Email Editor
So here is the question. If 2003 was the best year, in
terms of price performance, for senior care stocks, followed by 2004 as
the second best year, what are we supposed to look forward to in 2006 when
2005 ended with yet another stellar performance, beating every stock index
by significant margins? A bull market has been great for the industry, but
contrary to the belief of some people that the senior care industry is not
cyclical, it is, and we have lived through a few cycles in the past 20
years.
We are now three years into the strongest bull market our
industry has ever seen, with everyone eyeing 2011, when the baby-boomers
start turning 65, when we will see some real froth in the market. It would
be unusual, however, not to have a correction before then, especially with
valuations so high in both the public equity market as well as the
property acquisition market.
We have been accused in the past of trying to throw cold
water on a party that is going strong, showing the negative, the glass is
half empty, side of our personality. We like a party as much as anyone
else, but at some point it is time to sober up and face the reality of the
next day, and the risks that everyone faces. To our dismay, too many
people are hesitant to remove their rose-tinted glasses, perhaps afraid to
be left behind, perhaps with the earnest belief that the time has finally
come for the senior care and housing market to be in the longest bull
market of its life. This may be true, if the participants are careful not
to spoil it, but there will still be cycles within that long stretch, with
winners as well as losers along the way.
On that sobering note, let’s take a look at the results
for 2005, and the best thing that can be said is that the
assisted/independent living sector as a whole was the winner last year. In
2003, almost every skilled nursing company stock doubled or tripled in
value and captured the top six spots in percentage return. By 2004, the
price performance of the skilled nursing and IL/AL stocks were evenly
mixed, but last year the top five spots were taken by the IL/AL sector. We
all have our moments of glory.
Taking the top spot in 2005 was American Retirement
Corp. (NYSE: ACR) with a return of 113%, and this after more than
tripling in value the previous year as the number two performer. ACR was
followed by Capital Senior Living (NYSE: CSU) with a total return
of 83% and Emeritus Assisted Living (AMEX: ESC) with a return of
62%. Both of these companies are still trying to find their way to
consistent profitability excluding gains on asset sales, and despite CSU’s
stellar price performance last year, there is at least one shareholder
still not happy (more on that later).
The top skilled nursing company was Beverly Enterprises
(NYSE: BEV), with a total return of just 28% despite the flurry of
activity associated with the unwanted takeover attempt, the formal auction
of the company and the disappointing final results. BEV’s stock closed the
year at just $11.67 per share, despite an initial agreement at $13.00 per
share and a final deal cut at $12.50 per share. Many investors still
believe the company is worth more than that, but the way that the board
and management handled the final few months of the process, it made it
difficult for a true alternative investor to jump back into the fray. Most
of the other skilled nursing companies did not fare as well last year, but
for the most part because of company-specific reasons, either missed
earnings results, lease reset overhang issues or still cleaning up the
mess from the 1990s. If it is spared any shocks from Medicare and
Medicaid, this sector should perform better this coming year.
Speaking of auctions, when looking back on 2005, the past
12 months can be best described as "The Year of the Auction," and we are
not talking about the Beverly Enterprises deal. Although a formal auction
process has been used for some of the larger single-property asset sales,
it has become quite prevalent with the portfolio sales, and we have had a
record number of portfolios coming on the market in the past 18 months.
The two-step process, involving a preliminary bidding round, which is
really an indication of interest without the normal due diligence of a
final offer, is followed by a second and "final" offer round, where the
top five or six bidders are picked from the first round to participate.
At this stage, buyers are often told a price range that
they must meet to possibly be the winning bidder, and this is where some
of the controversy has been. If told that they have to top $100 million,
for example, to walk away with the deal, buyers have offered $101 million
(perhaps more) and still gone away empty handed, feeling that they had
been misled by the intermediary because they did what they were told was
necessary. The problem is that everyone else was told the same thing, and
this can result in a variety of bids above the $100 million mark. And
then, once those top bids are in, the unofficial third round takes place
where the top two or three bidders are asked to really sharpen their
pencils if they want to come out on top. We are sure this happens even
when there is just one top bidder, but the broker is simply trying to
squeeze the highest price possible for his or her client, which some
people forget is the seller, and not the buyer. In a rising market, when
several high-end portfolios are coming into play for the first time in
years and financial buyers are more aggressive than ever, this strategy
has helped push prices higher and higher, sometimes to levels that even
the sellers thought were unattainable.
Some buyers (operators) have opted out of this process,
believing the only way they are going to win is by overpaying, and
figuring that it is not worthwhile to spend the required time on due
diligence when the likelihood of coming out on top is slim. The financial
buyers, however, are much more comfortable with this sort of process, and
it really has become a numbers game with many of them, with less attention
to the actual operating side of the business, and the associated risks.
The acquisition market, in fact, has become much more of a strict
financial play than at any time in the past seven to eight years, and
although some may say it is similar to what happened in the mid- to
late-1990s, it is different in this environment because there is more real
equity being put into the deals with less of the 110% financing that
occurred in the 1990s.
The increasing role of the financial buyers has also
resulted in the widest spread in prices paid between single property sales
and portfolio sales. Although we will not have our year-end statistics
available until early March, our guess is that the spread in the IL/AL
market may be as high as $75,000 to $100,000 per unit. This reflects both
the willingness of buyers to pay up for bulk as well as the overall higher
quality of the assets in those portfolios. The high quality, as well as
the unprecedented demand, is expected to result in record prices paid for
assisted living and independent living units in 2005, which will be
detailed in our forthcoming publication, The Senior Care Acquisition
Report, 11th Edition.
We are also expecting to see the largest single year drop
in cap rates for assisted living, independent living and skilled nursing,
perhaps in the 100 to 200 basis point range. This is huge, especially
since the year-to-year changes are usually less than 50 basis points. The
risk premium has been diminishing as financial buyers, and their lenders,
have become more comfortable with the management intensity of the
business, as well as the availability of alternative managers, than in the
past. If cap rates go any lower, however, they may be doing so at their
peril.
Last year will also be memorable for being the first year
we have had an IPO since 1998 when Balanced Care made its debut.
Timing is everything, and Brookdale Senior Living’s (NYSE: BKD) IPO
just six weeks ago could not have been timed any better, and no one
thought it would end the year up 57% with a $2.0 billion market cap. The
market is definitely open, and skilled nursing provider Tandem Health
Care should be next, with eyes on Atria Senior Living to
possibly tap the market later in 2006, but apparently they are in no
hurry.
As we enter 2006, the debate will continue about the high
level of valuations, with most market participants we have spoken with
believing that we have hit the peak and there is little economic
justification to go higher. The question remains, however, how long we
will still be in a holding pattern at these levels? Interest rates will
have an obvious impact, as well as what alternative investments emerge for
the investors not wed to a long-term relationship with seniors housing. We
also expect the build versus buy debate to heat up, and as occupancy
levels continue to strengthen, development will increase, but no one
believes we will see the reckless building of the 1990s.
