The SeniorCare Investor: Beverly Going Private - Third Major SNF Chain To Do So

As the market now knows, a newly created entity called North American Senior Care (NASC) ended months of speculation with a "final" $13.00 per share offer for Beverly Enterprises (NYSE: BEV) which, combined with the debt outstanding and the "assumable" cash on hand, comes to a transaction value of $1.9 to $2.0 billion. NASC is funding the acquisition with $330 million of equity, $1.325 billion in debt financing from Wachovia Bank (which we assume is secured by the real estate assets) and $550 million in operating loans from CapitalSource Financing, which is most likely for working capital and the value of the ancillary businesses. This financing totals $2.2 billion, so all of it may not be drawn down, depending on how much cash is left and NASC’s working capital requirements.

Some investors were surprised at the less than aggressive bidding for Beverly, with the initial winning bid by NASC coming in at just $12.80 per share, not much more than the market price, before Formation Capital upped the ante a bit. In fact, somewhat incredibly, at least one investor paid $13.44 per share for Beverly in the open market after the bids came in, when the rumor mill had it that there was perhaps at least 50 cents to $1.00 per share left on the table for NASC, Formation or some other bidder to try to come out on top. But one investment banker, not involved in the deal, said before the bids came in that he would not be surprised to see the bids come in below $13.00 per share, because "there is no reason the bidders have to bail out the investors who bought the stock at $12.50 per share or more." And right he was.

One of the unfortunate things about the world of large mergers and acquisitions, especially when it involves publicly traded companies, is the so-called break-up fee. With NASC’s initial bid, the break-up fees increased from $3.5 million to $20.0 million to $40.0 million based on certain events. When Formation Capital topped NASC’s bid by 10 cents per share, NASC had until August 23 to respond with a higher bid, and technically Beverly could not have entered into negotiations with Formation until that date. But what upset shareholders, and we assume Formation and its partners, was that Beverly agreed to an enhanced break-up fee of $40.0 million (increasing to $60 million) when NASC topped Formation by 10 cents per share, knowing full well that at those levels, it would be difficult for any other buyer to keep the bidding process going. The true cost of going higher included a "penalty" of at least 40 cents per share, because any break-up fee to be paid would come from Beverly’s balance sheet (and not technically from the bidder, as per CEO Bill Floyd’s letter to employees), and all buyers were including the use of the more than $200 million of cash on Beverly’s balance sheet when calculating their bids. Or were they?

What some investors, in trying to determine what Beverly was "worth," had factored in was the more than $200 million in cash on the balance sheet. But what they may not have figured in, especially that poor soul who paid $13.44 per share in late August, was the size of "change-in-control" and severance payments that will be paid out to executives, with Bill Floyd presumably the largest recipient. The bidders had to know the amount as part of the due diligence process, but our guess is that they will total somewhere between 50 cents and $1.00 per share in value. And that is money investors thought was due to them (the missing link, so to speak), keeping the bidding below the $13.00 to $14.00 per share range that many had expected. The details will come out in the proxy statements sent to shareholders, but by then no one will really care.

So, assuming that nothing else happens, what will NASC do? The Wachovia debt that is being put on the books totals $49,000 per owned bed, a level that is higher than any average price paid per bed in the history of the nursing home acquisition market (the record was last year, at $44,600 per bed). Even though Beverly has divested a lot of its less desirable nursing facilities, the remaining facilities are still considered to be somewhat average, with a 70% Medicaid and nearly 14% Medicare census. When the CapitalSource debt is added into the mix, the debt per owned bed rises to $69,000 per bed, even though this part of the debt is not related to the owned facilities.

The only name that has surfaced with NASC is Leonard Grunstein, who we assume is related to one Harry Grunstein, who is involved with the old Mariner Health and its related newly named entities. Leonard is also in partnership with Ruben Schron, the mastermind behind the purchases of Integrated Health and Mariner Health. The only way to make these deals work, especially when the amount of debt for a company triples, is to cut costs and sell assets. This is what happened at both Integrated and Mariner, and at the latter company we hear that the buyer raised $150 million by selling the LTAC division earlier this summer, and that overhead as a percent of revenues has dropped by 20%. And we have heard some rumors regarding lack of payments promised to certain Mariner executives. As far as Integrated Health is concerned, we hear that what little staff is left is working at Trans Healthcare Inc., which is managing a portion of the former Integrated Health nursing facilities.

We recently received an amusing e-mail from a Beverly executive accusing us (me) of having a "lust to close Beverly’s doors and layoff all the hardworking men and women at the corporate office." Unfortunately for the Beverly employee, life is not so boring for us that "lust" comes to mind when thinking about Beverly, or its corporate staff. This naïve executive believes that NASC will be leaving everything as is at Beverly, a prospect that seems unlikely with up to $1.875 billion of debt on the books. If history repeats itself, jobs will be lost and assets will be sold, because that is how the game is played, like it or not.

But a new twist has entered into the scene. Apparently, U.S. Senator Mark Pryor (D.-Ark) has asked the federal office of the Inspector General to determine if Beverly’s Corporate Integrity Agreement, crafted in 2000 after BEV entered into a plea agreement with the federal government and agreed to pay $170 million, transfers to the new buyer. And a state representative is asking for hearings to ensure that NASC will be a responsible care provider to the elderly of Arkansas. Our guess is that these are political responses to look good for their constituents and will amount to little more than extra legal fees, but you never know.

The Beverly buyers are basically real estate investors, and after they have taken most or all of their invested equity out of the deal, through asset sales and refinancings, our guess is that they will have two potential exit strategies. One would be to throw all of the real estate assets still owned into a REIT, and find an investment bank to take it public. This could include the re-sale of some of the Mariner and Integrated Health facilities as well. The other would be to merge the operations of Integrated, Mariner and Beverly into one operating company, presumably with few owned assets, and take that public. While it could be a logistical nightmare, and result in a company with no real geographic focus or strategy other than size, the trend has been away from real estate ownership and toward the operating company model. The REIT concept would seem to be the easier of the two, but the public equity market would not be happy with the concentration of tenants and would question who the tenants really are, as well as their creditworthiness. Whatever happens, it is remarkable to think that a group of investors, unknown to the skilled nursing industry just a few years ago, would now control three of the formerly largest players in the sector with more than 700 nursing facilities. As Harry Grunstein is reputed to have stated when asked how he could come out of nowhere, "America is a great country. God bless America."