Post-acute-care company Integrated Health Services has created a private management company and will use the services of a newly formed real estate investment trust in an effort to reduce its $3.3 billion debt load.
The REIT, Monarch Properties, plans to buy 44 of the current IHS facilities. Robert Elkins, M.D., IHS' chairman and chief executive officer, will be the REIT's chairman. Elkins, 54, is IHS' largest individual shareholder with a 7.6% stake in the company (May 4, p. 16).
In addition, IHS will use Lyric Health Care, a privately held company owned on a 50-50 basis by IHS and current IHS board member Timothy Nicholson, to manage the facilities. Lyric was created in February and is run by Nicholson, who serves as its managing director. He was executive vice president of IHS from 1986 to 1993. Nicholson owns 1.2% of IHS' stock.
Owings Mills, Md.-based IHS, with nearly $2 billion in annual revenues and more than 2,000 post-acute facilities in 48 states, is the nation's largest post-acute-care company.
Rather than sell facilities to an-other REIT, which would mean the company would lose control of the assets, IHS has chosen the Monarch-Lyric structure.
In a deal announced in April, IHS said it plans to initially sell 44 long-term-care facilities to Monarch for $371 million in cash. Monarch, based in Naples, Fla., will lease the facilities to Lyric. In return, Lyric will get undisclosed fees to manage the facilities using IHS employees already familiar with their operations.
"The structure is designed to sell the facilities to obtain cash and pay down debt," says Marc Levin, IHS executive vice president.
The companies acknowledge conflicts in the arrangement. A statement on the creation of Monarch, filed April 27 with the Securities and Exchange Commission, reads: "Several conflicts of interest exist between the company and its directors and officers, IHS and its directors and officers, and Lyric and its directors and officers."
IHS executives wouldn't comment on how they plan to address those conflicts, but they said the arrangement is legally sound.
To eliminate one possible conflict of interest, Elkins resigned in April as a board member at Capstone Capital Corp., a Birmingham, Ala.-based healthcare REIT that owns healthcare properties including some IHS facilities. Elkins also owned more than 57,000 Capstone shares, according to Capstone's proxy filed with the SEC.
Like other long-term-care companies that have created REITs in the past six months, IHS is attempting to eliminate assets from the operating company's balance sheet and boost the stock price.
At least two other long-term-care companies have created REITs and then arranged sale-leasebacks of the facilities. Louisville, Ky.-based Vencor spun off its physical assets into a separate, publicly traded REIT, Ventas. About six months ago, Kennett Square, Pa.-based Genesis Health Ventures created the REIT ElderTrust.
Wall Street analysts believe IHS' debt has been impeding the company's growth and aggravating its bankers.
"IHS ended 1997 as a highly leveraged company and needed to either sell some noncore assets or do something like this," says Charles Lynch, an analyst with Schroder & Co. in New York.
He says IHS didn't have enough cash flow to pay down its debt.
"At the levels of debt they were at, they were fairly strapped," Lynch says. "They were very aggressive (with acquisitions) last year. That's good, but investors wanted them to address their debt load."
As of March 31, the end of IHS' first quarter, the company had a debt-to-capital ratio of 74%. Analysts say they are more comfortable with debt-to-capital ratio of 50% or less.
IHS drew a critical look earlier this year from Standard & Poor's, which lowered the company's corporate credit and bank loan ratings to B+ from BB- after the company com-pleted acquisitions of long-term-care centers from HealthSouth Corp. in January. IHS acquired the facilities for $1.2 billion in cash and the assumption of $100 million in debt (Jan. 19, p. 24).
IHS said its new structure will lower its debt-to-capital ratio significantly as more facilities are sold to Monarch.
"Our target is to get it down to 60% to 62% by the end of this year and to 50% to 52% by the end of 1999," Levin says.
One advantage of the Monarch structure is that it will allow IHS to expand operations without incurring additional debt. "Monarch could go out and make new acquisitions and lease the operations to IHS," Lynch says. "That would be new business to IHS. It's as if they had a salesperson out there."
REITs offer tax advantages unavailable to other corporations. For example, they don't pay federal taxes on income distributed to shareholders.
Monarch is expected to acquire even more IHS properties in the future.
"There will be additional sales of our nursing homes to (Monarch)," Levin says. "There could be sales to other REITs as well."