Expanding Care Needs Benefit Brookdale Senior Living


The aging of America has created huge market opportunities for the retirement industry in recent years, but owners of long-term care facilities haven't had an easy time translating the trend into profits.

Brookdale Senior Living ( BKD ), t he country's largest operator of senior housing, hasn't seen one year of net income since going public in 2005. But a marquee deal, a thriving new business segment and the housing recovery are coming together to persuade investors that the company is well poised to take advantage of the burgeoning market.

In February, the Brentwood, Tenn.-based company announced it would acquire competitorEmeritus ( ESC ) in a deal valued at $2.8 billion, including $1.4 billion in mortgage debt. The transaction is expected to close in the third quarter.

It is the latest in a string of acquisitions for Brookdale, which has a history of successfully absorbing rivals. If the merger goes through, 6.5 million people 80 years or older will live within 10 miles of a Brookdale community, according to the company, solidifying its position as the largest player in the industry.

Merger Effects

The purchase of Emeritus is expected to generate synergies and earnings accretion for Brookdale, plus more real estate -- assets that can be turned into cash. Management sees the merger as 50 cents per share accretive to cash from facility operations by the third year.

"Emeritus looked like it had been trading below the fair value of its real estate alone, so it was probably ripe for some potential suitor," said Stephens analyst Dana Hambly. "In retrospect, this makes a lot of sense, and probably no other operator would be able pull it off."

The combined firm will operate more than 112,000 units and own about a third of them. Roughly half are assisted-living facilities. The rest are independent-living homes; Alzheimer's, dementia and memory-care centers; and nursing homes.

Most such living arrangements tend to be paid for by the residents or their families, as opposed to Medicare or private insurance. In 2013, 80% of Brookdale's resident-fee revenues came from private-pay customers. Its average monthly revenue per unit rose 2.6% to $4,383 from $4,271 a year earlier.

Brookdale said in April that as part of the merger with Emeritus, it will partner with health care real estate investment trustHCP ( HCP ) on a $1.2 billion joint venture that will own and operate 14 sites.

Brookdale's revenue grew 4.9% year over year in the first quarter to $747.3 million, slightly above the consensus $746.8 million expected by analysts polled by Thomson Reuters. However, the company incurred a loss of two cents per share, even though analysts had forecast a six-cent profit. The loss followed year-ago earnings per share of 3 cents.

On a conference call with analysts May 8 to discuss first-quarter results, Brookdale CEO T. Andrew Smith cited an impact from "extraordinary" weather-related costs.

"We believe that the prolonged, severe winter across much of the country had a material impact on our first-quarter occupancy," he said.

Regional Winter Woes

Occupancy at Brookdale's Florida communities increased sequentially, California was flat, and Texas was down slightly. "The Midwest and Northeast, however, fared much worse, with certain regions experiencing sequential declines of 100 to 200 basis points quarter to quarter," Smith said.

Brookdale's first-quarter results were in line with the company's internal expectations and its full-year guidance, he notes.

Cash flow from operations (CFFO), ex items, came in at 64 cents a share for the quarter, up 13% from a year earlier and, Smith said on the call, representing the third straight quarter of double-digit CFFO growth.

Many trends influence the senior housing and care industries. Americans are living longer even as they cope with multiple chronic illnesses, driving demand for residential care. At the same time, facilities are becoming more comfortable and sophisticated, helping the industry gain credibility with consumers.

Amenities Aplenty

Meanwhile, independent or continuing-care living communities have become a viable retirement-planning option for seniors seeking a supportive environment where they can live in their own homes but have ready access to upkeep, health care and meal services.

Brookdale faces competition from other operators of senior housing -- many of which are also adding perks such as personal fitness coaches and on-site culinary schools to attract wealthy seniors.

But while many of its rivals run their homes like hotel portfolios, Brookdale has long viewed itself as a health care company.

Rather than outsource outpatient therapy, home health services or "post-acute" care for patients recovering from surgery, Brookdale has embraced the full spectrum of care, steadily building its capabilities and even marketing those services outside of its walls -- to other senior living communities and independent seniors.

"They have historically operated continuing-care retirement communities, and a portion of their business has always been skilled nursing care. It's in their DNA," said RBC Capital Markets analyst Frank G. Morgan. "That's something most others don't really get."

Such "ancillary" services currently represent less than 10% of Brookdale's revenue, but they offer a better return on capital and are growing faster than any other business segment at the company.

The model also presents other benefits. According to Morgan, such services could have a positive effect on the length of customer stay because they can improve the independence of residents, allowing them to live in a Brookdale community longer before requiring a higher level of care.

Brookdale is the largest company by market cap in IBD's Medical-Long Term Care industry group, followed by Emeritus,Kindred Healthcare ( KND ) andEnsign Group ( ENSG ). The group ranks No. 16 of the 197 that IBD tracks.

Bets on senior living facilities are not without risks. Government subsidy cuts are real challenges for the nursing home segment, and researchers predict little or no growth on that front in the near future.

However, Brookdale's reliance on private-pay customers means it faces minimal exposure to reimbursement from Medicare or Medicaid. Also, with government health care reform aiming to contain taxpayer costs partly by encouraging home care, Brookdale's ancillary-services strategy bodes well for the company's bottom line.

The economy is another risk factor. The recession and the housing crisis hit retirement communities hard. Some potential residents couldn't move in because of difficulties selling their prior homes or getting enough money for them.

Some senior housing construction projects were canceled or went bankrupt. Developments are now recovering, and occupancy rates at Brookdale and elsewhere are approaching 90%.

Aging Ahead

People age 75 and over are expected to represent 12% of the population by 2030, compared with just 6% in 2012, according to the U.S. Census Bureau.

But Bruce Carlson, publisher of Kalorama Information, a market research firm, notes that the number of people who will actually need a group home is not as boundless as some predict. A recent Census Bureau report put the number of people who need help with one or more daily activities at 15 million.

"With about 4 million in institutional care, you've got 26% of the potential, and then if you add the 3.5 million who get home care, that's closer to 50% of the likely market served," Carlson said in an email. "The true growth metric, of course, would be the growth of the pool of the 65+ population and the growth of the 80+ population, which will drive this market well into the future."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas

Referenced Stocks: BKD , ESC , HCP , KND , ENSG

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