Indiscriminate or forced selling by event-driven hedge funds driven by market volatility, redemptions, or sheer impatience creates attractive entry points for patient bargain hunters.
A recent casualty on sale at the moment: Brookdale Senior Living (ticker: BKD).
Company overview -
BKD is the largest owner-operator of senior living communities in the US, with ~1,150 communities in 46 states, effectively making BKD the only national provider of senior living solutions in the country. BKD's full range of services give it a diversified product mix: Assisted Living (53%), Independent Living (29%), Memory Care (13%), and Skilled Nursing (5%). ~80% of resident fee revenues are generated by private-pay customers. An aging population coupled with increasing economic/housing wealth creates a long-term demographic tailwind for BKD. Of particular interest is BKD's significant owned real estate portfolio.
The stock is down 38% from its peak earlier this year. How did we get here?
In February 2014, BKD announced its merger with Emeritus Corporation, its largest competitor and the #2 senior living operator in the US. Investors generally liked the deal, as it gave BKD a great deal of scale and the promise of material accretion (Emeritus's properties had been poorly managed and underinvested in for years). A spate of negative press related to the mistreatment of seniors at Emeritus had given BKD an opportunity and they pounced.
The background to the merger revealed a number of parties interested in partnering with BKD in the deal, or simply buying BKD's real estate. Since the Emeritus deal closed last year, integration has proved more difficult than management expected, leading to a lousy Q4 2014 print. Less than a month later, Sandell Asset Management went public with an undisclosed stake, calling on the company to separate the company into an OpCo/PropCo to crystallize the value of the company's real estate. Hedge funds piled into the stock. Sandell's white paper can be seen here: http://www.sandellmgmt.com/documents/FG/sandell/activism/328721_Brookdale_Public_White_Paper_February_2015.pdf
Two months later, BKD and Sandell signed a standstill, BKD added 2 directors to the board (one nominated by Sandell), and formed an "investment committee" to assist the board in its review of strategic opportunities associated with the company's real estate, a review the company claimed had been ongoing since before their merger with Emeritus. Since then, there have been numerous press reports that BKD was considering selling its real estate, and that Healthcare Reits were considering making a bid for the company. Q2 2015 results revealed a more challenging integration of Emeritus than management had expected, resulting in reduced occupancy and a reduction in 2015 guidance. The poor recent execution, the market volatility of Aug/Sept, recent cautious commentary from the IRS around companies seeking to spin their real estate into a REIT, and the lack of any update/clarity on the company's review process have scared/angered investors, who have sent the stock down 38% from its peak earlier this year, and 28% below BKD's unaffected price (defined as the day before Sandell went public).
What's next for BKD?
Management has described 4 basic paths forward:
1) OpCo/PropCo split
2) Sale of entire company
3) RMT involving a smaller portion of the company's real estate
4) No change to the status quo
At these levels, shareholders should win in any of the above scenarios.
1) OpCo/ PropCo
Healthcare REIT cap rates are currently in the low 6s. At PropCo NOI of ~$400m (Sandell estimates NOI of $490), a 6.5% cap rate would put BKD's real estate alone at over $6.5B vs the current market cap of $4.7B.
There is more uncertainty around how the market would value the OpCo, but BKD's closest public peer (CSU) is currently trading at an EBITDA multiple of 16.1x. This would yield an OpCo TEV of an additional $6.5B off of consensus 2015 EBITDA estimates. Deducting BKD's net debt yields a proforma equity value for the two pieces of ~$13B, or $33.75/share, 36% upside from here.
2) Sale of entire company
Who knows what BKD would fetch in a takeout, but in a marketed sale, the cap rates on BKD's real estate would likely be much lower than 6.5%. From a multiple standpoint, BKD trades at a discount to CSU on both an EBITDA basis (13.6x vs 16.1x) and EBITDAR basis (11.8x vs 12.6x)
I don't have a strong view on valuation in this scenario, but putting a marker on the company's real estate by monetizing even a small portion of it can only be good for the stock price.
4) No change to the status quo
In this scenario, one of two things is likely to happen. Either management begins to perform, occupancy improves, and investors begin to see the promised accretion from the Emeritus deal, OR it doesn't, in which case I believe management will come under an enormous amount of pressure to pursue strategic alternatives or step aside (note Jana Partners is a top holder).
Rising interest rates could put upward pressure on cap rates, but cap rates should arguably be driven more by fundamentals. In addition, rising rates are good for pricing, as seniors generate more income from their fixed income investments.
Talk of increases in construction have been floating around the industry, which would lead to an increase in supply and downward pressure on pricing and occupancy. This risk is offset to a certain degree given that rising rates make it more expensive to build (construction loans are more expensive).
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Improved execution/integration and synergy realization
Clarity on strategic trajectory of the company (sale of company, separation of real estate from operating company, etc.)
|Entry||10/09/2015 06:32 PM|
Thoughtful write up.
How are you thinking occupancy going into the quarter relative to guidance vs. consensus thinking?
|Entry||11/30/2016 12:29 PM|
Azia, in looking for stocks near 52-week lows where insiders are recent incremental buyers, this one came across my screen. Wonder if you have a current perspective if you are still involved? Thanks in advance.
|Subject||Re: Re: Any update?|
|Entry||05/09/2017 03:29 PM|
Any updated thoughts azia1621?
Looks like BKD posted a decent set of results, but reiterated 2017 EBITDA and cash flow guidance implying a decent step-down for the rest of the year (even ex-dispositions). If they were able to sell the entire company, I'm not sure why they would lay out conservative guidance. I am therefore left to think that the incremental earnings data points will be negative, but would appreciate your view here.
Also, the "strategic review" continues to drag on without much material progress. Do you think that something will come of the review at this point? From my understanding the lease contracts have covenants (net worth and change of control) that restrict BKD's ability to do anything drastic on the owned portfolio (where the majority of value exists).
|Subject||Re: Re: Re: Re: Re: Any update?|
|Entry||05/10/2017 03:02 PM|
Thank you Azia. That is really helpful.
I think there is a net worth covenant in most of the leases blaueskobalt. If the real estate was gone, so too would the net worth.
Jefferies seems to be out there spreading the word this week that a Chinese buyer might buy BKD. I certainly wouldn't buy banking on a sale, but at what point do you buy on business fundamentals? I'm surprised NOI has held up as well as it has (giving up occupancy for rent growth thus far has worked). Perhaps this doesn't get that much uglier beyond 2017 from an industry supply issue standpoint and perhaps 2017 isn't all that ugly with just flat SSNOI growth instead of positive growth. If so, can occupancy start ticking up next year with these higher rents? That would be pretty good and is certainly what the Street is imbedding in their estimates.
The biggest issue I have is that the 80+ age trends (where BKD really deals) don't really start inflecting positively until beyond 2020. So do we wait until the 2020s to see the industry improve, or do we believe management that it starts improving next year and earnings can improve? At that point, maybe you can start underwriting the secular demand growth of baby boomers and the stock trades up for good.