The SeniorCare Investor: Ensign Group Prices Weak IPO--

 
Pricing Is Severely Cut Amid Market Weakness and Turmoil

Since August, the capital markets have had quite the rollercoaster ride. One day the Dow Jones Industrial Average is up 300 points, the next day down 200 points, then up 150 points. Investors are reacting to any latest news that may impact what the Federal Reserve will do with interest rates, how the economy will react to oil price increases, what the fallout will be with the mortgage meltdown and whether we will have a consumer-led downturn at best, or a recession at worse.

The truth of the matter is that investors really don’t have a clue. One day it is euphoria, the next day the world as we know it is coming to an end. The only thing that stays constant is Wall Street bonuses, even though the risk managers fell asleep at the wheel and cost their firms a few billion here, a few billion there. Did they really think that borrowing short and investing long was going to be profitable forever? No, but then they don’t have to pay back those bonuses either.

So this was the environment The Ensign Group (NASDAQ: ENSG) found itself in during the past two months as management huddled with the lead underwriters for its IPO, D.A. Davidson & Co. and Stifel, Nicolaus & Company. Following in the footsteps of Skilled Healthcare Group (NYSE: SKH), which went public last May, we assume ENSG thought there was a small window between the time when some calm appeared in the market six weeks after the August meltdown and the traditional Holiday break when everyone is beginning to close the books for the year. They didn’t realize, apparently, how small that window was going to be, and it looks like it caught them while it was closing.

Just a month before the actual pricing, the company filed its disclosure with the SEC that it planned to sell 4.0 million shares at a range between $20.00 and $22.00 per share. But just a few weeks later the range dropped to $18.00 to $20.00 per share. That can happen, especially in a market as jittery as this, when no one knows if the Dow is going to drop another 1,000 points or not….next week. When the IPO was finally priced on November 8, it came with a $16.00 offering price, or nearly 24% below the mid-point of the original range. In the world of IPOs, that can be called a disaster, but at least it closed the month at a slight premium.

We don’t understand why it had to take such a large haircut when other skilled nursing companies were faring reasonable well. Three of the six other publicly traded SNF companies advanced in November, while two dropped less than 3% in value and one by 7%. But Ensign was punished, and by more than 20 lashes in a Saudi public square; either that, or D.A. Davidson, the sole book-running manager, was reading the wrong tea leaves, to put it mildly. Let’s just say this deal is not going to win them much future IPO business in the senior care sector, although they could make the argument that they did, after all, get it done. And they did exercise the underwriter’s over-allotment option for an additional 600,000 shares. Yes, but…

At its current price, Ensign’s market capitalization is just under $350 million, or a third less than Skilled Healthcare, ranking it as the second-smallest publicly traded skilled nursing company, only larger than Advocat (NASDAQ: AVCA). Size doesn’t always matter, but it is important to investors, and others, and ENSG’s public float is just $75 million, which isn’t going to excite anyone. Last month we mentioned that its financial performance in the first six months of this year was underwhelming, posting a slight decline in operating income on a 17% increase in revenues compared with the first six months of 2006. Or perhaps it’s the fact that the company’s EBITDAR margin dipped by 220 basis points in that same time period, or maybe that they own less than 38% of their facilities. Whatever the reason, management can’t be happy that they ended up with $20 million less than they had expected two months ago, and while it won’t kill them, it means less money for acquisitions and growth. Speaking of acquisitions, from March 2006 through March 2007, Ensign was on a buying spree, acquiring a little more than one nursing facility per month, on average, in 14 separate deals. Now that the IPO is done, we expect management will focus on growth again and put its new funds to use.

Some may blame the November meltdown of the assisted and independent living stocks, which dropped by an average of 13% in the month. Emeritus Assisted Living (AMEX: ESC) led the way with a 24% plunge, followed by Assisted Living Concepts (NYSE: ALC), which lost 22% of its value in November and hit a new low of $6.49 per share. The reality is that these stocks should have no impact on a skilled nursing facility company’s valuation during an IPO, but as silly as it sounds, there are still investors who group all of the seniors housing and care stocks together despite the reimbursement, regulatory and asset quality differences.

The big drop in Emeritus’ value was blamed on the distribution by its major investor, Saratoga Partners, of 937,500 shares to their investors, most of which was probably then sold. This should not come as a surprise to ESC shareholders, as Saratoga has stayed with Emeritus through thick and thin, mostly thin, over the years and should be compensated for their perseverance. And what looked like a dog of an investment for too many years ended up being profitable. There was also some speculation that when Brookdale Senior Living (NYSE: BKD) was dropping in value, Emeritus was forced to decline to keep their relative values in parity. The trading volume in Emeritus is so light, and the holdings so concentrated, that we don’t believe this was the cause for the drop.

We have to believe that both Brookdale and Assisted Living Concepts have been selling off because of occupancy concerns related to the housing market (BKD) and the private pay/Medicaid swap census issues at ALC. The company has been trying to reduce its Medicaid census and replace them with private pay residents. While ALC had a record number of private pay move-ins during the third quarter, it also had a record number of private pay move-outs in the same period, so the company did not see the private pay census growth it was expecting. Management believes many of the private pay residents who moved out had the original intent of converting to the Medicaid program, and when this option was removed, they went elsewhere. Despite these problems, private pay revenues as a percent of total revenues increased in the third quarter to 86.2% from 84.4% in the second quarter. Still, the company has a ways to go to convince investors that its strategy will work.