The SeniorCare Investor: Kindred vs. Ventas: Round II-

Who Will Take Over The Ventas-Owned Properties?
 
As everyone knows, health care REITs have been aggressive buyers and growing rapidly.  For portfolios of any real size, other buyers often do not want to spend the time putting together an offer, lining up the financing and completing due diligence because they know that if a REIT wants the acquisition, it will get it.  It’s just which REIT.  When it comes to price, it all comes down to cost of capital, and right now no one beats the REITs, especially the large ones. 
But what happens when some of these expensive portfolios begin to underperform?  In many cases, the results can be buried until operations turn around.  Perhaps they can be re-tenanted, perhaps a few offending properties can be sold.  REITs, however, need to grow their cash flow in order to increase their dividends and drive their share price higher.  That is one reason why the leases tend to be for relatively long periods, with multiple renewal options and annual escalators in the lease payment regardless of the financial performance of the tenant.  Single properties can be easily disposed of, but when there is a large portfolio, the decision is more difficult with perhaps too many options.
Take the case of Kindred Healthcare (NYSE: KND) and Ventas (NYSE: VTR), with the announcement in late February that Kindred decided not to renew a portfolio of 54 skilled nursing facilities with 6,140 beds and 10 LTACs with 1,066 beds and total revenues last year of $790 million.  We reported on this news last month, but at the end of March Ventas engaged an advisor to help them work through the process, which includes selling some or all of the properties or re-tenanting some or all of the properties.  The “rumor mill” has Houlihan Lokey as the firm being tapped to take on what will be a complicated process and potentially a very difficult one. 
This portfolio should not be classified as troubled, as it did produce close to $162 million of EBITDARM for the 12 months ended September 30, 2011, with a corresponding margin of about 20%.  But that period did include the entire four quarters of the higher RUGs-IV Medicare reimbursement for skilled nursing, which resulted in a 14% increase in KND’s income from operations for its skilled nursing division.  Subtracting a 5% management fee (which would be high for a portfolio of this size) and the $77 million in lease payments (before the increase effective May 1), results in EBITDA of about $45.5 million for that same 12-month period. 
Kindred’s income from operations for its skilled nursing division increased by 14% for the first three quarters of 2011 (which includes the full RUGs-IV impact) compared with the first three quarters of 2010 (before RUGs-IV), and we have to believe that most of the increase came from the higher reimbursement, which is now gone.  Although we don’t know the number, a reasonable assumption is that the SNF portfolio NOI would decline by something close to that 14% number. Since the leased properties that Kindred is not renewing also include LTACs, which operate at a margin that is almost double that of SNFs, we have estimated a $10 million reduction in the total EBITDA for the portfolio not being renewed, taking it down to about $35 million (sorry Paul and Debbie if we are way off).  The point is that after the current lease payments and adjusting for the reimbursement change, there is still an estimated $70 million to $75 million to cover G&A and provide some profit to a new owner or tenant, if they buy or lease the entire portfolio.  But that is the rub.  Is there one tenant or buyer?……….Want to read more? Click here for a free trial to The SeniorCare Investor and download the current issue today