The SeniorCare Investor: In Search Of The Financing Grail: Has ACR Found It?

Over the past two years, the amount of negative news in the senior care industry has overwhelmed what little positive news has slipped out. Bankruptcies, failed deals, lenders leaving the market, foreclosures and collapsing stock values have all made the headlines. Yes, companies are emerging from bankruptcy and there are always the small, regional firms, in both assisted living as well as skilled nursing, that have weathered these bad times in reasonably good financial shape. But the distress signals have been many, and it is a welcome respite to have some good news to report.

In the senior care market, all eyes have been on Alterra Healthcare (AMEX: ALI) and American Retirement Corp. (NYSE: ACR) to see if either company could restructure its various debt and lease obligations without filing for bankruptcy protection. While we may have to wait a little longer to see what ultimately happens to Alterra, ACR came out with some unexpectedly good news.

We say unexpectedly because the company has been working at a feverish pace to refinance several properties, mostly through sale/leasebacks, in an attempt to clean up its balance sheet and extend debt maturities. Several of the recent transactions were described in last month’s issue. All of this was to better position the company in its negotiations with the holders of the $139.2 million of convertible bonds that are due in October. The assumption was that the company would try to obtain an equity-linked commitment from a new investor to deal with the onerous October maturity, but most market observers were hard pressed to come up with a likely candidate.

As it turns out, the financing ACR is contemplating will not involve an equity piece, and we understand that it will not include warrants or options to purchase common stock of the company. Even though it is the biggest news in months for ACR, the company did not get around to describing the financing until the eighth paragraph of a recent press release. The company has entered into a non-binding letter of intent with a single lender to provide approximately $125 million of term mezzanine financing relating to certain of ACR’s retirement communities. These funds, together with the proceeds of some of its other refinancings, should be sufficient to retire in full the convertible bonds. These bonds, which earlier last year had been trading at 65 cents on the dollar, are now above 85 cents on the dollar. A week before the announcement, ACR’s common stock started rising and has now almost doubled in value. Obviously, news of the pending announcement must have leaked out.

While this is great news for the company, as well as for the current equity holders who, for the time being, will not have their holdings diluted, this financing (assuming it gets completed) will come at a price. Although the terms of the mezzanine financing have not been revealed, because there is no equity component the interest rate will most likely be close to double the 5.75% on the convertible bonds. With 34 free-standing assisted living facilities reaching just 65% occupancy at the end of last year, an extra $5 million of annual interest expense is going to make a financially tight 2002 even tighter. Still, if ACR can close on this commitment in the next several months, the industry will breathe a big sigh of relief as one of the most prominent senior care providers will avoid taking the bankruptcy plunge.

Simultaneous with the mezzanine financing announcement, ACR disclosed that it completed two sale/leaseback transactions involving six communities. In the first deal, CNL Retirement Corp. (CNL) bought a Denver, Colorado, facility that has 90 assisted living units and 90 skilled nursing beds for an initial price of $18 million, or $100,000 per unit/bed. Two earn-outs, one in the next six months and another in three years, could bring ACR an additional $2 million. Last month, CNL closed on the sale/lease back of two ACR properties for $28 million, or $102,000 per unit (see last month’s issue for details).

In the second transaction, Health Care Property Investors (NYSE: HCP) purchased a total of five properties with 796 units for $73.2 million These included a 298-unit congregate care community in Florida and a 244-unit CCRC in Texas for $55 million, or $101,500 per unit, and three assisted living facilities in Florida, Ohio and Texas for $18.2 million, or $71,650 per unit. The retirement communities have an average occupancy rate of 95% and the assisted living facilities, which are less than two years old, have a current average occupancy rate of 60%. In the near future, HCP plans to purchase an additional 92-unit assisted living facility in Florida for $6 million, or $65,200 per unit. The average yield on all of the HCP transactions will be about 10.73% in the first year of the 15-year lease. Of the approximately $91 million in proceeds from the completed CNL and HCP transactions, $68.1 million will be used to reduce outstanding debt and the rest will cover transaction costs and other capital requirements.

While the finance team at ACR, as well as its advisors, Cohen & Steers, have been working overtime to get these transactions completed, the company is still not out of the woods. Assuming the mezzanine financing does get closed by early in the third quarter, ACR must turn its attention to making money. The company’s 24 owned and leased retirement communities posted an 11% increase in revenues in the fourth quarter of 2001 compared to the same quarter in 2000, and a 12% rise in community operating income over the same periods. More significantly, the net operating income at these 24 communities rose by 8% from the third quarter to the fourth quarter last year, an unusually large sequential increase.

These communities represent 75% of the company’s total unit capacity, but it is unclear what will be required to cover the new debt and lease payments. It is the 34 free-standing assisted living facilities, however, that will be the key to ACR’s turnaround now that its immediate debt problems appear to have been resolved. These ALFs reached only 65% occupancy by the end of last year and produced just $0.6 million of operating profit before overhead and capital costs. If the company can get these to over 90% occupancy by the end of 2002, that should provide between $15 million and $20 million of cash flow to cover capital costs and, hopefully, some profits. This will be management’s task for the rest of the year once the funding is firmly in place to retire the convertibles. While not an easy assignment, it will be a welcome relief from the torrid pace of refinancings.