The SeniorCare Investor: Erickson Auction Price Jumps

In A Wild Night, Redwood Capital Comes Out On Top
 
On December 22, the two remaining bidders gathered in a large room in New York City to begin the formal auction process for Erickson Retirement Communities. There were more than 80 bankers, lawyers, investors, consultants and other interested parties crammed into the room, all figuring they would be home for dinner. An auction that was supposed to begin at 10:00 am didn’t really get started until the afternoon. With the large numbers in attendance, one would think there were many competing bidding groups, but by auction day, it was down to the final two, both of which had to pass several tests.
In one corner was the original stalking horse bidder, Redwood Capital Investments LLC. In the other corner was a bidding group led by Kohlberg Kravis Roberts (KKR), which partnered with Coastwood Senior Housing Partners (Dan Decker) and Beecken Petty O’Keefe (we will refer to the group as “KKR”). The original stalking horse bid was for $75 million of cash, a $25 million promissory note, the assumption of some portion of the campus-level debt (but we are not sure how committed they were to that) and a commitment of up to $50 million of new capital for future development. This would buy them the management company (and management of all the Erickson properties), the construction and development business, which was basically shut down, plus the real estate of eight campuses in various stages of build-out, but with about 5,700 completed units. Excluded were the two campuses in Illinois and one in Massachusetts which, because of the cash already received by Erickson (and spent) for purchase option deposits by the three local not-for-profit entities that were going to own the campuses – funds raised by issuing more than $300 million in tax-exempt bonds – Redwood most likely did not want to take the economic risk of possibly being forced to refund those option deposits if it bought these three campuses.
A major “problem” arose with KKR’s December 14 formal offer. In short, KKR believed that it was a mistake to exclude these three campuses because if they deteriorated further, or compromised the Erickson reputation with a less than satisfactory outcome in the process, then it would have a detrimental effect on the Erickson brand which could diminish the future value of any potential investment. We are simplifying things, but KKR had already begun discussions with the bondholders of the three other campuses, and two of their proposals involved all-cash payments to them, with the other a restructuring of the debt. We are under the impression that Redwood also finally came to this conclusion, but we still don’t know the details about what will be included and how the bondholders will be dealt with when everything gets approved.
KKR’s December 14 offer for the eight other campuses included $207.2 million of cash and $198.2 million of pro forma debt for a total transaction value of $405.4 million. Obviously, this was higher than the Redwood offer, and as part of its stalking horse agreement, Redwood had to be notified of the terms of any other offers coming in. Consequently, when they arrived at the auction, they knew the price was going up, and apparently their opening bid was $245 million cash, but we assume they didn’t expect it to end where and when it did. At about 4:00 am (yes, the wee hours) the next day, the bidding was finally over, and Redwood was the winner with a cash price of $365 million and a total enterprise value, we believe, of possibly up to $625 million. This “enterprise” value assumes something will happen with the three campuses we mentioned, but that is still up in the air. About $100 million of the cash portion will go to pay off the $195 million of senior debt at the corporate level, with the remainder going to the secured lenders at the campus level, with four of the eight receiving more than 75 cents on the dollar and two receiving about 35 cents on the dollar. Given what the stalking horse bid had been, our guess is that the creditors walked out with more in their pockets than they were expecting, and Houlihan, Lokey may have received more than a few pats on the back for a job well done. There is still much work to be done, however, and bankruptcy court approval is still necessary (which should not be a problem). It is expected that the process will be completed by the end of the first quarter, but then the real work begins. It would have been more interesting if KKR had won, because that would have put a brighter spotlight on the industry with such a well-known name making such a large commitment. But there will be other deals for them down the road, and this auction may have been what the industry needed to jump-start the new year.