Description

Sonida Senior Living is an owner and operator of independent living, assisted living, and memory care communities. Sonida and the industry have faced a difficult four years, first led by covid-driven occupancy challenges and then followed by inflation. The company was recapitalized in 2021 and more recently has further addressed their balance sheet through a combination of a refinancing and equity issuance while margins are on the cusp of increasing to the point of where they will be FCF positive.

Today the industry is at an inflection point toward a multi-year cycle of favorable supply and demand conditions which should allow operators to take excess pricing and improve margins to at/above 2019 levels. At the same time, the past four years of challenges have left lenders exhausted and a looming wall of maturities for the industry is likely to create an opportunity-rich environment for acquiring properties at distressed valuations below replacement cost. Sonida’s recently improved balance sheet leaves them in a position to play offense in this environment, enabling them to transition from a sub-scale levered equity stub to a consolidator of complementary assets at discounted valuations.  

We estimate that at a 6-7% cap rate of normalized NOI of $100m, the stock could be worth $57-72, vs. $28 today. There is further upside optionality as Sonida executes on their roll-up strategy of acquiring properties at double-digit stabilized cap rates.

Business Mix:

SNDA provides independent living (low acuity), assisted living (provides help with more activities of daily life), and memory care (Alzheimer’s and Dementia patients) services for seniors typically age 75+. The company is concentrated in four main states – Texas, Ohio, Indiana, and Wisconsin - which make up >70% of revenue.

SNDA’s portfolio includes 71 communities of which 61 are owned & operated, while 10 are managed on behalf of third parties in exchange for a management fee. SNDA sits in a ‘mid-market’ position, with rents that generally average ~$2,500-3,000/mo for Independent Living, $4,500-4,750/mo for Assisted Living, and ~$6,000/mo for Memory Care.

Industry Inflection:

The senior living industry has experienced four years of difficult conditions. Initial challenges were driven by declines in occupancy which troughed in early 2021, though margins did not trough until 2022 due to a tight labor market and high inflation. As pricing started to cycle through in 2023, margins began to inflect back towards historical levels.

Sonida has so far outperformed peers operationally and the company sees a path to occupancy exceeding pre-covid levels. SNDA has increased occupancy by ~1040bps from the covid trough to 85.9%, vs. an average of a 760bp recovery for peers to 80.5%. NOI margins have also increased 960bps off of the trough to 26.9%, but are still below pre-covid levels of 30-35%.

While a recovery to 2018/2019 levels of profitability would be a meaningful tailwind to NOI, current industry conditions could potentially support the potential for margins to exceed pre-covid levels. 2018 and 2019 results had been pressured by a multi-year period of elevated deliveries and supply, leading to declines in occupancy and margins.

Looking forward the supply/demand balance has shifted with demand accelerating while new supply into the market has declined.

On the demand side of the equation, the industry is looking forward to an aging population. From 2010-2020, the annual growth rate in the ~80+ population was ~1.7%, a rate which will step up to 4.4% from 2020-2030. Put another way, the average increase in the 80+ population was ~154,000 per year. In the next few years (2024-2026), that will increase to 479,000 per year, and in the back part of the decade from 2027-2030, that will go to 816,000 per year, >5x the rate at which the 80+ population was growing pre-covid.

Source – Ventas Earnings Presentation

As demand is accelerating new supply into the market has been continually declining. A combination of excess supply heading into covid, followed by the occupancy/inflationary challenges, tightening lending conditions and increasing construction costs have led to the lowest number of new construction starts since 2009.

Source – Welltower Earnings Presentation

SNDA Turnaround: Sonida is in the late stages of a turnaround of both their operations and their balance sheet.

Operations:

Beginning with occupancy, SNDA has already surpassed 2019 levels and has the potential to improve occupancy above pre-covid levels to ~90%+ given the favorable supply/demand dynamics in the industry. Currently 50% of the portfolio already exceeds 90% occupancy, though there is still a tail of 14 properties (>20% of the portfolio) that are below 80% occupancy with improving trends. 

NOI margins have also improved off of the lows, though on a lag vs. the occupancy gains. The biggest driver of margin recovery has been pricing in excess of inflation. SNDA has become more programmatic with price increases and has moved to an annual pricing schedule, with the most recent increase in March 2024. Additionally, SNDA implemented level of care reviews for each of their assisted living residents, to optimize pricing for each patient’s level of care/acuity.

SNDA has also maintained relatively consistent labor expenses in the face of sharply increasing occupancy, leading to strong leverage. The main source has been a decline in contract labor, which is generally a multiple of the cost of internal labor when used. During the post-vaccine occupancy ramp, talent was difficult to find which led operators to use contract labor to fill the gaps. Contract Labor usage peaked mid/late 2022 and has steadily worked its way towards zero. Management has also made progress on other cost categories, such as using a GPO to reduce F&B costs, reassessing properties and using litigation when necessary to improve property taxes, and more.

Source – Sonida Earnings Presentation

The net effect has been an increase in EBITDA from a quarterly run-rate of $3-5m to >$9m in 1q24, and >$11m PF for recent pricing actions. Run rate FCF has improved from burning >$7m/quarter to burning a little over $1m on a run-rate basis. Further occupancy and margin gains this year should push FCF into positive territory. 

Balance Sheet Turnaround:

SNDA has made a number of changes to their balance sheet over the past few years. The company took advantage of covid to shed money-losing communities and exited over half of their portfolio, including all of their leased communities and multiple highly levered communities which had little/no path to recovery. In October 2021 the company was recapitalized through a rights offering and preferred equity investment anchored by Conversant Capital, which now has a controlling position. Conversant established their initial position through a $25/share private placement as part of the deal and through their backstop of the $30/share rights offering.

As inflation challenges persisted the company elected to forgo interest and principal payment in 1q23 on certain non-recourse mortgage loans from Protective Life covering four properties, which led to a going concern warning in SNDA’s financials. This decision took advantage of Sonida’s fairly flexible capital structure in that the vast majority of their debt, with the exception of a $113m term loan from Ally Bank secured by 12 properties, is non-recourse mortgage debt (The Ally Term loan has partial recourse back to the parent company).

Later in 2023 the company took a large step to addressing pending maturities through refinancing mortgages covering 49 properties financed by Fannie Mae and Ally Bank. As part of the refinancing, SNDA pushed the maturities for 18 of their community mortgages to December 2026 (the earliest of which was scheduled in July 2024). Another 19 communities with maturities after December 2026 had their maturity dates pushed to December 2028. Fannie deferred or waived any scheduled principal payments on the mortgages for three years and reduced the interest rate by 150bps for a period of 12 months. In exchange, SNDA is required to make two $5m principal payments, the first was made in 2023 and the second is due in June 2024. SNDA is also providing a $10m guarantee through June 29, 2025. To support this refinancing, Fannie supposedly wanted a display of commitment from Conversant, which led SNDA to issue and Equity Commitment Agreement to Conversant for up to $13.5m at $10/share, of which the company has drawn down $10m.

Most recently in 1q24 SNDA entered into a private placement and issued >$45m of stock at $9.50/share. This followed a 60-70% decline in the stock price from where the key participants established their positions at $25-30/share through the initial rights offering. The proceeds were used to 1) buy back the defaulted Protective Life debt at a 52% discount and 2) invest in high-return growth capex projects / M&A opportunities at double-digit stabilized yields, all while eliminating the going concern language. Following the private placement, the stock rallied to >$25/share (closer to the initial cost basis at which many of the key investors participated in the rights offering) and the company has put an ATM in place which has been used to provide capital for SNDA to deploy in M&A/growth opportunities. This should also help with trading liquidity, which will also be boosted by SNDA’s pending addition to the Russell 2000 in June.

Sonida’s current leverage remains optically high at ~12.5x run-rate EBITDA of ~$46m. However, SNDA’s net debt balance of ~$580m (including the ~$50m preferred outstanding) is effectively valued at ~$90k/unit. This compares to industry transactions which have averaged >$200k/unit and bottomed at ~$70k/unit in April 2020. On normalized EBITDA, SNDA would be levered around ~8x through the Preferred. Again, the vast majority of their debt is non-recourse mortgage debt secured by the underlying properties.

Growth Opportunities:

Sonida’s improved balance sheet has put them in a position to play offense in an industry experiencing distress. While margins have begun to recover for the industry, many operators are still struggling to service their debt, especially with record levels of pending maturities. The main lenders to the industry are the agency lenders (Fannie/Freddie) and regional banks. Data from the agency lenders show a high proportion of distress/near-distress, while regional banks have highlighted similar issues (BOK Financial, Regions, Comerica, Cadence, Fifth Third, First Horizon, etc).

Source – Welltower Earnings Presentation

SNDA has already begun to take advantage of fatigued capital providers. In May SNDA acquired a single property in Ohio at a 43% discount to the in-place senior mortgage loan. The transaction was at ~$105k/unit, vs. industry transactions which have averaged ~$200k+ since 2020. SNDA also is finalizing two JV acquisitions which will add 8 properties at <50% of replacement cost and below $120k/unit. This likely represents the beginning of an M&A cycle, and SNDA indicated that depending on the opportunity set, they may pursue a larger equity raise later this year.

Importantly, SNDA feels they have a G&A base that can remain relatively fixed even should they add a considerable number of communities. The company today is still at a point where it is relatively sub-scale (G&A running around ~$30m vs. run-rate revenues of ~$250m, run-rate NOI of ~$67m, and normalized NOI of ~$100m). So long as SNDA can acquire properties at attractive enough valuations, they should be able to de-lever through growth.

Valuation:

SNDA is currently trading at a 7% cap rate based on run-rate NOI, though margins are still below pre-covid levels. If NOI margins were to normalize towards 30-32.5% (vs. pre-covid range of 30-35%) and we give credit for the anticipated benefit of the M&A SNDA has already announced, we would estimate normalized NOI to be ~$94-100m, implying a 9.8-10.4% normalized cap rate. This compares to opportunities SNDA has to deploy capital to acquire properties at low-double digit to mid-teens stabilized cap rates.  

At a 6-7% cap rate on normalized NOI, SNDA would trade for $52-72, or 85-155% above current levels. If SNDA were to reach an occupancy level in the low 90% range with NOI margins equal to the high-end of the pre-covid range (possible given the supply/demand imbalance in the industry), at a 6% cap rate we estimate the stock could trade for >$90/share, roughly a triple from current prices.

Risks:

While Sonida has successfully addressed their near-term balance sheet issues, the next question mark will be the December 2026 Fannie Mae maturities. Fannie has proven to be a highly accommodative lender and in the case that operating performance goes severely backwards, SNDA does always have the option to walk away given the non-recourse nature of the debt.

If margins and occupancy do not continue to improve, SNDA may look to Conversant to provide capital to extend the runway as they did in 2023 through the equity commitment. For the most part the company and Conversant have provided opportunities for other shareholders to participate (the rights offering in 2021, as well as the private placement in 2024 included non-Conversant investors), though in certain instances Conversant has swept value on the margin such as the 2023 equity commitment. Given Conversant likely doesn’t have an unlimited well of capital to draw upon – they have put in >$150m already vs. AUM of ~$1.9bn – there could be opportunities for other shareholders to participate.

Catalyst

Earnings Improvement

Accretive M&A