margin business proposition. So the acquisition of Chindex is a curiously risky play by Fosun Pharma.
Why then did Fosun Pharma acquire Chindex? In a 2013 stock prospectus for overseas buyers, Fosun stated it is competitively positioned to become the dominant player in the pharmaceutical and medical device distribution industry, especially owing to the success of its sub Sinopharm. It is possible then that Chindex value as a distributor is the primary driver of the acquisition.
On the other hand, it makes much more sense that Fosun acquired Chindex primarily because of the latter’s proven ability to create a profitable private hospital, albeit one with margins so low that other institutional investors were not willing to risk an investment, and only secondarily because of its value to Fosun’s distribution business.
When you add up all of Fosun’s hospital and clinic investments, Fosun’s acquisition of Chindex’ hospitals makes it one of the largest private owner of healthcare service institutions in China . But, Fosun’s other properties are almost certainly not making money. China’s public hospitals are only starting to implement the most rudimentary elements of private for-profit businesses that would allow them to even track profits, let alone pave the way for sustained profitability.
For example, accounting in Chinese hospitals is extremely segmented. Every department keeps its own accounting, and the standards used are arbitrary. Consolidation of balance sheets is seen as a formality and will be hastily carried out by non-finance specialists. Also, management structure in public hospitals is still a lockstep system that very often favors seniority over competence and ability to create profit. Indeed, the very question of what “the ability to create profit” means is a very thorny issues that leads to a conversation about graft, corruption and public distrust of the medical care system in China that is too big to be addressed here.
Therefore, a public hospital that is contemplating a path to success as a private institution has to overcome the challenge of using the same personnel, institutional knowledge, and resource mix it had as a public hospital – a mix uniquely suited to China’s public hospital system and little else – to overcome the set of regulatory and socio-economic challenges that private hospitals have to contend with.
Up until now at least, China’s public hospitals have not been up to the task. Whichever way you cut it, then, Fosun’s acquisition of a hospital business with low margin profitability improves a healthcare services portfolio that otherwise boasts no profitable healthcare service institutions.
In the long term, however, the benefits of Chindex’ institutional knowledge offer a much more tantalizing prize for Fosun’s business future than mere low-margin profitability. It is not possible to overstate that business opportunity that Fosun could create for itself if it became the first company in China to figure out how to scale up a healthcare services business.
Its market dominance in pharmaceutical and medical device distribution, and the fact that the Fosun brand is a highly respected one in the Chinese market generally would provide them with a native, first mover advantage that would add up to billions of dollars of revenue, largely owing to the fact that acquisition targets for those who understand how to make healthcare service business profitable, literally number in the thousands.
Applying the lessons of the Fosun and Chindex deal (link) can tell us a whole lot about the potential partnership between Evergrande and Harvard Brigham Women’s Hospital announced last week.
Evergrande is a major real estate company, but it is also a conglomerate, with over 200 subsidiaries in various fields (link). The real estate business is perhaps the most competitive industry in China, and it is certainly one of the most profitable, if not the most profitable, so Evergrande’s success here should not be underestimated.
Specifically important for the sake of the Harvard partnership, real estate companies like Evergrande have founded a boom industry on top of China’s healthcare reforms, which have authorized billions of dollars for the purpose of building and updating tens of thousands of hospitals across China. This boom has arguably not been very beneficial for China, and I’ve covered that on THCB before, but it has arguably taught real estate companies like Evergrande a lot about the limitations of the healthcare services business.
Given that Evergrande is no doubt aware of the potential of the healthcare services market to be a new boom industry, and given Evergrande is a sophisticated, modern company that understands the necessity of an operational model that brings hospitals in China into the 21st century, the desire to partner with Harvard must be irresistible.
Via this partnership, Evergrande could acquire the ability to build, from the ground up, a hospital with a modern, corporatized management structure, with personnel that would be prepared to work in a modern, corporatized hospital environment. Brigham is, of course, a member of the Partners HealthCare, a non-profit organization, but its non-profit status is in many ways akin to the non-profit status of the NFL or the NCAA; to be sure, Brigham knows how to run a profitable hospital.
On top of that Evergrande could use its real estate market dominance, and the cache of the Harvard brand to quickly scale up a healthcare services business once it has a profitable model figured out. This is, to be sure, a very similar strategic line of thought to the line of thought I claimed for Fosun further up in this article.
If I’m right, what are the implications for Harvard Brigham Women’s Hospital? The implications are that Harvard is going to be dealing with an extremely naïve partner as far as hospital building and hospital management is concerned. Despite the fact that Evergrande’s real estate experience may have exposed it to the potential of the healthcare services market, and may have even allowed it to participate in several hospital construction projects, this does not mean that Evergrande learned anything about how to develop a profitable hospital organization.
Potentially, anything from facilities design to facilities staffing is going to be a detail that Brigham Women’s will have to address on its own. Evergrande knows how to acquire real estate and manage a development project, but even if it has constructed healthcare facilities before, nobody should assume that they have developed the necessary competencies to either build a facility that meets the expectations and assumptions of Brigham, or even that they have the competencies to set up the real estate transactions itself in a way that lays down favorable groundwork for a profitable hospital.
Obviously, the strength of Harvard’s network in China, and the strength of its brand with Chinese people, means that Brigham will receive more favorable treatment from regulatory authorities and other relevant transaction partners than any regular Medical Inc that wants to establish a hospital in China. But, a favorable reception is not predictive of ultimate success, especially because the end result of a successful partnership would be an extremely lucrative payday.
 That’s not to say that healthcare should be profitable, or that single payer and other formulations of social healthcare systems are by implication (or omission on my part) somehow inferior; that is an all together different, and rich discussion with serious policy implications, best left for a different time. Despite the promise of China’s latest healthcare reforms, which began in 2009, to facilitate the further development of private healthcare alternatives to China’s overwhelmingly public hospital system – mainly by constructing policies that would attract foreign investment – there has so far been little in the way of private capital flowing in the hospital sector, limited mostly to firms from Taiwan, Macao and Hong Kong, as well as a handful of Chinese holding companies operated by conglomerates and large public and university hospitals.
 It is the ubiquitous, go-to-example for any English-language discussion of healthcare opportunities in China owing to the universal familiarity of exaptriates in China with Chindex hospitals.
 This will be Fosun’s third acquisition of hospital service operations since the beginning of 2013. In total, not counting the Beijing United group of hospitals and clinics, Fosun has acquired the following hospitals since 2011: Guangji Hospital (2011), Jimin Cancer Hospital (2011), Suqian Hospital (2012), Guangzhou Nanyang Cancer Hospital (2013), Foshan Sizhen District Central Hospital (2013). You can compare that to other major hospital ownership groups here.