For Carlyle, a Deal on Demographics

Private-equity firms have been picking off companies faster than bankers can draw up the papers. The targets are varied: Clear Channel Communications, Equity Office Properties, Harrah's Entertainment, the Hilton Hotel chain.

And now, nursing homes.

Carlyle Group's $6.3 billion purchase last week of HCR Manor Care has turned a few heads, with some wondering why one of the world's top private-equity firms is following up a major deal for part of Home Depot by hooking up with the infirm and elderly.

The answer, Carlyle Group's strategists say, is baby boomers, particularly the more than 60 million boomers preparing to retire.

"You are taking advantage of the favorable demographics," said Karen H. Bechtel, a Carlyle Group managing director who heads its health-care practice. "We believe this is really coming. You are going to serve more patients and have the capability to serve more patients and improve your business."

District-based Carlyle is particularly interested in expanding the company's offerings to help people who don't necessarily need or want to move into a nursing home, but who do need to recover from heart attacks or from injuring their knees on the ski trip they probably shouldn't have taken. Medical advances may keep us alive longer and let us do things our grandparents didn't do at their age, but it won't always be comfortable.

"This is an operations play," Bechtel said. "Our mission to maximize long-term value is best accomplished by . . . investing in, and growing the number of facilities, and adding personnel to serve patients."

The idea is to spend hundreds of millions of dollars expanding the company's offerings, with the hope that the investments will translate into steep revenue increases.

Analysts and Carlyle Group officials said they targeted Manor Care because it owns all its real estate. That allows Carlyle to borrow against the company's 340 facilities at favorable rates and then put money into building more homes, hiring more highly trained nurses and upgrading facilities, whether that means installing new treadmills or setting up Internet cafes.

Steven R. Howard, a New York lawyer who specializes in private equity, said Manor Care should position itself like Ritz-Carlton has in the hotel industry.

"If you can distinguish yourself as the national chain that provides high-quality care -- the Ritz of elder care, you've got a lock on a huge market," Howard said. "You emphasize service, top facilities and first-class care. They have got to do it quickly. You get rid of facilities you think will never be profitable in your low-population centers but enhance the profitability in those urban and suburban centers that make sense. Then you go out and tell your story."

Turning profits in health care, however, is not easy. The hurdles that patients sometimes have to jump to get insurance companies to pay for treatment are nearly cliché, and many doctors have decided to forgo accepting insurance altogether. Payments to providers can take a while. Also, private-equity companies are known for bringing operational efficiencies to the companies they acquire, but it is easier to be efficient when dealing with Dunkin' Donuts or Hertz than with elderly care.

Also, Howard, the private-equity lawyer, cautioned that if interest rates go up sharply and if Carlyle cannot control costs, the plan to create a high-quality national chain could go awry.

"While the baby-boomer retirement population is increasing significantly, the expectations for quality care are also rising," Howard said. "If the costs of satisfying those rising expectations are higher than projected, then the plan of establishing a national brand of high-quality elder-care service may be put in jeopardy. Also, rising interest rates, which raises cost of borrowing, could derail the plans."

If operations sputter, Carlyle could fall back on Manor Care's real estate holdings.

"We have seen several [private-equity firms] take private transactions in the skilled nursing-care space, mostly structured as real estate deals whereby the company is split into an operating company and a property company after closing to maximize the real estate value," said John K. Delaney, who once ran a health-care finance firm and is now chief executive of CapitalSource, a Chevy Chase business finance company.

Health care is one of seven investments in which Carlyle specializes, but it historically has not had the same level of expertise as the company's experience in aerospace, defense and telecommunications. The health-care team, based in New York, has seven people, administering its growing portfolio, and Carlyle says it will expand to 11 next month.

Bechtel, a veteran in the health-care investing field, was recruited from Morgan Stanley two years ago. The private-equity firm recently completed two large health-care deals, including last year's purchase of MultiPlan, the nation's oldest and largest independent preferred provider organization network. PPOs are among the most common form of health insurance.

The Manor Care acquisition is Carlyle's second deal in the acute-care sector. The first was in 2005, when it bought LifeCare Holdings, the operator of about 20 acute-care hospitals.

Manor Care has a reputation as one of the nation's best nursing home chains, according to several experts. The key for Carlyle is to maintain that reputation without straining resources.

Carlyle must also invest wisely.

"You have to invest and pay for more skilled nurses," Bechtel said. "We have to make the investment in the physical plant, rehabilitation equipment, gyms, even Internet cafes. We have to make that investment and make a return, and we have to hire higher-quality people to provide that care. But if we can treat enough patients in that higher-quality mix, we can make an attractive return."

Bechtel said Carlyle is likely to hold on to Manor Care for at least five years.

If the company performs well, Howard said, "you sell it to the guys in Dubai, who will pay a fortune for it."