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January
2008 issue
Senior Care Stocks Sag In 2007--
After A Four-Year Rally, Most
Senior Care Stocks Declined
Senior care stocks did not perform well in
2007 after four straight years of above-market returns. The best performers
were in the skilled nursing sector, driven mostly by acquisition premiums.
...
Capital Senior Living Buys Big--
With Large Acquisition, CSU Expands In The ALF Market
In its largest acquisition to date, Capital
Senior Living is buying the leased interests in 32 assisted living
facilities operated by Hearthstone Senior Services.
...
Epoch Senior Living Recaps
...
Assisted Living Transactions
Carlyle Seniors Housing closes a few deals, plus a one-off in Michigan.
...
Independent Living Market
Christopher Place ends a busy year with a Texas acquisition, and Hyatt sells
one in California.
...
Skilled Nursing Market
...
Market Updates
The Manor Care deal gets done, and The Arba Group buys HQM.
...
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Companies Mentioned in this issue:
January 2008
A
Altus Group Income Fund p14
American Retirement Corporation p10
Arcadia Communities p12
Avery Enterprises p13
B
Bain Capital p10
C
Cambridge Realty Capital p17
Cantor Fitzgerald & Co. p18
Capital Funding Group p18
Capital Senior Living p2, p5
CapitalSource p14
Care Investment Trust p18
Carlyle Seniors Housing, LLC p11
CB Richard Ellis p12
Christopher Place Senior Communities p12
Classic Residence by Hyatt p13
Consolidated Resources Health Care Funds p13
Contemporary Healthcare Capital p17
E
Eastdil Secured p12
Emeritus Assisted Living p2
Epoch Senior Living p10
F
Fannie Mae p18
G
Geer Senior Housing p17
Genesis Healthcare p2
H
Harborside Healthcare p2
Haven Healthcare Corp. p16
HCP p13, p14
Health Care REIT p14, p18
HealthTrust, LLC p14
Hearthstone Senior Services p5
Home Quality Management p14
HUD p17
L
LaSalle Bank p13
Life Care Centers of America p13
Love Funding Corporation p17
M
Manor Care p1, p14
Marcus & Millichap p13
Merrill Lynch p18
Morgan Stanley p10, p18
N
National Health Investors p18
Nationwide Health Properties p5, p10, p18
O
Omega Healthcare Investors p14
Omnicare Value Health Care p16
Orchard Securities p13
P
Pacifica Companies p13
R
Raymond James & Associates p14
Red Mortgage Capital p18
Retirement Management, Inc. p18
S
SEIU p14
Senior Housing Properties Trust p18
Senior Living Investment Brokerage p12
Silverado Senior Living p18
State of Florida Public Employees Retirement Fund p10
Sun Healthcare p2
Sunrise Senior Living p2, p16
Sunrise Senior Living REIT p19
T
The Carlyle Group p14
The Ensign Group p13
U
UBS Investment Bank p18
V
Ventas p18
Vintage Senior Management p11
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Senior Care Stocks Sag In 2007--
After A Four-Year Rally, Most Senior
Care Stocks Declined
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Email Editor
What a difference six months can make. By June 30,
2007, senior care stocks were performing okay, with only a couple of
companies posting significant declines. Just one month later, however, all
but four were in the red, and by the end of the year only two stocks
posted any real gain for the year, and one of those, Manor Care (formerly,
NYSE: HCR), was up solely as a result of the takeover premium. Including
Manor Care, the average decline was 5.5%, which does not look too good
when the Dow Jones Industrial Average was up 6.4% for the year and the
broader S&P 500 was up 3.5%.
But let’s put some perspective on what appears to be a dire situation. For
four years in a row, senior care stocks significantly outperformed every
stock market index, and usually by a factor of at least two times. Just
like in the acquisition market, where buyers (and sellers) expected prices
to continue to rise, some thought that may be true with senior care stocks
as well. But cycles do exist, and we are in one now.
Because the sale of Manor Care closed in late December, we kept the
company in our stock chart and the
table on page 2 of the January
issue ranking the sector’s
stock performance in 2007. With a 43% price increase, the company took top
honors last year, but shareholders of Genesis Healthcare, which was
purchased in early July, actually had the best return with a nearly 47%
price increase after the rather unruly bidding war which was spread out
over several months, a fight that provided much color to our editorial
pages. With the exception of these two companies, and their respective
takeovers, Sun Healthcare (NASDAQ: SUNH) was the only other senior care
stock to show any real price appreciation by the end of the year, rising
by 36%. The acquisition of Harborside Healthcare certainly helped the
valuation, but the company has been sticking to its knitting and
concentrating on increasing margins and cash flow without making any
mistakes (at least that we know of). Sun also ended the year the closest
to its 52-week high, and reached its highest price in more than five years
in 2007, with the other skilled nursing stocks ending the year down 10% to
38% from their 52-week highs.
Reimbursement always plays its heavy hand with skilled nursing stocks, and
in the 1980s and early 1990s, it was always Medicaid. While Medicaid
payments may come into play in the near future as state budgets go from
black to red, Medicare has been the payment source of concern for 10
years, and any little whisper from Washington or MedPAC about a reduction
or freeze sends SNF investors into a twitter because that’s where the
money is.
But skilled nursing providers were spared late last year (did Carlyle use
its invisible hand?), and the 3.3% rate increase, which could have been
trimmed (and may be in 2008), was encouraging and helped bolster equity
prices. However, anyone who thinks that pressure on Medicare reimbursement
is going to ease anytime in the next 20 years really needs to see a shrink
and find out what happened in their childhood to provide them with such
fantasies.
The skilled nursing stocks fared better than the assisted/independent
living companies, partly because the former did not have quite the ride up
that the latter did in the past few years, and also because the weakness
in the housing market, and real estate market in general, has made some
investors nervous about the more real estate-oriented properties in the
senior care market. Only one company, Emeritus Assisted Living (AMEX: ESC)
eked out a small positive return, after being up by about 58% in June.
Five of the six assisted/independent living stocks ended the year down
anywhere from 30% to 43% from their highs in 2007, but Capital Senior
Living (NYSE: CSU) was down only 19%.
The surprise of the group was Sunrise Senior Living (NYSE: SRZ), with any
acquisition premium removed from the stock—despite no announcement from
the board that they have suspended the “strategic alternatives” search—and
with some analysts and investors still valuing the company at a 30% to 40%
premium to its current levels.
So what has changed? Not to be cute, but...everything. First of all, after
the subprime mortgage meltdown last summer, and the end of the easy-money,
private equity deals that became as common as Santa at the mall in
December, takeover premiums have all but disappeared, at least in the
senior care sector. With few takers for the debt involved in these
transactions, or the cost becoming too high to make the economics work,
there aren’t many investors expecting to get taken out at a premium in the
current environment. And there aren’t many likely targets either.
Now, this may change as public equity prices continue to deteriorate,
especially if the economy goes into a recession, the housing market gets
much worse and the mortgage market in general becomes as parched as a
Georgia reservoir (tune in to our January 31 audio conference on
navigating the current seniors housing and care mortgage market). But
remember, many of those private equity firms still have a lot of dry
powder, and when (if) values get low enough, they will pounce at the first
chance regardless of any Congressional investigations into private equity
ownership. We still believe those investigations and hearings are a paper
tiger and will get lost in more pressing matters, such as budgets, wars,
Social Security, Medicaid, Medicare, to name a few, not to mention a
presidential election where both parties’ nominees seem to be truly up for
grabs for the first time in 50 years.
Second, the overall softening of the real estate market, both residential
and commercial, is having its impact on the seniors housing market in more
ways than one. We have all heard about the occupancy impact, especially
with regard to CCRCs and some independent living communities where
potential residents can’t sell their homes at last year’s prices, or at
all, but this has not been consistently felt by all operators across the
country (yet).
For investors, the impact is more psychological, because when “real
estate” gets a bad name, the fallout is larger than it should be. Some
readers will remember several years ago when assisted living stocks
dropped when there was a threatened cut in Medicare reimbursement, and
everyone got grouped together, driving CEOs crazy when they had to explain
to some of their more intellectually challenged investors that Medicare
does not, has not and probably never will pay for assisted living (if it
does, then it will be time to move to Michael Moore’s health care
nirvana—Cuba—because our country will truly be bankrupt). The same is true
for real estate, and the proverbial baby often gets thrown out with the
bathwater.
Where the softening real estate market does come into play with public
equity prices for senior care stocks, however, is when the property values
start to come down, and those same intellectually challenged investors
begin to realize that while cash flow is king, $250,000 per unit is for a
very select group of assets for a very select group of buyers in this
market, not to mention lenders.
While we “know” that seniors housing property values have come down since
last summer, because cap rates have increased by 50 to 150 basis points
(take your pick), no one is really sure what exactly that means. But
investors have figured out that without the debt markets, specifically
securitized debt, and with debt that is available coming at a higher cost
with more equity required, premium pricing is gone with the wind, so to
speak. How this will impact the TIC market for seniors housing properties,
which has grown substantially in recent years, is anyone’s guess, but it
can’t be positive.
Third, some cold reality is coming back into the market. While most
lenders now want to underwrite on hard numbers, not pro formas midway
through the next president’s first term, investors are also joining the
bandwagon and want to see the results now. Paying for future results can
be fine, and is common, but high price/earnings multiples on earnings
forecasts which may become more dubious as the uncertainties in 2008
unfold are getting questioned. And while it is true that it is cash flow
that counts, investors, even those intellectually challenged ones, do like
to see GAAP earnings, especially when they have to explain to their
clients why they invested in your stock which just dropped by 40% in
value. In the long run, this will be good for the seniors housing and care
industry, but in the short term it will be quite painful.
As we stated after the mid-summer market meltdown, the state of seniors
housing remains quite good. That being said, if the economy continues to
deteriorate, it is questionable how much longer those 5% to 8% rate
increases can be pushed onto residents, especially if new development
begins to pick up steam. While that seems unlikely in the current
environment, despite the interpretation of some recent statistics, with
investment portfolios sagging and housing prices dropping, the customer
base will be watching their wallets a bit more carefully this year. And
that will mean cost control will be the key this year, not to mention
occupancy levels.
Senior care public equity prices may seem low right now, but there is a
better than even chance that they will head lower in the first half of
this year. It will really have nothing to do with the companies’ financial
performance and everything to do with investor sentiment in general, which
is growing more negative by the day. At some point, a little bell will go
off that says “too cheap,” but trying to time that is difficult, as
always. While the opportunities will not be as dramatic as they were four
years ago, bargains will be had, money will be made and private equity
will return...at some point.
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