The SeniorCare Investor: Is Time Running Out For Some Financially Troubled Providers?

History may be repeating itself with a second wave of assisted living bankruptcies looming on the horizon. This time, at least, management at some of the companies, as well as their creditors, may have learned something from the earlier round of nursing home bankruptcies. In most cases, when a Chapter 11 filing appears imminent, creditors do not listen to management’s pleas that restructuring outside of bankruptcy will be less damaging to all parties, or at a minimum, that entering bankruptcy with a pre-packaged plan of reorganization will save time and money for all concerned. Assisted Living Concepts (AMEX: ALF) is pursuing the latter strategy, while Alterra Healthcare (AMEX: ALI) is pinning its future on the hope that someone besides E.F. Hutton will be listening.

Assisted Living Concepts may be the next company to file for bankruptcy protection, and although there are many operational issues, the major financial problem that has no resolution are the two outstanding convertible bond issues that total $161.2 million. There was a total of $4.7 million of interest due this past May 1 which was finally paid on May 24, despite having just $4.1 million of cash as of last March 31 (which included tenant security deposits). With the payment, ALF entered into a "confidentiality agreement" with holders of 64% of the principal amount of the bonds to negotiate a financial restructuring of the company as part of a pre-packaged Chapter 11 filing.

If these discussions are not fruitful, there is little chance that the company will be able to pay off the bonds at maturity. Because the bondholders know this, we expect an agreement to materialize within a month or two. The question remains, Why would these bondholders react any differently from other investors in the more than one-half dozen major bankruptcy cases so far in the senior care industry? The answer, simply, is that creditors have grown quite weary of bankruptcies, and are now more willing to deal. In addition, investors are realizing that emerging from bankruptcy is taking longer than expected, which in turn lowers the final return they can achieve on the discounted debt purchases.

Meanwhile, ALF released first quarter earnings results on the last day possible without obtaining an extension from the SEC. The level of disclosure was minimal, with no mention of same-store or stabilized occupancy rates or facility margins compared to prior quarters. Reading the 10-Q was depressing enough to make you feel worse than Trent Lott. The company’s EBITDAR margin, at 19.1% in the first quarter, is about the lowest in the industry and resembles that of a nursing home company. But this makes sense, since ALF received 19.3% of its revenues in the first quarter from Medicaid (the highest ever), while Medicaid in some states accounted for up to 47% of revenues (Oregon and Washington). Operating margins at the facility level declined to 30.7% from 31.5% in last year’s first quarter.

On a more positive note, overall occupancy at the end of the first quarter increased to 83.3% compared to 79.6% at the end of last year’s first quarter, and the average monthly rate rose by 4.8% to $2,041. However, residence operating expenses increased by 12.7% year over year while revenues increased by only 11.3% and the number of residents rose by only 6.4% (358 residents, or 1.9 residents per facility).

What this means is that with ALF’s current capital structure, if the company achieved stabilized occupancy of 95% tomorrow (an additional 837 residents), it would need an 80% operating margin on the incremental revenue to break even on a GAAP basis. Cash flow would be about $2.5 million per quarter, but the 80% number is obviously unrealistic, as is 95% occupancy any time soon.

With an average of 38 units per facility, the economies of scale just are not there, a fact that we questioned with the underwriters and the founder when the company originally went public in 1994 with five leased facilities and 137 units. This is why the convertible holders are at the table and why a pre-packaged bankruptcy filing is the best solution.
The other company that has mentioned the "B" word if things cannot get restructured out of court is Alterra Healthcare, perhaps the most watched senior care company in the market today. The company did not make debt service payments in March and April on mortgages covering 75 facilities and did not make lease payments on 51 additional facilities. ALI has also defaulted on its headquarters’ lease.

While the situation is certainly bleak, the first quarter finally showed some improvement. Stabilized residence operating margins increased from 29% in last year’s fourth quarter to 32% in the first quarter this year, while same-store margins rose from 30% to 35% in the same time period. Margins were still considerably lower than in the first quarter of 2000, however.
Occupancy rates continued to decline, with stabilized residences falling to 86% from 88% in the fourth quarter and same store occupancy dipping from 89% in the fourth quarter last year to 88% in the first quarter this year. Normally, an erosion in occupancy results in lower profit margins. ALI avoided this, however, with a 5.2% increase in the average rate from the fourth quarter to the first quarter of this year for the entire portfolio. In addition, expenses at the facility level declined by $2.9 million, or 3.2%, from the fourth quarter to the first quarter. In other words, based on average occupancy rates for the past two quarters, it appears that spending per resident per month dropped by about $75, or 4.6%. Admittedly, we may not be comparing apples to apples because ALI has terminated some leases, but facility expenses have definitely declined.

Management is hoping to raise some capital, or at least pay off debt, with the $157 million of assets for sale. While a few of the sales are beginning to close (see Acquisition Market), the current market environment could not be worse for a company trying to divest more than 60 properties. Although pricing for some facilities may be realistic, we have heard that others are way off the mark. It may all be moot if the current convertible debenture holders do not agree to exchange their holdings for new equity or equity-linked securities and if other creditors do not get paid in full with the asset sales. Creditors may see the writing on the wall, but they had better negotiate quickly before there is nothing left to read.

Another company in negotiations with creditors is Emeritus Assisted Living (AMEX: ESC), which has interests in 134 facilities with 12,400 residents. In late April, ESC secured a 30-day extension until May 29 on $73.3 million of secured debt, but we have not heard about a second extension or whether a new source of funds has been found. The financial prospects for the company continue to improve, even though ESC has yet to turn a profit. The company’s first quarter EBITDAR was 28.7% compared to 22.4% in last year’s first quarter. Facility operating margins increased from 31.3% to 37.0% over the same period.

Another encouraging sign is that same-community income after interest, rent and depreciation (but before a management fee) was $1.5 million in the first quarter, compared to breakeven in last year’s first quarter. On a cash flow basis these facilities produced a $1.1 million profit after a 6% management fee. While all of this is good news, the company must turn cash flow positive by the end of the year and successfully renegotiate its debt to avoid the path of Assisted Living Concepts or Alterra. To keep employees motivated, the company also announced that employee options can be exchanged for new ones that will have an exercise price equal to the higher of $1.50 per share or the fair market value of the stock on the grant date. While it is understandable why the board did this (an all too common event), shareholders do not have the luxury of benefiting from management’s past follies.