Private Equity Pulse on

Healthcare & Life Sciences

OCTOBER 2011

ContentsExecutive Summary

Page No.3

Private Equity and M&A in Healthcare & Life Sciences - What the data shows..

4

What PE/VC investors think.. - Survey Result

11

Private Equity & M&A in Indian Healthcare - Challenges and Opportunities

13

The Case for Specialty Focused Healthcare Services

18

Issues with respect to Foreign Direct Investment in the Healthcare Delivery Sector in India

22

Medical Devices as the Next Promising Area for PE Investment

27

New Formats for Healthcare Retailing in India

31

Listing of Active Investors in Healthcare & Life Sciences

38

Listing of Active Advisory Firms in Healthcare & Life Sciences

40

Executive SummaryAmit Mookim of KPMG sets the tone for the report in an article highlighting the opportunities and challenges facing Private Equity investments and M&A transactions in Healthcare & Life Sciences. Favourable demographics, along with a confluence of various factors such as rising income levels, increasing proportion of middle aged population, high incidence of lifestylerelated diseases and increasing awareness of new healthcare technology and benefits of regular check-ups, have stimulated the growth potential of the still nascent healthcare sector in India, he writes. In the near term, evolving delivery models in healthcare such as medical ancillaries (diagnostics, ambulance services and equipment maintenance), dental care and daycare facilities may emerge as promising avenues for PE investments, he adds. The Venture Intelligence survey among Private Equity & Venture Capital investors found Diagnostic Chains, Specialized Clinical Chains, Medical Devices, Affordable Healthcare and Personal Care Products as among their favourite sectors within the industry. A significant majority of the investors participating in the survey said that the consolidation story in the pharma sector continues to present investment opportunities. The highly fragmented nature of the market and the need for scale to attract better valuations will drive M&A activity, they feel. Apart from regulatory uncertainties, investors highlighted the long gestation periods and lack of ventures with sufficient scale as among the key challenges in making investments in the HLS space. Pointing out how, so far, most PE investments in the healthcare sector have been concentrated on multi-specialty tertiary care in the tier-I cities, Siddharth Dhondiyal of India Value Fund makes a case for single specialty or service focused business models. These business models - including in specialities like eye care, dental care, IVF, renal care, chemotherapy delivery, orthopaedics and plastic surgery and service focused models like daycare / ambulatory or minimally invasive surgical procedures - focus on a narrow service offering. This enables them to optimize processes to reduce costs and reduce the minimum capacity per facility required for profitable operations. This in turn enables increased penetration of healthcare services at lower costs. The specialty focused investment themes also reduce risk concentration in a single location, enabling staged and modular investments and reduce the overall gestation period of investments. Writing on issues relating to Foreign Direct Investments (FDI) in the Healthcare Delivery Sector, Manav Nagaraj and Ekta Bahl of Tatva Legal, point out that, given the way in which a whole host of services are clubbed under healthcare delivery in India, investors need to carefully assess the specific operations of the investee company to ensure there is no violation of FDI norms. Giving examples of sectors where the definitions are open to interpretation, they stress the need for a clear and stable regulatory regime to attract investments in this high priority industry. In his article, Dr. Sanuj Ravindran of Asian Healthcare Fund points out how the anticipated growth in the hospitals and diagnostics sectors will lead to a proportionate growth in the demand for medical devices, equipment and technologies. Giving actual examples of both Indian and multinational companies operating in each sub-sector, he summarizes the various opportunities and challenges facing investors in medical devices companies. Dr. Ravindran also highlights the emerging opportunity to invest in "cross-border plays" in the sector that leverage, for example, differentiated technologies available in developed countries like the US and the comparatively lower manufacturing costs and faster growing markets in India. Shiraz Bugwadia and Gawir Baig of o3 Capital outline the dynamics of various healthcare retail areas and their attractiveness for investments. The authors highlight emerging healthcare retail formats including "Patient Service Centres" (catering to healthcare checkups and diagnostic testing), "Single Specialty Clinics" (eye, dental, dialysis and IVF), "Integrated Pharmacy Clinics", (a combination of pharmacy outlets, collection centres and a clinic) and "Spas and Wellness Centres".

Private Equity and M&A Healthcare & Life SciencesWhat the data shows

PE Investments in HLS - By Value1% 1%7% 10% 55% 24%CRO Biotech Devices Others Hospital & clinics Pharmaceuticals Diagnostics

2%

57%

*Period FY08 - FY11

PE Investments in HLS - By VolumeHospital & Clinics

2%Pharmaceuticals

7% 13%11% 10% 7%

5%

Diagnostics

35%

CRO Biotech

57%27%Devices Others

*Period FY08 - FY11

PE Investments in HLS

1200 1000 800 600 400 200 0 FY08 FY09 FY10 FY11

50 45 40 35 30 25 20 15 10 5 0

PE Investments in Hospitals

800 700 600 500

18 16 14 12 10

400 8 300 200 100 0 FY08 FY09 FY10 FY11 6 4 2 0

PE Investments in Pharmaceuticals

300 250 200

14 12 10 8

150 6 100 50 0 FY08 FY09 FY10 FY11 4 2 0

PE Investments in Diagnostics

180 160 140 120 100 80 60 40 20 0 FY08 FY09 FY10 FY11

4.5 4 3.5 3 2.5 2 1.5 1 0.5 0

PE Investments in CRO

120 100

8 7 6

80 60 40 20 0 FY08 FY09 FY10 FY11

5 4 3 2 1 0

PE Investments in Biotech

25

7 6

20 5 15 4 3 2 5 1 0 FY08 FY09 FY10 FY11 0

10

PE Investments in Medical Devices

16 14 12 10

3.5 3 2.5 2

8 1.5 6 4 2 0 FY08 FY09 FY10 FY11 1 0.5 0

Top PE Investments in Healthcare & Life SciencesCompany Global Hospitals Max India Apollo Hospitals Narayana Hrudayalaya Metropolis Healthcare Global Hospitals Hospitals Hospitals Hospitals Hospitals Diagnostics Chain Hospitals Sector Amount (US$M) 116 115 104 100 85 74 Investors Samsara Capital Goldman Sachs Apax Partners JP Morgan, AIG Warburg Pincus Everstone Date Jul-07 Dec-09 Sep-07 Feb-08 Jun-10 Jun-07

Source: Venture Intelligence PE Deal Database; FY08 - 11 by Investment Size

M&A in Healthcare & Life SciencesSectorwise M&A deals in HLS

Pharmaceuticals7% 6% 57% 10% 7% 6% 7%

Hospitals CRO Medical Devices Diagnostics Biotech Others

*By Volume. FY 08-11

Yearwise M&A deals in HLS

7065

60 50 40 30 20 10 0FY 08-11

59 50 49

FY08

FY09

FY10

FY11

M&A in Healthcare & Life SciencesType of M&A deals in HLS

Domestic 41% Outbound 43% Inbound 16% 43%

FY 08-11

Top M&A Deals in Healthcare & Life SciencesTarget/Seller Co. Ranbaxy Laboratories Piramal Healthcare* Paras Pharmaceuticals Shantha Biotechnics Orchid Chemical & Pharmaceuticals* Acquirer Daiichi Sankyo Abbott Laboratories Reckitt Benckiser Sanofi-Aventis Hospira Sector Pharmaceuticals Pharmaceuticals (Domestic Formulation Biz) Pharmaceuticals Biotech Pharmaceuticals Amount (US$M) 4600 3720 726 625 400 100 78 Stake (%) 70 Date Jun-08 May-10 Dec-10 Jul-09 Dec-09

Source: Venture Intelligence M&A Deal Database; FY 08 - 11 by Investment Size * Asset Sales

What PE/VC Investors think .Here are the key highlights of a poll conducted among Private Equity & Venture Capital firms for this report. Fund managers from about 60 firms participated in the poll. Investors chose Diagnostic Chains, Specialized Clinical Chains, Medical Devices, Affordable Healthcare and Personal Care Products as among their favourite sectors within the industry.

Most Attractive Sectors for InvestmentsDiagnostic/Pathlab chains Specialized Clinical Chains (Renal, Maternity, Dental, Eye, etc) Medical Devices Affordable Healthcare Personal Care Products Day care surgery clinics Contract Research & Manufacturing (CRAMS) Clinical Chains (Primary Care/General) Domestic Pharma Cos Neutraceuticals Clinical Research Outsourcing (CRO) Hospitals (Secondary & Tertiary) Healthcare Software Health Insurance Medical Education Beauty & Wellness Chains (Like VLCC, YLG, etc.) Fitness Centers (Talwalkars, etc.) Rural Healthcare Medical Tourism Biotech Alternative Medicine (Ayurveda, etc.) Tele medicine Bioinformatics Pharma Retail Pharma Distribution Drug discovery 0.000 0.500 1.000 1.500 2.000 2.500 3.000 3.500 4.000

How Investors Rated Each Sector80% 60% 40% 20% 0% -20% -40% -60% -80% -100% Biotech Medical Education Medical Tourism Pharma Retail Contract Research & Manufacturing (CRAMS) Clinical Chains (Primary Care/General) Clinical Research Outsourcing (CRO) Alternative Medicine (Ayurveda, etc.) Healthcare Software Affordable Healthcare Specialized Clinical Chains (Renal, Maternity, Dental, Eye, etc) Hospitals (Secondary & Tertiary) Beauty & Wellness Chains (Like VLCC, YLG, etc.) Domestic Pharma Cos Diagnostic/Pathlab chains Personal Care Products Day care surgery clinics Fitness Centers (Talwalkars, etc.) Pharma Distribution Tele medicine Health Insurance Rural Healthcare Medical Devices Neutraceuticals Bioinformatics Drug discovery

% Voting 3 or Less

% Voting more that 3

The investors surveyed also indicated that sectors like healthcare supplies, outsourced hospital management, Healthcare BPOs (focusing on the US market), electronic medical records (EMR) and Hospital-Insurance link platforms were also of interest. A significant majority of the investors participating in the survey said that the consolidation story in the pharma sector continues to present investment opportunities. The highly fragmented nature of the market with more than 500 players and with even the leader having a market share of just 6% - and the need for scale to attract better valuations will drive M&A activity, they feel. Also, these investors are betting that MNCs will continue to find it attractive to acquire their way into the Indian market. The recent news regarding the government placing curbs on acquisitions of Indian pharma companies by foreign players has led to concern among the investors. Apart from the regulatory uncertainties, investors highlighted the long gestation periods, lack of ventures with sufficient scale (especially in sectors like Medical Devices, Biotech and Drug Discovery) and high valuation expectations as among the key challenges in making investments in the HLS space. In the Hospitals segment, the dynamics of dealing with doctor-promoters and issues relating to real estate (both the high cost aspect in cities as well as governance issues with respect to land purchases) were citied as among the challenges. Among early stage ventures, the binary nature of the outcome and the risks with respect to failure/negligence pose another challenge. The technical and specialized nature of the industry has also led some investors to conclude that the domain is best left to sector focused funds.

Private Equity & M&A in Indian Healthcare Challenges and Opportunities

Amit Mookim, Partner, KPMG in IndiaAdvantage IndiaThe USD 40 billion Indian healthcare industry is growing at a CAGR of 21 percent and is expected to be worth USD 80 billion by 20201. Key drivers to spur the growth will be enhanced healthcare facilities, private-public projects, evolution of newer segments such as medical diagnostics, speciality clinics and the growing healthcare insurance penetration. Favorable demographics along with a confluence of various factors such as rising income levels, increasing proportion of middle aged population, high incidence of lifestyle-related diseases and increasing awareness of new healthcare technology and benefits of regular check-ups has stimulated the growth potential of the still nascent healthcare sector in India.

In addition, as of 2009, the number of beds available per 1000 people in India was only 1.27, which is less than half the global average of 2.64. As per research data available in FY 10, India had approximately 300 medical colleges, 290 colleges for Bachelor of Dental Surgery and 140 colleges for Master of Dental Surgery. To be able to meet the global average of doctors and nurses, India needs to open 600 medical colleges (100 seats per college) and 1500 nursing colleges (60 seats per college5). In summary, the proportionality in terms of infrastructure/service and investment in the sector will need to be balanced to enable a healthcare system which is accessible and affordable to all.

A fundamentally supply constrained marketTo align with the immense growth potential, the Healthcare infrastructure in India too needs to scale-up. India has an average 0.6 doctors per 1000 population against the global average of 1.232 which indicates an evident manpower gap. Moreover, the medical personnel are concentrated in urban areas which comprises one-fourth of the country's population. Rural doctors to population ratio is lower by 6 times as compared to urban areas3. Therefore, the overall proportion ratio of doctors to population needs to be balanced.1 Industry Insight- Hospitals in India- Nov 2010- Cygnus Research Consulting 2 CII, Technopak report 3 CII, Technopak report 4 Source: National Health Profile 2009 5 Emerging Trends in Healthcare, a KPMG-Assocham publication 6 J. P. Morgan Asian Pacific Equity Research (India Heathcare Services)

Limitations being addressed by investment from the private sectorWhile the government budgetary allocation on healthcare has increased at 26 percent CAGR from the year 2006 to 20116, it is not sufficient to meet the growing consumer requirements for high-end healthcare infrastructure. Therefore, driven by demand for further investment in the sector, the last decade saw private participation in the sector increase significantly on the back of enhanced interest from investors and rising PE and M&A activity.

Increased level of fund raise & M&A to provide impetusOver the past four years, the healthcare sector (comprising CRO, Diagnostics, Hospitals, Medical devices) has accounted for 83 M&A transactions valued at USD 1.3 billion and 80 private equity deals valued at USD 1.6 billion, as of FY 20107A. Notable transactions over the last two years include fund raise by India's two largest healthcare houses (IFC's investments in Apollo Hospitals and Max Healthcare, GIC's investment in Fortis) and domestic transactions such as Fortis' acquisition of Wockhardt hospitals. Standalone regional leaders such as KIMS, Vikram Hospital, Kaveri Medical and Narayana Hrudayala have successfully raised funds through Private Equity. We have also seen early stage investments in sunrise sectors such as in daycare, ophthalmology and dental care.

However, in the near term, evolving delivery models in healthcare such as medical ancillaries (diagnostics, ambulance services and equipment maintenance), dental care, and daycare facilities may emerge as promising avenues for PE investments. The returns in these evolving delivery models are attractive as the CAPEX required is significantly limited in these models. Moreover, it is beneficial for these new business models to explore fund-raise through Private Equity as besides providing them with the necessary impetus to grow, Private Equity investors with their experienced management skills can bring in the desired efficacy in these evolving models. Some of the investments made by Private Equity in these new business models include NEA's investment in Nova Daycare centre, CX Partners' investment in Thyrocare Technologies, TA Associates' investment in Dr Lal's PathLabs. PE Exits We also witnessed some PEheld investments come up for sale trend setters being the successful exits made by Sequoia (Dr Lal), ICICI Ventures (Metropolis) and IDFC (Manipal hospitals) in 2010. Private Public Partnership (PPP)8 PPP is described as a private business investment where two parties comprising government as well as a private sector undertake a project and form a partnership. It has, in recent times, emerged as a viable avenue to promote reforms as well as bring in an influx of desired funds in the sector. To leverage on the strengths and weaknesses of both the public sector and the private sector, it is evident that they need to operate in conjunction for the best interest of the health system. Also, there is a growing awareness that if well structured, both sectors can benefit each other while functioning in the healthcare domain. However, there are some challenges in the adoption of this kind of model and these include: Meeting the motive and interest of the private sector (Profit/Not for Profit). Acquiring adequate support from all the stakeholders (both public and private) for acceptance of the concept of PPP. Political instability

Key prevailing themes in M&A and Private Equity (PE)Consolidation In the near term, the focus will be on consolidation as larger players are seeking growth by acquiring small regional/stand alone players. Moreover, high up-front CAPEX requirements, long gestations periods, burgeoning real estate costs and resource crunch are some of the factors on account of which smaller players are expected to merge with or be acquired by larger groups. Standalone hospitals, centers could either be acquired or come under the O&M arrangement with the larger players. To put things in perspective, we have highlighted below some of the recent investments7B made Fortis Healthcare ('Fortis'): A joint venture with Karnataka based Cauvery Hospital to set up a cardiac centre in Mysore. Fortis will own a majority stake in the joint venture. Fortis along with Cauvery Hospital will set up, operate and manage the Cauvery Hospital's Mysore facility with an investment of INR 120 million. Acquired Vivekanand Hospital and Research to strengthen its presence in India's tier-II Cities. Post transaction Fortis will increase its network to a total of 51 hospitals and Vivekanand Hospital will be re-christened as Fortis Vivekanand Hospital. Acquired 10 hospitals from Wockhardt Hospitals Limited, the India based healthcare institution, for a total consideration of INR 9.09bn (USD 189m). We also have other examples of regional consolidation / expansion such as KIMS and Care hospitals (Andhra Pradesh), Sterling Hospitals (Gujarat), Moolchand and Paras Hospitals (Delhi), Manipal and DM Healthcare (South). Possible opportunities for PE Over the last couple of years, we have seen active Private Equity participation in Indian healthcare. PE penetration in the sector has been across the entire healthcare delivery chain from standalone tertiary care hospitals in metros/ tier II cities, chains of hospitals to emerging healthcare delivery models such as diagnostic labs, daycare.7A Venture Intelligence PE and M&A Deal Database 7B Mergermarket 8 KBuzz, Sector Insights -- KPMG

Well thought mitigation strategies need to be formulated to overcome the challenges for all stakeholders. Policy innovations such as public private partnerships are, of course, highly contextual. However partnership with the private sector is not a substitute but fortification of the public sector in provision of health services. It is necessary that there should be a clear rationale for partnering with the private sector. It is important to understand not only what services are to be provided under private partnership but also the basis on which such decisions are made to make this a need based successful intervention. Examples of successful PPP projects have been listed below9: Karnataka Karuna Trust; Yashaswini Scheme Tamil Nadu Mobile health services Andhra Pradesh Aarogyasri Andhra Pradesh Diagnostic Services for 4 Medical Colleges West Bengal Mobile health services Madhya Pradesh Community outreach program Rajasthan Contracting in public hospitals Gujarat Chiranjeevi Project Inbound interest FDI interest despite government initiatives remains lukewarm. This is evident with the presence of a limited number of 100 percent foreign-owned healthcare players in the Indian market. However, as evident from the recent partnership ventures, we believe that foreign players are showing a keen interest in forming partnerships with Indian healthcare players in Greenfield projects. Some of the recent partnerships formed between Indian and foreign players on Greenfield projects10 in healthcare have been listed below: Singapore's Pacific Healthcare made its entry into the Indian market by opening an international medical centre in a joint venture with India's Vitae Healthcare, in Hyderabad The Singapore-based Parkway Group Healthcare PTE Ltd formed a joint venture with the Apollo group to build the Apollo Gleneagles hospital, a 325-bed multi-specialty hospital. The Parkway group had also entered into a joint venture with a Mumbai-based Asian Heart Institute and Research Centre to set up specialized centers of medical excellence in Mumbai.

Other key considerations to seek long term growth in the Healthcare segmentAsset light model -- One of the key challenges for private players in the hospital space is the real estate cost. Mounting real estate costs very often make projects unviable, especially in Metros and Tier I cities. To counter this challenge, some of the players are making a shift from real estate ownership models to lease models. Skilled talent pool -- Adequate supply of quality professionals is critical for healthcare operators to scale-up in India. Retention of the right people at the right cost is vital, especially for tertiary care segment. In addition to experienced medical staff, it is also now increasing important to induct finance professionals with entrepreneurial skills to execute and implement the high-scale, ambitious ventures and to spur innovation in the business models. Brand recognition to sustain competitive intensity A strong brand image clearly plays a pivotal role in the long-term success of a healthcare player in his addressable market. To be a success, one has to invest time in building up the brand image. With the increasing focus now on quality care, it is essential for players in the healthcare space to bring about a consistency in the quality of their healthcare delivery. This will help in developing strong brand equity to succeed in the long term.

9 Source: Technopak Report A Peek into the Future of Healthcare: Trends for 2010 10 IDFC India Research on Indian Hospitals Disclaimer: The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. 2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. Printed in India.

About the AuthorAmit Mookim is the Partner Strategic Services Group (Transaction Services) and National Industry Head of the Healthcare Practice for KPMG in India. He has advised several PE funds and corporates in investments/ due diligence on healthcare formats such as Day Care Centres, Specialised Tertiary Care Centres and Multi-specialty hospitals. He has also advised several multi-national corporations in strategic decisions relating to entering the Indian markets for medical devices and consumables. For corporates, he has conducted several strategic engagements relating to new business planning, market entry and partner search/ pre-funding assistance. For PEs, he has assisted on building the investment thesis for the sector, as well as on preinvestment due diligence and modelling. Amit is a Bachelor of Economics from University of Kolkata and holds an MBA from FMS, Delhi.

Contact details: T : +91 22 3090 2141 M : +91 96190 01400 E : amookim@kpmg.com

About KPMG in India

KPMG in India is one of the leading providers of risk, financial and business advisory, internal audit, corporate governance, tax and regulatory services. With a global approach to service delivery, KPMG responds to clients' complex business challenges with rapid and technology-enabled services across industry sectors and national boundaries. KPMG in India operates from 10 cities with a work force of over 6000 employees. KPMG India's Transactions and Restructuring (T&R) Services team offers a broad range of financial and strategic advisory services to clients across a wide array of industries. We strive to provide insightful and objective advice to our clients as they contemplate mergers and acquisitions, financing options and evaluate better alternatives for their businesses. Our international network and our deep sector knowledge together help us in our aim of assisting our clients develop and pursue their strategic and transactional objectives. In Healthcare, KPMG assists its clients as a globally integrated health practice, comprising senior clinicians, health workers and consulting professionals. KPMG works across the globe in various healthcare projects with Government departments, Aid agencies, Hospitals, Laboratories, Medical Device companies, Insurance and Private Equity/ Venture Capital firms. KPMG in India provides several relevant solutions to healthcare and allied organizations such as Business Strategy, Tax Structuring, Joint Ventures and Fund-raising assistance, Policy, PPP and Transaction advisory, Process, Governance and Technology in Health.

Systematix Capital is a boutique investment banking firm committed to providing value added services to its clients in the field of capital raising and M&A. We advise companies in various stages of its growth right from Venture to Mature for their funding requirements. We also offer M&A advisory services to our clients for their inorganic growth plans and exits to the stakeholders. Besides our two dedicated offices in Mumbai and Delhi, we also operate through our associate partners in Japan, US, Singapore, Germany and UK. Since inception in 1995, we have been instrumental in closing deals in various sectors including Education, Healthcare, Real Estate, Pharmaceuticals, IT, Hospitality and Engineering. In the healthcare / pharmaceuticals industry, we have recently concluded a private equity placement of INR 450 Mn for Symbiotec Pharmalab Pvt. Ltd, already a global leader in research based Active Pharmaceutical Ingredients for corticosteroids and hormones. Historically, we have also assisted other pharmaceutical companies like Granules India, Parenteral Drugs India and Surya Pharmaceuticals in raising capital. Currently, we are exclusively advising a leading pharmaceutical MNC to inorganically grow its formulations business in India. We are also assisting a south India based hospital group and a chain of dental clinics raise capital through the private equity route.

Has invested in

Sole Advisor to: Symbiotec Pharmlab Pvt. Ltd. September 2011

About Systematix Group Systematix Group is a two decade old diversified financial services company providing various services like investment banking, merchant banking, institutional and retail broking, wealth management, NBFC and mutual fund distribution to its esteemed clients. The group is headquartered in Mumbai and has a pan India presence with 35+ offices and 400+ employees spread across the country.

Contact Details: Systematix Capital Services Pvt. Ltd, G2 A Platina, Near Citibank Tower, Bandra Kurla Complex, Bandra (E), Mumbai - 400 051 Tel: +91 22 6704 8000 / 4228 7000 Fax: +91 22 6704 8022

Contact Person: Nikhil Khandelwal E: nikhil@systematixgroup.in Abhishek Khandelwal E: akhandelwal@systematixgroup.in

The Case for Specialty Focused Healthcare ServicesSiddharth Dhondiyal, Director- Investments, India Value FundHealthcare Services IndustryDemand for healthcare services in India is expected to grow at 1215% pa over the next 20 years. The fundamental demand growth drivers are well known and clearly irreversible. The private sector currently accounts for 75% of current bed capacity and is expected to add over 90% of the incremental supply required to meet this demand. The Indian healthcare services industry faces the challenge of significantly ramping up supply of high quality affordable healthcare services and making them available across the country. Clearly, the public sector is neither geared up nor has the funds to meet this challenge. The private sector on the other hand has struggled to find profitable business models to be able to meet this challenge.

Accessibility & Affordability: The Unmet ChallengeThe last ten years have seen significant capacity additions in the healthcare services sector driven by private sector investment and as a consequence the overall demand supply situation in key metros has improved dramatically. However this very visible growth in supply of high quality multi-specialty healthcare facilities in large urban centers distracts from the fact that this segment accounts for less than 20% of the overall demand. The capacity addition by the private sector has largely been limited to the higher end price points and in metros and tier-1 cities. Very few corporatized private sector healthcare institutions have been able to address the challenge of offering affordable healthcare, with Care Hospitals and Narayana Hrudalaya being notable exceptions (E.g. Both offer Coronary Artery Bypass Graft surgeries for less than Rs. 100,000) Moreover, despite tax incentives corporatized private sector healthcare operators have been unable to penetrate and offer healthcare services beyond the tier-II cities in any form or manner, with the exception of Bangalore based Vaatsalya which has managed to setup 10+ secondary care facilities in tier-III & IV cities.

Investment Themes: Dominance of the Multispecialty Tertiary Care ModelWe've seen an increase in the size and number of corporate healthcare platforms driven by the favorable industry dynamics and availability of long term capital from private equity investors. The bulk of these investments, barring a few exceptions, have been focused on the traditional tertiary care, multi-specialty business model. Investment strategies in the tertiary care segment have focused on two key themes

Capital Efficiency ThemesRight sizing facilities based on the location Optimizing Greenfield project execution Asset light models based on leasing of real estate.

Risk Mitigation ThemesPartnering with / tying up good doctor teams Consolidation of existing hospitals to drive scale and network efficiencies. Most of the PE investments in the multi-specialty tertiary care segment have done well due to the overall demand supply gap for these services in the tier-I cities. The implication of the above hypothesis is that the TCMH business model is not ideally suited to provide accessibility to smaller towns and cities which may not have a large enough catchment and demand to support profitable operations. Additionally the TCMH model is not ideally suited to maximize efficiencies given the complexity of its operations. To meet the challenge of accessibility and affordability the industry needs a profitable business model which can work effectively at much lower capacities (say < ~50 beds) and has the structural freedom to optimize processes to improve efficiencies to deliver healthcare services at much lower costs.

Multispecialty Tertiary Care Model: ChallengesThe success of the multispecialty tertiary care investments have depended on the quality of execution underlying these themes. However challenges inherent to investing in the multi-specialty tertiary care format remain. These challenges are Long gestation period for investments: Investors need to get comfortable with hold periods of 5+ years to capture full value Chunkiness of Investments : Large minimum ticket size for each investment Difficulty in building a brand and differentiation: Doctors brands continue to over shadow the corporate brand. Limited or no consumer experience of the most important element of service delivery (surgical or other non-surgical procedure) to build brand differentiation. Given these challenges, the industry needs to come up with alternative formats or business models to increase the level of PE investment in the healthcare services sector.

Meeting the Challenge: The Focused Factory Approach.A healthcare service delivery model (The Focused Factory) which narrows its service focus to a single specialty (specialty focus) or a set of procedures which have some common service delivery features (service focus) can be profitable at much lower capacities and at comparatively lower price points by optimizing the entire service delivery processes to deliver services in the chosen area of focus. A successful focused factory business model requires careful consideration of certain key elements of the design of the business model. These three elements are the (i) choice of the area of focus, (ii) Brand value proposition and the (iii) Doctor value proposition. The various factors to be considered in deciding on the structure of these key elements are discussed in sections which follow

Healthcare Delivery Processes & Operations: Understanding the TradeoffsThe tertiary care multispecialty hospital (TCMH) has an extremely complex service delivery system from a process and operations point of view. Driving this high level of complexity is the potentially unlimited services and procedures that the TCMH is geared to provide. The TCMH is a one stop shop which can provide all the diagnostic services, procedures ranging from planned procedures like organ transplants to emergency critical care for trauma cases. Clearly from a process and supply chain viewpoint this capability to handle complexity and provide high service levels has inherent costs which the healthcare delivery system in such a facility has to bear. Clearly there is a need for TCMH which can handle complex procedures as well as manage care requiring more than one area of expertise. However this imposes some limitations to the situations where a tertiary TCMH business model can be profitable. Namely it needs a minimum size of patient volumes to achieve the scale required to make the entire setup cost effective. Hence the TCMH model will work well in a location which has a large catchment of patients who require complex procedures and have the capability to pay for these procedures; it works well in large urban agglomerations like the metros and tier-1 cities. Given the economics of providing healthcare services in India, the minimum size of a TCMH in Indian metros would be ~ 200 beds.

Choice of Focus Area/ SpecialtyThe choice of the area of focus or specialty lies at the core of the focused factory business model. We have seen various specialty focused or service focused models existing in the healthcare industry globally and a few emerging models in India. Specialty focused models include, eye care, dental care, IVF, renal care, chemotherapy delivery, orthopedics and plastic surgery and service focused models like daycare / ambulatory or minimally invasive surgical procedures. Five key criteria need to be met while choosing an area of specialization, (a) The specialty or focus area should have procedures which are amenable to standardization with limited variations in processes required for bulk of the patients being treated. E.g. Cataract removal surgery (b) the process of diagnosing the requirement for the procedure/ treatment should be relatively simple and standardized. E.g. Presence of kidney stones (c) Focusing on a specialty area and/ or service should significantly reduce investments or unit operating costs and improve service levels compared to a multispecialty model. E.g. Day care surgery removes need for inpatient infrastructure (d) Outcomes and quality of treatment/procedure are easy to measure Eg. Laser eye surgery (e) Good supply of relevant medical skills to perform treatment/procedure should available or can be created through training.

All these criteria listed above are important, however the availability of medical skills is the most critical criteria without which the focused factory model cannot work. Take the example of Dialysis care in India, the availability of nephrologists has been a significant impediment in scaling up standalone dialysis centers. In addition to these criteria other factors like the minimum scale at which the operations are profitable and availability of relevant medical skills in various locations will determine the penetration and scale the chosen focused factory business model can potentially achieve.

Brand Value PropositionBuilding a strong brand is critical to the success of a focused factory business model in healthcare. Given that the focused factory business model scales up through multiple small sized facilities spread geographically, a powerful brand enables faster scale up of volumes in new units and builds a barrier to entry for new or local players looking to replicate the success of the focused factory business model in the chosen specialty area. A successful focused factory brand needs to differentiate itself vis a vis other competing healthcare service delivery business models and in particular the multispecialty care model. 1.Superior/ high quality of treatment outcomes 2.Superior service levels and consistent experience 3.Lower total cost.

It is important to understand that in a focused factory environment there is always a focus on de-skilling the treatment process as far as possible to improve efficiencies. This is done by following standardized treatment protocols and selecting patients without any complications which would require variations in treatment protocols. Hence the process of building skills in such an environment through experience is valuable for more inexperienced or younger medical practitioners and less so for more experienced professionals who want to expand their skill set in terms of the range of treatments/ complications they are able to offer/manage. To some extent this can be mitigated by the fact that the focused factory environment would enable access to the latest techniques and equipment which potentially improve outcomes or increase efficiencies. However managing aspirations of medical practitioners with respect to building a range of skills is a challenge inherent in focused factory healthcare delivery business model. Often the success of a focused factory business model in healthcare depends on how well doctor aspirations are managed.

ConclusionsThe twin challenge the Indian healthcare industry faces of providing access to healthcare services at an affordable price can be met by appropriately designed single specialty or service focused business models (Focused factories). These business models focus on a narrow service offering enabling them to optimize processes to reduce costs and reduce the minimum capacity per facility required for profitable operations thereby enabling increased penetration of healthcare services at lower costs. These single specialty or service focused business models provide a set of alternative investment themes for PE investors in healthcare services by enabling a range of investments across deal sizes and business model stage of evolution. The specialty focused investment themes also mitigate some of the investment risks associated with investments in tertiary care multi specialty hospitals by reducing risk concentration in a single location, enabling staged and modular investments and by reducing the overall gestation period of investments.

Doctor Value PropositionThe ability of any healthcare service delivery business to capture value its services generate depends on its negotiating leverage with medical professionals in terms of the sharing the value created by providing treatment to patients. Profitable business models therefore are characterized by situations where the healthcare institution provides the medical practitioner with an eco system which provides (i) superior access to patients, (ii) enables the medical practitioner to build skills and ultimately (iii) earn more than he/she would be able to do so without the institution. A successful focused factory brand provides medical practitioners with targeted patient flow, an eco system which enables the practitioner to improve his/her efficiency in terms of number of patients treated in any given period of time which in turn enables faster buildup of experience in terms of cumulative number of procedures performed. Ultimately this improvement in efficiency enables the medical practitioner to earn more than he/she would in most other situations.

About the AuthorSiddharth is a Director at India Value Fund and is based out of Bangalore. Siddharth looks at the healthcare, education and consumer sectors amongst other sectors for investments within IVF and has been instrumental in developing the firm's viewpoint and investment thesis in these sectors. Siddharth has a Bachelor's degree in Mechanical Engineering from the Indian Institute of Technology, Kanpur, PGDM from the Indian Institute of Management, Calcutta and an MBA from INSEAD, France

Contact details: Siddharth Dhondiyal India Value Fund Advisors Rocklines House (Ground Floor) 9/2, Museum Road, Bangalore - 560 001 India.

M T F E

: +91 99 4519 4541 : +91 80 4132 1845 : +91 80 2559 0800 : siddharth@ivfa.com

About India Value Fund

India Value Fund Advisors (IVFA) was established in 2000 and is one of the most experienced private equity fund managers in India. IVFA manages over US$ 1.4 billion in assets across four funds of India Value Fund (IVF). IVF investment strategy is to acquire majority / significant minority stakes in mid-size companies in India to build high growth and enduring businesses, which are admired by all stakeholders. An in-house business management team supports IVF's unique value creation approach of partnering with portfolio companies to 'invest & build' great businesses. The business management team provides deep management & operating experience, access to best-in-class processes & systems and a network of service providers to portfolio companies to enable their growth. IVF's framework for engaging with portfolio companies is based on building resilient partnerships with management teams based on mutual respect, integrity, and transparency. IVF investments include a diverse range of industries such as healthcare, retailing, outsourced services, media & entertainment and manufacturing.

For more information visit the IVF website at www.ivfa.com

Issues with respect to Foreign Direct Investment in the Healthcare Delivery Sector in India

The healthcare industry is one which has been in the news of late not only due to the amount of medical tourism, investment and consolidation in the space but also due to a host of legal as well as ethical concerns with respect to the healthcare industry. While it is commonly assumed that the healthcare industry is synonymous with the establishment and running of hospitals and medical treatment centres, the healthcare industry is much wider could also take into account other services and industries that are related to the medical profession and would also include medical / nursing education, pharmacy operations, diagnostic / pathological laboratories, clinical trial establishments, research and development establishments, medical equipment manufacturers, medical insurance, etc. The healthcare industry is probably one the most legislated and regulated sectors in India. In addition to the laws enacted both at the Central and State Government levels, there are multiple regulatory bodies such as the Medical Council of India, the Nursing Council of India, the Pharmacy Council of India, the Drugs Controller General of India, the Department of Biotechnology, etc. that have issued regulations and guidelines on divergent aspects ranging from establishment and operation of hospitals to medical education to operation of pharmacies and administration of medical drugs.

Additionally, the healthcare industry is also constantly plagued with several ethical issues and concerns including those relating to stem cell research; clinical trials; sex determination; surrogacy; medical tourism; data mining, confidentiality and privacy issues; waste management; drug pricing, etc. It becomes important for any participant in this space including an investor to have an understanding of the legal regime applicable to the concerned entity as non compliance with a particular regulation especially in relation to procurement of approvals and consents may in addition to having financial implications, result in interruption or stoppage of business. It would be impossible to deal with all the legal and regulatory concerns and issues concerning the healthcare industry in this article, therefore we have restricted the scope of this article to briefly discussing certain issues and concerns pertaining to foreign direct investment (FDI) in the companies engaged in the healthcare delivery sector such as hospitals, nursing homes and diagnostic/pathological laboratories, with a view to provide an insight to both investors and entrepreneurs on options, perils and pitfalls with respect to these issues.

The healthcare delivery space (hospitals, nursing homes and diagnostic/pathological laboratories) is one that has attracted the attention of both private equity and strategic investors both from within and outside India. The extant FDI Policy sets out the sectoral caps with respect to FDI in the specified sectors. 100% FDI is permitted in the sectors in which FDI is not prohibited or where no sectoral caps are not provided. While healthcare as a separate sector is not specified in the FDI Policy as a sector in which FDI is prohibited or which is subject to sectoral caps, there could be restrictions that could be applicable depending on the nature of activity that the company is actually involved in. In this article, we would deal with 4 specific examples:

Lease of hospital spaceWith the increasing number of multi-speciality hospitals being established with larger number of beds, resulting in larger built-up areas, we see more and more hospitals having outlets such as florists, bookshops, departmental stores and third party pharmacies on the hospital premises. These outlets are usually leased or licensed. The question arises as to whether the company operating the hospital is also engaged in real-estate business in the event the company charges a lease rental from these various outlets. Again, there are divergent views on this issue. A highly conservative view would be that the company is also engaged in the real estate business and no FDI is permitted in such company. The other view is that the mere leasing of the outlets would not be construed to be a leasing business since the same is for the benefit of the patients and the families of the patients. In order to avoid issues around leasing, healthcare delivery companies choose to adopt either licence models, revenue sharing models or hybrid models where no interest in immovable property is created. While there is a need for the Government to clarify the position in this respect, it is unlikely that there would be full certainty on this aspect and as such structures which mitigate risk for the investors including housing such activities in a resident Indian owned and controlled subsidiary are considered by Investors.

PharmacyAn interesting question arises when one considers pharmacies. Pharmacies typically buy their goods in bulk from wholesalers / distributors and thereafter sell them to retail customers. Pharmacies can be classified broadly under two categories. The first comprises a pharmacy or pharmacy chain that operates on a stand-alone basis while occupying premises within the hospital and the other is a pharmacy that is part of a hospital or other healthcare delivery mechanism. The latter could also operate on two distinct models, the first where the pharmacy has been established for the purpose of captive consumption of the hospital and its patients and the other where the pharmacy caters to the hospital, its patients as well as outsiders. While the position on whether FDI in a company engaged in operating stand along pharmacies would mean investment in a company which is also engaged in retail trading (which is not currently allowed under the automatic route), is itself not free from doubt, as regards FDI in healthcare delivery companies which also have a pharmacy as part of such delivery mechanism, the views are even more varied. One view is that since the pharmacy is owned and operated by the company which has established the hospital, therefore the company itself is engaged in retail trading and accordingly no FDI is permitted in such healthcare delivery company. Another view is that the pharmacy is an integral part of healthcare delivery and the same is not to be construed as a stand-alone business given the percentage of pharma sales as a part of the business. An analogy may be drawn to a restaurant that sells a branded soft drink or mineral water to a customer who also dines, which does not mean that the restaurant is engaged in retail trade. Given that there is a lack of clarity on this aspect, many investors choose to take a conservative view to avoid a regulatory pitfall. There have also been divergent responses from the DIPP in this respect. There is a need for the Government to clarify the position in this respect in order to ensure that vital funds needed for development of the healthcare sector are not caught in regulatory quagmires.

Hospital ConstructionThere is also a lack of clarity on the FDI norms applicable to entities that establish hospitals that are managed by third party hospital operators. One view is that such entities are also engaged in the healthcare sector. However it can also be argued that such entities are engaged in real estate business and as such the provisions of the FDI Policy as applicable to real estate business need to apply to investment in such companies, which also reduces possibility for fund raising in the form of ECB etc. If in terms of the extant FDI Policy it is construed that development of hospitals is construction and development for the purposes of FDI, some of the restrictions such as size and minimum capitalisation would not be applicable to such construction and development activity. However, this does not address the aspect of existing buildings that are managed by third party hospital operators and as such the ability to spin off of existing hospitals (non greenfield hospitals) into separate companies to unlock real estate value is not free from doubt and therefore requires structuring to ensure compliance with the FDI norms. Whilst there is no doubt that there is a compelling need for investment in the healthcare infrastructure space, clarity on whether the same falls within real estate development, healthcare or even infrastructure is the need of the hour. Granting infrastructure status to such entities would catalyse investment in such space.

Medical InsuranceFDI in companies engaged in insurance companies is limited to 26% provided that they have obtained the necessary license from the Insurance Regulatory and Development Authority. While there is no ambiguity in this when dealing with medical insurance companies, the question arises as to whether hospitals, nursing homes or diagnostic / pathological centres that offer cashless facilities or treatment on payment of an annual fee or charge are in effect providing insurance services as well. While the Insurance Act, 1938 does not define what would constitute 'insurance business', the Supreme Court in the case of National Insurance Co. Ltd. v Seema Malhotra and Ors. (AIR 2001 SC 1197) has observed that The essence of the insurance business is the coverage of risk by undertaking to indemnify the insured against loss or damage. They agree to pay the damages arising out of any accident by taking a chance that no accident might happen. Motivation of the insurance business is that the premium would turn to be the profit of the business in case no damage occurs. Such business of the insurance company can be carried on only with the premium paid by the insured persons on the insurance policy. The only profit, if at all the insurance company makes, of the insurance business is the premium when no accident or damage occurs. Further, the Delhi High Court in Gamma Investments v. National Insurance Company Limited (CS (OS) No. 1445 of 2002), observed that the insured sum could be by way of money or its equivalent.

While it could be argued that the scheme or plan offered by hospitals, nursing homes or diagnostic / pathological centres are not insurance activities in the strict sense, in the absence of the term insurance being defined, it is open to the regulators to interpret such an activity to be that of insurance business. In light of the above, while there is no doubt that healthcare delivery as a sector has attracted the attention of foreign private equity as well as strategic players, where it is generally assumed that upto 100% FDI is permitted on the automatic route, given the method in which a whole host of services have traditionally been clubbed under healthcare delivery in India, there is a need to objectively assess the method of operations of the investee company to examine that there are no operations that violate norms applicable to FDI in India. There is no doubt about the need to rapidly develop healthcare delivery in India including in Tier 2 and Tier 3 cities where hospitals integrate multiple aspects of delivery including pharmacies, cashless payment methods etc. Clarity on these aspects is the need of the hour in order to allow for a clear and stable regulatory regime that is free from doubt and ensure that investors are clearly aware of restrictions if any on their investment and to enable ease of investment and exit without regulatory risk.

About Tatva LegalTatva Legal brings together a like minded group of professionals who aspire to create a professionally managed legal services firm providing support to national/multi-national clients across a broad spectrum of businesses. The firm is a full services national law firm with 10 partners and over 70 lawyers across India. The firm focuses on Private Equity and M&A, Infrastructure and Real Estate, Corporate Advisory and Employment Laws and Banking and Finance.

Contact details: Bangalore B-3, 2nd Floor, Embassy Heights Annexe 13 Magrath Road Bangalore-560 025, India Delhi Unit 1101-1104 , Tower D Global Business Park Mehrauli Gurgaon Road Gurgaon-122002, India Hyderabad Level-II, Plot No. 1246 Road No. 62, Jubilee Hills Hyderabad-500033, India Mumbai 101, 10th floor, Sakhar Bhavan, Block No. III, Plot No. 230, (Behind Hotel Oberoi) Nariman Point, Mumbai-400 021, India

T : +91 40 44680000 to 04 E : delhi@tatvalegal.com F : +91 40 44680005 T : +91 80 4331 1433 E : hyderabad@tatvalegal.com F : +91 80 4331 1438 E : bangalore@tatvalegal.com T : +91 22 43342500 F : +91 22 43342505 E : mumbai@tatvalegal.com

About the Authors

Manav Nagaraj, PartnerManav Nagaraj is a partner of the firm based in the Bangalore office. Manav practices in various areas related to corporate investment and general corporate law. He has handled various complex transactions involving private equity, mergers, acquisitions, joint ventures and corporate restructuring, inbound and outbound investments, investment structuring, legal due diligence, distressed assets and project finance. Manav holds a Bachelor of Laws degree from the National Law School of India University, Bangalore and a certificate in private international law from the Hague Academy of International Law, The Netherlands. Manav has advised extensively on the healthcare sector in India including advising on restructuring of healthcare delivery companies, advising foreign investors in investment in Indian healthcare companies as well as Indian companies and promoters in this field. Manav can be reached on manav.nagaraj@tatvalegal.com

Ekta Bahl, PartnerEkta Bahl is a partner of the firm based in the Hyderabad office. Ekta has significant experience in corporate and commercial laws, with specific focus on corporate restructuring, project finance, private equity and M&A. Ekta has substantial industry specific experience in the areas of real estate, information technology, biotechnology, education, healthcare and infrastructure (including power and roads). Ekta has also provided legal assistance to various social sector enterprises. Ekta graduated with a BA.LLB (Hons) degree from National Law School of India University, Bangalore.

Ekta's experience in the healthcare sector includes diligence, structuring and advising private equity funds and promoters on investment in healthcare delivery in India. Ekta can be reached on ekta.bahl@tatvalegal.com

Ventureast is an early stage fund entrepreneurial manager with more than a dozen years of investing experience in India. We are now into our third generation of funds with more $300 million under management. Ventureast Life Fund III focuses on such the Life sciences sector and specifically targets investments in the Healthcare, Cleantech and Food/Agriculture. The Fund focuses on early growth and growth stage companies in the Life Fund sectors that are addressing fundamental needs are typically growing faster than the balance of their respective sectors. Some specific areas of interest include Access to affordable healthcare Yield in agriculture & quality in food processing sectors Access to potable water & cleaner sources of power Our team comes from diverse backgrounds with professional, entrepreneurial and financial expertise. We are passionate about our portfolio companies and like to work closely with our entrepreneurs in creating value . For further information please visit ventureast.net.

Medical Devices as the Next Promising Area for PE Investment

Dr. Sanuj Ravindran, MD, Asian Healthcare Fund

IntroductionPrivate Equity investors are generally excited about the rapid growth that is being witnessed within India's healthcare industry. Within the broader healthcare sector, most of what is talked about is specific to healthcare delivery, and much of what PE investors debate is whether the best opportunities for healthcare delivery investment are in the major metros vs. tier III cities; in multispecialty hospitals vs. single-specialty clinics; or in asset linked models vs. asset light models. And when the discussion moves beyond healthcare delivery, the next focus area typically centres on diagnostic servicesboth lab-based and imaging diagnostics. As a healthcare focused investment firm, we agree that there are excellent investment opportunities within most of the areas aforementioned, but the jury is still out on which models will ultimately yield the highest returns for both promoters and investors. That being said, what is most interesting is the fact that regardless of which models ultimately prevail, any growth within the aforementioned sectors will de facto result in a proportionate amount of growth in the areas of medical devices, equipment and technologies. After all, hospital rooms require monitors, ECG machines and ventilators; operating theatres require surgical tools and implantable devices; cath-labs require fluoroscopy machines, stents, valves, ICDs, pacemakers, etc.; path labs require analytical instruments; and diagnostic centres require a variety of imaging equipment.

So, as a firm focused exclusively on the Indian healthcare landscape, we are attracted to the area of medical devices, equipment and instrumentation, and will herein try to outline for you: some observations about the sector; some thoughts on where the most promising opportunities are likely to be; and some concerns about the various challenges that this sector represents.

Key StatisticsCurrently, the overall market for medical technologies (including medical equipment and medical devices) is estimated to be over $3BN USD, and growing at an annual rate of 15% [Cygnus, 2010]. This represents less than 10% of the overall $40BN healthcare market in India [Cygnus, 2010], but is at the same time driven by the growth of India's overall healthcare market. The med-tech market can be further segmented into various components including [Deloitte-CII Med Tech in India, 2010]: Medical instruments and appliances (25%) Orthopaedic and prosthetic implantables (20%) Cardiovascular implantables (e.g. stents, pacemakers) and GI (15%) Imaging equipment (10%) Electro medical machines and monitors (10%) Syringes, needles and catheters (12%) Other supplies (8%)

From an investors point of view, each of these segments are poised to grow as the overall healthcare industry grows, but that does not necessarily mean that each of these segments represent viable investment opportunities. Some further observations that are both in favour of and in opposition to medical technologies as an investment opportunity include: Over 75% of the current medical technologies market is import driven and in the hands of MNCs [Deloitte-CII Med Tech in India, 2010]; most of the higher value devices fall into this segment The domestic medical technologies market is highly fragmented (over 700 local manufacturers of medical devices and technologies) [Reuters, 2010] Most of what constitutes the locally manufactured medical technologies market is in commoditized categories (e.g. syringes, bandages, catheters) that do not offer differentiated investment opportunities Over 60% of medical devices that are locally manufactured are exported from India [Deloitte-CII Med Tech in India, 2010]

MNCs Eye IndiaIt's been mentioned above that MNCs constitute over 75% of India's current medical devices industry, and given recent trends, it is likely that this ratio is only going to increase. While, as a PE investor, one is not likely to be able to invest directly into these established MNCs, the following examples of MNC initiatives are tell-tale signs of the impending growth spike that the Indian medical technologies landscape has begun to see: GE Healthcare GE Healthcare was one of the first MNCs to make a significant splash into India's medical technologies market, having established a 50,000 sq. ft. R&D facility in Bangalore in 2000, wherein GE most notably developed a portable and battery operated ECG machine that produces ECGs at 10 Rs. each. Siemens Siemens, which has actually manufactured imaging and ultrasound systems in India for more than 50 years, has recently begun building mobile diagnostics units with integrated X-ray, ultrasound and pathology systems. Medtronic Medtronic's CEO recently announced that he sees India as the biggest hole in its global operations, and that he intends to fill that hole quickly. In fact, this past year, Medtronic increased its Indian field force from 200 to 800 individuals, and has announced plans to build an R&D centre in India, with a made for India mantra that's not too dissimilar from that of GE's.

Drivers of GrowthA core thesis is that the rise in the number of hospitals and the increasing requirement of healthcare facilities is creating a needgap for differentiated medical devices and equipments which can provide high quality treatment options for both physicians and patients. This rise is further fuelled by the following drivers:

Increased awareness: Largely driven by flattened global media, the expansion of corporate hospitals and easier communication with friends/family abroad. Increased availability: While a more aware and affluentpatient base continues to drive demand for quality healthcare, corporate hospital groups such as Apollo, Fortis and Max have been quick to meet the demand by setting up new hospitals and by investing in impactful high-end medical equipment.

Opportunities for InvestmentWith the understanding that the medical technologies sector is indeed growing, being driven by the factors aforementioned, and keenly being eyed by world class MNCs, the question arises, where can one find attractive investment opportunities? Most PE investors cannot likely invest directly into an MNC producer of higher end devices; and one would likely not want to invest into the commoditized lower end segments. That being said, we are starting to see an increasing number of investment opportunities into Indian companies that are taking a differentiated approach to creating value within the Indian medical devices landscape. These opportunities can be segmented into the following categories: Innovation It's rarely been difficult for promoters and investors to create differentiated value when truly focused on innovation. While innovation has not historically been what has driven the Indian medical devices landscape, there has been a recent emergence of companies that are developing clinically relevant products that are better, faster and/or cheaper.

Increased affordability: Since India remains essentially a cash-pay healthcare market, the growth of India's healthcare and medical technologies markets are highly dependent on continued GDP growth. This increase in affordability, while mainly driven by significant GDP growth, is also being fuelled by significant growth in private health insurance coverage, and by increased government spending by way of PPP initiatives, BPL schemes and rural health initiatives. Medical Tourism: India, being a destination for medical tourism, provides treatments in complex areas such as cardiology, orthopaedics, dentistry and cosmetic surgery at one-tenth to one-fourth of the cost incurred in the United States [Global Data, 2010]. The medical tourism industry is expected to continue to grow, as international consumers look to reduce their healthcare expenditures, and since medical devices are involved in the care of most medical tourism procedures.

One of the most significant drivers of innovation that has emerged in India over the past five years is the Stanford-India Bio-Design Program (SIB). SIB, which is a joint multidisciplinary effort between Stanford University, AIIMS and IIT Delhi, is the Indian off-shoot of the highly regarded Stanford Bio-Design Program, a fellowship program from which several successful medical device companies in the U.S. have been hatched. Launched in India in 2007, with the goal of fostering medical device innovation aimed at the Indian market, SIB has already yielded several new graduates (i.e. next-generation entrepreneurs) focused on medical device innovation, as well as a handful of new companies that could one day impact Indian healthcare in a truly differentiated manner. Of note is that SIB is largely funded by the Department of Biotechnology as well as the Ministry of Science and Technology, signalling the Indian government's increased commitment towards medical device innovation. Some examples of interesting medical device companies that are focused on innovation include Perfint Healthcare, a medical electronics company based in Chennai; and Sushrat Surgicals, an Orthopaedic devices company based in Pune. Cross-Border Collaboration Based on the international-finance concept of comparative advantage, investors should think about cross-border models for building companies wherein the best ingredients from disparate geographies can be brought together to create an opportunity that would otherwise not exist. With regard to medical devices, that fact remains that, despite the innovation examples mentioned above, relatively little medical innovation is happening in India, compared to the amount of innovation that is taking shape in places such as the U.S. (advantage: US). However, funding for such innovation has significantly contracted in the U.S. due to decreased VC investment (advantage: India); FDA approvals have become increasingly delayed (advantage: India); and as a result, valuations for accessing such innovation have steadily declined over recent years (advantage: investors). This being the case, U.S. based device companies are increasingly looking to places like India (and China) to access new markets and reduce costs (advantage: India); but are unlikely to be able to commercialize in India without a local partner (advantage: investors and India). As such, there is an emerging opportunity wherein Indian device companies and/or investors that: i) have access to differentiated technologies in the U.S.; and ii) have the ability to build an Indian operating presence will be in a position to build value by leveraging the comparative advantages and comparative needs of India and the U.S. (or Europe). One example where this is already happening is that of Ahmedabad based Intas Pharma. Intas recently entered into a marketing tie-up with California based Insightra Medical to market medical devices in India and Nepal. A separate subsidiary called Intas Medi Device was floated in April this year, and will source and market devices used in cardiovascular therapies like coronary stents and gynaecological surgeries. Similarly, there is an increasing numbers of Indian promoters and investors jumping into the medical device market by leveraging cross-border comparative advantages.

Distribution One of the key hurdles to growth in the Indian medical technologies segment is the lack of high quality distribution infrastructure. Medical device distribution remains highly fragmented, especially in the higher end segments. While this presents a hurdle to growth, this also presents an opportunity for investment. Two companies that have identified this gap and have been working diligently to meet the emerging need are Chennai based Trivitron Healthcare and Hyderabad based Orbees Business Solutions. Manufacturing It is not to be underestimated that India holds a 40% to 60% costadvantage over the West, in terms of manufacturing, assembly and packaging. Increasingly, as Western companies are looking to improve their operating margins, they are looking to places like India, China and Malaysia as destinations for OEM and Contract manufacturing. Furthermore, as foreign device companies continue to access India as a local marketplace, they will increasingly become incentivized to manufacture in India, as the impact of import tariffs are significantly reduced for medical devices that are at least assembled in India. One company that has developed a first-mover advantage as a preferred manufacturer of advanced Class III medical devices is Bangalore based Medived Inc.

ChallengesWhile the opportunities for investment into India's medical devices and technologies segment are encouraging, the challenges are equally plentiful. The largest barriers to rapid growth include: Poor Infrastructure As mentioned earlier, medical device distribution infrastructure is highly fragmented, and furthermore, with regard to Class III advanced medical devices, there are relatively few distributors in India that are technically qualified to promote and/or service advanced implantable devices. Furthermore, poor geographic access to medical care in certain areas of India is also a barrier. Distance to high quality medical facilities, lack of usable roads in certain remote locations and limited transportation can all serve as hindrances to growth. Dearth of Qualified Implanters India has 1/3rd the number of doctors per capita as does China, and 1/10th that of the US. Furthermore, since the US and China train far more specialist physicians compared to the legions of MMBS qualified GPs that constitute most of the India physician force, this would translate into a significantly even greater dearth in the number of specialist-physicians that are qualified to implant specialized medical devices.

Affordability While increasing GDP figures over the past several years have yielded increasing affordability among the middle class, the lower socio-economic segments of India still cannot afford the majority of procedures that involve medical devices, and only as the Indian government continues to increase its commitment towards healthcare, will more and more segments of the population be able to drive pan India growth in medical devices. Physician Referral Incentives This is not a problem that is unique to medical devices within the overall healthcare landscape; Diagnostics for example is another area of healthcare in which referral fees in the 25% to 40% range can severely cripple growth. While this problem is unlikely to be resolved anytime soon, it is likely that the more innovative and differentiated a product is, the less likely that product would be subject to additional incentives being required. Regulatory Inconsistencies The medical device industry in India has no separate legal status, and is currently regulated by the Drug Controller General of India (DCGI). And to date, DCGI's regulations cover only 14 medical devices (e.g. cardiac stents, catheters, orthopaedic implants). Pacemakers, for example, are not covered. Not only is it problematic (from the standpoint of quality control and entry barriers) that only certain devices are currently covered, but it is even more problematic that, because DCGI was originally created to cover drugs and cosmetics, the regulations and metrics that DCGI uses to cover devices are often ambiguous as they seem to be borrowed from drugs/cosmetics regulations, and as such are often not really applicable to medical technologies and devices. This creates confusion and delays on many levels, and is an impediment to innovation and growth.

ConclusionThe Indian medical devices (med-tech) industry is relatively small when compared to the Indian healthcare industry overall (10%), and when one further segments the Indian medical devices industry into what is actually investable , the landscape amounts to approximately 1% of the overall Indian healthcare industry. While this represents a small number today, the need-gap is quite real, the drivers for growth are quite real and the resultant market potential is significantly greater than what is represented today. As such, medical devices and technologies, as an investment category, is indeed at an inflection point in its growth trajectory, and represents a very promising area for investment and significant value creation.

About the AuthorDr. Sanuj Ravindran is the Managing Director of New Delhi based Asian Healthcare Fund (AHF), investing in a diversity of healthcare companies in India. Prior to AHF, Sanuj was a Principal at Radius Ventures, a NY based venture capital firm focused on leading-edge health and life sciences companies. Prior to joining Radius in 2007, Sanuj was a Director at Burrill & Company, a San Francisco-based life science venture capital firm. At Burrill, Sanuj created and led its India group, through which he assisted a number of portfolio companies in establishing US-India cross-border collaborations. Previously, Sanuj worked in the Healthcare Investment Banking Group at Merrill Lynch, where he assessed financing and M&A candidates for a variety of biotechnology and pharmaceutical clients. Sanuj received a BA, with Honours, from Northwestern University, an MD from Jefferson Medical College, and an MBA from the Kellogg School of Management, where he was a Rothschild Scholar. Sanuj Can be reached at sanuj.ravindran@asianhealthcarefund.com

New Formats for Healthcare Retailing in India

The Indian healthcare sector, currently worth USD 63 bn, is highly fragmented and dominated by private hospitals. The sector has grown from being largely public funded before the 1980s to a developing sector fuelled by large investments from existing corporate hospital chains and new corporate houses entering the healthcare sector. While 62% of healthcare beds are owned by public healthcare in India, it accounts for only ~20% of annual spend. Moreover, public health delivery is also suffering from

Given this, new capacities are being built in private sector which we believe will reap benefits of an exploding market. It is also expected that Government will finance not more than 10-20% of future bed requirement; thus Private sector will meet majority of the investment requirement. Increasing prevalence of lifestyle diseases, larger proportion of senior citizen population, increase in the coverage of health insurance and government initiatives are some of the factors fuelling the growth of the healthcare sector. The sector is currently poised to grow at 15% p.a. to reach the market value of USD 280 bn by 2022 (Source: IBEF). In comparison to the hospital sector of a developed country like the US, the Indian hospital sector is growing at a faster pace and exhibits a much better operational and financial performance. Indian hospitals are exploring innovative methods to improve their performance metrics. Over the last few years, the concept of healthcare retail has emerged strongly, mid-way between retail and healthcare. It is a model that has emerged through a synergy brought about by the two giant industries. Some hospitals are now getting into tele-medicine and the establishment of health cities. Hospitals are increasingly focusing on specialty centres such as those for eye care, dental care as well as day care surgeries. This article briefly outlines the major 'healthcare retail' areas within healthcare in which private equity is still aggressively investing and several areas where things have slowed down.

Severe crunch of human resources Lack of funds for equipment maintenance/upgrade and Political interference Exhibit 1: Reasons for not using public healthcare

58% 47% 25% 13% 9% 4%

Poor quality of care

No nearby facility

Waiting timing Facility timing Health personnel Other reasons too long not convenient often absent

Source: National Family Health Survey 3

Emerging Healthcare Retail FormatsPatient Service Centres catering to healthcare checkups and diagnostic testing Single Specialty Clinics eye, dental, dialysis, IVF Integrated Pharmacy Clinics a combination of pharmacy outlets, collection centres and a clinic Spas and Wellness Centres

becoming franchisees in the hub and spoke model; partnering with large chains on referral basis; or getting acquired by large chains, which lowers the cost of expansion and start-up time for the latter Attractiveness of the space can also be vouched by the recent deals in the space. Of considerable importance is the investment from global private equity giants like Warburg and TA Associates in Metropolis and Dr. Lal Pathlabs respectively. The space has also witnessed domestic consolidation with SRL buying out Piramal Diagnostics. However, this is just a beginning of a fairly long innings. Indian Diagnostics space is about 10 years behind emerging markets like Brazil and more than 20 years behind the more mature markets like US.

Diagnostics Clinics (Patient Service Centres)The organized players in the Indian diagnostic space have been pioneers of express diagnostics clinics, which are also termed as patient service centres. A typical patient service centre can house a group of phlebotomists, general practitioners and nurses to facilitate quick diagnostic checkup for preventive care. Large corporate chains in this field are SRL, Metropolis and Dr. Lal Pathlabs. Together these three players have more than 350 satellite labs and patient service centres, which are served by more than 1,000 collection centres. However, these numbers are fairly small in comparison to the large untapped market lying in the Tier 2 and Tier 3 cities, where the organized players have still not forayed into. Given the state of the industry where we have more than 45,000 to 50,000 labs, organized players account for only 15% of market.

Exhibit 3: Comparison of US, Brazil and India's Diagnostics Market and Competitor's ShareSize USD 55 bn USD 5 bn USD 1.4 bn

Exhibit 2: Diagnostics Lab Market Forecast (2010-15F)Market Size (in INR Cr)

100% 80% 60% 78% 72% 90%

15,000 13,000 11,000 9,000 7,000 5,000 3,000 1,000 -1,000 2010 2011FOrganized Chains*

14,200 11,900 10,000 7,000 8,400

40% 20% 0% US Brazil India LabCorp Quest Fleury DASA Dr. Lal Metropolis SRL

6,000

2012F

2013F

2014F

2015F

Private Hospitals

Independent Labs

A quick comparison of the three economies shown above hints at significant consolidation activity in the years to come.

*Organized Chains include Metropolis, Dr. Lal, SRL (including Piramal) and Thyrocare Source: Industry Research, Expert Opinions and Consulting Firm Analysis

Single Specialty Retail ModelsSingle Specialty Clinics have evolved by offering best in class treatment in certain defined therapy areas and position themselves as centres of excellence in those therapies. They tailor their care and facilities to fit the chosen type of condition, patient, or procedure on which they focus. This enables the Specialty Clinics to attract the best specialists in the respective segments and clearly helps to drive in-patient volumes overriding geographical constraints. Given they are focused on one field, they can offer end to end services and personalized care in that core area. It is also well established internationally that hospitals focused on limited specialties demonstrate superior performance both therapeutically and financially.

The industry currently is about INR 7,000 Cr in size and is expected to grow at a 20% CAGR to about INR 14,200 Cr by 2015, the organized players being the most aggressive in terms of creating market growth as well as grabbing market share from the unorganized sector. The organized players are expected to grow at a CAGR in excess of 25% driven by increasing affluence (10%), tests per person (5%), price inflation (5%) and complex test share gain (5%). As these large players grow their share, small, independent labs are either:

Eye Care: Although it is largely in the unorganized domain, this market has witnessed high growth on account of the entry of new corporate players and the ramp up in facilities of existing ones. Some of the important players are: Vasan Eye Care, Center for Sight, Eye-Q, Medfort, Nethradhama, Dr Agarwal's Eye, Lotus Eye, Aravind Eye and Sankara Nethralaya. Many of these eye care centres have opted for equity funding to ramp up in scale to further their presence in either their region of operations or to explore new ones. Exhibit 4: PE Activity in Eye-Care SpaceKey Players Key PE Investors Date of Investment

Typical Economies for a specialty dental care clinic: Setting up a 3 6 chair dental centre costs close to INR 15 20 mn, with an estimated asset turnover of 2.0x. Mature state EBITDA margins are in the range of 30 35%. Dialysis: The size of the Indian dialysis services market is estimated at INR 480 Cr with haemodialysis accounting for 77% of the market. There are about 6,000 installations of haemodialysis machines in the country, having grown at a rate of 17% CAGR in the last 2 years. In India, majority of the patients (85-90%) who chose to undergo treatment choose to go for haemodialysis. It is estimated that around 35,000 ESRD (end state renal disease) patients avail of haemodialysis; 5,000 opt for CAPD and approximately 3,000 patients undergo renal transplants. The dialysis market in India is primarily restricted to metros. Further, more than 95% of haemodialysis machines are in hospitals, unlike the west where there are several standalone dialysis centres and many of these centres are operated by the manufacturers of the haemodialysis machines like Fresenius Medical and Gambro, who treat more than 60% of the patients undergoing dialysis.

Vasan Eye Care Eye-Q Centre for Sight Dr Agarwal's Medfort

Sequoia Capital SONG, Helion and Nexus Matrix Partners Listed Entity TVS Capital, ePlanet Ventures

FY 09 10 May 10, Sept 11 Oct 10 NA Nov 10

Source: o3 research and analysis

Typical Economies for a specialty eye care clinic: Setting up a centre catering to a population of about 10 20 lakh people costs close to INR 20 25 mn, with breakeven in 6 9 months and an EBITDA payback in 3 years. Typical returns for a single specialty eye care clinic over a maturity period of 3 years is in the range of 30 35% ROE, which makes the space an attractive proposition for PE/VC investors. Dental Care: Indian dental care services market, constituted by dentists and dental ancillary services, was estimated at USD 660 mn in 2009 and is expected to double by 2014. Diseases such as dental caries and oral cancers are major public health issues in India. However as with eye care, dental clinics largely lie in the unorganized sector and are mostly concentrated in the metros and tier 1 cities. Dental hygiene in the rural parts of India and the ability to afford treatments is still poor, even though India is one of the most inexpensive places to be treated for dental complications. Some of the players who have set up some presence of scale and size are players like Narayana Hrudayalaya, Vasan Healthcare, Axiss Dental, Dentistree and Alliance Dental. Globally some of the listed players trading at attractive multiples are as below:

Exhibit 6: Penetration of ESRD

5%

Estimated Prevalence of ESRD Cases 8 lakh

Exhibit 5: Listed Players Globally in Dental SpaceListed Entity(Figures in USD mn wherever app)

EV 567.1 363.3 164.1 92.6 45.0

EV/Sales 12.2x 1.3x 4.7x 3.0x 0.7x 0.6x

EV/EBITDA 35.9x 7.3x 36.3x 9.9x 11.0x 7.2x

EBITDA Margins 34.0% 17.2% 12.9% 30.6% 6.8% 7.8%

Top Choice Medical Investment Co American Dental Partners Q&M Dental Group (S'pore) Ltd 1300 Smiles Ltd Oral Hammaslkrit Plc

Birner Dental Management Services 36.4

There is a huge opportunity to be catered to, considering only 5% of the patient volume has been tapped and the remaining 95% is yet to be tapped. The 3 largest players globally are Fresenius Medical Care, Baxter International, and Da Vita Inc. Indian players are Alliance Medcorp and Nephrolife.

Source: Capital IQ

Typical Economies for a specialty dialysis centre: Setting up a 10 unit dialysis centre costs close to INR 20 25 mn, with an estimated asset turnover of 2.0x. Mature state EBITDA margins are in the range of 20 25%. IVF: With over 300 infertility clinics in India, reports indicate that the sector is worth USD 450 mn. Indian Council of Medical Research (ICMR) estimates that for a population of 110 Cr, approximately 400,000 IVF cycles will need to be performed annually. This highlights the need for a large number of well equipped IVF centres all over the country. The cost of assisted reproduction ranges anywhere from USD 1,500 to 3,000 for one cycle (on an average it takes at least two cycles). Yet, it is less expensive than in the west, where it ranges from USD 10,000 to 15,000 per cycle. In India, Surrogacy costs about USD 12,000 compared to US where it is USD 70,000. Recently, this space has seen increased participation from the organized corporate sector. German fertility management group Morpheus entered India in 2010, and opened 3 IVF clinics in Mumbai, Pune and Nasik. It plans to add 5 more centres in other major cities in India. Nova Pulse, a venture between Nova Medical Centre and Pulse Women's Hospital started IVF centres in 2011. UK based Bourn Hall Clinic, is scheduled to establish IVF clinics in India by 2012.

Spas and Wellness Centres:Rising middle class income levels and changing lifestyles are undergoing irreversible changes, particularly in urban areas. These lifestyle changes are being felt in the form of India's shift in disease burden from acute towards chronic diseases. As preventive care gains importance, hospitals and wellness centres are looking at a comprehensive and holistic approach for treating patients. Wellness is a key factor in boosting medical tourism in India. Tie-ups of hospitals with holistic health centres have helped combine traditional healthcare knowledge and practices such as