Fran Kirley has impeccable timing. A former executive vice president at Integrated Health Services, Kirley left his job last November, soon after two national nursing home companies filed for bankruptcy protection in the wake of sweeping changes to Medicare payments for skilled nursing. A few months later, Sparks, Md.-based IHS followed suit, citing the same payment squeeze.
But by then, Kirley was hard at work on his next project. In March, he and two other ex-IHS employees founded a nursing home start-up, just in time to make the most of the sectorwide shake-up.
"I think we're in a valley right now in terms of the industry," he says, talking from a mobile phone in rural Indiana, where he's investigating possible acquisitions. "Demand (for buyers) has been greater than we expected."
Kirley says he's talking to several real estate owners and regional operators that want someone to take over the operations of their nursing homes, and quickly.
Triumph Health, which operates out of Kirley's home in Sykesville, Md., doesn't own any nursing homes yet, and hasn't bagged the $25 million in venture capital it needs to get started. But things are moving fast, Kirley says. By mid-June, the financing should be in place and the firm will make a round of acquisitions toward its first-year target of 40 buildings, Kirley says.
From the ashes. Triumph is a recent addition to the small but growing number of start-ups with plans to rebuild from the rubble of the financially ruined nursing home industry.
Nursing homes generally don't attract venture capital. They're not new, they're not sexy and few would argue that the industry's not in a tailspin. But that's exactly what's attracting private investors and investment banks to the industry.
"It has all the ingredients of an industry in turmoil. Anytime any sector is in turmoil you have contrarian people who look for value," says William Mulligan, a Milwaukee-based senior vice president at B.C. Ziegler and Co., a healthcare investment banking firm.
From March 1998 to December 1999, the value of the public nursing home industry fell 83%, from $13.4 billion to $2.3 billion, according to Charles Lynch, a New York-based healthcare analyst at CIBC World Markets. "The implications are fairly profound, in the sense of capital flowing to the industry," he says.
But Mulligan and others say there's still some money out there if you know where to look.
In the 1990s, nursing homes needed to look no further than the public markets, which funded massive consolidation and expansion by the top companies. Driving that growth was the cost-based reimbursement Medicare provided for subacute care. As hospitals discharged patients ever more quickly, nursing homes stepped in to take more and more patients needing complex medical care. Medicare paid liberally for such care, so firms borrowed and bought facilities to add bulk and Medicare patients with little attention to keeping down costs.
It was what some have called a loophole of giant proportions.
But the introduction of a prospective payment system for skilled-nursing facilities in July 1998 turned the loophole into a noose for the long-term-care chains that had exploited it.
Strangled by the combination of deep debt and suddenly lower payments, four chains went bankrupt in rapid succession: first Vencor, then Sun Healthcare Group, Mariner Post-Acute Network and Integrated Health Services. Last month, a fifth chain, Genesis Health Ventures, defaulted on its interest payments and announced it was initiating restructuring talks with lenders. Other smaller nursing homes chains--including Lenox Healthcare, the Frontier Group and Texas Health Enterprises--also filed for bankruptcy protection in recent months.
Many of those bankruptcies were precipitated by the inability to make good on debt accumulated from acquisitions.
"Every nursing home purchase made in '97 and '98 in retrospect was bad," says Rob Mains, an analyst for Advest, a Saratoga Springs, N.Y.-based investment analysis firm. Today, he says, there's an "extreme influx of supply at a time when financing to support demand is running dry."
Slimming down. As the chains work through their financial restructurings, many plan to sell some facilities and drop leases on others as they slim down to a more manageable size.
Small-scale regional operators, for their part, reportedly have found the rules for the new PPS cumbersome and complex. Add to that the severe labor shortage and escalating regulatory pressures and many of them have decided to get out of the business before it's too late.
"The industry is kind of forced to go back to its real estate roots," says Lynch. "At the end of the day (nursing homes are) a bare-bones business with slim margins, massive labor shortages and regulations."
Margins are especially slim in the public sector, he says. Nursing homes now earn 90 cents before interest and rent for every dollar they owe on those fixed costs, compared with $1.90 earned for every dollar owed in 1998.
The result: large chains downsizing and small operators selling out to mid-sized regional operators. And private money is facilitating the makeover.
The most obvious evidence of the influx of new capital to the industry is the pending privatization of two publicly traded nursing home chains. Both companies escaped the heavy financial losses that have typified the public industry in the past year, but neither could avoid the industrywide erosion of stock prices.
First to go is Centennial Healthcare, which by May 1 will be taken private by private equity firm E.M. Warburg, Pincus & Co. The buyout of the Atlanta-based company's 100 nursing homes is valued at about $65.5 million, and is expected to be completed even though the company is under investigation by HHS' inspector general's office for possibly fraudulent Medicare labor cost allocations.
When the deal was announced, Centennial's chief financial officer, Alan Dahl, said that as a private company Centennial would use some of its newfound access to capital to be a consolidator in the industry.
A privatization effort is also in the cards for Manor Care, the industry's best performing public company. The Toledo, Ohio-based company, which operates about 300 nursing homes, is considering a buyout offer by management. No details have been disclosed.
Capital is also available to young start-ups, so long as they've got experience on their side.
"To even be in the game you have to have a credible management team, people who have done it before in other settings," Mulligan says.
"Secondarily, 25% to 30% equity is now generally the norm that senior lenders are looking for. That's a lot more equity than they would have looked for two to three years ago."
Lenders are also demanding more security, higher coverage and shorter-term commitments, he says, all of which can make it difficult for some to get financing.
Tandem Health Care, based in Moon Township, Pa., is one new firm that has won private equity backing. Chairman and CEO Larry Deering founded the company in April 1997 after leaving Mariner Health Group shortly before that company expanded rapidly into contract therapy.
Tandem completed its first deal in March 1998 after raising $30 million in equity capital from N.Y. investment bank Behrman Capital. Tandem operates 45 facilities in six states, which generate about $200 million in revenue.
Bargain hunting. Deering says that the industry's financial upheaval is creating opportunities for companies like his. Last year, the firm bought six Florida nursing homes from Milwaukee-based Extendicare Health Services for $40.5 million. At $53,000 per bed, the facilities were pricier than the average, which last year didn't fall as many had thought it would. In fact buyers typically paid about $40,700 per bed in 1999, almost the same as the average price in 1997, according to a report by New Canaan, Conn.-based Irving Levin Associates.
"The reason it didn't go down is because the quality of the facilities sold went up. They were a little bit newer, a little bit more profitable," says Stephen Monroe, who edits the report. "Buyers were less interested in the dogs, and lenders were choosier. This year, there is a reasonable possibility that prices will stay flat again," he predicts.
Still, Deering says he's paying a lower multiple--five or six times cash flow--than had been the norm a few years ago, and money thus saved can be used to improve quality.
"You will see the care improve and there will be money going into improvements in the facilities," he says. Private regional operators will operate facilities on an individual basis, avoiding "the cookie-cutter approach that public companies had to have because they were growing so fast," he says.
Tandem's watchword is decentralization, with three regional divisions in Ohio, Pennsylvania and Virginia. "We believe that these are very local businesses, and every facility is a stand-alone business with its own personality," he says. "You have to operate each and every facility extremely well."
Gregory Stapley is vice president and general counsel of the Ensign Group, a San Juan Capistrano, Calif.-based start-up founded in May 1999 by long-term-care veteran Roy Christensen, who also founded Beverly Enterprises.
The firm, funded by private investors, operates eight facilities in Arizona, California, Texas and Washington, and generates about $25 million in revenue, Stapley says. Most of the Ensign Group's purchases have been of facilities operated by financially troubled chains.
By May 31, the company expects to close a $1.3 million purchase of a Mariner Post-Acute Network facility in Phoenix.
Eliminating middlemen. Like Tandem, the Ensign Group is big on being a low-cost operation. So much so that, Stapley says, "We don't operate as a chain. There is no middle management. We put highly qualified individuals in leadership spots at the facilities. Quality control is most effectively achieved at the facility level."
Corporate headquarters acts as a "resource center," he says, housing all the accounting, human resources, legal backup, financing and overall operational leadership. Facility administrators, whose salary packages are tied to the financial performances of their facilities, have a vested interest in keeping costs down.
Triumph's Kirley says he doesn't plan to bargain hunt at bankruptcy sales.
"One reason we're not looking at the larger organizations is that they are not going to sell the good ones," he says. Instead, Triumph is looking at regional and small-scale operators in the Midwest, Southwest and Mid-Atlantic, many of which want to get out of the business because "the complexities of managing under PPS is more than they want to do."
Like the other start-ups, though, Kirley says he intends to avoid creating a top-heavy corporate structure. Many functions such as human resources and computer services that the large chains typically keep in-house will be outsourced.
Kirley says his facilities will also cater to a different type of patient. "I think you are seeing people move away from the high-end acuity patients. That's what we're doing--the middle acuity."
That clinical shift comes as no surprise. Medicare reimbursement for subacute patients has fallen with the new payment system. With reimbursement rates down, new operators can be expected to use the facilities less for the subacute purposes for which many of the new ones were built, and more for the custodial purposes that were more common a decade ago, according to Advest analyst Mains.
"It's a little bit like using a stretch limousine for a school bus," he says.
"It's an adage in healthcare that form follows funding," agrees David O'Malley, a principal with Legg Mason Wood Walker, a Baltimore-based investment bank which has worked with Tandem and Triumph to secure financing.
Turning up the volume. O'Malley says the nursing home market is heating up. "Going into 2000, I would imagine that transaction volumes will go up and valuation levels will go down."
Others are less certain.
"I'm not sure that we will see the flood of transactions that we thought we were going to see," Mulligan says. Because the large companies in bankruptcies lease, rather than own, most of their properties, "there is not a lot of assets these companies can sell. And if the goal is to come out as a restructured company, the senior creditors are going to want to preserve the high-quality assets," he says.
Still, a large number of facilities may change hands because the real estate investment trusts that own the properties will be looking for new tenants and in some cases new owners, he adds.
Hospitals should be on the lookout for facilities in their communities that are owned by the big chains, Mulligan says. Although he expects them to close about 1% to 2% of their portfolios, a much larger proportion could go up for sale.
"If I were a hospital and did not have a skilled-nursing center, I would take a pretty hard look at who owns the centers in my market," he says.
Despite the drop in Medicare reimbursement, it's still cheaper to take care of a subacute patient in a skilled-nursing facility than in a hospital setting, he adds. "I still would want to have a quality nursing home in my system, especially as affordable as they are now," Mulligan says.