The SeniorCare Investor: As Summer Ends, Will Patience Wither?

The senior care industry is at a crossroads in its relatively young life. Desperate for capital in an environment filled with risk and uncertainty, the skilled nursing and assisted living sectors have stumbled badly in the past few years. In addition to several billion dollars of equity value that has been lost (not to mention the same amount of debt), credibility has been lost as well in the minds of many providers of capital. The skilled nursing home industry needs to redefine its market niche, while at the same time replace or renovate at least 50% of the facilities across the country. This cannot be done without significant amounts of capital. The assisted living industry needs to deliver on its promise to consumers that it can provide quality care in attractive, home-like settings and to investors that it can do so profitably. To date, that scorecard has been mixed. By the end of 2002, when existing properties should be stabilized and the development cycle begins again, new capital will be required and hard questions will be asked.

Creditors
There are few "national" lenders in the market right now, partly because many of them are still licking their wounds from the nursing home bankruptcy debacle of 1999 and 2000 and the assisted living meltdown which quickly followed and is still not over. Most of the original lenders have already sold out of their positions to vulture funds and other opportunistic investors, but their credit committees have not yet forgotten (or forgiven) the headaches caused by their senior care portfolios.

By the third quarter of next year, the bankruptcy cases will be past tense, with creditors at Sun Healthcare (OTCBB: SHGE), Integrated Health Services (OTCBB: IHSVQ) and both Mariners (OTCBB: MPANQ) looking for a resolution sooner rather than later. Kindred Healthcare (NASDAQ: KIND, formerly Vencor) is already off and running (literally, we hear) and Genesis Health Ventures (OTCBB: GHVIQ) and Multicare are expected to emerge by the end of the year. The question marks that remain are Alterra Healthcare (AMEX: ALI) and Assisted Living Concepts (AMEX ALF), both of which are in negotiations with creditors, except ALF is leaning toward a pre-packaged bankruptcy filing while ALI is trying to avoid one. While everyone is trying to work things out, patience is becoming a scarce commodity.

Investors
Because of sudden gyrations in capital markets that have dominated Wall Street for more than a decade, almost by definition investors have become traders, with a long-term investment horizon looked at as naïve. Many lost money as senior care stocks tumbled in the past three years, but they have little problem getting right back in for the ride up when prices hit bottom. Beverly Enterprises (NYSE: BEV) provides a good illustration. If an investor purchased BEV’s common stock exactly 10 years ago, the total return would have been about zero. But in that 10-year period, small fortunes could have been made by selling and buying at the peaks and valleys. So while we applaud the great turnaround in BEV’s stock price, which is now triple its 52-week low, in reality the price has merely returned to where it began 10 years ago, a sobering thought in the midst of escalating nursing home company values.

While equity investors finally have something to cheer about in the nursing home sector after a long drought, the assisted living side is another matter. Institutional investors had their semi-public cat-fight with American Retirement Corp. (NYSE: ACR) earlier this year, and lost the battle, but the cold war continues. Stuck at $3 to $4 per share when it had once been above $20 per share, investors are puzzled as to what the plan is to refinance the more than $300 million of debt that matures next year. Patience is dwindling, and there are no easy answers.For some unknown reason, investors have been very patient with Emeritus Assisted Living (AMEX: ESC), a company not in default of any obligations but struggling to achieve profitability. Although the company lost $1.4 million in the second quarter, its total community operating margin improved 270 basis points to 39.1% in the second quarter while the same community operating margin was 41.5%. These are margins that many competitors would love to have, but the company still has not made money. Since almost the entire portfolio is "stabilized," overall occupancy levels have to increase from the current 84.3% if any profits are ever to be seen. There are still believers in ESC’s CEO, Dan Baty, but if profits do not materialize by the first half of next year, their numbers will dwindle.

And now we come to the belle of the ball, Sunrise Assisted Living (NYSE: SRZ). As the only publicly traded assisted living company with any real investor following, the market would like to see management put its money where its mouth is. Several months ago, SRZ put on its Web site the company’s investor relations presentation which included, among other things, a net asset value analysis which showed that the company was really worth $42 per share. Some have questioned the riskiness of being so blatant, especially because the SEC generally does not like companies to tell investors what they think their stock is worth.

The problem investors have is, if management really believes the stock should be as high as $42 per share, why does the senior management team own no stock (with the exception of the Klaassens)? In fact, in June and July, five top executives (including the president and CFO) and two directors exercised options for a total of 237,000 shares and sold them all at prices ranging from $24 to $29 per share. Why give up $10 to $15 per share in value if the company really is worth $42 per share, whether today or in the near future? And since the stock price is where it is because of the earnings contribution of asset sales (see Second Quarter Earnings), what does this say to other investors?

Consumers
The last thing the senior care industry needed was Time magazine’s four-page article in August called, "Better Than A Nursing Home?" While the article was certainly slanted and brought up some old news regarding troubling incidents, those of us in the industry have to remember that the consumer believes that all these things happened yesterday (not that the date really matters), and that the problems are as common and systematic as they are made out to be in the article. No one is perfect, but until there is some consistency in the quality of care at both nursing facilities and assisted living facilities, the consumer will periodically get bombarded with negative stories in the national press. One cannot promise to take care of someone and then use the "we are not a nursing home" defense when care gets complicated and things go wrong. This will only serve to confuse the consumer who is already confused enough.

As the senior care industry and investors descend on the nation’s capital for the 11th annual NIC Conference beginning September 19, one has only to look at the conference theme, "Investing in Seniors Housing & Care: Making the Case. Understanding the Risks." Making the case for investing in this sector is not difficult, despite the recent problems, but the hard question is whether investors really want to understand the risks and, perhaps more importantly, deal with them. Most operators understand the risks, but do they want to be accountable for them? If the answer is yes to these questions, then we could see a long period of profitable growth and stability for the senior care market. Unfortunately, it is a big if.