When Beverly Enterprises was put into play in
January 2005 after an unsolicited offer from Formation Capital and
a group of investors, the next name mentioned as a potential takeover
target, most likely to be taken private, was Genesis HealthCare
Corporation (NASDAQ: GHCI). Although smaller than Beverly, it has a
much tighter regional concentration in the Northeast, generally higher
quality facilities and, with 65% of its properties owned, a base of assets
that could be leveraged, sold or repackaged in any way a buyer might want
to structure a recapitalization of the assets. We waited, and even
mentioned its attractiveness as a target on more than one occasion, but
nothing happened. Until now.
On January 16, a joint venture between affiliates of
Formation Capital and JER Partners announced it had entered into an
agreement to acquire Genesis for $63 per share, plus the assumption of
about $450 million of debt, for a total acquisition price of approximately
$1.7 billion. Capitalizing the $27 million of annual lease payments, which
include the recent acquisition of the Sandy River Health System
leases in Maine, would take the entire value to almost $2 billion. The net
purchase price represents about a 10.3x multiple of EBITDA for the fiscal
year ended September 30, 2006, but about 9.5x 2007 estimated EBITDA. The
$63 per share price also represented a 31% premium over the 30-day average
price, but 20% above the last trade before the announcement.
So why did it take so long for Genesis to
finally come into play in a market flush with cash looking for anything
with good cash flow, quality assets or both? We don’t have an answer as to
why it took so long, but we do know that Genesis management, with
financial backing from a venture capital firm, approached the Genesis
board late last year about taking the company private for somewhere, we
believe, between $50 and $55 per share. Goldman, Sachs provided the
board with the appropriate advice that it was necessary to seek a few
alternatives to see whether the pricing was kosher, and, no surprise here,
the market was willing to go higher. Although we do not know how many
potential buyers were able to take a hard look, we have heard that in the
end there was Formation Capital, Fillmore Capital Partners (the
Beverly buyer) and perhaps even Dan Straus, who sold his Multicare
Companies to Genesis in partnership with two investment firms back in
1997 (before the crash, and for all cash) for approximately $1.4 billion.
We would have thought Blackstone Group would get involved, but they
may have been busy with their own $40 billion bid for an office REIT.
So what is the Formation/JER joint venture (we will call
it Formation to keep it simple) getting in this transaction, and how does
the valuation really look? As of December 1, Genesis owned 137 facilities
with 16,665 beds, leased 31 facilities with 4,220 beds and managed 42 with
4,915 beds for a total of 210 facilities with 25,800 beds, 95% of which
were skilled nursing and the remainder assisted living. The key, however,
is that 71% of these beds are in just four states, which are Pennsylvania,
New Jersey, Maryland and Massachusetts. Three additional states represent
another 20%, and with the exception of West Virginia, 97% of the
facilities are in the Maryland to Maine corridor. In other words, this is
the largest regional concentration of skilled nursing facilities that we
know of, located in the relatively wealthy Northeast, which is known for
its high Medicaid and private pay rates, as well as relatively high
occupancy levels.
The nursing facilities have current annual revenues in
excess of $1.6 billion with EBITDA approaching $210 million (before
overhead). While the EBITDA margin of 12% to 13% is a little low, the cash
flow of almost $10,000 per bed is attractive, which is driving the overall
price for the company. And as we all know, it’s not the margin that
counts, but the cash flow that is generated. We also hear that the
operating performance has improved since the quarter ended September 30,
2006, so the numbers should be even better. We assume there will be some
savings in the liability insurance area, as well as overhead costs, all of
which will increase EBITDA moving forward.
Genesis also has a contract therapy company that provides
services to more than 600 health care providers in 20 states, with a
revenue run-rate of $240 million. With EBITDA of just $13.4 million in the
fiscal year ended last September 30, we assume that its value is somewhere
between $75 million and $125 million. When it was trying to purchase
Beverly two years ago, Formation planned on selling Beverly’s rehab and
hospice businesses to raise some cash, so it is likely they will consider
the same thing in this acquisition.
The question we have been asked is, what is the price per
bed? While not necessarily relevant in these types of deals, we will take
a stab. After deducting an assumed value for the rehab business, and
capitalizing the leases at 10% (and giving no value to the managed beds),
we get a value just over $80,000 per bed, which seems to be in the middle
of what Sun Healthcare Group is paying for Harborside Healthcare
and GE Healthcare Financial Services paid for the six Formation SNF
portfolios last year. If GHCI’s most recent fiscal quarter ended December
31 was stronger than usual, and Formation can save money on insurance and
overhead, we would not be surprised to see an annualized EBITDA run-rate
after the deal closes approaching $175 million to $200 million, compared
with just over $150 million for the last fiscal year, which would bring
the EBITDA purchase multiple down to 8.5x. We understand that the
management team will be mostly staying in place, and that the company will
be split into an operating company and a property company (or "Opco" and "Propco"
in today’s lingo), which has been the structure favored by Formation and
its investors in the past. The transaction should close this summer, and
UBS Investment Bank represented Formation and JER.
The news of this transaction obviously sparked more
interest in the shares of publicly traded SNF companies, most of which
went up in the following days. But it also is putting everyone on alert
that, with so much capital available, everyone is a target in this market.
Well, Brookdale Senior Living (NYSE: BKD) may be an exception, but
a number of investment groups keep trying to figure out what the "true"
value of Assisted Living Concepts (NYSE: ALC) is, since it owns the
majority of its facilities and from an operational and cash flow
perspective seems to have nowhere to go but up. And don’t forget
Capital Senior Living (NYSE: CSU), which has been hounded by a
shareholder to auction off the company. While we don’t think that will
happen anytime soon, the company could be a nice platform for someone with
capital who wants to get into the seniors housing business.
One company that should be attracting investor interest is
Manor Care (NYSE: HCR), since it basically owns all of its assets
and, without going too far out on a limb, probably has the highest quality
assets (in terms of physical plant) among the publicly traded skilled
nursing companies. It also has one of the largest home health and hospice
businesses in the country, which could be spun out at any time, but we
assume management is trying to incorporate this service with its nursing
and assisted living facilities. The problem comes down to valuation, and
at its current price level, when the outstanding debt is added in, the
multiple of 2007 estimated EBITDA is close to 9.5x, which doesn’t leave a
lot of room. But, with the Genesis deal, you never know.
And finally, the one everyone seems to be talking about is
Sunrise Senior Living (NYSE: SRZ), which is surprising for two
reasons. First, it doesn’t really own many of its properties anymore,
other than joint venture interests, and has intentionally turned itself
into a huge management company that is growing by development (more on
that later). So being able to leverage an asset base seems out of the
question. Second, there have been no financial statements released since
the 2005 10-K, and that one is going to be re-released with new numbers in
the next few months. It would seem difficult for anyone to be able to
really sharpen their pencils when they are largely working in the dark.
When SRZ’s shares were heading down toward $25 per share last summer, that
would have been as good a time as any for someone to take a stab in the
dark. But they are about 40% higher now, and Sunrise is the only company
we know of that can come out with another announcement that there will be
yet another delay in reporting its 2006 financial results, and still see
its shares move up.
The rumors about Sunrise have been twofold. First, it was
a management buyout, which actually does make sense since we are pretty
sure Paul Klaassen does not get his jollies from being the CEO of a
publicly traded company and all the disclosure rules that come with it.
But more importantly—and this is crucial—Sunrise does not need public
equity to grow, so there is little reason to remain public, other than as
a means to reward management with stock options and as a tool to attract
employees. In fact, they probably have more capital available to them than
they know what to do with, which includes things like the recent agreement
with Prudential Real Estate Investors to fund and develop up to $1
billion of senior living properties in the United Kingdom. With that kind
of backing, who needs the public markets? If there were sufficiently
attractive locations to build in this country, we are sure there would be
another billion or two thrown their way to invest. And, without worrying
about what the GAAP accounting treatment would be, we suspect that being
private would provide Mr. Klaassen with a lot more flexibility in
structuring partnerships.
The second rumor, which seems to be the more current, is
that it may be an outside group that takes Sunrise private. While anything
is possible, this would only seem to make sense if the investor really
wanted the Sunrise development pipeline and expertise, here and abroad,
believing that was where the money would be made in the next five years
since the company has been so dominant as a developer. We hear that one of
the rationales for the high multiple for the Holiday Retirement
Corporation acquisition was its steady flow of 15 or more new
developments each year. Sunrise easily tops that, but in more upscale
markets with much higher monthly rates, which would be a huge plus for a
real estate-oriented investor. And so far, we have not heard of any other
companies willing to jump back into the development game with any scale.
We just keep coming back to the fact that Sunrise may be better off as a
private company. But who knows, rumors can be just that, but it does make
one think a bit more about what is going on in the market. And speaking of
rumors, we hear that three major portfolio sales could be announced in the
next month or two, all with very high valuations. A few other portfolios,
but not quite as large, are expected to hit the market soon as well. Stay
tuned. As these are announced we will post them on our
blog.
