The fate of the Southern Cross care homes group hangs in the balance. With 3,000 job cuts already announced and landlords in revolt over an attempt to impose a unilateral 30 per cent rent reduction, the company set out a dramatic restructuring plan on 9 June, under which it will return almost 50 of its 750 homes to the freehold owners immediately and pull out of a further 85 over the coming two to five years. Southern Cross is currently the largest care homes operator in the UK. If it does survive, it will be as a much smaller operation.
The sharp decline of the business's fortunes will be investigated by a parliamentary committee. However, in a speech in the House of Commons, the Business Secretary, Vince Cable, stressed that the government would not provide a bailout to a company that is widely presented by the press as the victim of private equity vultures.

Selling made sense

A fast-growing start-up founded in 1996, Southern Cross benefited from the privati­sation of the care home industry in the late 1990s. In 2002, the firm was bought by the private equity arm of the German bank WestLB for £80m. A secondary buyout was engineered two years later when Blackstone, one of the world's largest private equity firms, purchased the business for £162m.

Under Blackstone's management, the firm expanded rapidly, and in 2005 Southern Cross was merged with its competitor Highfield Care, creating the country's largest operator. A further merger, with Ashbourne Homes, secured the company's market-leading position. After the Southern Cross buyout, Blackstone also acquired the NHP group, a property company from which Southern Cross rented most of its properties. And in May 2005, Southern Cross completed the "sale and leaseback" of the 21 properties it owned freehold, a transaction that earned the firm £100m.

“Sale and leaseback" is a vital strategy for private equity firms looking to release profits from underperforming businesses. The idea is that companies which have previously owned their properties on a freehold basis should sell them to professional landlords (or a self-created "propco") and then lease them back, realising a profit in the process. Looking after the elderly, rather than managing a property portfolio, was Southern Cross's raison d'être, so selling the homes made sense. Yet this relatively minor transaction, involving less than 3 per cent of the firm's care home portfolio, is being cited by the press as an example of relentless asset-stripping by Blackstone. The parent company, however, merely enshrined "sale and leaseback" at the core of Southern Cross's business model.

Many homes were already leased by Southern Cross; many more would be sold and leased back subsequent to Blackstone's sale of the firm. The real error was not ensuring that rents could be altered if the economic climate soured. The private equity business model, which raises financial risk by increasing debt while attempting to reduce business risk through diversification, operational efficiencies and better management, has certainly had its share of casualties. In February, Terra Firma, the private equity business run by Guy Hands, was forced to write off the entire £1.7bn it invested in EMI in 2007. Other businesses that have struggled under private equity ownership include Borders, Foxtons, Endemol, Threshers, Chrysler and Reader's Digest. However, in the case of Southern Cross, the vituperative headlines blaming Blackstone and Blackstone alone are missing the point.

Southern Cross flourished under Blackstone's ownership, floating successfully on the stock market in July 2006. The company's share price rose from £2.70 at launch to just over £6 in late 2007 as the business continued to thrive. It was only when the financial crisis hit, and the company's revenues were put under pressure by falling receipts from the local authorities that paid it to look after their elderly, that the firm's business model was subjected to scrutiny and found wanting.

Scapegoated

Southern Cross's difficulties were easy to predict. It had fixed costs - the rents it had agreed with its landlords increased at a preordained pace - but variable income from the local authorities. The drop-off in revenues as government spending cuts hit was exacerbated by Southern Cross running significantly lower occupancy rates than its competitors, due at least in part to its worsening reputation for poor standards of care. As its income fell, the company found itself unable to lower its outgoings accordingly. Inevitably, it became incapable of paying the annual £200m rent bill.
There have been protests outside Blackstone's European headquarters in Berkeley Square in London. It is true that Blackstone made signi­ficant profits from its ownership of Southern Cross, but the company's business model was always vulnerable to a slowdown. It is easy to hate Blackstone, but using it as a scapegoat for the Southern Cross debacle diverts us from asking more important questions.

Rather than just demanding whether private equity firms should be allowed to run businesses such as Southern Cross, we should also be questioning the role played by profit-driven enterprise in the running of businesses where "rationalisation" and "streamlining" have a direct impact on quality of life. Perhaps care and cash shouldn't be forced into uneasy cohabitation at all? At a time when we seem to be launching on another wave of privatisation, and as Andrew Lansley's NHS reforms are likely to hand greater control of critical services to the private sector, Southern Cross is a haunting example of how it can all go wrong.

Alex Preston's novel "This Bleeding City" is published by Faber & Faber (£7.99)