Mumbai: High valuations and a shortage of investment opportunities in the big cities are leading investors in healthcare companies to turn to small town India.

Private equity (PE) investors indicate that deal flow involving healthcare providers from non-metropolitan cities has doubled over the last one year.

“The number of hospital chains approaching us for fund-raising has doubled in the last one year. If earlier of 10 healthcare deals, two were from non-metros; now it’s four,” said Sreenivasulu Srini Vudayagiri, investment director at Peepul Capital, a PE fund that invests $15-25 million in each transaction.

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PE investments are expected to focus on pharma, healthcare and biotech, followed by manufacturing and BFSI (banking, financial services and insurance), said the report.

Mergers and acquisitions (M&A) and PE deals in the healthcare sector are already looking up this year. Till date, PE investors have infused $156 million into three healthcare firms, half of what was invested in the whole of last year.

PE firms invested $319.8 million in 26 healthcare deals in 2011, compared with $1.68 billion across 41 deals in 2010, according to VCCEdge, which tracks investment activity.

“In the healthcare service business, PE has more interest in tier II cities because metros and tier I cities have become expensive and the valuations are very high. Also, if the model is scalable and the management dependable, tier II should have as good profitability and more attractive growth,” said Muralidharan Nair, partner, business and advisory services, Ernst and Young Pvt. Ltd.

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Like any other industry, healthcare companies in tier 1 and metros are the first to receive attention from investors due to their proximity to investment bankers and mediators, Vudayagiri said.

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Metros see more action simply because they are easy to access, talk to and target, he added.

Also, the shift in geographical focus reflects the industry’s evolution in terms of readiness to absorb PE and ability to grow and scale up operations.

“There is a lag of one-two years for small city companies to reach the scale of big city companies due to price differences,” he said.

For instance, if it takes a Bangalore hospital 100 surgeries to reach Rs50 crore in revenue in 12 months, a hospital in tier II/III cities will have to perform 150 surgeries over 14 -16 months to earn the same revenue.

Experts say another attraction is that people in smaller cities tend to be insured under the Rashtriya Swasthya Bima Yojna (RSBY), a central government health insurance scheme, which will readily be availed by them if low-cost delivery models are available.

“In tier II and tier III cities, the demand for healthcare is high and so the opportunity for financial returns is high. Another plus in these cities is that cost of land, support staff etc. are lower,” said Arvind Singhal, chairman of Technopak Advisors Pvt. Ltd, a management consulting company.

Investors are also taking the cue from some of the rather successful investments in tier II and III cities that are doing well in terms of growth, profitability and are scaling up.

“We make early-stage investments with certain assumptions and ideas and they have panned out well with Vaatsalya Healthcare (Solutions Pvt. Ltd). Companies like Vaatsalya have come up and are of the size that can interest PE funds,” said Bharati Jacob, founder-partner of Seedfund, an early-stage fund.

But there are challenges too. “PE deals are driven by what you have access to and are aware of, or are made aware of by mediators,” said Harish Gandhi, director at AIF Capital, a PE fund that’s looking at investment opportunities in this space.

As a lot more investment bankers are beginning to focus on non-metro cities, access to companies will increase considerably, Gandhi says.

In the meantime, there are many healthcare services companies in small cities requiring funding.

According to a report by Venture Intelligence, a research service focused on PE and venture capital deals, The Mission Hospital, Durgapur, a 250-bed healthcare centre, needs Rs100-200 crore for expansion and to set up two 250-bed multi-specialty hospitals in Siliguri (West Bengal) and Ranchi (Jharkhand).

Spectrum Health Group needs funding of Rs100 crore for creating health check-up centres, pathology units and clinical research facilities.

deepti.c@livemint.com