Nursing Homes: On The Sick List

These Street darlings of the '90s have been laid low

The nursing-home business, once a thriving industry, needs a good dose of intensive care. Just last year, the seven leading publicly owned companies had a market capitalization of $35 billion. Now, they're worth less than $5 billion. Some may not survive.

In the past few weeks, trading in Vencor Inc., the country's sixth-largest nursing-home operator, has been suspended by the New York Stock Exchange. One of the reasons, says the NYSE, is that Vencor's restructuring will leave its stock with "little, if any, value." The stock of the second-largest nursing-home operator, Sun Healthcare Group Inc., will be suspended by the NYSE next week for failing to meet financial requirements. Although it has been spending money on the construction of a corporate office building, Sun recorded losses of over $700 million in 1998, precipitating significant corporate layoffs. Meanwhile, Mariner Post-Acute Network Inc., with $2 billion in revenues, "could be headed for possible bankruptcy," according to Andrew A. Gitkin, a PaineWebber analyst. Mariner does not comment on rumors, says a spokesperson.

LOOPHOLE. The companies' stocks reflect the carnage. Most are down over 90% in the past year, with some issues trading below 75 cents. Losses for the group during the first quarter of calendar 1999 were about $160 million. Losses are expected only to get worse over the next few quarters.

How did these companies end up in such shambles? In the early 1990s, this least glamorous of industries, which represents 8% of the health-care industry, stumbled on what Wall Street saw as a bonanza. As cash-strapped hospitals began sending their sicker patients to nursing homes, operators of those facilities turned to a Medicare loophole unique to nursing homes. In effect, there were no reimbursement caps on treatments such as respiratory, physical, and occupational therapies. So when it was discovered that "rehab" or "ancillary" services could produce 30% margins, Wall Street jumped on the sector, producing a spate of initial public offerings. In 1993, right-out-of-the-box offerings were quickly trading at 20 times earnings.

In that lush environment, says Daniel E. Straus, former CEO of Multicare Cos., a chain of nursing homes sold to Genesis Health Ventures at the industry's peak, "a lot of nursing homes bet the ranch by leveraging up." Lured by the rich margins, nursing homes became hot properties.

But the timing couldn't have been worse. To cut soaring costs, Medicare instituted a new policy consisting of a daily price cap that in one fell swoop wiped out rehab margins by at least 50%. The blow to the public nursing home companies was catastrophic. "I've never seen an industry hit the wall so quickly," says Straus.

The impact on the privately owned nursing homes, some 80% of the industry, appears to be much less severe. Most mom-and-pop operations and not-for-profits tended to avoid the "rehab" game.

"OBSCENE" MARGINS. Today, the public companies are busy instituting big cost cuts--but they may not come soon or deep enough. Sun, Vencor, and Mariner are scrambling to renegotiate their debt payments. But the clock is ticking. Sun defaulted on its debt in May, Vencor missed rent payments in May, and Mariner violated bank covenants during their most recent quarter. Large restructurings are expected to be announced shortly.

Industry officials blame the government, as do some on Wall Street. The government has "devastated" the nursing-home industry, says David Tepper, president of Appaloosa, a $1.5 billion value-oriented fund based in Chatam, N.J. Says another health-care analyst, who asked not to be named: "The government beat these companies up. Eventually, they will just have to hand their keys over to the government."

But some experts blame greed in the industry, complaining that rehab services were merely a device to gouge the government. "Those margins should never have existed in the first place," says Straus. "The prices they were charging were obscene and in certain instances flew in the face of the intent of Medicare's program. It abused the system."

Ironically, companies that refused to exploit the loophole were punished by Wall Street. Says Boyd W. Hendrickson, CEO of Beverly Enterprises Inc., the largest nursing-home company in the country: "We did it differently than our competitors, who indicated they would pay whatever they had to to buy a nursing-home bed in order to market ancillary products.... [People] didn't care what they had to pay." Not surprisingly, Beverly's earnings multiple was only about 12 in 1996, only about half that of its competitors.

But now, the high-priced acquisitions and other excesses are coming back to haunt the industry. And it wasn't just nursing-home operators that misstepped; even savvy Wall Streeters got burnt. Apollo Advisors, a leveraged-buyout firm, got into the market at the worse possible moment, merging three nursing-home companies within two years with a debt-to-capital ratio of over 90%.

"They made a big bet in the sector right before the sky came crashing down," says Gitkin. "They combined three companies together--two of which were very questionable... The sum of the three parts actually equalled zero."

The nursing-home game has also featured examples of lavish compensation. Take Robert N. Elkins, chief executive and founder of Integrated Health, whose stock has tumbled 78% since June, 1997. That year, he made over $14 million in compensation, a Lou Gerstner-type pay package--but without the performance. Elkins still gets corporate loans to buy stock which he doesn't need to pay back if he stays on for five years. And 50% of his annual bonus is paid in advance each year. To top it off, he has a separate retirement trust to which Integrated must make "irrevocable" payments, so that by 2001 the trust will hold $23.9 million. Elkins refused to be interviewed for this article.

"Integrated looks like a company out of control," says compensation expert Alan Johnson, managing director of Johnson Associates Inc. in New York. "The company's financial problems, he helped create. It seemed like he tried to find every conceivable way to figure out how to pay himself."

Not all nursing-home companies have such bleak stories. Those that stayed away from towering leverage and the rehab businesses, such as HCR Manor Care Inc. and Beverly, are in the best shape today. But the going will be tough for the others. "The government has basically eliminated the get-quick-rich games," says Andre C. Demitriadis, CEO of LTC Properties Inc., a health-care real estate trust.

But there could be a ray of relief after this generally sorry story. The reason: demographics. The cohorts of individuals 65 and older are expected to grow to 79 million by the year 2050, compared to about 34 million today.

STILL A VALUE? Some nursing-home investors are now poised to help revitalize the industry. Joseph K. Piper, a partner with Seattle-based venture-capital fund Integra Bio-Health, which specializes in investments in the health-care industry, sees a new chapter for nursing homes.

"We're looking for entrepreneurs who have a fresh view of how nursing-home services can be provided," says Piper. He hopes to create nursing homes that are smaller and homier. And through better technology, operators will spend less time on paper work and more time with patients. "For the dollar spent, nursing homes are still a very good value," says Piper. "It's a fantastic industry," adds Straus.

Maybe. But meanwhile, the industry needs a heavy dose of rehab.

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