The Health Care M&A Monthly: Extendicare To Explore Strategic Alternatives -

 

Possible $2 Billion Breakup and Sale of Extendicare May Help Jumpstart Skilled Nursing M&A Market in 2006

Two paragraphs into its otherwise routine fourth-quarter and year-end earnings report, Extendicare (NYSE: EXE) revealed that it had engaged Lehman Brothers to help it "provide value to shareholders," which, when decoded, means that the senior care provider is poised to pursue alternatives that could include the sale of part or all of the company.

Extendicare has grown to become one of the largest senior care providers in North America, with 439 skilled nursing and assisted living facilities. It generates annual revenue of about $1.7 billion, 75% of which comes from its U.S. operations, with the remainder coming from Canada.

The U.S. portion of the business, Extendicare Health Services, is one of the largest skilled nursing operators. With its $280 million acquisition of Texas-based Assisted Living Concepts, a deal that closed in January 2005, EXE also has a strong presence in the seniors housing side of the business. The Canadian side of operations includes skilled nursing and seniors housing with revenues of $325 million, as well as a home health business with revenue of nearly $110 million.

But despite its growth, looking around at the current market environment apparently persuaded insiders that they were sitting on a group of assets, the sum of whose parts might prove to be worth more than the whole. Investors readily agreed, sending the stock up 40% on the first day of the news. The price has risen a bit since, hitting a high of $21.48 per share.

Extendicare’s stock was stuck in the $2.00 to $4.00 per share range from mid-1999 to mid-2003, when it finally took off, climbing to a peak of $18.09 per share in 2005. In doing so, it managed to outperform the overall market in the past three years.
Some equity analysts at Canadian firms, buoyed by the recent news, have sharpened their pencils and calculated a breakup value for EXE in the range of $24 to $27 per share, or a roughly 25% premium its current price. At the current price, EXE boasts a market cap of $1.45 billion, to which net debt of about $650 million may be added, pushing the total value of the company just over the $2.0 billion mark.

To "maximize" shareholder value, the Canadian operations might be sold off to a Canadian buyer, perhaps a REIT, given the more liberal REIT regulations north of the border. The remaining U.S. operations could then go to another buyer with little interest in the Canadian side of the business, even after recent elections tilted the government more to the right and, theoretically, the United States.

Not enough is known about EXE’s home health business or the relevant payor sources to determine whether there could be a third buyer for that component. Finally, since the Assisted Living Concepts operations may not be fully integrated into the overall business, they could be spun out separately to take advantage of the high valuations in the assisted living market (see the forthcoming Senior Care Acquisition Report). With all these various combinations in the offing, bankers must be very, very happy.

Who, then, would the buyers be? Though possible, we think it unlikely that one of the major skilled nursing chains would want to buy Extendicare Health Services lock, stock and barrel. What seems most likely is that companies who have recently bid on such major portfolios as Beverly Enterprises (NYSE: BEV), Skilled Healthcare Group and Tandem Health, but who came up short, will want to have a run at Extendicare’s skilled nursing business. (They will likely buy it along with the assisted living business, which can then be spun off to help finance the deal.) The Blackstone Group, KKR and Formation Capital come foremost to mind, but there will be many others.

Despite the optimism of the Canadian analysts, it seems to us that any acquisition premium is already built into the now higher price of $21 per share. While the sum of the parts may ultimately be worth more than the whole, with two or three competing deals, one may risk bumping into and hurting the others before closing, so navigating the cross-currents will be key. Skilled nursing may also start receiving the attention showered on the seniors housing market.