The SeniorCare Investor: Haven Healthcare Deal Dies--
And Other Troubles With Some Private Companies
This time last month, we thought the sale of bankrupt Haven Healthcare was the proverbial "done deal," at a price that was nearly 20% below the original stalking horse price of $105 million, which, we might add, some people thought was unrealistically high in the first place. In early June, Formation Capital inked a deal to purchase the 27 Haven Healthcare skilled nursing facilities for approximately $85 million, subject to a two-week final due diligence period and regulatory approvals, with an expected closing by August 1. Everyone seemed happy with the situation because Genesis HealthCare, owned by Formation Capital and its partners, is well-known to Connecticut regulators and was going to manage the operations and perhaps close one or two of the facilities. Omega Healthcare Investors (NYSE: OHI), which owns 15 of Haven’s properties, had to be happy with that developing outcome because it would have an experienced manager in place and a stronger credit on the hook for its leases.
Unfortunately, by the end of June, negotiations unraveled, either because the buyers found something they hadn’t expected or the situation had deteriorated even further than anyone had thought. We assume the latter, because we had been hearing from local sources that occupancy had been steadily slipping each month, perhaps as much as 500 basis points since the beginning of the year, and that losses were mounting. Although Genesis is very experienced in Connecticut, where the majority of the Haven facilities are located, as well as the other states in the portfolio, turning them around may have been more costly than they had expected. The negative local press certainly didn’t help, and it is always very difficult to determine how long it will take to overcome that kind of an obstacle when you need to improve occupancy so drastically.
We have not heard whether the stalking horse bidder, LifeHouse Retirement Properties (OTCBB: LHRP), will be back in the picture, but we doubt it, especially with the recent decision by Omega Healthcare. Omega has decided to form a new company with "an experienced nursing home management team" to operate the 15 Haven properties owned by OHI. The transition to the new operating management team will be subject to approvals from the U.S. Bankruptcy Court and, we assume, the state of Connecticut. The new company will be led by Tim Coburn, who has been the court appointed "Patient Care Officer" for the Haven facilities since last November and is a licensed nursing home administrator in both Connecticut and Massachusetts. He has been in the business for 30 years and has been a senior member of several national health care companies. The good news is that he is knowledgeable about the situation; the bad news is that he is knowledgeable about the situation.
The situation is still fluid, so we do not know whether the current lease rates will stay in place or whether they will be reduced on a temporary basis to give Mr. Coburn a little breathing room. Omega has committed, however, to provide the new management company with working capital funds, which it obviously needs, as well as money for capital improvements, which could be necessary to improve the local reputation of some of the facilities. We don’t know what will happen to the rest of Haven’s nursing facilities, but our guess is that they will be sold off, with any funds going to the lenders on those properties and the rest of the unsecured creditors getting the big zilch. The lenders, by the way, will be walking away with a significant hole in their pockets as well. All that can be said is that this was a big mess, but the Haven creditors, if it’s any consolation, are not alone.
Out on the West coast, a few other problems have been brewing. In the smaller of the two, Asset & Real Estate Investment Co. (known as AREI) is finally shutting down amid a series of lawsuits filed against the founder, Jim Koenig. This company got its start in the late 1990s and ended up purchasing more than 20 assisted and independent living properties on both coasts. AREI sort of worked as the acquisition and financing arm while operations for the acquired facilities were handled by a sister company called Oakdale Heights Management Company. It was always hard to tell who was really running Oakdale Heights and whether they were competent enough to manage the acquired properties, many of which involved turnaround situations. Our guess is that they may have been in over their heads, but if a more conservative approach had been used, the outcome would have been different.
In the years 2002 through 2005, when perhaps 50% of the assets were purchased, the deals did not seem outrageous and from our records, the per-unit prices ranged from $42,000 to $77,000 in that time period with average occupancy rates near 85%. Those prices are obviously on the low side, and some were purchased in that bargain-basement period of 2002 to 2003 when some sellers had a hard time giving away properties. One transaction, however, involved the purchase of six facilities from the troubled ManorHouse Retirement, and AREI couldn’t make a go of it with them and ended up selling the facilities to Sunwest Management in 2006 for about $51 million, or $104,000 per unit and a 6% cap rate (more on Sunwest later). So from a capital cost perspective, most of the acquisitions were fairly cheap and should have provided the management company some breathing room to improve operations and occupancy, but it seems as if they were not up to the task.
It probably didn’t help that Mr. Koenig decided to get a little glitzy with a new corporate headquarters and traded in the small plane for a corporate jet. For lenders, that is usually the first sign that trouble is coming; just look at the former Alterra Healthcare and its newly built HQ which became a "see-through" building a few years after it was finished...where you could see right through it because many of the floors were empty. One of the other signs that lenders missed was that apparently in 1986 Mr. Koenig was sentenced to 2 ½ years in prison and ordered to pay $5 million in restitution to investors after he and his partners were convicted of investment fraud. We don’t know if he ever served his time and paid up, or successfully appealed. Apparently, the lenders only went back 10 years when looking at his financial or criminal history, and didn’t ask about 20 years ago, even though buried in one of the investment offering documents it apparently stated that one of the partners had been sentenced to prison. This is a case where it would have paid to read the fine print and follow up.
We have heard that investors in some of the assisted living facilities have not received their rent since late last year, and the lawsuits allege a classic Ponzi scheme whereby AREI borrowed more money to pay off the earlier investors who were promised a 12% annual return. We understand that several of the facilities have already been sold off, and that Mr. Koenig is trying to sell the rest. It is doubtful he will go to jail this time, but investors are wondering whether the timing of his recent divorce was coincidental.
This is really a shame because Mr. Koenig’s timing was actually quite good, getting in when prices were low and financing was cheap and abundant. But it appears he was more of a finance guy and forgot that this is a management-intensive business, a mistake made all too often.
The AREI problem can be considered small potatoes compared with what is going on at Sunwest Management and its acquisition "sister company," Canyon Creek Development (we will refer to them simply as Sunwest). For the past five years or so, Sunwest was one of the fastest-growing companies in the industry, if not the fastest-growing, and unlike the growth companies of the 1990s, such as Alterra which was opening up more than one new property a week, Sunwest grew by acquisition. But "grow" is an understatement, as the company now has almost 300 properties across the country and ranks in the top five by size.
Less than six years ago, the company was considered large with just over 70 properties, but didn’t rank in the top 20 by units under management. In just five years, however, Sunwest acquired about 190 properties, adding the equivalent of more than one facility a week from 2005 to 2007, about the same growth rate as Alterra in the 1990s. No matter how good you are, it is next to impossible to grow that quickly and maintain any degree of control over operations, especially when many of the acquisitions were underperforming at the time and needed a lot of attention to boost occupancy, and cash flow, to service the company’s growing debt.
About two years ago the whispers began that Sunwest was having some problems, mostly sparked by some regulatory issues in California which, we heard, have recently been settled. The reality was that most everyone assumed that anyone who grew that quickly was bound to come unraveled, because it had usually happened to everyone in the past. Then, beginning this year, the whispers grew louder that something was stirring, and finally we heard a month or two ago that GE Healthcare Financial Services was camped out at Sunwest’s headquarters going over the books and trying to decide what to do with their significant mortgage exposure. Both GE and the former Merrill Lynch Capital had funded some of Sunwest’s growth by acquisition, and when GE purchased Merrill’s mortgage portfolio, they inherited the Sunwest loans; we hear the combined total exposure is well above $500 million. This explains GE’s decision to see what is really going on, otherwise known as protecting your investment.
Every large company has its "good" properties as well as the real bow-wows, with the latter ones usually suffering from poor location, dropping census or outdated physical plant, and often times all three. Sunwest obviously needs to get rid of some of these, if not all of them, but in this market that is easier said than done because we suspect their market values are less than the original purchase price in many cases, and coming to the closing table with cash to hand out is not exactly what Sunwest has in mind. It’s the better performing properties that represent a bit of a conundrum. We hear they may be looking to sell 100 or more of these, and assuming these are cash flowing nicely, there will be sufficient market demand. The issue, however, is whether they will (and can) be sold as a group, or whether they can be broken up. A portfolio of that size would probably be in the $1.0 billion to $1.5 billion range, and most buyers would not be able to finance that given the current capital markets. Financial buyers are currently in short supply, and most strategic buyers are not in a position to take this on right now. The one exception could be Dan Baty, who could be a strategic buyer through Emeritus Corporation (AMEX: ESC) or a financial buyer on his own (and he can do it). Whether the price would be right is another story.
This is, of course, all speculation on our part from the bits and pieces we hear, but it is clear that it is in no one’s interest to see Sunwest take a tumble in this process, and management really needs to be focused on operations, as difficult as that may be right now. GE is walking a tightrope because while it probably wants to get paid back on half of its mortgages outstanding in this process (if not more), if it pushes too hard things could unwind faster than anyone wants. And of course, Sunwest CEO Jon Harder has worked too hard building up his company to lose it now, although he probably realizes that half of it is better than nothing. The other thing that the participants have to keep in mind is that the industry does not need a major blow-up, especially when investors are nervous about the ongoing impact of the residential housing market crisis.