In news just released, Kindred (the post-acute, skilled, rehab and LTAcH behemoth) has made two separate offers to purchase control of Gentiva, the latest a $14 per share offer consisting of half cash, half stock ($7 and $7). An earlier offer of $13 per share was rejected and it appears the $14 offer will see the same fate. Prior to the news, Gentiva stock was trading in the mid $6 range, down 20% over the preceding 12 months. The value of the “deal” is pegged at $1.6 billion with $533 million of the total in cash and stock, the balance in assumed Gentiva debt. On a combined basis, Kindred/Gentiva would weigh-in at $7.2 billion in annual revenues, operating in 47 states.
To date, Gentiva has held fast that it is not for sale and that its present plan, implemented as One Gentiva will create more shareholder value over-time than the Kindred offer. In December, I wrote a similar analysis post on Gentiva/Harden (the merger) and the home health industry. The post can be found at http://wp.me/ptUlY-fV . In this post, I commented on the clear flaws in the One Gentiva strategy; principally the broadening of reimbursement risk strategy that is at the core of this strategy. While Gentiva posted a modest recent quarter profit after $180 million loss, virtually all of the reported gain was a result of accretion from the Harden transaction, not improved operations. For example, adjusted income attributable to Gentiva shareholders for the first quarter 2014 was $4,8 million compared to $7.1 million twelve months prior. Net cash provided by operating activities for the first quarter was negative $17.7 million vs. negative $20.6 million one-year prior – not a resounding improvement. Essentially, the fundamentals of the company are not improving and in some cases, set to erode going forward as the lion share of its revenues are Medicare home health and Medicare hospice (Odyssey) driven (88.5%). Both Medicare programs face down reimbursement trend pressure, home health dramatically more so than hospice. Hospice however, is under enormous industry-wide pressure due to continued fraud investigations among major players and the loom of federal program reform (the Medicare hospice benefit). Essentially, hospice is a no-growth industry now.
Reviewing multiple factors and general industry trends plus the health policy and economic outlooks for both companies and the post-acute industry globally, below is my analysis of the factors influencing (or should influence) the Kindred and Gentiva position.
Kindred: Where Gentiva has a reimbursement risk concentration problem, Kindred has a location of care or outlet concentration problem. Kindred is brick and mortar deep/heavy, actually too heavy. Institutional outlets, especially in-scale and capacity are shrinking. The revenue needs required to support institutional care, on a post-acute basis, are increasing while reimbursement is flat to falling. The LTAcH and SNF trends are flat and the operational efficiencies available to any provider are minimal, save offloading or minimizing debt. The quality expectations evidenced in regulation and pay-for-performance models won’t allow any significant reductions in variable costs today. To be an institutional player of success, one must have broad clinical capacity, right-sized bed compliments that match payer demand (occupied by the highest payers at high occupancy levels) and non-institutional outlets to capture discharge revenues plus participate in global contract arenas and networks (ACOs, etc.). Kindred lacks the home health/hospice scale, especially on a matching outlet basis in its respective markets. Gentiva adds this element, though at a bit of a risk via the amount of debt that Kindred would assume. The acquisition is not without risk or a sure-winner. True Gentiva brings the home health/hospice/community care component that Kindred needs as well as the scale to be immediately impactful, it simultaneously adds another level of reimbursement risk and industry risk that Kindred already has on a large-scale. Managing and integrating the Gentiva elements into Kindred’s longer range provider of choice model will not come easy. Likewise, the Gentiva acquisition will only mask temporarily, the fact that Kindred needs to right-size its own portfolio post its acquisitions of Rehabcare and Integracare (the latter a Texas limited home health/hospice provider) while still holding and operating, too much inpatient real estate that isn’t optimally performing in many markets. In essence, the play makes sense but not fully positive until all the pieces are brought tightly together; a difficult and time-consuming endeavor.
Gentiva: Gentiva has the same problems that Amedysis has and had – it needs to shrink but it can’t. Gentiva has too much debt and in a reimbursement environment that trends flat to down, it cannot grow itself out of its debt problem by “more of the same”. It’s diversification strategy through the Harden acquisition is too little, too late and not scalable fast enough to have meaningful impact. It similarly, can reduce expenses fast-enough via consolidation as it must chase revenue growth to survive and the revenue growth that pays the most is Medicare – a risk concentration it already has too much of. It needed to re-tool 8 to 10 years ago, balancing its revenue model and expanding its clinical capabilities beyond the typical home health outlet. Additionally, it needed to become more local-market centric and not simply a Medicare reimbursement machine like Amedysis (an accident waiting to happen). The notion that its One Gentiva plan can create more value for Gentiva shareholders that the Kindred offer is wrong-headed. Sans takeover talk, Gentiva trades between $6 and $8 and no upward trajectory is visible. A simple return analysis illustrates that a Gentiva shareholder will wait at least 18 months or more to equal a return of $14 today, excluding opportunity costs on the investment. Similarly, the risk concentration elements that could turn such an outlook even more dire are more than double on the Gentiva holding than on a comparable dollar for dollar holding with Kindred. Kindred simply has more ways to generate revenue, a more stable expense base, lower fixed costs and less reimbursement risk concentration than Gentiva. If Gentiva chooses not to sell, holding out for more than $14, I think the shareholders will pressure such a move in the near-term future. The Kindred offer, with debt assumption is in my opinion, a max value offer that 12 months from now, is off the table.
A regular, although not necessarily routine, exercise that I go through is a re-evaluation of recent acquisitions in the senior housing/long-term care industry to see “how they are doing or performing” post transaction. Perhaps the primary reason that I do this is my curiosity regarding the effectiveness of the due diligence process and the accuracy of the valuation or economic value proposition created by the acquirer as translated into purchase price. In short, I’m always curious as to whether the buyer got what he/she/they expected at the anticipated cost (purchase price plus other investments required over the first year or so) he/she/they expected to pay. As the mechanics and theory behind valuations and due diligence vary between deal to deal (from what I have observed), it is interesting to look at “how things are turning out” once the feeling of accomplishment and the haze of the deal have passed.
When things don’t go well or aren’t going well at the one year mark, something I find more common in health care transactions (SNFs, Home Care, Hospice, etc.) and less so in Assisted Living or Senior Housing, it nearly always seems to a be a flawed due diligence process that led to an over-estimation of value. More succinct: Because the due diligence process missed too many issues the price became over-stated as the costs associated with achieving stable operations were under-estimated or the classic, “he/she/they paid too much for what they got”. Where I notice the largest number of errors occurring during due diligence is when the due diligence is treated as a justification for the purchase price or, a process of validation rather than a process to quantify the economic risks and benefits that are modifiers to the valuation and ultimately, to the negotiated price. Proof of a what a friend of mine always says; “It doesn’t take a rocket scientist to overpay”.
Separating the issues a bit, valuation is effectively a financial quantification of the relative worth of the business as it stands today, including business/commercial value (cash flow, revenues, expenses, etc.) and tangible and intangible asset value (bricks and mortar, equipment, trademarks, name, etc). When Buyers capably test the values against their own business models and the available universe of comparable values, the Buyer has established a range of possible purchase price points. Ideally, within this range lies a number that the Seller will accept or that matches closely, the Seller’s asking price. At this stage, I would argue that a Buyer should never impute any assumptions on a go-forward basis about “how much” expenses could be lowered or revenues increased to massage an improved value. A wise Buyer would best assume that upon acquisition, almost all aspects of the business “as is” are set as constant and these same constants are the financial constraints that place the boundaries on the project’s range of values. This is not to suggest that a pro forma assumption about “go forward” operations that assumes lower debt costs (if applicable), some efficiencies via scale and some reduction in overhead may not be applicable (if in fact they are real and quantifiable). It is however, a caution based on too many valuations completed at the behest of or by Buyers, that include unrealistic assumptions of census increases, revenue increases, expense reductions, etc., that are hardly quantifiable or even in fact, justified for the particular transaction. To illustrate: A few years ago I helped an out-of-state buyer get into a particular nursing home transaction (nursing home was for sale). The buyer owned nursing homes in other locations so the industry was not totally foreign. The location of the facility was decent but the plant was old and the facility’s reputation marginal. The asking price had yet to be set “in stone”. The buyer, accustomed to paying higher prices in other areas, began talking numbers that were far too high for the project, justifying the price with claims of significant improvements in Medicare census and Medicare revenue per day that were unrealistic for the facility (never happened at this location before) and were beyond the norms of the market area. While I tried to counsel the buyer to be more judicious, the buyer went ahead and acquired the facility. Within two years, the buyer abandoned the site, having substantially over-paid, never achieving the projections for revenue and census “touted” for the facility.
Due diligence encompasses the financial valuation but extends the tasks into a level of greater detail that adds or subtracts (creation of debits and credits) from the range of possible values/prices. In the best of due diligence processes, the methodology also incorporates a review of risks and assists in quantifying costs associated with these risks. In reality, due diligence should attempt to paint a complete picture of all elements of the transaction, providing final quantification of the price and qualifications to the transaction that must be accounted for by the buyer. Thought of or approached this way and using the example I presented above, the buyer would never have paid what they paid for the facility and would have realized that achieving a stable, successfully operating SNF in that location would take them years and significant financial and human capital investments.
While buyers tend to approach due diligence and valuation different, each varying upon a theme and using their own methodology and checklists, I’ve found that the problem transactions that I follow each tend to miss one or more of the following elements. Some of these elements are absolutely critical if the buyer is out-of-state or out of the area and the acquisition represents his/her/their first foray into a given market area.
- Economic Location Analysis: Not to be confused with market research principally relying on demographics, this analysis looks deeper into the key economic location elements that are critical to the success or failure of the transaction at the given purchase price. For example, location analysis would quantify labor resources and costs – key elements for a healthcare provider. Location analysis would also quantify the strength and depth of referral patterns and the quality of such referrals by desired economic value (payer sources, etc.). Location analysis also examines the market economy and the up or downward trends that are present. Too many providers over-estimate the value of a particular location without understanding the economic factors that create or detract from the project’s value.
- Provider Status Assumption Risks: Buyers that are acquiring healthcare projects with existing Medicare business and expecting to assume the former provider’s Medicare number (most common in acquisitions) need to understand that the assumption of the Medicare number brings the assumption of risk. While it is true that lawyers will create indemnities and warranties that seek to limit the buyer’s assumption of risk, using these clauses to enforce terms when risks are present or encountered is often an expensive and fruitless exercise. In other words, the seller may no longer exist or as is often the case, will require the buyer to use an expensive legal process to enforce the indemnity and warranty provisions, all while the compliance requirements are inescapable to the current owner. Preferably, although not an expeditious process, buyers should obtain a new provider number and status for the project from CMS, targeted effective on the change of ownership – for Part A and Part B as applicable. It can be done as I have done it with each of my “former” acquisitions. By not assuming an existing provider number, the buyer avoids a whole host of issues and compliance problems that may or may not be disclosed or even known by the seller. CMS, as one would suspect, will only chase the “owner” of the existing provider number when problems arise or are detected and if that is the new owner, regardless of whether the issues pertained to a former operator/owner, the new owner is expected by CMS to be the sole source of remedy. CMS does not care about the terms of the deal between private parties.
- Billing Risks and Revenue Accuracy: This is a problem area that I see all to frequent. The buyer relies on the seller’s representation of revenues and does no further testing. I lost count of how many times buyers relied on accountant prepared or audited statements as being “gospel” only to find upon ownership that the revenues were over-stated. Why? First, even during an audit, accountants do not devote sufficient time or have often, sufficient expertise to analyze, the accuracy of the Medicare claims submitted by the seller. The typical tests are for basic paper-trail elements such as RUGs groups in SNFs matching the billing, matching the revenue postings. What needs to occur is a much more in-depth, technical review to determine if the Medicare claims that correlate to patients are in fact, correct. Again, I have seen circumstances where the Medicare revenue per day is grossly incorrect as the seller had no idea how to properly bill Medicare claims. Last, I rarely see buyers benchmark the revenue and occupancy numbers against area comparables. Payer mix and revenue per day numbers across the industry tend to fit pretty narrow ranges and when, in any transaction, they are out of this normative range, a red flag should rise.
- Compliance Risks: Another area that I see cause buyers problems time and time again. Compliance with certification, survey and accreditation standards is a function of past and yet to be. Acquiring a provider with past problems in these areas requires very careful analysis and discussions with regulatory authorities. Regulators need to be queried extensively and even, negotiated with when the buyer is acquiring a provider with a record of moderate to serious non-compliance. Don’t have the discussions or do the additional analysis and assuredly, run into compliance problems that cannot be deemed as “owned” by the prior owner/operator. Likewise, acquiring a provider with a reasonable or decent history doesn’t mean that the current status of compliance is clean. Sellers tend to wane on their commitments to compliance the closer the time comes to deal “certainty” or closing. A fair amount of time may also have passed since the current owner was re-accredited or surveyed. Complaints may be pending requiring regulatory review. What is certain is that once the acquisition is complete, regulators/surveyors will descend on the new owner in fairly short order. Take the time necessary to thoroughly review the past and current status of compliance.
- Market and Reputation Risks: Simply stated: How is the current provider viewed within the market? New ownership doesn’t mean new perceptions about the quality of the current operation. If the current operation is viewed marginally or even negatively, a new owner will have a great deal of work ahead to establish an improved or new reputation. If the business relies heavily on referrals (and most health care provider organizations do), it pays to check referral sources and other common influencers to understand the “market” perception that is in place.
- Environment and Infrastructure Risks: Assuming that acquiring an existing provider means that existing brick and mortar and equipment doesn’t require improvements immediately can be a false assumption. Existing providers may operate under waivers or as in some states, new ownership necessitates that the entirety of the project be brought to current code with the issue of a new license. Such is the case in Wisconsin. A thorough review of the environment and the infrastructure tied to building code requirements, completed by qualified individuals/organizations will minimize this risk.
- Employment Related Risk: Here I am not talking about the legal risks associated with handling employment issues during the closing processes. The risk that I am talking about occurs when buyers make one of two (or both) assumptions about the quality and stability of existing management personnel and/or, their own management personnel. The error I see too often made occurs with out-of-state buyers not acquiring sufficient local or area expertise and/or, having enough local support available via contractors (consultants, etc.) to ease the transition. Each market area and certainly, each state brings forth nuances and issues that require stable management and unique knowledge requirements. I’ve seen too many new owners underestimate the resources needed and over-estimate the ability of their management to handle new areas and states foreign to them.
In Part I, I wrote about my last week’s conversations, etc. regarding the home health industry, specifically Amedysis, the Senate Finance Committee inquiry, the industry impact via the PPACA and the likely consolidation and merger trends that are approaching. Suffice to say, not all of last week’s news and conversations focused on the home health industry as over the last thirty days, much has happened in the hospice industry as well. The difference between the two industries is that in hospice, the major news involved a significant merger and in home health, the major news involved the legal and compliance issues of the largest provider entity – Amedysis.
The hospice industry saw, via the merger between Gentiva and Odyssey, the creation of the largest home hospice company in the industry. Gentiva, while also a provider of home health, clearly chose to direct more of its attention to the hospice industry, moving from a moderate player in the industry to the predominant player via the acquisition of Odyssey. Odyssey, while not as large as Vitas (the former largest hospice provider), held substantial market share and presence and in many regions and distinct market areas, competed head to head with Vitas for patients. For more information on the Gentiva/Odyssey transaction, see a related article in my company’s E-Newsletter at http://wp.me/pD9Ac-4Q .
Analyzing this merger leads me to a series of assumptions about where the hospice industry is at present and where it is likely headed.
- Hospice is now clearly a mature market or in other words, a market that is unlikely to grow significantly over the near to intermediate term horizon. Despite a fairly profound demographic shift occurring over the next twenty to thirty years (the maturation of the baby-boomers), there is no real indication even with this influx of older adults, that hospice as model of care, will gain in referral popularity. While seniors utilize hospice more in total numbers than any other age cohort, as a percentage of the total cohort, utilization trends show little forward growth. There are a number of reasons why;
- Culturally, U.S. medicine and the U.S. population still values the process of cure or health restoration far greater than the concept of natural death. As hospice is a downstream referral (the referral comes typically from non-palliative medicine trained physicians or via hospitals and/or long-term care providers), the hospice industry relies on the referral source to be; a) knowledgeable about the value of hospice and how it works for patients and their families, b) willing to forego potential incremental revenue for continued care by making the referral to a hospice, c) willing to engage the patient and the family in a difficult conversation regarding end-of-life and treatment futility. As long as these dynamics remain in place to the extent they presently are, the growth of utilization will remain fairly stagnant.
- Financially, the incentives for referrals to hospice don’t truly exist within the current U.S. system. There are no barriers in-place to reduce the reward (payment) for continued acute, diagnostic or curative care (choose your own verbiage) and as a matter of fact, the reimbursement systems (private and public) pay incrementally more for more intense care than palliative care, even if arguably, the care is futile. As only patients and their respective treating health professionals can conclude that continued curative care is futile or unreasonable, the process of garnering more money for more treatment remains intact as a perverse incentive.
- While not for hospice people or physicians trained in palliative medicine, terminality remains an uncomfortable and even disputed condition for many physicians. Patients and there families still wish to avoid discussions far too long and in some cases, avoid the discussion altogether. While in-roads are perhaps being made in some medical centers and in certain communities, these in-roads are miniscule and not evident of a ground-swell movement toward open discussions regarding end-of-life decisions.
- As with the home health industry, the movement in Washington is toward curtailing the growth of hospice spending. The prevailing feeling in Washington policy arenas, supported by Medpac, is that the hospice reimbursement under Medicare is too generous and the benefit itself, easily manipulated and poorly defined. While the PPACA did little to negatively impact the hospice benefit or payment, the recommendations directed to the Secretary of HHS in the language intones significant changes forthcoming.
- Reimbursement under Medicare will change such that early days in the initial benefit period will be paid more as will days at the end of the patient’s stay (proximal to death). Days during the interim, longer stays will be reimbursed with lower payments. The point here is supposedly a recognition that patients with long stays have periods of stability necessitating far less care from the hospice.
- More emphasis will be placed on denying stays for non-specific terminal conditions or denying portions of stays. CMS has determined that too many longer stays are related to diagnoses such as terminal dementia, failure to thrive, etc. In order for these stays to be covered, the onus will fall on the hospice to provide very detailed documentation supporting patient decline.
- More emphasis will be placed on physicians to document terminal conditions and to prognosticate length of likely survival, especially at recertification periods. More direct “hands-on” involvement of physicians will also be required (physically seeing the patient).
- Certain types of stays and relationships between hospices and nursing homes will be closely monitored and reviewed. CMS and Medpac have determined that hospice stays in nursing home environments on behalf of nursing home patients are considerably longer and possibly in many cases, in violation (the hospice) of the conditions of participation as hospices utilize nursing home residents as sources of revenue but often, fail to meet the care requirements (using the nursing home as the source of care and service) under the hospice federal code. Additionally, CMS and Medpac have placed the target for reform squarely on the large for-profit hospices such as Vitas, Gentiva and Odyssey which have typically used nursing homes as major sources of referrals for hospice patients.
- The PPACA, while not bending the cost curve or reducing the overall level of national expenditures on health care, does change in the interim, the overall health care economy. Providers are re-positioning and re-grouping to combat what they perceive, and in some cases know, will be negative changes to how they presently do business. Providers which rely heaviest on Medicare as the bulk of their overall revenues will move the fastest and the most aggressively to alter their current business practices, knowing that regardless of the overall status of the PPACA (repeal, restore Medicare cuts, etc.), the health care economy is entering a long period of fiscal constraint – payments will never be as high or as fluid as they once were.
- Because of points 1, 2 and 3 above, the industry will head into a period of consolidation and even, contraction. The Gentiva/Odyssey merger is a signal of the maturity of the industry and the trend toward tighter regulation of hospice stays under Medicare (the bulk of the hospice revenue) and less economic value per each stay. Lower future revenues per stay, either via reimbursement cuts or regulatory constraints placed on the length of stay, means more overall stays are required to equal the same or greater revenues going forward. As the growth curve of new “potential” referrals is flat, the only real source of new business or referrals for a provider is acquisition of existing market share (buying someone else’s referrals). In order to maximize profitability in an environment where the market is mature and the total revenue per each case is flat to shrinking, providers will have to adopt one of the three strategies below.
- Acquire other providers to build more referrals or volume. While each patient stay will be economically less valuable, increasing the total number for a provider while maintaining expenses on a ratio basis, lower than revenue, will provide a method to achieving overall net income targets – critical for publicly traded provider organizations.
- Shrink the organization to fit the new revenue and length of stay realities that are in place and forthcoming. An organization that can right-size its operations to fit the new business paradigm will be smaller but potentially equally or perhaps, more profitable. The risk here is that provider organizations that are acquiring market share may marginalize some markets such that a shrinking provider (by choice) loses desirable market share.
- Expand non-Medicare business and add complementary businesses that may provide incrementally equal or more revenue than that which is lost under Medicare. Arguably, this strategy may only work for regional or single market providers and those that have strong system ties (hospital owned, etc.).
One final point to note concerns the economy. Absent from the above factors I laid out influencing the hospice industry is the stagnant economy. With recovery a daily discussion regarding likelihood and timing, current uncertainties persist that impact hospice providers rather dramatically.
- The overall number of paying patients available to all providers within the health care economy has shrunk in recent years. This shrinkage is primarily due to job losses and benefit losses. Until employment rebounds and jobs with benefits become more plentiful, consumers for health care in the form of paying patients will remain down.
- When fewer paying patients are in the queue, those patients that do have a payer source, even a less than optimal government payer source, are prized commodities. Each provider wants a piece of the same paying patient.
- Hospice is as I pointed out, a downstream referral. When the upstream referral source, principally hospitals, lacks sufficient paying patients in the queue to replace current patients it “may” customarily refer downstream, it holds the paying patient longer, either delaying the referral and the portion of revenue that comes with a longer stay or avoiding the referral all-together. Similarly, all downstream referral sources such as nursing homes compete aggressively for the referrals even though a referral of a terminal patient (or potentially terminal patient) is ordinarily, not a prize catch for most nursing homes. This competition erodes the number of total possible referrals available to a hospice.
- Each patient has an economic value to a provider. When a patient with a higher economic value (a better payer source) are lacking, providers sort down to the next patient level. This sorting process occurs as a result of too few patients with payment sources available to match the supply or capacity within the existing provider universe. Some markets hit hardest by the downturn will evidence this reality in greater depth and unfortunately, with greater persistency. For hospices (and all downstream providers) in these heaviest hit markets, referrals have trended down and will stay down until the supply of patients with payment sources increases and specifically, the supply of patients with better payment sources and today, deferred health care needs (e.g., elective surgeries such as joint replacements, etc.).
Sorry for borrowing (piece of) a soap opera title for this post but it is rather appropriate given the news that occurred over the past 30 days. Just this past week, I’ve been interviewed by two business newspapers and on the phone with an investment banking firm I consult with from time to time regarding Amedysis, Gentiva and Odyssey’s merger, the pending impacts of the PPACA on the home health and hospice industry, mergers in the industry in general and using a “catch-all”, what the “heck” is going on in the home health and hospice sectors. With a chance to recoup over the long 4th of July weekend (and organize my notes from last week’s conversations), a post on what all the conversations were about seemed appropriate.
Amedysis: A month ago, on my company’s E-News site (http://apexhealthcareconsultants.info), I edited an article regarding the Senate Finance Committee’s inquiry into the Medicare billing practices of a handful of very large home health agencies (Amedysis, Gentiva, LHC Group etc.). The inquiry is a result of an article that appeared earlier in the year in the Wall Street Journal, focused quite intently on Amedysis’ billing practices; principally as applicable to therapy visits. The fall-out since the Wall Street Journal article and the Senate Finance Committee article is two-fold. First, the class action suit (I’ll touch on it in a bit) and the hefty drop in Amedysis stock price.
In brief, the class-action suits (there are three) focus primarily on the perspective of shareholders (the “class”) and alleges that the questionable Medicare billing practices (none of which at this point, CMS or the OIG has taken specific issue with) served to artificially increase the share price of Amedysis stock. The allegation of abuse of the Medicare system, prior to any action taken by the federal regulatory system in the form of a fraudulent billing investigation or claims investigation, is a bit different in-so-much that it essentially accuses the company of manipulating its earnings as opposed to causing harm to any patients or group (class) of patients. The “harm” for shareholders is the drop in price that would/did occur as a result of the alleged fraudulent billing practices. To add a twist, the suits also allege Sarbanes-Oxley violations which require the corporate officers of publicly traded companies to abide by a code of ethics. Amedysis settled an allegation of fraudulent Medicare billing practices in 2003 (for Medicare activity between 1994 and 1999) and as part of the settlement, expanded its corporate compliance activity/program. Additionally, since 2003, Amedysis has had notable turnover of the key financial executives (CFOs primarily) with active rumor-mill chatter focusing on the cause related to overly-aggressive Medicare billing practices. Medicare represents 87% of Amedysis annual revenues, by far the largest percentage for any home health provider in the industry.
As Paul Harvey (famous radio newsman now deceased) was famous for; “Now, for the rest of the story”. There are a number of different and integral factors in play that are unique to Amedysis but also, symptoms of an industry, a payment system and a flawed health care reform law.
- The issues regarding possible Medicare over-billing or at least, aggressive billing are not new for Amedysis. Their growth has been remarkable and unique for an agency so fully immersed in a government revenue stream. What is unique at this point in time is that the Senate Finance Committee inquiry, Wall Street Journal article and now the class-action suits come in advance of any customary federal regulatory actions. I do suspect that CMS and the OIG will enter the fray in the near future.
- Medpac has reported to Congress repeatedly that the Medicare payments to home health agencies were “lavish”, producing double digit profit margins on average, for most Medicare home health encounters. The PPACA (reform law) effectively cut Medicare payments to home health agencies and increased the documentation requirements for agencies to justify the necessity of continued visits.
- The feds have aggressively stepped-up their search via Recovery Audits and targeted billing inquiries for Medicare over-payments or more appropriate, Medicare fraud activity. This activity is two years old and growing each year with additional force. The writing is/was “on the wall”.
- To fully understand “what” is at the core of the Amedysis issue is to understand the age-old economic axiom that states, “what gets paid for (rewarded) gets done”. Medicare provided a utilization incentive tied to a certain number of therapy visits ($2,200 for 10 visits). Agencies thus targeted patients and developed care practices that maximized the opportunity to garner the incentive payments. In a typical government move, CMS rescinded the incentive payment as it became obvious that agencies were “gobbling-up” the requisite visits and conforming patients to achieve the incentive. A more meager incentive of a few hundred dollars is now provided at six visits, fourteen visits and twenty visits. Oddly enough, companies today seem to provide far more “six visit” encounters than twenty visit encounters (profitability vs. cost for twenty visits as well as a likely evident decline in medical necessity by the twentieth visit). Amedysis of course, is not alone in seeking to tie care provided to reimbursement nor is the home health industry alone in gaming the Medicare reimbursement system for additional dollars. For-profit hospitals, nursing homes and hospice agencies (and non-profits) alike are skilled at “Medicare maximization”, effectively matching what Medicare will pay with certain types of referrals, matched against the costs incurred to care for certain types of patients. This game goes on year-in and year-out with CMS constantly tweaking PPS categories to incent providers to take certain patient types (payment was too low) and to reduce the profitability of other patient types. In short, what gets paid for gets done.
- The PPACA did nothing to reform the system and arguably, it made it worse by attempting to extract funds via reimbursement cuts from Medicare. Of course, it is unlikely these cuts will be fully made or sustained as Congress has never shown the political will required to cut provider payments. By not truly reforming how Medicare reimburses providers for care, the PPACA only served to layer on huge amounts of bureaucracy to an already antiquated reimbursement system. In the end, nothing changed in terms of how Part A and Part B of Medicare pays providers; only the amounts “theoretically” changed. As a system, Medicare pays more for more care and higher acuity care. Providers will naturally gravitate their referral gathering efforts and marshall their care delivery systems toward the patient encounters that create the most “spread” (cost vs. payment). As the overall universe of these “profitable” patients is somewhat fixed, the provider universe is forced to unnaturally stretch the definitional boundaries of patient types (upcoding in plain health care vernacular). In other words, there are not enough truly “organically” existing patients that fit the best (most profitable) reimbursement categories but there enough that are perhaps, at the fringes. Add the fringe patients with a bit of creative tweaking via assessment and documentation to those that organically exist (fit the exact patient type) and presto, sufficient current volume for all providers. The difficulty for regulators and others who would charge that the fringe patients are not truly members of the organic group (those whose care requirements exactly match a certain reimbursement category or categories) is “proof”. The provider and medical communities are far better versed in assessment techniques and documentation requirements and as such, little can be done to reign in this reimbursement “three-card Monty” game. Until the reimbursement is reformed to reward better, more appropriate and efficient care versus “more” care, the over-reimbursement problem will remain, as it has for decades dating back to when providers ballooned certain costs to receive higher per diem rates from Medicare (under the cost-based reimbursement system).
What comes next in this paradigmatic shift in the home health world is merger/consolidation. As the profitability of one element of Medicare business shifts, larger agencies will acquire smaller to medium-sized agencies in order to increase market-share, lever infrastructure, and to supplement lost incremental margins with volume. Simply put, if the relative margin for one type of encounter shrinks, recouping that lost margin (or at the least the majority of it) becomes a function of incurring more encounters with smaller margins. As long as the incremental costs of additional capacity to handle greater volume remains in a ratio, lower than the net revenue received from the greater number of “less profitable” encounters, it is possible to generate a similar level of organization-wide, net operating income. The fastest and arguably most efficient way to create incrementally more encounters is to acquire someone else’s encounters at a price-point that is sufficiently low enough to create virtually (virtually to mean within a short time-frame) instant margin via the increased volume/market-share.
In effect, smaller agencies with less volume to spread the reimbursement loss/risk become attractive targets in this environment. A smaller agency’s value drops as its revenue/margins shrink and with limited geographic presence and referral markets to spread the lost revenue risk across, the entity price declines. The decline in entity price is attractive for a large acquirer seeking solely market share and/or incremental volume. In short, the acquirer is capable of paying less for the economic value of the entity (it has declined or will declined) which it really doesn’t want, save the referral market or incremental patient volume which it desires. The value is purely found in the market share or referral base, not in the economic metrics or financial value of the entity. For a larger provider, acquiring smaller agencies within areas that the larger provider presently doesn’t serve or undeserves is the goal. The “merger” is almost protectionist; protecting profit margins or revenue streams that are shrinking by increasing volume and thus (hopefully), more overall revenue, equalizing the lost revenue once gained per encounter during periods of higher reimbursement.
In the next post, Part II, I’ll review what is going on in the hospice industry and why the Gentiva/Odyssey transaction is significant in terms of a harbinger of activity yet to come.
Lately I’ve been running across intermittent publications/blog posts, etc. regarding a general decline in hospice census. At the end of this post, I’ve attached a couple of links for anyone who wishes to see some examples of what I’ve been reading. Naturally, being the curious consultant and health policy junkie that I am, I started to do a bit of digging. What I found was rather interesting and perhaps, indicative of another trend that may soon emerge.
In my prior career as a health system CEO, I first became seriously interested in hospice in the mid-eighties. The impetus for this was my VP of Religion and Pastoral Care who happened to train with Dr. Elizabeth Kubler-Ross and was (still is actually) a highly respected expert in the field of spirituality, bio-ethics and end-of-life care. Over the years, he often engaged me in debate regarding the high cost of institutional care at the end of life. He also pointed out how inefficient and somewhat demeaning it was for individuals to die in an institutional environment. In our system at the time, we experienced hundreds of deaths annually, the majority in SNFs. With the enormity and complexity of all the SNF regulations, it was extremely difficult to provide lower cost, more creative and thus, more humane end-of-life care in a nursing home. To further complicate matters, like most SNFs at the time (and even still today), our beds were generally configured as semi-private; hardly ideal to accommodate visitors, guests, and privacy.
To resolve the above issue, we started a hospice in the early nineties. We took a different tack however, developing a place of residence and a site for inpatient care initially. As our focus was principally geriatric, we saw the greatest market need as an alternative site to hospitals or SNFs; a hospice site that would provide a lower cost of care, a private room and incorporate all of the latest knowledge in palliative care. We knew at the time that the majority of our patients died in SNFs and hospitals simply because there was no real alternative and given the age of the patient and the lack of willing or able caregivers to accommodate death at home, home hospice was not the solution. To make a long story short, we quickly expanded to a second location and incorporated a home program within our hospice division. Oddly enough, at the time, we became the first free-standing, inpatient and residential hospice in Wisconsin and the sole “geriatric only” hospice in the State and the in the nation. Also at the time, there was one inpatient hospital unit and one free-standing residence. When I left my position as CEO to form my consulting partnership, there were five additional inpatient/residential hospice options and nearly a dozen home hospice options (some related to the inpatient/residential options).
To the point of this post and my observation: Hospice census is getting soft for a number of reasons but the primary driver of the decline that I can verify is too much supply for what is truly, an undeveloped demand. The primary payer for hospice care is Medicare and as I have written in numerous other posts, Medpac and CMS both have targeted hospice as an industry in need of reform. Their scrutiny is born out of a steady increase in the benefit utilization, rapidly increasing lengths of stay, and an increase in the number of hospices that have SNF contracts. To Medpac and CMS, this means potential abuse and to me it means too much supply chasing too little “real” demand. This is particularly true in a down economy where potential demand ( the universe of all terminally ill individuals at any one point) is somewhat disconnected with the health system due to unemployment related job losses and lack of insurance and other providers compete for a scarcer share of patient days.
The difficulty of gauging the true demand for hospice in the U.S. is that the health system presently in place, somewhat restricts the growth of legitimate patient referrals. Combine this with a traditional cultural and religious predilection which values life and technical advancements focused on the restoration of life and hospice becomes relegated to a choice paired with futility. Physicians, the gatekeepers of hospice referrals, are fundamentally incented to do everything (financially, legally, etc.) other than to make the referral. Patients and their families, ignorant about hospice, often know nothing about the benefits available under Medicare, the care that is delivered in a hospice setting, or that a referral to hospice can occur (and should) significantly in advance of imminent death. Without sufficient information about hospice, save the stereotypes, patients and their families must rely on a health system that actually competes against making referrals. While I know this sounds rather harsh, the reality is that most hospitals and physicians are pushed by economic factors, especially of late, to maximize treatment, to maximize tests, and to maximize patient contact that correlates to higher reimbursement, even if the same will in all probability, not change the ultimate outcome: death. A phenomenal source of data on this very subject is available from the Dartmouth Atlas (http://dartmouthatlas.org/).
While I cannot universally verify a trend of softer census, I can verify that census issues are occurring in a variety of hospices, particularly in larger urban and fully developed suburban areas. From the limited research I did conduct, this issue is not new and in fact, has likely been going on for some time. Where census trends are up or a bit more stable is typically in rural areas, fast growing areas or as a result of new or expanded nursing home and assisted living contracts (the latter a somewhat new but growing phenomenon). Areas that have been hit the hardest in the economic downturn are logically, areas with the greatest number of hospices struggling to capture census. Areas that are truly over-bedded in terms of SNFs and hospital capacity are the areas where the “soft census” trend is evident back to late 2008 and early 2009. Not too surprising, these over-bedded areas will not recover any time soon, if at all.
A new trend that is likely to emerge in the immediate future is consolidation or renewed merger/acquisition activity. Industries that have reached a growth plateau or stage of maturation provide marginally higher opportunities for businesses within the industry to consolidate, especially if the overall, longer-term growth prospects remain solid. I like to think of this phase or stage as a period of digestion. Hospice has grown markedly in the last decade, so rapidly in certain areas that the market area is or was saturated and the recent downturn in the economy served to illuminate, how saturated the market really was. In the period or time when the economy was advancing, a hospice could survive on the margins; the leakage that hospitals, physicians and other providers were willing to forego as other business or patient encounter opportunities were perceived as more valuable. As the economy tightened and reversed, the queue of “other more valuable” business evaporated and all remaining revenue generating patients became valuable again, closing the gaps that once leaked patients deemed “played-out”. This cohort of marginal patients (marginal only from the perspective of revenue opportunities) was a few years ago, the life-blood of a number of hospices in an over-developed market. As all providers are now willing to utilize even the most marginal patient encounters today, marketing or census development activities alone will not generate sufficient new referrals (they simply don’t exist) and the remaining strategy is to merge or be acquired.
I would not be surprised to see a steady growth pattern of hospices affiliating with other hospices, either via merger or outright acquisition. The general prospects for the industry are solid but the intermediate future with likely Medicare payment reform, greater OIG scrutiny and new referral and relationship regulations means that marginal hospice providers probably can’t survive sans an affiliation of some sort. Additionally, while the market will grow slightly year over year, I believe hospice has reached a point of maturity as a service or product line. It is truly a niche’ product, one not fully embraced by physicians or for that matter, the general market of patients and their families. As long as the economic incentives remain heaviest on “cures” and the cultural trend continues to embrace life-elongation at all cost, hospice will remain a secondary option for care, offered too late in the end-journey to a population, woefully uneducated and unaware of how valuable a care option it truly is.
The following are a few links to articles I read, prompting this post.
Moody’s Investor Service released their annual sector outlook today for not-for-profit health care organizations, stating that they (Moody’s) continue to maintain a “negative” outlook on the industry. Important to note in this report is that the focus is principally on hospitals and since the report is produced by Moody’s, its primary perspective is on credit and investment. That said, even with the predominant focus being on hospitals, there is quite a bit of take-away information for non-profit health care providers in general, including those in the post-acute sectors.
The emphasis Moody’s places on their negative or dim outlook is economic related primarily and public policy weighted secondarily. They point to the continued weak economy as the cause for slack patient volumes and concerns regarding provider debt levels, particularly those providers that may be facing an expiring Letter of Credit (LOC) situation over the next twelve to eighteen months. With regard to public policy issues, Moody’s points to budget insufficiency issues in Medicare and Medicaid foreshadowing tighter or declining reimbursements and uncertainty of the outcome of health reform although, as they indicate, the legislation today, is effectively in limbo.
According to Moody’s, the weaknesses inherent for non-profits are their reliance on governmental sources for payment more so than proprietary operators and their need to be cautious of their tax-exempt status in terms of a political culture requiring more and more justification of expenditures made on behalf of the uninsured or under-insured population. I would also add that other forces such as unions are today, targeting non-profits more so than ever and the result is higher labor costs and higher legal defense costs (to abate organizing campaigns). Similarly, the plaintiff’s bar is far more active today and for non-profits, their fair-haired status once given due to religious affiliations primarily, is all but gone. It is not uncommon any longer for attorneys to seek damages against large or for that matter, even small to medium-sized non-profit providers.
The report cites the following reasons as the primary factors contributing to Moody’s negative outlook.
- Sluggish patient volumes due to high levels of unemployment combined with the loss of health insurance.
- Pressure on revenue streams, particularly Medicare and Medicaid combined with intensified recovery activity (RACs and Probes).
- Greater difficulty in cutting costs due to the cost-cutting measures already undertaken in 2009 and late 2008. There is little room remaining for significant expense reductions.
- Increasing bad-debt exposure.
- Debt structure and liquidity risks driven by high bank exposure, potentially expiring LOCs and less than a full recovery of investment losses.
- Greater or increasing capital needs after a year or more of deferred capital spending.
- Expiration of the federal stimulus program at year-end 2010.
In addition to the above negatives, Moody’s cites three positive factors.
- For some providers, strong management capability that allows the provider to respond quickly to negative operating changes and positive improvements as they occur.
- Partial recovery of investment losses adding back some liquidity.
- Likely increase in merger and acquisition activity which Moody’s believes is good for the market.
As I reviewed the report, my conclusions are as follows. These conclusions I believe, are universal for all non-profit health care providers.
- The pace of economic recovery will push forward or hold back, the recovery of non-profit health care provider’s fortunes. A quickening pace including job growth will help providers recover quicker although a lag in terms of patient volume increases will clearly be present. A slow, mixed recovery with equally elongated new job creation will hurt providers and potentially, lead to insolvencies and failures. The key to remaining solvent in the event of a slow recovery is debt structure, depth of product/service mix and generally low non-wage related labor costs (turnover, legal issues, compliance problems, supplemental staffing costs, etc.).
- Access to capital at reasonable terms will remain an issue for the sector throughout the bulk of 2010. While I see some softening, the present stance the Feds are taking on taxing the banking industry could very quickly, chill any warmth that has softened the credit markets. Within the next twelve to eighteen months, a very large ($19 billion) amount of Letters of Credit will come due. Providers with struggling balance sheets or under-performing newer projects may struggle to meet new conditions and terms to enhance their credit. Without question, debt costs and the related costs associated with debt issuance will continue to be higher than any period over the last five plus years. The significant question remaining about access to capital is what role the Feds will play and will they continue to bolster lending activities via HUD to help stabilize some of the credit/lending markets.
- Of particular concern to me and in concert with the point immediately above is the growth in deferred capital investing that is occurring, particularly in the SNF industry. This industry is already dominated by aging physical plants and as providers have been forced to defer capital investment due to the economy and due to the reimbursement climate, the industry continues to shed asset wealth via depreciation and become more functionally obsolete. With growing regulatory pressure for SNFs in terms of environmental standards and new mandates on fire suppression systems, access to reasonable cost capital will be imperative for this industry to modernize and recapture at least a portion of its physical plant asset wealth.
- With health reform on the Washington back-burner for the moment, I believe providers will tend to breath a collective sigh of relief – prematurely. While I believe that a reform conflagration is not imminent, the fiscal woes of Medicare and Medicaid trudge on and as a result, the reimbursement outlook from my perspective, remains rather bleak. There will be continued financial pressure at the federal and state levels to reduce or reign in the trajectory of entitlement spending and as a result, I believe providers need to be vigilant about the prospects of flat to declining reimbursement rates. Of particular concern to providers should be Medicaid which today, is heavily bolstered by federal stimulus dollars set to evaporate in December. With state budgets remaining in the “tank” due to the slow recovering economy, states are going to be looking for Medicaid savings with a vengeance unless the feds continue additional matching provisions or add new dollars.
- In the merger and acquisition area I’m less of a believer that this market will heat-up than Moody’s is. I think that the time is certainly ripe for some increase in activity but I believe that the credit markets will have more to say about the volume than the desire of providers to acquire or be acquired. I do believe however that this is an opportune time for non-profits to look at merger and affiliation arrangements as opportunities are plentiful, the benefits of consolidating balance-sheets are obvious, synergies can be maximized across and within markets, and the costs of mergers/affiliations are far less and can be completed with minimal to no need for new debt.
Any readers that would like a PDF copy of the Moody’s report can go to the Author page and send me an e-mail request. In your request, please provide me with your full name and a working e-mail address that I can use to forward the document.
According to the most recent release of the Dealmakers Forum published by Irving Levin Associates, July witnessed a sizable increase in transaction volume across the long-term care sector. As I noted in my last post on Assisted Living and Senior Housing, we have begun to see some volume pick-up in these segments although modest in comparison to prior years. What we have yet to see, and confirmed by Levin Associates, is stabilized deal pricing and closings involving traditional lending channels.
The SNF deals that were closed in July demonstrated to us, only a modest rebound within the segment and principally driven by a couple of one-off deals and the continued shedding by Golden Living (f/k/a Beverly) of certain groups of facilities that are either marginal performers or facility sales driven by financial statement and balance sheet needs on behalf of Golden Living. The interesting factors in these deals are the demographics of the facilities and the metrics of the deals.
Consistently, the facility sales that are occurring show low occupancies (60% to 85%), high Medicaid census and are in markets that tend to be more rural to suburban than urban. In some cases, the deals are structured around facilities that have financial troubles or have been in default or close to default. Not too surprising, the pricing has reflected the sub-par conditions of these properties, significantly below 1x revenue. In summary, these transactions still support a low pricing period for facility sales; below the typical industry norms.
Is the market back? The answer is simple – nowhere near. There are factors on the horizon that support some additional volume movement such as buyers gaining access to the HUD Lean program for financing, slightly loosening lending provisions, and suppressed prices sufficient to stir buyer interests. Across the broader market, concerns remain however for the immediate industry future. Chief among these concerns is Medicare with an initial payment reduction certainty looming (see post on SNF Update) and the prospect of additional cuts arising out of the healthcare reform proposals pending in the House and the Senate. Secondary in concern is the financial woes of state Medicaid programs. Many states have bolstered their programs temporarily via Federal stimulus funds but without a source for additional, long-term funding beyond the stimulus dollars, the deficits in these programs foretell certain fiscal woes in the Medicaid program. In short, the revenue side of the industry looks rather dreary in the near future and of course, this dread will continue to fuel lender caution.
For buyers, this may be an excellent time to bargain shop provided they are well capitalized and capable of securing funding for the acquisitions. While there likely will not be a plentiful source of “A” properties or for that matter, “B plus” properties, there will be sites available and likely, more forthcoming. The prices should remain on the better side of a bargain (below traditional norms) and most properties should have more up-side potential than down-side. The key for buyers however is to have a solid turn-around strategy and an ability to drive a more diverse and deeper payer mix than likely exists in the facility that is being acquired. It also should be noted that buyers that can quickly integrate additional product or service lines such as in-house rehab services and specialized care services such as ventilator or dialysis have a better chance of success than buyers deploying a traditional SNF/Medicare improvement strategy.
For the past nine months we’ve watched the cap rates trend up, occupancy trend down and the transaction market remain stagnant. The credit crisis of one year ago definitely chilled the “buyer” side and as a result, shoved values downward. The deals we did see done were few and far between, lots of one off deals in regional markets and clearly, value plays. Where we did see some larger deals in the works, these deals were slow in closing and in some cases, did not close at all due to appraisals that did not support the purchase price or sellers that were unrealistic about values once the appraiser confirmed the “lower” market value.
Despite the fact that the credit markets haven’t really expanded dramatically and lenders are still a bit gun-shy and conservative on terms, we are seeing the makings of more deals and predict that the third and fourth quarter will see more closings. The two biggest factors contributing to this “modest” rebound in market dynamics and deal dynamics are sellers coming to terms with where the values are today and occupancy rates that have moved upward (in general) across the industry. This is not to say that these occupancy increases have come without a price as many providers have been forced to get creative in terms of discounting and packaging to fill incremental units. Incidentally, as the residential real estate market is still lagging in most geographies, we don’t see the discounting trend to fill units abating any time soon. Many markets are border-line overbuilt and/or close to saturation and as a result, demand is still lagging compared to the supply of units available at traditional, pre-recession price per unit levels. In short, providers will still be challenged to stay creative if they wish to keep their occupancy numbers trending upward or stable. Interesting to note is that in comparison to a year or so ago, the incremental additional unit sales for most providers are not contributing to profitability at the same rate as a result of the discounting that was required to fill these units. We believe that it may take as long as an additional year to wash this effect through the market, essentially returning to post-recession per unit pricing levels in mid 2010 or the third quarter of 2010 (of course, some regional markets may take longer and some may recover a bit quicker).
On a product level, Assisted Living facilities that offer a higher-level of care within a more bundled pricing structure have tended to weather the down times better. For example, we have seen better performance and stronger occupancy levels from facilities that “specialize” in areas such as memory care and/or are specialized to a targeted population such as extremely frail elderly. Additionally, facilities that are connected with an SNF, CCRC or hospital have performed better than those that are free-standing. This trend may remain for quite some time as the maturity of the market implies that the next step toward success for the Assisted Living industry is less real-estate focused and more program and product specific. Without question, values in the industry will rebound but likely not soon to the to the pre-recession levels witnessed in 2007 and early 2008. For free-standing facilities, especially those that are non-distinct in terms of their product via a specific program or other twist (connected to a CCRC or SNF), their value expressed in a CAP rate may not return anytime soon to 2007 early 2008 levels, especially if they continue to struggle for occupancy or have to discount fees to attain higher occupancy levels.
In specifics, this remains a Buyer’s market for Assisted Living facilities. Sellers should continue to be prepared to be creative and reasonable if they wish to sell their property. What is reasonable? As few sellers are attempting to rid themselves of Grade A properties, the majority of the market is full of product that quite honestly, has some “hair” on it. By “hair” I mean either a dated building or a building in need of some improvement, one that has some occupancy problems or both. Sellers also need to be conscious of the market area in which they are attempting to sell their properties. Regardless of what anyone quotes as deals done with a particular cap rate of “X”, the reality is that cap rates are regionalized and definitely market specific. In other words, a deal done at an 8 cap in suburban Illinois does not translate to the same cap rate for a deal looking for a buyer in suburban Green Bay, Wisconsin. Similarly, rural markets and even over-bedded suburban and urban markets can dramatically influence pricing and valuations. Even facility size and of course, age of plant can have a dramatic impact on what a Buyer is willing to reasonably pay for a particular property. In some cases, Seller creativity can also play a role in what level of deal is attainable. Sellers, for example, that have some wherewithal to assist with financing either via a land contract or a similar lease to own or installment sale clauses can add value to the transaction without taking a “price haircut” to get the deal done.
On the Senior Housing side (non- ALF), the market remains rather tepid. Similar to the ALF side, financing is difficult to obtain and values are down, though not as dramatic as in the ALF market. Perhaps the strongest product remains the CCRC and as such, precious little volume in terms of transactions is occurring. Occupancy rates in this product are wide-ranging with nearly all markets seeing a continued softness in demand, though some far less so than others. Free standing, older congregate style (apartments) remain the most common type of property on the market and cap rates seem to have stabilized for the most part, north of 9. Again, markets and regions play a major factor as does the actual property, in terms of what cap rates are tied to what deals. For example, I have seen listings with occupancy problems seeking a 7 cap that have been on the market for a substantial amount of time – wholly unrealistic. I’ve also seen decent properties, solid A minus or B plus facilities that as little as a year or so ago that would have sold in the 8.5 cap range sit, even though the pricing is negotiable above a 9.5 cap. And still, I see properties close at 10 caps and higher; deals that literlly make sense. Projects that remain fairly attractive in the market are modest to lower income sites with stabilized occupancy, a clean building and are tax-credit financed or HUD financed. As the initial owners/operators explore the “out” windows in these deals, buyers still seem willing to step in and pay solid prices for these properties (no wonder).
Where the ALF market will take perhaps another year or more to recover, the Senior Housing market appears to be less far away from recovery. New development is still occurring, though not at the pace it was a couple of years ago. Lenders also seem to be a little more willing to work on straight senior housing projects, perhaps because the real estate component is the majority of the finance. Older projects with deferred maintenance or occupancy issues will still encounter wary buyers and depressed prices. A seller needs to be particularly cautious and understanding of the economics of the market and his/her property. If for example, the project is older and needs some upgrades, a buyer will be looking to acquire the property based on the “up-side”, necessitating a pretty solid discount to replacement cost. If the market area has a depressed economy and modest to declining wealth demographics, the buyer will be cautious and may have to seriously consider a re-development or re-packaging stategy to turn the project to profitability post-deal, again necessitating a more sizable discount than perhaps, the seller had considered. In summary, the projects most likely to find buyers are those that are priced at 50% to 60% of replacement cost, in decent economic markets with solid demographics, and can be viewed as having “up-side” potential, either in terms of additional occupancy, additional room for expansion, or capital upgrades that can position the project for new, higher rent paying occupants. A final word of caution for sellers is to be extremely cautious about current pricing for current tenants and the occupancy demographics thereto. Depressed rents, while presenting an up-side to a buyer in theory, may also foretell a problem that a buyer does not wish to inherit; having to play market “catch-up” with a tenant base that cannot afford it or within a market area that will view rapidly rising rents as “negative”.
On a final note, for non-profit owners of ALFs and Senior Housing projects, the most fertile ground for transactions today remains sales to or mergers with, other non-profits. The economics make far more sense for a non-profit to seek another non-profit as a partner and value can be extracted out of the deal for the “seller” in ways that a true asset sale to a for-profit buyer would never allow. This is not to say that a non-profit owner should seek exclusively a non-profit buyer, especially if the product for sale has solid occupancy and is well positioned in the market. It does mean however, that non-profits can leverage value and take advantage of a presently, more flexible and fluid market for transactions, by exploring a transaction (merger, other) with another non-profit – food for thought for non-profit buyers and sellers.