Steve's Blog on Senior Care

Update

To read the latest senior care news and blogs go to www.seniorcareinvestor.com

Regrettably, No Rent-Reset Resolution

In early May, Ventas sent to Kindred Healthcare its formal notice of rent reset, asking for an additional $111 million in annual rent.  Obviously, Kindred does not believe that increase reflects the fair market rental value of the nursing facilities and long-term acute care hospitals (LTACs) it leases from Ventas.  So they had 30 days to negotiate an agreed upon change in annual rent, together with the annual rent escalators, which are currently an above-market 3.5%.  If they did not come to terms by June 8, according to the agreement entered into five years ago, each firm then would have 30 days to hire an appraisal firm, and these two appraisers will appoint a third appraiser to value the entire Ventas/Kindred portfolio in terms of what the fair market rental value is.  We expected an announcement one way or the other after the June 8 deadline, but the silence has been deafening.  There is no requirement for them to make an announcement, since the various steps that will be taken have been clearly spelled out, but we expected one anyway.  Since they have 30 days to decide on the final appraiser, we assume negotiations are continuing. 

Ventas is not sitting around with its hands tied, however.  The REIT announced today an acquisition from a third party of a 137-unit retirement community in Minnesota for $19.1 million, or $139,400 per unit, that it will lease to Capital Senior Living.  The cap rate based on the first quarter’s annualized results is just under 10%, so it appears to be an attractive deal for Ventas, and Capital Senior Living will make a $150,000 cash flow profit after a 5% management fee and an 8% lease rate.  We still have no word yet on Ventas’ negotiations to buy privately held, and Canadian-based, Senior Care REIT, which planned to go public this year.  If successfully consummated, it would be the third REIT that Ventas will have acquired.  And with Chartwell REIT taking itself out of the running for Retirement Residences REIT, you never know what Ventas may do.       

Related links:

For more articles on the senior care acquisition market, see Index links for The SeniorCare Investor

Get the inside scoop on senior care M&A at The SeniorCare Investor

Database of health care M&A transactions, including senior care acquisitions

What’s Up? Stock Prices.

Oil prices have soared, inflation’s ugly head is popping up again and the Fed keeps raising interest rates, all of which should spell lower stock prices.  But in the seniors housing and care market, that does not seem to be happening.  Year-to-date, nine of the 13 publicly traded companies have posted double-digit increases, with most well over 20%, and only two have declined (but by just 1% and 2%, so they hardly count).  Leading the pack is Advocat, up 208% for the year and hitting an eight-year high of $16.45 per share, followed by Brookdale Senior Living (up 66%), Extendicare (up 45%) and Five Star Quality Care (up 40%).  The assisted and independent living market has been hot, but two of these four companies are primarily in the skilled nursing business, while Five Star is a hybrid, so the price performance can’t be attributed to “the Brookdale effect.”  Perhaps investors have become more comfortable with SNF companies because of relatively robust state coffers and the continued profitability of Medicare.

Brookdale jumped by 57% in the six weeks after its IPO late last year and now, with its continued surge this year, it has a market cap that is larger than the five other seniors housing (not nursing facility) companies combined, including Sunrise Senior Living.  This is an astounding development for a company that underwriters thought was worth about $19 per share a little over six months ago and is now near $50 per share.  When it completes the acquisition of American Retirement Corporation, Brookdale’s market cap will exceed Manor Care’s and become number one in the entire seniors housing and care market. 

Meanwhile, the providers’ landlords are not faring as well.  For the first five months of 2006, not one health care REIT is up more than 4%, and if interest rates keep rising during the remainder of the year, they may all be in the red by December, except Ventas, if it comes out big in its rent reset negotiations with Kindred Healthcare.  But eventually, higher interest rates will begin to impact more than just the REITs, so the top of the market may have arrived.

The Brookdale Effect?

When Brookdale Senior Living announced its agreement to buy American Retirement Corporation after the close on Friday, May 12, many investors and analysts thought that the high price, multiple and premium would send the few remaining seniors housing stocks upward as they all could be viewed as takeover candidates (well, almost all).  But the only one to really rise, in addition to ACR, was Brookdale itself.  Brookdale’s shares jumped by 14% on the first day of post-announcement trading on Monday, followed by another 11% spike on Tuesday. 

Usually, the buyer in a large deal sees its shares drop a bit as current shareholders worry about dilution and risk of assimilation.  But in this case, with Brookdale’s shares trading at such a high multiple, the deal was presented as accretive even before some of the benefits of the merger are accounted for, such as bringing ACR’s ancillary services know-how into Brookdale’s facilities.  In addition, the ACR portfolio enhances the average quality of the Brookdale portfolio, and investors may have perceived that little benefit as well.

But what happened to the other seniors housing stocks?  Not much, is the easy answer.  The remaining four companies all hit their 52-week highs two and three months ago, and only two of them, Capital Senior Living and Five Star Quality Care, are within 10% of the highs.  It certainly didn’t help that the overall market sort of collapsed last week, with almost daily declines in the various indices.  But seniors housing stocks often are not impacted the same way that the overall market is, especially since the trading volume is usually quite low in each of the specific stocks. 

Even another public letter to the independent directors of Capital Senior Living from one of its largest investors, Mercury Real Estate Advisors, demanding yet again a sale of the company to maximize shareholder value, and using the Brookdale/ACR deal as an example of the acquisition demand, did little to push Capital Senior Living’s price up.  The reality is that the seniors housing stocks are for the most part fully priced, with Sunrise Senior Living a question mark because of its recent plunge as a result of some unresolved accounting issues.  In other words, there is little room to move up, with Brookdale being the only likely buyer in the market being able to pay up should it want to buy again, but its hands should be tied for a while with the ACR transaction.  So for now, Mercury may just have to wait, and investors may have to take a breather to see where the market will go, and whether seniors housing has any steam left after a couple of great years.  The “Brookdale effect” will just have to be put on hold for now.

Earnings Delay At Sunrise, And Brookdale Buying Binge Bags A Biggie

There was almost enough “big news” last week to have a weekly newsletter, but sometimes it helps to wait, reflect and analyze before deciphering everything that happened.  The big three (and we are not talking about Detroit) last week were the Ventas rent reset announcement with Kindred Healthcare, the Sunrise Senior Living earnings release delay and the late Friday afternoon announcement that Brookdale Senior Living is buying American Retirement Corporation for an all-in cost of more than $1.3 billion, creating the largest seniors housing company in the world with more than 500 facilities with 50,000 units combined.  We will have a more detailed analysis of the first and third news items in our June issue of The SeniorCare Investor, preferring to look at the Sunrise issue for now.

Sunrise Senior Living was supposed to release its first quarter earnings results on the morning of May 9, but the only thing investors received was a curt, two sentence notice that the company was rescheduling the earnings release to allow time “for further review of the accounting treatment applied to investments in unconsolidated senior living communities.”  Almost in unison, you could hear investors moan, “Here we go again.”  And fearing the worst, investors sent the stock down by more than 22% before it recovered a bit by the end of the day to close at $32.35, or a 17.7% plunge from the prior day’s close. 

Unbelievably, the next day Sunrise issued a second release, stating that the accounting issue had to do with the allocation of profits and losses for a limited number of older joint ventures where the capital partner receives a preference, and that they did not expect the review to materially affect earnings guidance for 2006 and 2007.  Come again?  It is difficult to believe that they did not know this little fact the prior day, and that specific knowledge would certainly have gone a long way to soothe investors’ fears about valuation.  Apparently, the accounting issue was something that Sunrise’s internal finance people stumbled upon several months ago and brought to the attention of their outside auditors, and that these JVs are relatively old.  Management believes that the change in how they would be accounted for would be “better” because they would reflect the actual results of the JV. 

What is a little disconcerting is that the company filed its 10-K on March 16, just two weeks before the close of the first quarter, without worrying about this potential accounting change.  Although we are not CPAs, it is our understanding that the change they are looking at would allocate more of the losses in the early years of the JV, when they actually take place, with more of the profits being allocated in the later years, when the facilities are mature, and profitable.  What is surprising is that if Sunrise itself started the ball rolling on an accounting change, why couldn’t it manage the timing of it better and not cause a disruption in the market, which shareholders are getting a little tired of?  Also, putting our skeptic’s hat on, if the accounting change would result in a higher profit allocation in the later years of the JV, it would seem that this would inflate earnings a bit, while increasing losses in years long forgotten, with few investors carrying about increased charges to financial statements from the late 1990s (and rightfully so). 

Is it this slightly higher earnings contribution that will keep the 2006 and 2007 earnings guidance in line with past disclosures?  We don’t know the answer to this, but it goes back to Sunrise’s problem of not being very transparent with its financial presentation, and this has been a problem for several years.  At best, the handling of the delayed earnings announcement can be called clumsy; at worst, it raises a question as to motive beyond simply a “better” presentation for what are old JVs using a structure that is not too common anymore.  In other words, who cares, and why rock a boat that has already sailed into port?  Sunrise is at a stage in its corporate life when it should not have to keep tweaking its accounting policies and should offer its shareholders the most transparent view of the company possible, each and every quarter.  Their shareholders deserve no less.

CNL Retirement Properties Is Sold

Last Monday, we wrote that CNL Retirement Properties was “on the block” and that we would publish who we heard was the winner a few days later in the May issue of The SeniorCare Investor.  Unfortunately, we did not know that the deal had progressed as fast as it did, with the formal announcement coming the next day, Tuesday, that Health Care Property Investors (HCPI) was the winning bidder at $5.2 billion plus the $120 million cost of the “external advisor” to CNL, for a total price of just over $5.3 billion.  The price we had heard was $5.4 to $5.5 billion, so we were close, but the transaction is not expected to close until sometime in the third quarter. 

Equity analysts are having a hard time trying to figure out the impact the acquisition will have on HCPI, because the final structure will not be known for a while and HCPI stated that it plans to sell off some of its existing assets (primarily skilled nursing facilities and hospitals) and put up to $2.0 billion of the CNL assets into joint ventures and other off-balance sheet vehicles.  The goal of HCPI management is to position the REIT for the future, with a large portfolio of newer assets for the most part built in the past five to 15 years (CNL) to supplement (and replace) the older real estate of the original HCPI, with the average age of the nursing facilities at 30 years.  While out with the old, in with the new makes sense, we hope the new properties will all be in the black soon from a rent coverage basis.   

The CNL acquisition is a bold move for HCPI because of its size as well as the fact that up to 50% of the seniors housing portfolio does not quite have sufficient cash flow after management fees to cover current rent payments.  While rent coverage has been increasing, it is going to be tight for at least a year, so there will be little room for error.  And, while there are plenty of good assets, any portfolio is going to have some warts, and when you get to the size of $5 billion, there are going to be more than a few.  CNL came up with a value of $180,000 per unit for the seniors housing portion, stating that the figure was below replacement cost.  That may be the case, at least in many of the markets, but $180,000 per unit for a portfolio of that size is certainly at the high end, even in a bullish market.  And then there is the matter of some of the “shell” lessees, which are thinly capitalized companies used by CNL that in turn hired companies such as Sunrise Senior Living to manage the facilities.  REITs are used to having the operating company on the hook for lease payments, not a company with few assets, so we don’t know how HCPI will deal with the issue, if at all. 

The big question we have not found an answer to is, What was the amount of the back-up offer?  If it was close, then the market is even stronger than we thought.  If it was at least 10% lower, or $500 million below HCPI’s bid, then HCPI may have an interesting ride ahead.      

Related links:
For more articles on the senior care acquisition market, see Index links for The SeniorCare Investor

Get the inside scoop on senior care M&A at The SeniorCare Investor

Database of health care M&A transactions, including senior care acquisitions

Goldman Mature Market Report

CNL Retirement Properties On The Block

With prices at record highs and cap rates at record lows in the seniors housing market, it has been said that almost everything could be available for sale in an environment not really seen before, and one that we may not ever see again (although this bull market still has plenty of steam).  There is a certain amount of sentiment in the market that cap rates have further to go on their downward trend, and when this is combined with rumblings that the cost of new construction just does not “pencil out” in several markets because of soaring land and construction costs, we have a situation where existing properties will just continue to increase in value.  That just may have been on the minds of the limited number of prospective buyers who were given the opportunity to take a look at the CNL Retirement Properties (CNL) portfolio over the past 45 to 60 days in what was a well-kept secret in the market, at least until now.

CNL was organized as a REIT in December 1997, but was relatively quiet in the market until 2003.  At the end of 2001, real estate investment properties totaled just $35.2 million, but jumped to $1.5 billion by the end of 2003 and $3.5 billion by the end of last year.  In 2003, just four transactions accounted for more than $700 million of investments, and its largest acquisition to date, the $562 million acquisition of the Horizon Bay Senior Communities portfolio, came in early 2004.  As of the end last year, CNL owned 184 senior housing facilities with 21,857 units with an investment of just under $2.9 billion and 73 medical office buildings with an investment of $665 million.  In addition, there are more than 258 million shares outstanding with 91,280 shareholders who paid $10 per share, usually in increments of $10,000. 

As CNL’s buying spree took off in 2003, there were many people in the market chuckling over the prices that were being paid.  Cap rates of 10.2%, 8.4%, 7.8% and 5.4% on annualized operating income for four large deals in 2003 just did not seem to make sense at the time, with CNL’s pricing dependant on occupancy increasing in order for cash flow to catch up with the stated lease rates in some of the deals.  In some cases sellers were required to post deposits or guarantees to fund the differential between cash flow and lease rates, leaving the market to shake its collective head at the high level of risk of the deals.  Well, shake no more.

According to its corporate structure, CNL had to either go public or dispose of its assets and remit the proceeds to shareholders by the end of 2008.  After the disaster of one of its sister REITs under the CNL umbrella a year or two ago in an attempt to go public, the board obviously decided a sale of the entire company would make more sense, especially in this extremely bullish market environment.  We also heard there may have been a little difference of opinion between the outside board and the REIT’s “captive” advisor, a relationship that is somewhat of a relic in the health care REIT market. 

So we estimate that sometime in early March between seven and 10 prospective buyers were approached, which probably included Ventas (NYSE: VTR), The Blackstone Group, Fortress Investment Group/Brookdale Senior Living (NYSE: BKD) and Health Care Property Investors (NYSE: HCP), among others.  To find out what happened, just check out the lead story in the May issue of The SeniorCare Investor, coming out this week.

Related links:

For more articles on the senior care acquisition market, see Index links for The SeniorCare Investor

Get the inside scoop on senior care M&A at The SeniorCare Investor

Database of health care M&A transactions, including senior care acquisitions

When Care Counts

I recently had a conversation with a friend of mine about the last few months of her mother’s life, which were spent in a local, community-based not-for-profit skilled nursing facility.  The conversation came up because her husband’s mother is at the stage where she needs 24-hour care or supervision, with the choice being at home care or an assisted living/Alzheimer’s facility.  My friend had some strong opinions of the way to go, and about where her mother spent her last weeks.  This facility enjoys a tremendous local reputation and has even won a few national awards for some innovative design concepts.  It also has an unusually high number of volunteers, from high school kids to retired adults living in the community, and is always at the top of everyone’s list of where they would place their parent when and if the time comes. 

But this friend of mine spent many hours at the facility, often late at night or early in the morning, when the staffing tends to be light and the managers tend to be home.  In one situation, her mother’s feeding tube had become dislodged, and after her long-time friend and local doctor re-inserted it, she asked the nurse to help and clean her mother’s stomach area, which was covered with a variety of things that had oozed out of the hole when the tube popped out.  The response, and one she will never forget, was “I’m already late for my one-hour break, so it will have to wait.”  My friend had to clean up the mess herself, rightfully deciding that to leave all the fluids on her mother’s already raw skin would certainly not be in the patient’s best interests.  Too bad the nurse did not have her patient’s best interests in mind as well.

In another situation, my friend’s mother had to go to the bathroom late at night.  She rang the call button and explained the situation to the nurse on duty.  The response?  “It’s not the scheduled time to do that, you will just have to wait.”  This temporary employee was from an outside agency, which was promptly notified, and she was not allowed to work at the facility again.  The problem, however, is that she will be in someone else’s facility, doing and saying the same thing to someone else’s mother (perhaps yours).       

After listening to her stories, and squirming a bit in my seat, I tried to point out that even the best assisted living and skilled nursing facilities in the country run into quality of care problems from time to time and that mistakes will always happen, as unfortunate, and unacceptable as that may be.  That was not a good enough answer.  One company that has been criticized by some of its competition (and the media) for keeping residents in place beyond its ability to “adequately” take care of them is Sunrise Senior Living.  But Sunrise views the situation as one of patient choice, and if the resident, and the family want “mom” to spend her last months at the Sunrise facility, so be it, as long as there is a coordinated care plan regarding additional help and aids.  A few years ago, Sunrise initiated a hospice program in its facilities, whereby the company contracted out hospice care to an outside firm that does nothing but hospice care, both to allow the resident to receive the most appropriate care, but also to allow her to stay where she wanted to.  We have been surprised that more of this has not occurred in the industry, as we believe the hospice program has been successful at Sunrise.

So with all the consolidation occurring in the industry, will quality of care suffer or improve?  Will being part of a large company mean that uniformity of care will prevail, with expectations spelled out from headquarters?  Or as the front lines are further removed from the decision makers, will day-to-day problems go unnoticed, and uncorrected until a disaster happens?  To my knowledge, there have been no reliable studies or statistics concluding one way or the other.  But my friend with the dying mother will never be convinced that small and local means high quality of care, no matter how good the intentions.  The problem, however, is that she does not have any answers, or solutions.  Unfortunately, neither did I.         

Related links:

For more articles on the senior care acquisition market, see Index links for The SeniorCare Investor

Get the inside scoop on senior care M&A at The SeniorCare Investor

Database of health care M&A transactions, including senior care acquisitions

Goldman Mature Market Report

How High Will They Go?

A friend of mine recently asked whether he should short a certain senior care stock that had seen a nice run-up in price to a level that some would say was at least a few years ahead of its time from a price to earnings ratio basis (or any other basis).  I told him of an old rule of thumb on Wall Street, which was never to short a rising stock.  By shorting a stock that keeps on rising, there are obviously forces driving that rise that have little to do with your belief that the stock is overpriced.  And while eventually your short position may pay off, the better likelihood is that you will close the short position to minimize your loss, as the stock continues to rise, well before the expected (looming) drop.  The problem is that most short sellers are fully hedged, either locking in the gains on their existing holdings or hedging convertible bonds, and are not just willy-nilly shorting stocks because they expect them to drop in value. 

In looking at the senior care sector, the bull market in assisted and independent living properties, as well as publicly traded stocks, over the past few years has been well documented.  But the question keeps on popping up, How much higher can prices go?  All of the AL/IL stocks hit 52-week highs in the first quarter of this year, and this was after all but one jumped by 45% to 113% in 2005.  By any standard, the performance and valuations are unusual, especially when considering that half the companies have not yet reported consistent positive earnings. 

Has the market peaked?  It is hard to tell, but anecdotally, in the facility acquisition market it would appear that the buying frenzy of the past 12 to 18 months has taken a breather.  Either that, or the supply of high-end portfolios coming to market has dwindled.  The actual M&A activity is expected to be robust through the end of the second quarter, but most of those properties went to market last year and are just now closing.  Prices are still high, and cap rates remain low, but the buzz of last year can hardly be heard.  That is not necessarily a bad thing. 

Regarding stock prices, since the end of the first quarter, every AL/IL stock has dropped in price, ranging from just over a 1% decline to more than 11% in the past two weeks.  While this is not the end of the world, it may signify a new resistance level that will not be broken for several weeks without a better earnings performance, a major rally in the overall markets or both.  To put things into perspective, even with the recent minor drop in share prices, since the beginning of 2005 American Retirement Corp. is up 103%, Capital Senior Living is up 93%, Emeritus Assisted Living is up 62% and Sunrise Senior Living is up 60%.  Last, but not least, Brookdale Senior Living, which has been publicly traded for only five months, has doubled in price since the IPO last November.  At some point, investors will demand current performance to justify these lofty prices, and at the first sign that things may not be as promised, we could hear a loud thud, followed by another. 

Getting back to my friend who wants to short a stock or two, my advice is that it is still too early to short, but it may also be too late to buy.            

Related links:
For more articles on the senior care acquisition market, see Index links for The SeniorCare Investor

Get the inside scoop on senior care M&A at The SeniorCare Investor

Database of health care M&A transactions, including senior care acquisitions

Portfolio Sales Reign In The Assisted Living Market

We have reported, in our latest edition of The Senior Care Acquisition Report, that 2005 was a record year for average prices paid in the assisted living and independent living acquisition markets.  One of the major contributing factors was the large number of portfolio sales, and the relatively high quality of the assets in most of those portfolios.  In the assisted living market, the average price per unit sold jumped 48% from $95,100 in 2004 to $140,300 in 2005.  But when the market is split between portfolio sales (three or more properties) and the others, there was a huge difference in 2005.  Last year, the average price per unit for assisted living portfolios was just over $181,000 per unit, while the rest of the ALF market had an average price of just $83,000 per unit. 

For several years, investors and appraisers have been talking of the “portfolio effect” in the acquisition market, whereby a buyer will pay up to a 10% premium for a group of assets compared with just one property, everything else being equal.  Obviously, with the nearly $100,000 per unit difference between portfolio sales and single property sales in the 2005 assisted living market, there was something going on besides just size, although size still matters.  The real driving force was the quality of many of these portfolios, with very high net operating incomes per unit.  The independent living market experienced a similar pricing disparity, although not quite as extreme with a $53,000 per unit difference between portfolio sales and single property sales. 

The acquisition market continues to be strong in 2006, and although companies such as Brookdale Senior Living and American Retirement Corporation have been active, the average prices paid so far are below what we saw in 2005.  While portfolio sales reigned in 2005, the prices paid may reign for a while as well.

Related links:
Goldman Mature Market Report

For more articles on the senior care acquisition market, see Index links for The SeniorCare Investor

Get the inside scoop on senior care M&A at The SeniorCare Investor

Database of health care M&A transactions, including senior care acquisitions