The SeniorCare Investor: Battle For Genesis Escalates -

Two Bidders Up Their Offers, But Outcome Up In The Air

During the weeks before the shareholder vote to approve the sale of Genesis HealthCare (NASDAQ: GHCI) to a joint venture between Formation Capital and JER Partners, it became apparent that the necessary votes were not there for a clear majority to win. The hedge funds wanted to squeeze a little more money out of the deal, looking for perhaps another 50 cents or $1.00 per share to give their blessing. Some of these hedge funds didn’t even have a vote, since they purchased their shares subsequent to the shareholder of record date to vote on the transaction. But that didn’t mean they couldn’t exert pressure on other shareholders, as well as on other potential bidders to get into the game.

Feeling the heat, and not wanting to lose the deal for what would amount to a little over a 1% increase in the deal value, Formation Capital and JER, days before the shareholder vote, increased their offer by $1.25 per share to $64.25 per share. The board this time was unanimous in its support, and the shareholder vote was pushed out to May 4. One of the problems was that Institutional Shareholder Services, Inc. (ISS), an independent shareholder advisory service, recommended to shareholders that they vote no on the original Formation deal, not because they thought the value was too low (they thought it was fair), but because of how the process was handled.

When ISS recommends a no vote, it can be trouble for most any acquisition. Rather than potentially lose the vote and have to go through the process all over again, the Formation group upped the ante by enough to satisfy those shareholders holding out for a slightly higher price. At this point, everyone thought it was a done deal; everyone, that is, except the one buyer left at the altar last January, Fillmore Capital Partners.

On April 25, Fillmore topped Formation’s bid by a measly 50 cents per share, to $64.75 per share. The premium was so small that many people did not believe it would constitute a "superior offer" as defined in the merger agreement with Formation. One blogger (now, who could that be?) referred to it as "chump change," and not a serious counter-bid. One of the problems was that the financing was contingent on recapitalizing Fillmore’s Beverly Enterprises assets, and more than 50% of the "equity" to buy Genesis was going to come from that recap in the form of borrowed funds.

Another issue was timing, and despite Fillmore’s protests to the contrary, they would be at least a month or two behind Formation in the regulatory approval process. We had heard people say that the cost to shareholders of a delay could be as high as 60 cents per share per month; our calculation was closer to 25 cents per share per month. One investor, Farallon Capital Management, decided it didn’t want to wait, and on April 19 and 20 it unloaded about 1.9 million shares in dozens of trades between $63.10 and $63.63 per share. On April 27, ISS came out with an updated recommendation to vote for the revised Formation deal, noting that the risks inherent in Fillmore’s slightly higher offer were not worth 50 cents per share.

Obviously Fillmore got the message, but we were surprised that they listened. Late Sunday night on April 29, Genesis received a revised offer from Fillmore, increasing its bid from the prior week by 50 cents per share to $65.25 per share, or $1.00 above Formation’s bid. But the new bid had an unusual twist; the price would increase by just over one penny per day ($0.01073 per share) beginning August 15 if the deal was not closed, or the equivalent of about 32 cents per share per month. It was believed that Formation would be able to close sometime between July 1 and July 31, so this amendment was obviously meant to put to rest the timing issue. We have not seen the letter from Fillmore, so we don’t know if Fillmore has submitted a firm financing proposal with lenders in place. Formation, however, has its financing commitment in place.

The Genesis board and its advisor, Goldman Sachs, had to wonder why Fillmore pursued this two-step dance as opposed to belly dancing up to the bar with the higher offer a week ago. And it had to present a few questions. Since Fillmore has not had much time to review non-public financial and operating information, will their higher price stand the test of due diligence? And if the bidding rises, how does it impact the recap of the Beverly assets, which are of lesser quality than the Genesis properties? And if Formation and JER should decide to match the offer, at an increased cost of $20 million, will the Genesis board be back where it was last January, with two offers at the same price?

Well, that is exactly where it stands as we go to print. On May 1, Formation and JER upped their offer to match Fillmore at $65.25 per share, and taking a lesson from Fillmore, if Formation does not complete the transaction by July 31, their purchase price will increase by $0.01609 per share per day, or about 48 cents per month, significantly better than the Fillmore monthly increase and almost double our estimate. Our guess is that it really is a moot point for Formation, because they expect to have it closed by then anyway. As a result of the two new offers on the table, the board postponed the annual shareholder meeting and vote until May 11, but still maintained its recommendation to vote in favor of the Formation/JER transaction.

So the question remains, what will the shareholders do? The news of the new Formation bid sent Genesis shares up nearly 2% to a new high of $64.93 per share, indicating that they are sure one of them will win at a price no lower than $65.25 per share. Before the Formation announcement on May 1, Genesis shares had actually traded down a bit, indicating that investors may not have been fully on board with the Fillmore deal. With the price now the same from both buyers, but a better "timing premium" from Formation, we assume that ISS will stick with its support for the Formation bid. Under the merger agreement, Formation has the right to match any competing offers, so this could go on until someone cries "uncle." We just hope this is not drawn out in 50-cent increments and "fractions of a penny" timing premiums. One thing is sure, there is no "easy button" on this one. Who knows, at some point Manor Care could start looking cheap.

In the other rather raucous takeover battle, Ventas (NYSE: VTR) closed on its acquisition of the Sunrise Senior Living REIT (TSX: SZR.UN) assets on April 26 at a total cost of approximately $1.96 billion. The acquisition includes 77 assisted living facilities with approximately 6,200 units, and Sunrise Senior Living (NYSE: SRZ), which has an average 15% ownership interest in the real estate, is the manager for all of the properties. The grossed-up deal value is about $370,000 per unit, and the cap rate on estimated 2007 earnings (using 85% of EBITDA) is about 5.7%. Currently, the transaction is dilutive for Ventas, but as part of the purchase, Ventas picked up some exclusive development arrangements with Sunrise (the operator) which should help turn the overall deal accretive sometime next year, and increase the pro forma cap rate. But the acquisition also had strategic importance for Ventas as it tries to increase its proportion of private pay revenues and decrease the percentage of income from Kindred Healthcare (NYSE: KND).

Sun Healthcare (NASDAQ: SUNH) closed on its acquisition of Harborside Healthcare Corporation on April 19, paying approximately $349.4 million in cash and assuming net debt of about $275 million. Based on a 2006 pro forma adjusted EBITDA for Harborside of $74.5 million, the acquisition was about 8.4x EBITDA; the multiple was about 6.7x 2006 pro forma adjusted EBITDAR. Revenues were just over $650 million. This was a significant strategic acquisition for Sun and it will increase its proportion of owned facilities. The flip side of that is that with the Harborside assets, Sun becomes a more attractive takeover candidate itself in this market. Jon Santemma of UBS Investment Bank was the lead advisor to Investcorp, Harborside’s owner, in the transaction.

Also in late April, Brookdale Senior Living (NYSE: BKD) closed on its previously announced acquisition of two retirement communities in Ohio and North Carolina with a total of 675 units. BKD had been leasing and operating the facilities, and paid $101 million, or $149,600 per unit.