The SeniorCare Investor: Mariner Health Sets Sail, But Wind Direction Unknown

Where were the investors during the first 28 days of June? Can’t anybody read anymore? Although it came as no surprise to us when Mariner Health Care (OTCBB: MHCA) announced on June 29 that they signed a merger agreement for $30 per share, investors acted as if they had no hint that such a deal was in the works and bid Mariner’s shares up by almost 40% to close at just under $28 per share. The share price did rise by 20% during the month of June, but it was a slow ascent.

Up until a day before the announcement, we thought the deal would come in between $24 and $26 per share, perhaps a little higher. But it wasn’t until when Mariner’s board was meeting on Monday that we learned of the $30 price. Mariner’s staff was told on Tuesday of the sale of the company, but that could not have come as a surprise since the corridors at One Ravinia Drive in Atlanta had been abuzz about the upcoming deal while senior management had to keep quiet on it. We even heard that some employees had sought contracts or termination agreements because of the "rumored" sale.

This was a deal, however, that was supposed to be announced a few weeks earlier. Apparently, there were some issues regarding the risk of the buyer, at a later date, throwing the company into bankruptcy, which could result in the acquisition being viewed as a fraudulent conveyance. If that happened, other than huge legal fees, there would be the potential of being forced to unwind the deal. The buyer was able to demonstrate sufficient financial strength (equity in the deal) and the pooh-bahs were able to get the necessary legal opinions to satisfy the Mariner board, according to our sources.

So a buyer by the name of National Senior Care, Inc. is paying $30 per share, or a 49% premium to the prior-day closing price, for the 20 million shares outstanding, yielding a total price of $985 million, which includes $385 million of assumed debt. On the day of the announcement, at least one trade was done at $30 per share (what was the buyer thinking?) before settling down between $27 and $28 per share.

The next day, however, the price reached as low as $22.71 per share, which we believe can be attributed to a sale by a large holder wanting to unload his shares and take his profit and run. The arbs obviously do not think that another bidder will come in at a higher price, unlike the battle for NeighborCare (NASDAQ: NCRX), and we hear there is concern among some investors regarding the ability to finance the acquisition at the current price, but we don’t share their concern.
National Senior Care is a newly formed entity controlled by the same group (Abe Briarwood) that purchased Integrated Health Services (IHS) 18 months ago. Behind it all is Rubin Schron and Cammeby’s International. Affiliates of the buyer have committed to invest $200 million of equity, and they have applied to Column Financial, an affiliate of Credit Suisse First Boston, for debt financing.Additional debt and equity financing may be sought from other lenders and investors. The buyer has also put up a $40 million letter of credit to secure the payment of a break-up fee, payable to Mariner under certain circumstances if the deal does not go through. J.P. Morgan Securities issued a fairness opinion as to the value of the offer.

There are many ways to look at this deal from a valuation perspective, none of which are completely clean. When approximately $33 million of lease expense is capitalized and added to the debt and equity components of the deal, the transaction grows to about $1.25 billion in size. Using this figure and total beds (owned, leased and managed) yields a price per bed of $38,800, which is not too high without considering the location of the beds, but there is a high concentration in Texas, where older SNFs tend to trade under $30,000 per bed, and often close to $20,000 per bed. There are 613 long-term acute care (LTAC) beds as well, representing 7% of total revenues, but only one of these 11 facilities is owned.
Adjusted EBITDAR for the first quarter this year was $33.9 million, or $135.6 million annualized. The $1.25 billion total acquisition value is a 9.2x multiple of this annualized EBITDAR, or a 10.9% cap rate. For small nursing home deals, this would be rich, but it is considerably lower than the irresponsible 10x to 15x multiples we saw in the 1990s for some of the major chain acquisitions.

The main reason for the high offer is that just over 22,000 of the beds are owned, not leased or managed, and that gives the buyer significant flexibility in financing the acquisition, as well as raising cash with asset sales. In today’s nursing home market, however, the deal is fully priced, Mariner shareholders couldn’t be happier and it would be highly unusual if another bidder materialized.

There is one significant factor that has been left out of the valuation puzzle, and that is the cost synergies that the buyer will be able to gain when its entire nursing facility portfolio is viewed in the context of this deal. Mariner has annualized insurance and G&A expense of $168 million, based on the first quarter, and we are sure that there is an expectation of reducing this, but we do not know by how much. To put it into perspective, a decrease of just 10% as a result of merged operations would increase value by more than $130 million, and decrease the EBITDAR multiple on the original purchase to 8.2x.

From what we hear, the buyer has been very successful in decreasing the cost of liability claims with its Integrated Health assets, and there is no reason to think that success will not continue with Mariner. Mariner’s EBITDAR margin is only 8.3%, up significantly from a year ago, and with just 85% occupancy, the buyer is most likely looking for some improvement here as well.

The acquisition is expected to close by the end of the year, but the story may have many twists and turns over the next several months. When Abe Briarwood completed the Integrated Health acquisition, a deal where most of the properties were leased from third parties, the buyer hired Trans Healthcare, Inc. (THI) to operate most of them. THI was already a sizable company before the Integrated Health relationship, but it moved its offices into the old IHS offices in Maryland after it started managing much of the IHS portfolio. Including its IHS facilities, THI is the largest privately owned operator of nursing facilities with 225 locations, 35,000 employees and more than $1.0 billion in revenue under management. At that size, looking at the IPO market makes sense.

Last month we mentioned that THI’s founder abruptly "resigned" and that plans for an IPO may have been delayed. According to our sources, the new Mariner deal throws a whole new twist into the future of the various entities. The venture firm GTCR Golder Rauner controls about 80% of THI and we assume it would like to get some piece of the Mariner deal, whether through leases, management contracts or the purchase of some of the facilities.

Remember that Abe Briarwood had no operations experience and basically used what was left of Integrated Health’s management and THI to manage the portfolio. Now, with the Mariner acquisition, the buyer has a whole new management group and the "partnership" with THI will become less critical.

We have heard that what Rubin Schron would like to do is take back the leased Integrated Health properties from THI and merge them with the Mariner assets into one entity, creating the largest privately owned senior care company in the country (and one of the largest nursing home chains) with a very good chance of going public in 18 months or so. We understand that structurally THI is really two separate entities—the original THI and the one operating the IHS facilities—so it would not necessarily be a difficult separation to consummate. While this may make sense on paper, this is not exactly in the best financial interests of GTCR, which had been the leading bidder (with THI) for the Integrated Health assets and subsequently worked out the deal with Rubin Schron.

One possibility that has been thrown out there is for GTCR to become a minority investor in the Mariner/IHS combination, but it seems unlikely that GTCR would want to have the fate of a substantial investment in someone else’s hands. For the next six months we assume that National Senior Care will be reviewing all of Mariner’s assets, lining up those that it will sell outright or sell and lease back shortly after the closing.

But while this is going on, the real action will be behind the scenes as the various parties involved in the IHS/Mariner/THI triangle jockey for position. The outcome is anyone’s guess, but you have two very smart and shrewd investor groups, each trying to maximize their return on investment. That being said, both sides can be expected to come out winners.