Housing for Elderly Targeted After Top Premium: Real M&A

The takeover of Sunrise Senior Living Inc. at the biggest premium ever paid for an operator of homes for the elderly is turning companies from Brookdale Senior Living Inc. to Emeritus Corp. into the next targets.

Brookdale, the industry’s largest company with a market value of $2.7 billion, has the group’s lowest valuation relative to cash flow, and its operating margin is projected to reach a record high next quarter, according to data compiled by Bloomberg. Emeritus, the second-biggest, fell last month to the cheapest price since 2005 versus the cash it generates.

Occupancy rates at senior communities are rising, and real estate investment trusts are vying for deals because the properties are undervalued, Stifel Financial Corp. said. Health Care REIT Inc. agreed in August to pay an 87 percent premium for Sunrise, the highest ever for a retirement or senior-care center, data compiled by Bloomberg show. Royal Bank of Canada said suitors may now evaluate Brookdale, while JMP Group Inc. sees Emeritus and Capital Senior Living Corp. as likely targets.

Health-care REITS “have demonstrated a strong interest in senior housing,” Jeffrey Kolitch, New York-based manager of the Baron Real Estate Fund at Baron Capital Inc., which oversees $17 billion, said in a telephone interview. “We are in the early stages of a cyclical recovery. Many of the public senior housing operators, such as Brookdale Senior Living, Capital Senior Living and Emeritus, trade at meaningful discounts. Further consolidation in the senior housing industry is a strong possibility.”

Underlying Value

The Baron Real Estate Fund has outperformed 99 percent of rival funds in the past year, data compiled by Bloomberg show. The firm owned shares of Brookdale, Capital Senior, Emeritus and Sunrise as of June 30, the data show.

Ross Roadman, a spokesman for Brentwood, Tennessee-based Brookdale, didn’t return a phone call seeking comment. Sari Martin, a spokeswoman for Seattle-based Emeritus, declined to comment on whether the company has been approached by potential suitors or would consider a sale.

“The acquisition of Sunrise Senior Living brought to the attention of many investors the value of the underlying real estate in the senior living industry,” Ralph Beattie, chief financial officer at Dallas-based Capital Senior, wrote in an e-mail. “While I cannot comment regarding any confidential discussions that may have taken place, I can say that CSU remains committed to increasing value for all of our shareholders. Our interests are fully aligned and we have an excellent Board that will always serve our shareholders by professionally discharging their fiduciary duty.”

Higher Occupancy

The number of residents living in senior-housing communities is on the rise, buoying the revenue and profit outlook for the center operators, said Daniel Bernstein, a Baltimore-based analyst with Stifel.

With higher occupancy rates, “you start to see the ability to raise monthly rental rates to residents,” he said in a phone interview. “They’re starting to approach 90 percent. You’re going to see some accelerating rent growth.”

The average occupancy rate for U.S. senior-housing properties in the second quarter increased for a ninth straight period to 88.6 percent, as the pace of annual rent growth reached its highest level since 2009, according to data from the National Investment Center for the Seniors Housing & Care Industry.

Brookdale’s revenue is projected to surge to a record this year and next, and the business is expected to post a net profit for the first time in 2013, analysts’ estimates compiled by Bloomberg show. Emeritus and Capital Senior may also draw record sales next year.

‘Opportunistic Time’

“The industry looks to improve and it’s creating an opportunistic time to buy,” Peter Martin, a San Francisco-based analyst with JMP, said in a phone interview.

Health Care REIT, the industry’s third-largest company by market value, agreed last month to buy McLean, Virginia-based Sunrise for about $845 million to expand its assisted-living communities. The number of residents aged 65 and over will increase 79 percent through 2030, Health Care REIT said in a regulatory filing, citing Census Bureau data.

The $14.50-a-share cash offer was 87 percent more than Sunrise’s average stock price in the prior 20 days, according to data compiled by Bloomberg. That’s the highest premium a buyer has ever paid for a retirement or senior-care center operator, and more than double the average of 35 percent, the data show.

‘Improving Fundamentals’

Brookdale’s undervalued stock and attractive properties could lure suitors, said Frank Morgan, a Brentwood-based analyst with RBC. Brookdale, which runs 647 senior-living communities, was the largest U.S. operator based on capacity at the end of 2011, according to its annual report.

The stock traded yesterday at 10 times estimated cash flow for this year, a lower multiple than Emeritus and Capital Senior, data compiled by Bloomberg show. Analysts estimate Brookdale will boost its operating margin in the fourth quarter to a record, earning 5.8 cents on every dollar of sales.

“Brookdale’s stock price doesn’t really reflect the improving fundamentals,” Morgan said in a phone interview. Given the interest in Sunrise, “it should not come as a surprise to anyone that investors have also connected the dots for Brookdale as at least another candidate. It generates a lot of cash flow.”

Today, shares of Brookdale rose 6 percent to $23.39, the largest increase in more than a month and the second-biggest gain in the Russell 1000 Health Care Index.

Brookdale Chief Executive Officer Bill Sheriff said on Aug. 9 that he’s planning to retire and will remain at the helm until a successor is named. Some investors may view the change as potentially paving the way for a deal, Morgan said.

Private Equity

Fortress Investment Group LLC, a New York-based private-equity firm, acquired Brookdale in 2000 and took the company public five years later. The firm is still Brookdale’s largest shareholder with about a 14 percent stake. Gordon Runte, a spokesman for the firm, declined to comment on its plans for the Brookdale stake.

Emeritus and Capital Senior are even more appealing takeover candidates because they are smaller than Brookdale and own a large proportion of their properties, said JMP’s Martin. Emeritus, with a market capitalization of $944 million yesterday, and Capital Senior, at $409 million, each own almost 40 percent of the communities they manage, according to their annual reports.

Both companies are too small to make significant acquisitions on their own, and the premiums REITs are willing to pay would be enticing, Martin said.

On Aug. 1, Emeritus’ stock slipped to 7.5 times the value of its free cash flow for the last 12 months, the lowest ratio since Sept. 2005, according to data compiled by Bloomberg.

‘Best Decision’

The value of the company’s net assets is about $26 a share, Martin estimates. Emeritus shares ended yesterday at $20.95.

Capital Senior, which considered a possible sale in 2008, has a net asset value of about $20 a share, according to Martin, 38 percent higher than yesterday’s closing price.

“The best decision for their shareholders would be to sell to a REIT to deliver the most value to shareholders,” he said.

Today, shares of Emeritus increased 2.2 percent to $21.40, while Capital Senior rose 1 percent to $14.67, the highest closing price since 1999.

Still, Brookdale shares had already gained 69 percent in the past year through yesterday, while Emeritus had appreciated 45 percent and Capital Senior’s stock more than doubled. Analysts are projecting all three will continue climbing in the next year even without a sale, estimates compiled by Bloomberg show.

Property Trusts

Stifel’s Bernstein says buyers might include HCP Inc., Ventas Inc. or even Health Care REIT, which announced its deal for Sunrise on Aug. 22. The three potential suitors are organized as REITs, and their market values, ranging from $15 billion to $19 billion, dwarf Brookdale and the rest of the senior-housing companies.

REITs develop and own everything from warehouses to skyscrapers and assisted-living homes. The property trusts can avoid paying corporate taxes in the U.S. when they distribute at least 90 percent of their net income as dividends.

The possible acquirers all have low capital costs and good cash-flow generation, which would help fund a transaction, Bernstein said.

A spokesman at Health Care REIT in Toledo, Ohio, declined to comment. Representatives for Long Beach, California-based HCP and Chicago-based Ventas didn’t respond to e-mail or phone messages.

HCP, Ventas or Health Care REIT may prefer to purchase specific assets of the remaining publicly traded senior-living operators, rather than the entire corporations, according to Bernstein.

“There’s still a lot of real estate to be consolidated out of the public senior-housing operators, whether we see another outright sale of a company or not,” he said. “But the takeover of Sunrise certainly opens that door.”

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