The SeniorCare Investor: Industry Consolidation Play Or Opportunistic Investing?

With the financial distress that has been afflicting both the nursing home and assisted living sectors over the past 18 months, we have repeatedly stated that strange things would come to pass. Who would have thought that Bill Colson, the CEO of Holiday Retirement Corp., and Dan Baty, the CEO of Emeritus Corp. (AMEX: ESC) would team up with a group of investors and engineer a financial bail-out of Alterra Healthcare (AMEX: ALI) last spring, a move they may have regretted.

Or who would have expected Brookdale Living/Fortress to team up with Apollo Advisors to outbid Capital Senior Living (NYSE: CSU) for the general partnership interests and management contracts of Grand Court Lifestyles (OTCBB: GCLIQ), a company whose assets are not quite up to snuff with those operated by Brookdale.

Can you imagine two or three years ago proposing to a major Wall Street investment bank that they provide $500 million of six-month bridge financing to a single company for nearly 100 nursing homes, with the expected take-out coming from HUD? Rest assured, your phone calls would never be returned again, but that is exactly what happened last year between Donaldson, Lufkin & Jenrette and Life Care Centers of America.

A little over two years ago, American Retirement Corp. (NYSE: ACR) announced its intent to buy Assisted Living Concepts (AMEX: ALF), a deal that now makes the Brookdale/Apollo/Grand Court combination look like a marriage made in heaven. As everyone knows by now, the ACR/ALF deal blew up two months after it was announced because of accounting issues revolving around ALF’s use of the "gray box" financing structure. Since that rather embarrassing move, ACR has not garnered much attention. Until now, that is.

During 2000, ACR’s stock price drifted between $3.00 and $9.00 per share, ending the year at $3.05 per share, or just pennies above its all-time low. As the new year began, ACR’s stock price jumped by almost 75% in the first few weeks of January amid takeover rumors which were reported in our mid-month elert in January. As it turns out, the rumors were based, in part, on SEC filings by Dan Baty, Bill Colson, Holiday Retirement and affiliates of Lehman Brothers. Messrs. Baty and Colson, combined with Holiday, purchased approximately 290,000 shares of ACR common stock, representing just under 2% of ACR’s outstanding common shares.

While these purchases were occurring, various affiliates of Lehman Brothers, together with the Baty, Colson, Holiday group, purchased about $22 million face value of ACR’s 5.75% convertible subordinated bonds due October 1, 2002. With open market purchases estimated to be between 65 cents and 70 cents on the dollar, they will have a very tidy profit in 21 months if ACR can pay them off at face value.

The "if" is quite important because it is highly unlikely that the company’s share price will reach the $24 per share conversion price by the end of 2002. We have heard that ACR may try to sell several seasoned properties in a series of sale/manage-back transactions similar to what Sunrise Assisted Living (NASDAQ: SNRZ) has been doing, with Wall Street’s blessing (short-sighted as that may be). These sales, combined with other financing sources, may be enough.

Within the industry, ACR has always been considered a well-managed company that did not enter into a hyper growth stage that was the undoing of many of its competitors. Consequently, it would be understandable for Mr. Baty and Mr. Colson to believe that ACR’s shares were cheap at $3.50 per share or less, or that an annual yield to maturity of 35% (unleveraged) on the convertibles was too good to pass up. Lehman Brothers probably came to the same conclusion on the convertibles.

What is intriguing is, Why are the two groups acting together? Neither needs the other for a passive investment, unless Lehman is actually funding the Baty/Colson group. With a current market cap of about $80 million, ACR would not be an expensive company to take private (excluding the convertibles, which are a problem), but it does not appear that the company has been looking into this option. For the past few years, Dan Baty has been talking about buying up assisted living companies (or properties) when their stock prices hit distressed levels, but his own company is in the same boat right now. So with Emeritus unable to make money and Alterra struggling to survive (see below), one would think that ACR would be an unnecessary distraction.

Except, perhaps, for Bill Colson, whose Holiday Retirement Corp., the largest manager of retirement housing in the country, just seems to be chugging along in a classic case of "sticking with your knitting." From Mr. Colson’s perspective, an investment in ACR might complete the sweater and would seem to make more sense than Alterra, given ACR’s retirement housing focus compared to ALI’s assisted living and Alzheimer’s concentration. Then again, think of the overhead that could be cut with a Holiday, Emeritus, Alterra and ACR combination. Since mad cow disease has yet to make an entry into the U.S., it is doubtful that scenario would play out. Besides, there are a few capital structures that would have to be significantly changed for Mr. Colson to want to risk his life’s work.

The nagging problem is the role of Lehman Brothers, and the complicated structure for the purchase of the bonds with nine entities mentioned in the SEC filing, including Lehman ALI Inc. (is the "ALI" a coincidence, or is our suspicious nature breaking through?). On top of all this, there have been recent rumors that more may be cooking at Alterra than the sale of properties. We hope to have answers soon.