The SeniorCare Investor: Buying the Sunrise REIT Assets

Ventas and HCPI Battle It Out For The Prize
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Last month, we reported on the agreement between Sunrise Real Estate Investment Trust (TSX: SZR.UN) and Ventas (NYSE: VTR) whereby Ventas would be acquiring the entire portfolio of Sunrise REIT, which includes 74 assisted living facilities managed by Sunrise Senior Living (NYSE: SRZ), all of which were developed by Sunrise the operator. According to the signed acquisition agreement, Sunrise REIT shareholders will receive the equivalent of C$15.00 per share, and after adding in the debt Ventas will assume, the total deal comes in at about $1.8 billion. Because Sunrise owned an interest in 56 of these 74 facilities that ranged from 15% to 25%, an approximate grossed-up price comes to around $350,000 per unit, or a 6.2% cap rate based on 2007 forecasts. This excludes the value of five new developments and various rights of first refusal and first offer on future Sunrise developments in Canada and the U.S. Any way you look at it, however, the price is high but not unusual in this market, and there are a lot of advantages to Ventas in securing this deal, even though it will be dilutive in 2007.
We thought the price was so high, in fact, that we assumed that was how they won the bidding. Ventas probably assumed so as well. It was, after all, a formal auction process with the most likely aggressive potential buyers invited into the bidding process. But a full month after the agreement was signed, Health Care Property Investors (NYSE: HCP) sent a letter to the Sunrise REIT board offering C$18.00 per share, or 20% higher than the agreement with Ventas, but with several conditions and unknowns. Apparently, HCP was in the final round of bidders and, for reasons unknown, decided not to submit a final bid.
So what happened, did HCP figure out how Ventas was going to structure the deal, including various agreements with Sunrise the operator, and decided it wanted back in, but at a much higher price? Yes, most people thought the Ventas price was the top, perhaps even too high, but what we don’t understand is why HCP didn’t bid in the final round if it was willing, a month after the fact, to go a full 20% higher than the winning bid? And to add insult to injury, in his letter to the Sunrise REIT board, the CEO of HCP stated they had “greater experience in executing large acquisitions than Ventas,” and had a “greater certainty of completion than the proposed transaction with Ventas.” Really? Was the 2005 acquisition, by Ventas, of Provident Senior Living Trust for $1.2 billion small potatoes, or the late 2006 acquisition of the Senior Care, Inc. assets for nearly $650 million mere chump change? In addition, it appeared that Ventas already had its financing arranged, so why did HCP think there was less certainty for Ventas to close on the deal? It’s a mystery to us, other than a bit of hard ball tactics involved, and perhaps a little sour grapes on the side. Or does HCP management have other ideas? Hmmm.
When the initial letter was received by the Sunrise REIT board, there were too many unanswered questions to even respond to HCP’s proposal, including the need for agreements with Sunrise the manager. A few days later, HCP sent the board a letter trying to clarify a few issues, and two days after that, yet another letter for further clarifications. Meanwhile, Ventas stood its ground, maintaining it had a signed purchase and sale agreement with Sunrise REIT and was moving forward. Sunrise REIT then went to the Ontario Superior Court to seek an opinion as to whether HCP was prohibited from negotiating with Sunrise (the operator) under the terms of Sunrise REIT’s agreement with Ventas. At about the same time, Ventas filed an application in the same court demanding that Sunrise REIT comply with its covenants in the purchase agreement with Ventas and to take all appropriate steps to enforce Sunrise REIT’s rights under its confidentiality and standstill agreement with HCP, which, among other things, apparently prohibits HCP from making any proposal to acquire any or all of the assets of Sunrise REIT for a period of 18 months, ending May 2008.
Although we are not trained in legal nuances, especially when it comes to Canadian securities law, this last point regarding HCP not being able to pursue the Sunrise REIT assets for 18 months seems to be a major sticking point in favor of Ventas. Sunrise REIT shareholders will not be happy with it, especially since the shares have traded up to the C$18.00 offer by HCP. The court proceedings were supposed to take place on March 1 at 10:00 a.m., but we have no idea how long this legal process will take. The last news was that HCP contacted Sunrise REIT again stating its desire to have the same rights as Ventas should Ventas make any modifications to its original offer.
One interesting side note to consider is that when HCP entered into a $5.2 billion agreement to purchase CNL Retirement Properties (CNL) in April 2006 (presumably one of the large transactions it referred to as having experience with), the agreed upon price was $13.75 per share, according to the CNL proxy. But two weeks later, “as a result of its due diligence review,” HCP’s financial advisors informed the CNL board that they intended to reduce the price to $12.25 per share, representing an 11% drop. The board basically told HCP where to go with that revised offer, and a day later HCP came back with another offer for $13.50 per share, now just a 25-cent reduction, which the board decided to accept (probably because it wasn’t worth 25 cents to go back to the next two top bidders). The point is that if the Canadian court allows Sunrise REIT to negotiate with HCP, one of the conditions should be that the price cannot be lowered below that C$18.00 per share threshold since due diligence is apparently not a contingency this time.
At this point, we do not believe that Ventas will up its offer to C$18.00 per share, nor should they, since it probably would not be accretive at that level until sometime in late 2008, and also as a matter of principle. We are sure Ventas will exhaust every legal maneuver available to it, and we have to wonder how Sunrise the operator would feel about having HCP own another 74 of its managed facilities on top of the more than 100 facilities managed by Sunrise that are already owned by HCP. That is a huge concentration with one owner, and no matter how friendly they may be as a landlord, few operators want to be faced with that prospect. Publicly, Sunrise the operator has stated that they are fine with either REIT, but we wonder what is said in private. Regardless of what happens, this is an expensive transaction, which would be at a sub-6% cap rate if HCP prevails at C$18.00 per share.
The court is supposed to make its decision known in the first week of March (after we go to print). If it allows Sunrise REIT to negotiate with HCP, that 20% premium will be a nice reward for shareholders. If the court says no, however, shareholders can vote no on the Ventas deal, which they probably would do since we have heard there has been heavy turnover in Sunrise REIT shares since HCP came back into the picture with a higher price, so we have to assume that many of the new shareholders have a cost basis above the Ventas offer. Stay tuned.
 
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