The SeniorCare Investor: No Holiday For Bull Market —

 
Seniors Housing M&A Market On Three-Year Run
At this time last year, after the strongest acquisition market in the seniors housing industry we had ever seen, we tried to inject a little reality into what appeared to many of us to be a run-away market. We asked for the removal of the rose-tinted glasses which seemed to make all deals look like winners, at any price, and for a little sobriety at a party that was going too strong and that no one wanted to leave, hangover or not. Well, the party continued right on throughout 2006, with the only difference being that the menu of offerings was not quite as plentiful, or diverse, as in 2005. But that didn’t seem to matter in a year that saw a record-setting pace in terms of dollar value of transactions announced, topping $22.0 billion, which was triple the dollar volume in 2005, It also was a record year for mergers and acquisitions in the overall health care market, with more than $260.0 billion in announced deals.
The fear, however, is that the market is now dominated by financial buyers, not strategic buyers, and has become more of a numbers game than ever before. It is always easier to make difficult bets when using someone else’s money, especially when there is so much money being dumped into equity funds these days. The money has to find a home, and the fund managers are finding a way to make the deals pencil out, often depending on the terminal value and using low discount rates. While theoretically there is nothing wrong with this, some of these buyers will not be in this industry for the long haul, and when the next downturn occurs, which may not be for a while, the “long-termers” will have to clean up the mess and suffer from any fallout in the capital markets. This may be why so many owners are cashing out at this point, because they have never seen it this good, and that is often an omen of some sort. Let’s hope not.
In the stock market, the skilled nursing sector took center stage at last, posting three of the four highest returns, with Advocat (NASDAQ: AVCA) tripling in value and Sun Healthcare Group (NASDAQ: SUNH) nearly doubling. The others posted double-digit returns, with the exception of Kindred Healthcare, which suffered from its rent reset with Ventas as well as some worries about LTAC reimbursement. That being said, it probably has the most potential for value increases in the next year or two.
On the assisted and independent living side of the business, Brookdale Senior Living (NYSE: BKD) came out on top with a 61% share price increase in 2006, plus its dividend payments, which have been increasing every quarter. In its six weeks as a public company in 2005 it had jumped by 57%. And after posting a 62% return in 2005, Emeritus Assisted Living (AMEX ESC) added another 19% last year. Five Star Quality Care (AMEX: FVE) was the surprise in 2006, jumping 41% in value, perhaps because of, or in spite of (we’re not quite sure), the huge payments it made to Sunrise Senior Living (NYSE: SRZ) to get control of the management, and cash flow, of several assisted living properties. Sunrise had a little problem this year in the market because of the lack of financial information and the upcoming restatement of past financial statements. All of this should be cleared up by March 1 this year, at which time we will see how much momentum the stock can gain after being left on the sidelines for most of last year.
So the seniors housing and care industry outperformed the market in 2006, again, any way you look at it, and the year ended as it began, with some of the largest acquisitions we have seen announced. Although we reported it last month, Fortress Investment Group finally announced the execution of an acquisition agreement under which private equity funds managed by affiliates of Fortress will acquire most of the North American operations of Holiday Retirement Corporation. Although a purchase price was not disclosed, we believe it will be near $6.6 billion. The transaction includes 299 senior living communities totaling more than 35,000 units, including 265 properties in the U.S. and 34 in Canada. We still don’t know about the construction company, and what will happen to Holiday’s properties outside North America, but the acquisition will take care of the bulk of Holiday’s operations. Citigroup Global Markets and Goldman, Sachs are providing debt financing for the transaction and acted as financial advisors to Fortress. Banc of America Securities and Cohen & Steers Capital Advisors advised Holiday, and the acquisition is expected to close in the first quarter this year.
Although the next sale did not come as a surprise, as it had been rumored for months, the purchaser was not expected. We are referring, of course, to the mid-December announcement that Australia-based GPT Group acquired a 95% interest in 19 assisted living facilities with 1,982 units operated by Benchmark Assisted Living in New England for $428 million, with the remaining 5% of the portfolio to be owned by BAL Capital, which is owned by the senior management of Benchmark. Grossing the purchase price up to 100%, the value comes to approximately $450 million, or $227,000 per unit. GPT stated that this represents a 3.8% discount to its valuation, but we don’t know how they did the math. The primary owner of these 19 facilities was Greenfield Partners, based in Norwalk, Connecticut. The facilities have values ranging from $11.3 million to $34.0 million, and their sizes range from 56 units to 182 units. About 80% of the units are assisted living and Alzheimer’s, with the remainder independent living. The average age of the properties is about seven to eight years.
GPT is also buying a 20% interest in the management company, Benchmark Assisted Living, for $3.5 million, with Benchmark CEO Tom Grape retaining the remaining 80%. The investments in the 19 properties and the management company are expected to provide an initial return to GPT of 7.1% before certain costs. When the transaction closes, the CEO of GPT will join Benchmark’s board of directors. This is the second time in two years that Benchmark has gone outside the U.S. for investors in its properties. In October 2004, the company reached an agreement with Kuwait Finance House in a $148 million recapitalization of 11 Benchmark facilities previously owned by affiliates of AEW Capital Management. For some reason, Benchmark has not disclosed its agreement with GPT and may be waiting for the closing. Benchmark operates 43 facilities in the Northeast with occupancy in excess of 93% and annual revenues of over $200 million.