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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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Steve's BLOG on Senior Care
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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Capital Senior Living Buys Big--
With Large Acquisition, CSU Expands In The
ALF Market
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Email Editor
The acquisition market has been in the doldrums since last Au-
gust, seniors housing public equity prices have seen their worst decline
in five years, the mortgage market is squeamish and everyone is wondering
where values are and how far they will decline in 2008, if much at all.
About the only thing everyone seems to agree on is that cap rates have
increased. The problem is that no one knows to what extent, and our
limited expertise on the subject would suggest that the change in cap
rates will be very property-specific, with the best properties seeing a
much smaller increase than the B and C properties, and the stabilized
facilities being impacted less than the non-stabilized. And, of course,
wildly optimistic (even mildly optimistic) pro formas will be discounted
by just about everyone in today’s environment.
So upon our return from the winter wonderland of Vermont after the
holidays, we were surprised to find out that on the day after Christmas
Capital Senior Living (NYSE: CSU) announced it was making its most
significant acquisition yet, and one that should pacify a few of its
dissident shareholders. Readers will recall that two years ago a major
shareholder tried to force an auction of the company to enhance
shareholder value (specifically, that shareholder’s value), with one of
the complaints being that corporate G&A expense was way too high relative
to CSU’s revenues and the company should be part of a larger entity. And
late last year, another major shareholder tried to do the same thing.
Management has long stated that their platform could handle a significant
acquisition without much incremental overhead expense, and shareholders
have been waiting. Now they will get their chance to see how the theory
pans out.
Capital Senior Living has signed an agreement to acquire the leasehold
interests in 32 assisted living facilities operated by Hearthstone
Senior Services and owned by Nationwide Health Properties
(NYSE: NHP). Hearthstone sold these assets to NHP in May of 2006 for a
total price of $431 million, or $196,600 per unit. NHP also had the right
to finance the further expansion of the company, but it does not appear
that any facilities were added to the portfolio in the past 18 months.
NHP’s initial lease rate was 8.06%, with an annual 1% increase plus an
annual CPI-based increase of up to 2% together with a revenue-based rent
increase starting at 0.54% of revenues in the first year and increasing
thereafter. As part of the transaction with Hearthstone, we understand
that CSU will renegotiate some of these terms, which is prudent since
there are too many increases involved and it is usually better to keep
things simple.
At the time of the original sale to NHP, we estimated that annualized
EBITDAR would be about $39 million by the end of 2006, which may have been
high since the first nine months of 2007 annualized EBITDAR was about
$40.3 million, which excludes Hearthstone’s G&A but includes $2.6 million
of assumed incremental cost to CSU. What we don’t know is the G&A
assumption back in 2006, but that is old news now. The original lease was
structured with a 1.0x coverage, which was obviously expected to rise.
Of Hearthstone’s 32 facilities, 15 are in Texas, four in Tennessee, three
in Alabama and the remainder in seven other states. Capital Senior Living
has 18 communities in Texas, so there is some good geographic overlap,
with just four new states coming into CSU’s portfolio. The company has
stated it wants to buy a home health care agency in Texas, and with 15
additional assisted living facilities in the state, such an acquisition
becomes a larger priority.
The Hearthstone portfolio has a total of 2,192 units with a resident
capacity of about 3,800. Approximately 30% of the units are two-bedroom
apartments with two unrelated people sharing the living room, 40% are
suites that are used by one or two residents and 30% are studios or
one-bedroom units designed for single occupancy. While double-occupancy is
not our preferred model for assisted living, when it works it can be very
successful financially. According to an NIC study a few years ago,
double-occupancy assisted living units produced an average of 52% more
revenue per unit than private units, or nearly $1,500 more per month. That
more than covers any incremental cost for that resident, which is why the
Hearthstone portfolio will contribute at least a 39.8% EBITDAR margin to
CSU.
Capital Senior Living is paying $35 million for the leasehold interests,
or about 7x the adjusted annualized EBITDA of $5 million based on the
first nine months of 2007. On a combined basis, the annualized revenue and
adjusted EBITDAR for 2007 will be about $289.1 million and $94.4 million,
respectively, with $62.2 million of combined lease expense to be deducted.
One problem we have with this analysis, however, is that CSU’s third
quarter EBITDAR annualized is about $3.2 million higher than the first
nine months annualized, so we assume that Hearthstone’s financial
performance in the third quarter, annualized, was also better than the
nine months annualized. We were told that Hearthstone’s occupancy has been
increasing, so we assume cash flow has as well, which theoretically puts
its fourth quarter cash flow even higher, and consequently the purchase
multiple below the 7x we mentioned. Although no one can predict what will
happen in 2008, our guess is that based on 2008 pro forma cash flow, the
multiple comes down to 6x, if not even lower. Except pro formas are a
thing of the past, right?
No decision has been made as to how CSU will finance the $35 million
purchase price, but whether it is with cash on hand, debt or equity (or
some combination), the acquisition is accretive, and hasn’t it been
accretive acquisitions that certain dissident shareholders have been
demanding of management? Especially large, accretive acquisitions? The
transaction, which is expected to close in the second quarter, will
increase revenues by 54%, EBITDAR by 74% and resident capacity by 40%, and
this is before any financial synergies and higher occupancy levels. The
acquisition will change the nature of CSU’s business a bit, however, as
assisted living will rise from 22% to 45% of resident capacity. Some
people have made an issue of a supposed lack of expertise in the assisted
living field, but we disagree that there is a problem. CSU’s management is
not new to the area, and so much of “independent living” has come to
resemble assisted living that often there is a fine line between the two
when you get inside the building.
On the surface, it looks like investors have been under-whelmed by the
deal, but that is unfair since the overall market, which has not performed
well recently, has been a larger contributor to CSU’s recent share price
drop. Regardless of how the company finances the transaction, it will be
accretive to earnings immediately—perhaps significantly so in a year or
two. It could even be a transforming acquisition because of what it does
for residents, units and revenues under management, as well as the company
becoming more of a 50/50 assisted/independent living company, instead of
primarily independent living.
One thing that is a slight negative in our mind is that this acquisition
will lower the percentage of properties owned by CSU, but others do not
see this as a problem as long as it is accretive to earnings, which it is.
There has been speculation that some short-term investors may not be happy
because the deal may make a sale of the company less likely. But for the
long term, if it makes for a stronger, more competitive company, what’s
not to like? And besides, that G&A expense criticized by some investors
will now be under 5% of revenues in 2008. That should bring at least a
smile to some shareholders, even those pushing for a sale of the company.
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