The SeniorCare Investor: Sunrise Still Acquires, but Investors Wait for Earnings Reports

As the July 31 “deadline” for Sunrise Senior Living (NYSE: SRZ) to disclose the results of an internal accounting review came closer and closer, the company’s stock price dropped lower and lower. The results of the review were supposed to be out by the end of June, but a June 30 acquisition announcement ended with a revised “by July 31” disclosure. Investors assumed that was the outside date, so nerves were rattled during the week of July 24 with no news from Sunrise HQ.

After the market closed on Friday, July 28, a brief release went out announcing an 8:30 a.m. conference call on Monday, July 31, to provide an update on the accounting review, which meant they had not completed the review and investors would have to continue to wait. On the Monday conference call, management was smart enough not to give a firm date for when the review would be signed off by their outside auditors, but investors also learned that second quarter financials would be delayed as well, with just the limited disclosure on operational performance, similar to what had been provided for the first quarter, to be made available on August 8. Although you could feel their pain as they made their comments during the call, as management has better things to be focusing on, investors have felt the pain as well, and sent Sunrise’s shares down 7% to a new 52-week low of $24.40 per share within minutes of the conference call ending. That negativity was, as it turned out, short-lived, with the shares soaring 18% from that low to close the day at $28.88 per share.

Despite the rollercoaster performance of the shares, there was no real bad news in the conference call, other than another delay in reporting earnings for the first two quarters this year. But management did reveal that the restatement for the years 1999 through 2005 would result in a cumulative decrease in net income of between $60.0 million and $110.0 million, as the new accounting treatment will change the allocation of profits and losses from the old joint ventures that involved “preference returns” for the third-party investors, plus some other items. Most of that “loss” will be recaptured in 2006 and 2007 as “profits” when the assets in these joint ventures are sold or otherwise recapitalized. The practical result of this will be to give 2006 and 2007 a huge earnings goose, something that drives equity analysts (and their models) crazy, much like the asset sales of a few years ago that distorted earnings and made it difficult to truly understand how the company was performing financially from operations as opposed to capital transactions.

The good news is that there is no cash flow impact, and management will be presenting its “going forward” financial statements with and without the accounting adjustments so we will be able to compare apples with apples. It seems that this is much ado about nothing, as there is no cash flow impact from the accounting changes, and these were old joint ventures done in a way (preference returns) that Sunrise no longer utilizes. We understand that this all came about as a result of an internal accounting review, but it has unnecessarily created a lot of angst for something that is largely irrelevant to shareholders, has no real financial impact (other than the G&A expense to deal with it) and really deals with the past. What has been left unmentioned is whether the joint venture partners will have to adjust their accounting to coincide with Sunrise’s treatment, but we won’t go there because the whole thing is largely irrelevant. In addition, no one has mentioned if there are any tax implications, but since cash flow remains unchanged, we will have to assume there aren’t any.

So investors are left to rely on management’s comments that business is good, average daily rates are increasing and the company is benefiting from strong occupancy. But what we did not hear clearly was that, excluding the accounting adjustments, the earnings expectations for the first two quarters are exactly the same as they were three months ago. We have to assume they will be, but if there is any discrepancy beyond the extra cost for the accounting review, management will have to have a very good explanation.

Sunrise is a unique company in many ways, in addition to its varied accounting issues over the years. Not many companies could, with their quarterly financial statements still on hold, continue to make large acquisitions. Last month we reported on the $450.0 million, or $233,000 per unit, deal for the six Aston Gardens retirement communities. The only other financial details disclosed were the more than $65.0 million of annual revenues and occupancy of 95%. One reader called in and said that if the acquisition was done at a 6.0% cap rate, the implied operating margin was about 42%, which may be fairly close. The J/V partner, which will take a 75% ownership interest, has yet to be disclosed.

On the same day as the accounting review conference call, Sunrise also announced it signed an agreement to acquire the operating assets of three San Francisco Bay area “continuing care retirement communities.” We put the type of community in quotes because it is a liberal interpretation of the phrase that has a certain meaning for most market participants. But we are glad to see Sunrise using it, regardless of the interpretation.

Sunrise is paying a combined $26.0 million for one retirement community plus the operating assets (mostly the management contracts) of the two other communities, which are condominium retirement properties with the individual units owned by the residents. One is in the Cathedral Hill section of San Francisco and has over 100 units, and the other condo community is one mile from Stanford University and has over 40 units. The third community (not a condo) is in San Mateo and has about 75 units. Combined revenues are approximately $10.0 million.

All three are basically independent living with some assisted living services provided as well. The CCRC label comes from the fact that Sunrise already had 14 communities in the Bay area, and the residents can move into any of these (the continuum) if they believe they need a higher level of care. Although the three acquired communities do not have a contract with any local skilled nursing provider, we were not able to determine if any of the other 14 local Sunrise communities have skilled beds. The seller is a family-owned business, Raiser Senior Services, and it is believed that these were its only senior care assets. We have heard from other sources that these are very high-end properties. The closing is expected to take place before the end of the third quarter, and excluding the $2.0 million of transaction and transition costs, the acquisition should be break-even in 2006 and accretive in 2007.