The SeniorCare Investor: The Year In Review; Bleak Forecast For 2003

As the year began, it looked as if the worst was behind us. Genesis Health Ventures (NASDAQ: GHVI) and Kindred Healthcare (NYSE: KIND), having emerged from Chapter 11 bankruptcy the year before, appeared to be on healthy ground, and Assisted Living Concepts (NASDAQ: ASLC), Sun Healthcare (OTCBB: SUHG) and Mariner Health Care (NASDAQ: MHCA) were about to emerge from their own bankruptcies. American Retirement Corp. (NYSE: ACR) was working on restructuring its debt without a bankruptcy filing (which was completed last September), and Alterra Healthcare (AMEX: ALI) was making progress with both lenders/landlords and asset sales at reasonable prices.

Private, regional assisted living and skilled nursing operators, taking advantage of the virtual absence of big chains in the acquisition market, were finally able to pick and choose among the various targets over the past year or two. Medicare was profitable and it appeared that legislators were finally listening to the need for tort reform, particularly in the health care sector. And Sunrise Assisted Living (NYSE: SRZ) kept institutional real estate investors interested in the senior care sector with its aggressive asset sale/manage back program.

But something happened on the way to paradise, and no one is clicking their shoes and returning home to Kansas. By year’s end, liability insurance problems caused KIND’s shares to plunge by more than 50% while the Medicare "cliff" expired as Congress lost interest and left providers wondering if they would ever get even part of the $25 to $30 per patient day back. Now that the Republicans control both houses of Congress, the odds are slimmer. Medicaid reimbursement is in the toilet—it has been there for a while, but someone will finally flush—and by year’s end Centennial Healthcare had filed for Chapter 11 bankruptcy protection (more on that later). So the SNF market appears to be in tatters. Yet the former Beverly Enterprises (NYSE: BEV) portfolio in Florida continues to perform well, and an equity group is building up to 20 new SNFs in Texas. Go figure.

The assisted/independent living side of the business is doing "okay," but that’s not good enough. A little over a year ago, we began predicting that by the end of 2002, because of the virtual halt in new construction of assisted living properties by late 2000 (with the exception of Sunrise), facilities in most markets would be stabilized (and we’re not talking about 70% occupancy). Unfortunately, that has not been the case, as fill-up for most operators has taken even longer than the lengthened assumptions. This side of the business, however, will face far fewer challenges in 2003 than the skilled nursing sector.

In the public market sector, senior care stocks fared about as well as the overall markets, with just four companies posting positive returns to shareholders in 2002. The leader of the pack last year was Emeritus Assisted Living (AMEX: ESC) with a 155% total return, most of it coming in the last two weeks of the year. In late December, ESC hit a 52-week high of $5.85 per share after finishing November at just $2.52 per share. The only real news came in early December, when the company announced that it refinanced $74.9 million of mortgage debt, including a final payoff of debt owed to Deutsche Bank.

ESC’s only debt now maturing in 2003 is a mortgage on a single facility. But the refinancing news did not warrant a doubling of the stock price, especially after the not-so-stellar third quarter results. Perhaps investors are focusing on the fourth quarter revenues from a large acquisition that closed on October 1. The run-up in the price was good news for the company’s CEO, who now owns 1.07 million shares; unfortunately for him, he recently added 219,000 shares at prices between $5.00 and $5.40 per share, compared to the bargain prices available a few months ago.

Just behind Emeritus in stock market performance was ARV Assisted Living (AMEX: SRS), with a total return of 101% as a result of the tender offer made in September by Prometheus Assisted Living, LLC, an affiliate of Lazard Freres, for the 52% of SRS it does not already own. The original offer was for between $3.25 and $3.60 per share, but during the holidays the two parties came to an agreement at a price of $3.90 per share, and a definitive merger agreement has been signed. Two other buyers had also indicated an interest in SRS, and rumor has it that one of them was Emeritus. It is unlikely, however, that any offers would be high enough to break up the current deal. Another rumor floating around is that if Lazard’s transaction goes through, SRS would be the surviving entity with Lazard’s Atria Senior Quarters, based in Kentucky, becoming a regional office.

The only nursing home company to post a positive return was National Healthcare (AMEX: NHC), which rose by 22% last year on top of a 100% return in 2001. The financially strongest nursing home company, Manor Care (NYSE: HCR), dropped 22% in value last year (compared with a 15% gain in 2001), while the strongest assisted living company fell 14% in value last year (compared with a 16% gain in 2001). The biggest loser among the "active" companies was Five Star Quality Care (AMEX: FVE), which is down 81% since making its debut at the beginning of 2002.