The growth of the Chinese economy saw a significant slowdown in the year 2012, and private equity investment ("PE") in China also experienced the same "cold winter" as the overall Chinese economy. However, one of the emerging markets for China's economy and PE investment was the continued growth of medical industry funds. In fact, some PE institutional investment reports indicated that investors believed medical and health related investments along with consumer product investments were the most popular PE investment sectors in 2012.(1) On August 17, 2012, the PRC Health Ministry published the Health China 2012 Strategic Research Report, which states that the PRC Health Ministry will implement 7 new major health related projects that will involve investing RMB 400 billion into Chinese healthcare sector in the next 8 years. Over one quarter of this project investment, RMB 109 billion, will be spent building county hospitals throughout China.(2) PE has accelerated its investment plans into private hospitals in China and become active players in public hospital reform.

  1. Golden Times for Financial Investments in Hospitals
  1. Deregulation of Private Capital

The Implementation Rules for the Classification Management of Urban Medical Institutions(3) regulates the management of profit and non-profit medical institutions in China. The Chinese government differentiates between profit and nonprofit hospitals by requiring that they have different stated business purposes and services on their business licenses, and also requires different financing, tax, price, and accounting policies for profit and non-profit hospitals. Moreover, the Opinions on Further Encouraging and Guiding Social Capital towards Medical Institutions ("No.58 Policy")(4), the information in the 12th Five Year Plan for Medical Reforms, and the information in the "New 36 Article" have opened the door forprivate capital and foreign investment to enter into healthcare sector. In addition, the implementation of No.58 Policy and the promulgation of the 12th Five Year Plan provide that "medical institutions" are no longer categorized as a restricted industry, and instead the Foreign Investment Industrial Guidance Catalogue(5) now lists the healthcare sector as a permitted industry for foreign investment. Therefore, Chinese law now allows wholly foreign-owned medical institutions to be established in China.

  1. Urbanization Trend

At present, China's health care resources are unevenly distributed. Currently, China's major cities have the majority of access to health care resources while the Chinese countryside has very little. In fact, the distribution of health care resources is so skewed it is like an inverted triangle, where major Chinese cities receive the bulk of the health care and the Chinese countryside, at the tip of the triangle, receives very little. However, the Chinese government hopes that the implementation and development of the national medical reform system will gradually close the gap in the allocation of health care resources between China's cities and countryside. During 2012, the Chinese government implemented many new policies that were directed towards county level hospitals. For example, serious illnesses are eligible for additional medical insurance coverage; hospital projects in Anhui province are open for public bids; efforts to reform public hospitals are provided for county level hospitals. These policies are intended to strengthen the role of county level hospitals in health care that is provided in second and third tier cities and the Chinese countryside. These policies may enable county level hospitals to provide medical services for up to to 70% of the Chinese population. (6)It is likely that the Chinese government's new urbanization policy will increase the government's investment in county level hospitals and second and third tier city hospitals. Consequently, China's national medical system may be adopting a balanced structure, creating more financing and investment opportunities for private hospitals.

  1. Comprehensive Reform of County Level Public Hospitals

On June 7, 2012, the State Council promulgated the Pilot Opinion on Comprehensive Reform of County Level Public Hospitals ("Pilot Opinion"). In this document, the State Council encouraged efforts to be made to explore how to integrate, reorganize, and restructure medical resources in certain counties. The Pilot Opinion named 300 counties that are deemed to be pilot reform areas where these ideas will be implemented. Moreover, the Pilot Opinion implemented a reimbursement mechanism reform to the county level hospitals in the pilot areas. This compensation reform is meant to ensure that medical compensation and fee controls are more effective, and that the Chinese government's investments in health care are better implemented. The Pilot Opinion provides investment opportunities in the domestic medical services sector.

  1. Aging Population

The State Council indicated that the Chinese population is aging rapidly in the 12th Five Year Plan on China's Aging Population(7). Specifically, the State Council noted that from 2011 to 2015, the number of Chinese people who are 60 years or older will increase from 178 million to 221 million, and this population will require access to more hospital services and quality medical care.

  1. Challenges that Investors in Private Hospitals Could Encounter

China's current national laws and regulations encourage making capital investments into hospital construction, promoting better medical services, and comprehensively reforming medical services in China. However, private hospitals still face many challenges because of how China's medical resources are allocated, China's capital market situation, and the real condition of China's medical institutions.

  1. Hardships for Public Hospitals

Chinese public hospitals usually have a large amount of funding, which keeps them from taking actions to reform their operations or considering getting private investment to dilute the equity. Furthermore, Chinese public hospitals could potentially face challenges during reform processes because of the obligation to pay retired employees. In addition, it remains to be seen whether reformed hospitals could be eligible to be included in a national medical care payment system, and how they will fare when they are no longer eligible for tax free treatment. These are challenges that private investors should consider when planning to invest in Chinese the hospital service sectors.

  1. Huge Capital Investment Required in Hospital Service

As of June 2012, there were 9097 private hospitals in China.(8) Most of these hospitals are small in scale when compared with Chinese public hospitals, and because of their small size they are not able to compete against public hospitals, and face many challenges when attempting expand their services. For instance, it will be hard for them to buy the land to build facilities or to buy property, and it will be difficult for them to finance any purchases with bank loans. On the other hand, public hospitals in big and medium sized Chinese cities have plenty of funding to buy land, construct buildings, increase the number of beds, and expand to provide high-end services. While the private hospitals that provide low margin minimum services at the county level and in the countryside have a hard time being profitable, this makes survival hard, and improving services close to impossible.

  1. Difficulty in Retaining Quality Staff

Policy No. 58 guarantees that private hospitals have the right to enjoy the same treatment that public hospitals receive in terms of certifications and academic research funding and access. However, private hospitals do not have enough cash to retain high quality staff, or to train their existing staff to provide better service. In turn, it is hard for private hospitals to attract enough talented staff, and thus, they can only provide services by hiring retired doctors on a part time basis and new graduates with limited experience.

  1. Relationship between Doctors and Patients

Currently, Chinese private hospitals do not have a good reputation with the public, and it will take a long time for the public to accept private hospital service and for private hospitals to develop a good reputation. When compared with investments made in other industries, investments made in private hospitals take longer for PE investors to get returns on their investments.Therefore, there is a risk in private hospitals investment, which may cause some PE investors to be reluctant to make investments in private hospitals.

  1. Exits

Currently, there have been three medical service providers that have successfully listed on the Chinese stock market (Tongce Medical(9), Aier Eye(10), and Dian Diagnose(11)). Moreover, as of January 31, 2013, there are 332 companies waiting in line for IPOs on the Shenzhen Stock Exchange's Growth Enterprise Market, and there are 14 additional enterprises that had their trade on the Growth Enterprise Market suspended for the delisting process on the exchange. (12) With the large amount of enterprises in line to be listed in Shenzhen, it will be unlikely that any private hospitals will be able to make an IPO on the Shenzhen exchange in 2013.

  1. Private Hospital Investment Opportunity

Given the challenges the private hospitals are encountering, the government will need to formulate additional regulations and polices to provide solutions. The best course of action for PE investors is to focus on investing the following services sectors:

  1. New Health Care Industries

The fact that the Chinese population is aging rapidly means that services to the extremely large and fast growing Chinese elderly population will see growing opportunities. For example, investments to create additional long-term health care, psychological comfort and hospice treatment providers are needed. The Chinese health care industry may follow the Chinese IT industry's path, and become the fifth global wealth stream.

  1. High-end Medical Treatment

China's social and economic development and the diverse needs of the Chinese general public have created an opportunity to provide a high-end medical treatment market for certain consumers. Some PE investors have invested in providing Chinese people obstetrics and gynecology services, dentistry, and other health care services, which wealthy consumers are interested in purchasing. These investments are not only made in first tier cities like Beijing and Shanghai, but are also being made in the second-tier cities. The spread of these investments into second tier cities indicates that the emerging market for the high-end medical treatment, and these investments will give more Chinese people an opportunity to receive quality medical service.

  1. Specialty Private Hospital Chains

Policy No. 58 clearly establishes that the Chinese government wants private hospitals to make large new equipment purchases by simplifying the procedures that private hospitals must follow to make these purchases. This move by the Chinese government could stimulate private hospitals' efforts to expand the number of beds they have and expand their services to compete with large public hospitals by providing high-end services for one specific ailment. For instance larger private hospitals could specialize in treating one specific kind of illness and develop a brand under the guise of treating that ailment by providing high quality treatment, in chain hospitals. There already are examples of these kinds of chain hospitals in China that provide cosmetic surgery service and cancer treatment hospitals.

  1. Medical Devices

The development and reforms that have occurred in the Chinese medical device industry make the industry an attractive place for PE investors. As the Chinese health care systems reforms continue, additional medical devices and medical equipment will be needed to provide health care services to the consumers in small cities and the countryside. There will be a tremendous need for medical devices at private hospitals in second and third tier cities and in at county level hospitals, which can facilitate a Chinese medical device industry boom.

These new regulations and policies are reforming the Chinese health care environment and hospital industries, and are creating investment opportunities in these industries. PE investors need to make rational investment decisions due to the challenges that exist to private investors in these industries. However, there is a clear trend in the development of the Chinese medical services industry and the Chinese government is trying to encourage private investment into hospitals. We can expect to see corresponding regulatory guidelines and policy which may facilitate the implementation of those investments. Moreover, private hospitals need to be in a position to retain quality staff and to train their existing personnel to provide quality services in order to allow solid returns on PE investments in private hospitals.