The SeniorCare Investor: Sun Healthcare Closes Sale to Genesis HealthCare -
Sailing Into the Sunset, But on Better Financial Footing
Another chapter in the history of the skilled nursing business came to a close at the end of November, as privately-owned Genesis Healthcare completed its purchase of Sun Healthcare Group (formerly, NASDAQ: SUNH). As you may remember, Sun had basically divested all of its real estate, so Genesis purchased an operating business, and a large one at that. The company operates 158 skilled nursing facilities, 12 assisted and independent living communities and 13 combined SNFs/ALFs, as well as seven mental health facilities. In addition, it has significant ancillary businesses.
When Genesis announced the acquisition, based on the first quarter 2012 annual revenues were $1.834 billion, and that has increased by just $7 million two quarters later. And while you are always buying revenues, it is cash flow that matters the most. At the time, annualized EBITDA was $63.55 million with a 3.5% margin, and this was after $145.5 million of annual lease payments. When the large drop in Medicare rates, together with the change in therapy protocols, was announced in the summer of 2011, some investors left Sun for dead, believing that with no financial flexibility of real estate ownership, combined with its strategic focus on increasing Medicare census and revenues, there was no way to go but down. What went down was its share price, which plunged to a low of $2.06, a level often associated with a looming bankruptcy. Some investors remembered that the company had previously filed more than 10 years ago and were hoping not to have a repeat.
Much has changed since then, and while the net price after including assumed debt and deducting cash was about $270 million five months ago, it may have declined somewhat because of higher levels of cash on the balance sheet. Why? Because Sun has continued to improve its operating cash flow since the first quarter. Annualized EBITDA based on the third quarter results is about $85.0 million, 33% higher than the first quarter annualized. The EBITDA margin also increased by 100 basis points to 4.6%, and while that is still below the margin of its large competitors, kudos to CEO Bill Mathies and his team at Sun for continuing to improve the operating metrics while trying to wrap up the sale. Even though occupancy slipped a bit, they are turning over the company in better condition than when the deal was struck earlier this year, so Genesis and its investors must be happy, to say the least. Now, the hard part comes.
A good argument could be made that now is not a particularly good time to be in the skilled nursing business. Medicare rates are going to be under pressure for everyone whether we go over the so-called “fiscal cliff” or not. It’s not even worth talking about Medicaid rates, because in most states if you need to make money on Medicaid, it may not be worthwhile to stay in business. It hasn’t helped that the Office of the Inspector General of the Department of Health and Human Services just issued a report claiming that inappropriate Medicare payments to skilled nursing facilities cost the government (and the taxpayers) $1.5 billion in 2009 alone. The report claims that about 25% of all skilled nursing facility Medicare claims were in error, and the majority of the “errors” involved up-coding in therapy, many of which were in the ultrahigh therapy RUGs category. In the pejorative, this is known as “gaming the system,” and with trillion dollar federal deficits, no one in Congress will be in a very forgiving mood. How important is Medicare to the skilled nursing sector? In fiscal 2012, Medicare paid $32.2 billion for skilled nursing facility services, so this is not a payer to trifle with, especially when it is the most profitable part of the business right now.........Want to read more? Click here for a free trial to The SeniorCare Investor and download the current issue today