What are investors missing with Kindred Healthcare?

Valuations are always a hot topic in the seniors housing and care market, and everyone has their opinion on what the “right” cap rate or cash flow multiple is.  A single property with a stable cash flow in a good market is usually the easiest property to value because there is not much room for argument or manipulation.  But even then there can be a 200 basis point differential among several qualified buyers who believe they know how to value a property.  In today’s market, access to debt is often the crucial determinant in how aggressive a buyer will get, as is the cost of their equity.  But what happens when there are many parts of an asset that is being valued, and what happens when the payment source and methodology for those parts is subject to change? 
When Sunrise Senior Living (NYSE: SRZ) was unraveling a few years ago, investors tried to determine what the underlying value of its assets were, using “market” multiples for its various business lines.  These included one multiple for its management contracts, another for its leased properties and yet another for its owned communities.  This “sum of the parts” analysis was used to try to figure out what the breakup value would be in the event of a sale of the company in parts, or worse, a forced liquidation because of bankruptcy.  It was often used to justify the then current stock price even as it continued to decline.  But what happens when a very small part of a company is worth more than the entire stock market capitalization of the entire business, without any operating distress, and no one seems to be paying any attention to it?  This seems to be the case with Kindred Healthcare (NYSE: KND).
Kindred is a bit of an anomaly in the senior care market because it really is a hybrid company, but a large one with more than $4.0 billion in annual revenues.  On the one hand, it operates 223 skilled nursing facilities with more than $2.1 billion in annual revenues, and on the other hand it operates 83 long-term acute care hospitals (LTACs) with $2.0 billion in annual revenues.  And finally, it has a contract rehab therapy business with about $500 million in revenues.  Most of Kindred’s assets are leased, and many companies are currently taking advantage of the valuation discrepancy (or purchasing power differential) between REITs and operating companies.
In the case of Kindred, which owned a very small number of its properties several years ago, there is a growing discrepancy between what value the public market investors put on the company’s shares and what the assets actually are worth.  Kindred’s shares have dropped from a 52-week high of $20.00 per share to $13.02 per share at the end of September, which results in a market cap for the company of about $514 million.  For a company with more than $4.0 billion of revenues and $2.0 billion of assets, it has just $140 million of debt, all of which is unsecured.  Of the 306 properties, 267 are leased and just 39 are owned.  These 39 include 17 LTACs and 22 skilled nursing facilities, most of which were built in the past 10 years, which is very new in the health care world.  They have a combined book value of $476 million, but more importantly, they generate a combined $97 million of EBITDA (after a 5% management fee). 
So, what is that $97 million of annual cash flow worth today?   Want to read more? Click here for a free trial and download the current issue today