The SeniorCare Investor: Year-End Rush Is On: Spin-offs, Mergers, Divestitures

It is always amusing what an end of the quarter, or end of year, can do to (and for) management, as well as their advisors. Whether it is cleaning up the balance sheet, taking non-cash charges so the following period can start off clean or closing acquisitions and divestitures, there is always a big push to get things done, especially beginning in mid-November. So why should 2003 be any different?

Three major industry events occurred in the past two weeks, none of which were surprises, but all were important to either get done or at least announced by year-end. We have gone on record previously as stating that there are too many health care REITs chasing too few deals, and our group of 12 will now be smaller by one. The REIT that is being taken over, ElderTrust (NYSE: ETT), however, has not been one of the companies vying for new deals and was basically set up by Genesis Health Ventures (NASDAQ: GHVI) in 1998, a few years before GHVI’s bankruptcy filing, to finance some of its assets.

The November 20 announcement by Ventas (NYSE: VTR) that it is buying ElderTrust, with an expected closing in the first quarter next year, is welcome news for several reasons. ElderTrust was in the final stages of preparing for the spin-off of GHVI’s skilled nursing assets to a separate company (see below) and had been involved in a shareholder dispute with a group that believed a sale of the company was in the best interest of shareholders. As it turns out, they were right, but management nevertheless seemed to fight them every step of the way. The likelihood of ETT doing additional financing business, and increasing shareholder value beyond what it was worth as an acquisition by another REIT, was next to nil.

Although discussions between the two REITs had been on and off for some time, they apparently heated up in the past few months, according to VTR management. The timing was interesting because in late October ETT announced that it was going to reduce, over the next 15 months, overhead expenses by 50% and increase the quarterly dividend rate in December by two cents per share, which for REITs is quite sizable. In addition, Wachovia Securities was helping "to analyze the future direction of the company." Just three weeks later the deal was announced, leading us to believe that the October announcement was either a negotiating ploy in the final stretch of contract discussions, or a fallback option if the sale to VTR did not work out.

Ventas is paying $12.50 per share and assuming approximately $83 million of debt, which has an average interest rate of 7.5% and is not pre-payable. ETT’s shares had been as low as $6.22 per share in the past 52 weeks (historic low was $0.56 per share), and the offer price represented an 18% premium over the prior day’s price, and the highest price ETT shareholders have seen in five years (Merry Christmas). Although the total purchase price is $184 million, after deducting the cash on ETT’s balance sheet, the net price comes down to $152 million, or close to $76,000 per bed/unit after deducting an implied value for the two medical office buildings and a third office building that are in the portfolio.

Despite ElderTrust being a creation of Genesis Health, just 50% of the revenue stream currently comes from Genesis. Privately owned Benchmark Assisted Living, with four facilities, represents nearly one-third, while two other operators (one facility each) and the office buildings make up the rest. In total, the portfolio includes nine ALFs, five SNFs and one independent living community. Ventas management broke down the acquisition values as $60,000 per bed for the SNFs, $83,000 per bed for the ALFs and $150,000 per unit for the IL facility. The 15 facilities with 1,729 beds/units are located in Pennsylvania (9), Massachusetts (5) and New Jersey (1) with an occupancy of 91%.

Initially, some analysts voiced the opinion that VTR may have slightly overpaid for the acquisition. Although it was certainly not a "bargain" price, we disagree with their conclusion. On the monetary side, annual net operating cash flow from the facilities will be about $15 million, which will increase funds from operations for VTR by five cents per share. In addition, prior to the agreement, ElderTrust management had expected to cut overhead expense by up to 50% to the $1.2 million to $1.5 million range, but as an independent company. Ventas has stated that it expects to cut it from $3.0 million to $1.0 million, with no senior management coming over from ETT. Now, if Ventas (or any other REIT) had acquired a portfolio of assets with, say, 15 facilities and 1,700 beds, under a sale/leaseback structure, it might be necessary to hire at least one full-time finance person to handle the extra work, but not at an annual cost of $1.0 million. Despite her at times disarming manner, VTR’s CEO, Debra Cafaro, is one sharp cookie, and our guess is that the $1.0 million of overhead is a little extra padding, some of which will find its way into earnings over the next few years.

On the nonmonetary side, the transaction provides some diversification away from Kindred Healthcare (NASDAQ: KIND), VTR’s primary tenant. Currently, 95% of VTR’s revenues come from KIND, but that will now drop to 88%, and the nine ALFs in the ETT portfolio provide some facility diversification as well. This has been a primary goal for Ms. Cafaro, and we assume VTR will try to do more business with Benchmark and Newton Senior Living, another new tenant in the ETT portfolio. Both companies are strong regional providers that are in the growth mode. This is an important transaction for Ventas, and may be the first of a few large ones. With its share price almost doubling this year, Ventas is now the third largest health care REIT with a market cap of just over $1.6 billion and just behind Health Care Reit (NYSE: HCN). That’s quite a change from the $300 million market cap at the beginning of 2000. Well done.