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January 2004 issue
As Industry’s Prospects Improve,
Equity Investors Cheer
Never have senior care stocks recorded
a year like 2003, with the average return a whopping 152%. But if they
started the year undervalued, the fear is that investors over did it in
2003, and disappointment may follow in 2004. See page 1
Acquisition Market
More than a dozen deals closed as the
year came to an end, but the higher public equity valuations have yet to
impact the pricing for skilled nursing facilities. See page 3
Assisted Living Market
The last two Manorhouse facilities were
sold, plus four Alterra facilities in Florida. Emeritus started the year
with the purchase of five ALFs. See page 5
Back From The Grave
Atria Senior Living Group is alive and
well, with positive cash flow and much higher margins. An IPO in the
future? See page 8
REITs
A record year for shareholders, and a
large deal closes in December. See page 10
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As Industry’s Prospects Improve,
Equity Investors Cheer When 2003 began, things did
not look too encouraging for the skilled nursing facility industry.
Kindred Healthcare (NASDAQ: KIND) had seen more than 50% of its market
capitalization wiped out as a result of patient care liability issues,
Centennial Healthcare had just filed for bankruptcy protection, the
Medicare "cliff" had disappeared the previous October and, with the
weakened economy and associated state budget shortfalls, everyone expected
the worst from Medicaid reimbursement.
By July, sentiment clearly
turned, partly the result of the Medicare "give-backs," but also because
investors began to realize that the skilled nursing sector had been
grossly undervalued in the first half of the year, despite the inherent
difficulties. Now, with the unprecedented run-up in share prices (see
below), the problem facing investors, and companies trying to raise new
equity, is that the sector looks a tad rich, or at a minimum, fully
valued, with Kindred and National Healthcare (AMEX: NHC), based on
their adjusted P/E ratios, having the most potential for some additional
price improvement.
The assisted
living and retirement housing sector did not have the same degree of risk
as the skilled nursing sector, not to mention fewer opportunities for
public equity investors, but it performed almost as well as the publicly
traded nursing home stocks. Once again, the upside potential now appears
limited with the end-of-year price run-up, and not even the most bullish
investors and analysts expected Sunrise Senior Living (NYSE: SRZ)
to hit $40 per share in 2003, which it did on the last trading day.
Legg Mason finally had to cut its recommendation from Buy to Hold when
SRZ blew by its bullish price expectations in December; the lowered rating
at the beginning of the New Year resulted in an immediate 5% price drop.
Last year,
the senior care sector posted its best public market returns ever, and it
is unlikely there will ever be a better year. All but one company posted a
positive return (a record), the average return was 152% (a record) and the
median return was 131% (also a record). The best year prior to 2003 was
1997, when 24 of 35 companies posted positive returns, with the average
58% and the median 43%.
That year
CareMatrix ranked number two with a 119% return followed by Alterra
Healthcare (known then as Alternative Living Services) with a
106% return. Both ended up in bankruptcy and are now gone from the public
market scene, but the number one performer in 1997, Assisted Living
Concepts (NASDAQ: ASLC), is still around and doubled in value in 2003.
The worst year ever was 1999, when all senior care stocks declined,
ranging from a 35% to a 99% drop.
So the
overall winner in this year’s total return sweepstakes was Sun
Healthcare (NASDAQ: SUHG), with a total return of 616%, largely the
result of starting the year at just $1.39 per share before heading down to
just $0.11 per share based on fears that it may have had to file for
bankruptcy protection again. Those fears started to diminish during the
summer, and as the company’s second restructuring began to take shape with
additional poorly performing facilities divested, cash coming in from
asset sales and an improved operating performance, the shares just started
to take off beginning in July and investors never looked back. We are not
sure that if asked last spring, even SUHG management would have ever
guessed that the share price would close the year at $9.95.
Management
should be given a lot of credit for taking the reins of a company that
really had not been properly prepared to emerge from bankruptcy. Saddled
with too many unprofitable facilities and leases that still did not make
economic sense, they persevered in the midst of many naysayers (including
this publication), and slowly got their house in order against many odds.
Increasing cash balances, as well as cash flow, has been a primary goal of
management, and at the end of 2003 they announced an agreement to sell
Sun’s rehab business to AEGIS Therapies, a subsidiary of Beverly
Enterprises (NYSE: BEV), for $34 million, which will further bolster
SUHG’s balance sheet.
The top six
performers in 2003 were nursing home stocks, five of which more than
tripled in value. Although not making it into this group, Manor Care
(NYSE: HCR), the largest senior care company (measured by market cap),
turned in a not too shabby 86% return. In the assisted living/retirement
housing segment, Assisted Living Concepts led the way with a 154% return,
followed by Capital Senior Living (NYSE: CSU), up 131%. Although
close to the bottom of the rankings, the two largest publicly traded
assisted living companies, Sunrise and Emeritus Assisted Living
(AMEX: ESC), posted solid returns of 56% and 52%, respectively.
With
investors, option-holders and management jumping for joy with this kind of
performance, the bad news is that the best is behind us. While investors
are not oblivious to some of the major difficult issues confronting all
senior care providers, they seem to be temporarily ignoring them, buoyed
in part by the significant rise in the overall markets last year.
The key, as
always, will be earnings and whether they can be increased enough to both
justify current price levels as well as any potential price appreciation.
An increase in interest rates, new reimbursement cuts or stiffer
regulations are just some of the problems that could stop the rally in its
tracks, if valuation alone does not do it. It is still unclear, however,
whether this recent exuberance in public market valuations will result in
a stronger (i.e., higher prices) acquisition market.
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