When Alterra Healthcare (AMEX: ALI) completed its refinancing package last May 31, on the surface management was all smiles and looking forward to moving ahead with the company’s remaining development plans, and, of course, greener pastures. Those analysts and writers who did not believe ALI had raised enough funds to survive another year were quickly discounted as naysayers who did not like the assisted living industry, did not understand the company’s model and failed to comprehend the enormous profit potential from the large base of properties. The liquidity problem was short-term, profits would return in 2001 and everyone would wish they had bought the stock at the ridiculously low price of $2 per share. Wrong.
As it turns out, those who questioned the assumptions and maintained that ALI’s capital structure was too leveraged to ever make any money, with the only potential outcome a restructuring of the debt or, ultimately, bankruptcy, have earned their pay (and some). On February 26, ALI announced that the company had entered into preliminary discussions with its “principal lenders and lessors regarding the restructuring of debt and lease obligations.” Unfortunately for ALI shareholders, every other senior care company that has made a similar announcement during the past 18 months has ended up in Chapter 11 bankruptcy.
The reason is rather simple. No lender or lessor will voluntarily defer lease or loan payments, usually operating under the theory that if they do not get their hands on whatever cash the debtor has today, there will be less cash available tomorrow. In Alterra’s case, this would hold true because the company wants to use the cash to stabilize its remaining properties, which is of little interest to an owner or lender of the properties already stabilized and covering the lease or debt payments.
If there had been a time to try to get something from creditors, it would have been last May before the financing package was put together and the investors had some negotiating power (hellooo). But back then, management still did not believe the situation was as precarious as it obviously was. As Arthur Miller once said, “An era may be said to end when its basic illusions are exhausted.”
But some of the investors in the refinancing package had other things on their minds. Readers may recall that at least a few of the investors merely swapped one type of security for another, more senior, security, essentially moving up the seniority ladder. As the prospect of bankruptcy becomes more real, these investors will be in better shape financially and will have a stronger voice during the reorganization process, if it comes to that. Whether they will put more money into Alterra is another matter altogether.
Although the company has not released fourth quarter earnings, we have to assume that the third quarter trend of lower occupancy rates, slower fill-ups and eroding margins has continued and liquidity is a problem. While these problems are bad enough, ALI has debt maturities of $145 million this year and $325 million in 2002 with little prospect of being able to come up with the required funds. Asking certain lenders and lessors to defer debt and lease payments may help short-term liquidity, but it would just add to the pain later since those payments would have to be made at some point in time.
The REITs that have a stake in the outcome of Alterra’s liquidity crisis are a virtual Who’s Who of the industry. ALI represents 13% of Nationwide Health Properties’ (NYSE: NHP) assets, 10% of LTC Properties (NYSE: LTC), 8% of Health Care REIT (NYSE: HCN), 6% of National Health Investors (NYSE: NHI) and 4% each of Omega Healthcare Investors (NYSE: OHI) and Meditrust (NYSE: MT, although it represents 14% of remaining health care assets). Noticeably absent from the list is Health Care Property Investors (NYSE: HCP), a relatively conservative REIT that has seemed to dodge most of the senior care bullets in the past two years.
Health Care REIT was the first lessor to come out and announce how its Alterra portfolio is performing, which is not too bad. HCN owns 38 ALI assisted living facilities (1,443 units) with an investment balance of $86 million, or $60,000 per unit. While this per unit value seems reasonable, the average size of the facility is 38 units. This size property is not high in demand and offers no economies of scale. Thirty-two of the 38 ALFs are stabilized with 95% occupancy and a 1.62 coverage before management fees, while six are in fill-up with 70% occupancy and 0.33 coverage before management fees. Overall, the portfolio has 91% occupancy with a 1.24 pre-management fee coverage. We do not see HCN looking too favorably on the deferral of any lease payments.
With the largest exposure, Nationwide Health Properties appears to be in an even stronger position. NHP owns 54 properties (3,164 units) representing an investment of $192 million, or just over $60,000 per unit. One significant difference is that the NHP portfolio has an average facility size of nearly 59 units, which opens up the number of potential new lessees that would be interested should NHP take this step. All of the facilities are stabilized (all but two have been open for at least two years), and overall occupancy is 91% with a 1.50 coverage before management fees.
Given this performance and age of properties, NHP has little incentive to accommodate ALI on deferring lease payments. One only has to look at how swiftly NHP management reacted to Balanced Care’s (AMEX: BAL) attempt to get concessions, and several of BAL’s properties had significant working capital issues. NHP has told ALI that the REIT may be able “to accommodate Alterra’s restructuring efforts without any adverse earnings or cash flow effects to Nationwide.” What the accomodation is remains to be seen, but lease deferrals would result in a decrease in cash flow, and NHP does not need to do that. About the last thing ALI needs is to have its stabilized, and profitable, facilities removed from the company’s portfolio, so the company will have to tread carefully.
ALI has stated that initial discussions with lenders and lessors confirm their mutual interest in a restructuring plan that does not adversely impact residences, residents or employees. Creditors certainly do not want to harm the residences or residents, but that does not mean they are willing to defer payments, especially the REITs. The holders of the bank debt and convertible debt are the ones at most risk (as they always are), and we could see convertible holders exchanging the existing bonds for new paper with an extended maturity date and a much lower conversion premium. While dilutive, there are not many choices, and in a Chapter 11 filing, existing subordinated convertible holders would lose everything. Shareholders, of course, can forget about getting anything.
The wild card in the entire scenario may be Manor Care (NYSE: HCR), which inherited an assisted living portfolio (many in the development stage) when Healthcare & Retirement Corp. purchased Manor Care, keeping the latter’s name but the former’s ticker symbol. At the end of 1998, HCR entered into an agreement to sell to ALI 29 assisted and Alzheimer’s facilities (capacity for 2,611 residents) for $200 million in cash. In addition, the two companies established a joint venture to develop $500 million of ALI-branded facilities in HCR’s core markets over the following three to five years. Although we have not received confirmation, some of these properties may be experiencing difficulties and any future development plans have been put on hold. In fact, the entire joint venture is up for sale and ALI and HCR hope to use the proceeds to pay off the joint venture’s $57 million of debt which matures in June.
Although we give a Chapter 11 filing a better than 50-50 chance at this point in time, perhaps the only thing in ALI’s favor right now is that no creditor wants to go through another bankruptcy. All of the REITs and most lenders have been impacted in some way (whether financially or time spent, but usually both) by the high-profile bankruptcies of the past 18 months and will do all they can to avoid a repeat performance. The problem is that someone has to make the first move toward concession, and that first move is always the most difficult.
In addition, besides the leverage issues, there are some real operating problems at the company that will not be solved by reduced capital obligations, and creditors will be looking at this as well. Staffing issues, regulatory problems, litigation costs and higher acuity patients are all presenting Alterra with the same problems the nursing home industry has been facing for years. The company is being advised by Cohen & Steers Capital Advisors and Silverman Consulting, and no one is envious of the job they have. Time is not on ALI’s side, and if negotiations do not move swiftly, the residences, residents and employees may be better served by a Chapter 11 filing sooner rather than later.