The CLTC 50-plus.

Nursing chains hunkered down while assisted living forged ahead

Call 1998 a tale of two sectors.

Among nursing home chains, two new powerhouses resulted from mergers: HCR Manor Care and Mariner Post-Acute Network. But more chains were selling off assets than buying them. Nearly half of the top 10--Beverly Enterprises, Sun Healthcare Group, Vencor, and Genesis Health Ventures--posted declines in bed counts. And Integrated Health Services. Life Care Centers of America, and Extendicare Health Services grew by a scant 2, 3, and 4 percent. respectively.

Meanwhile, the leading assisted living companies continued to execute on their development plans despite the tightening of capital markets. Companies in this emerging industry continued to jockey for the lead positions, with contenders like CareMatrix and Advocat vaulting into our top 10 for the first time.

If the growth of nursing home chains was sluggish in 1998, expect it to be positively glacial in 1999. Most of the industry's 800-pound gorillas were knocked on their keisters by a prospective payment system that rendered their subacute business unprofitable, wreaked havoc on their contract therapy businesses, and prompted them to exit the home health field. That, plus government investigations and a barrage of bad press on everything from the dumping of Medicaid patients to resident abuse, tarnished the industry so badly in the eyes of Wall Street that stocks once in the $20 range now languish at $2-and the sector's dismal fourth quarter (see "Sniff SNF") is not likely to change Wall Street's mind anytime soon. And assisted livings gain has been skilled nursing's loss, as consumers opt for help with ADLs in a less hospital-like setting.

For the near term, therefore, expect nursing home chains to keep pruning their portfolios. "The last 12 months has already seen some de-consolidation, selected asset divestitures." notes one analyst. "Companies are determining what's strategic and non-strategic geographically."

To achieve bottom line growth, chains are "cutting a lot of costs, getting rid of a lot of overhead. creating much leaner organizations," says Richard Lee, an analyst with Hambrecht & Quist. 'If you can work on cost structure, you can increase profitability."

One way they're doing that is by downsizing their contract therapy services. Sun just laid off 4.000 therapists, and Vencor's respiratory therapy business has suffered a dramatic decline in contracts and in absolute revenues.

In addition, chains are deemphasizing their subacute business. Whereas they once sought high-acuity residents, "now the high-acuity people are money losers," Lee says. "So they have to be very selective about which patients they enroll. It may result in a declining top line, but they could be more profitable."

Home health is another area that has been plagued with problems, due to a pending PPS system of its own. 'The reimbursement is such that most want to get out," notes analyst James Kumpel of Raymond James & Associates, "Integrated recently sold off its home health operations. Vencor is out of home health." On the other hand, National HealthCare Corporation launched a home care program last year.

While the difficulties associated with transitioning to prospective payment might be expected to fall hardest on the small chains, leading to acquisition opportunities for the big chains, most companies with under 1,000 beds don't have much Medicare exposure. And for those that need to bail out, the currency of the public companies is so far down and their debt burden so great that it will likely be a year or two before they become acquisitive again.

With nursing home stocks so badly beaten up and the fear of overbuilding and possible government regulation in assisted living, nobody's talking about going public. The last initial public offering in the sector, Grand Court Lifestyles, occurred more than a year ago. "You need 7,000 to 8,000 units before thinking about going public," says NationsBank Montgomery Securities analyst Scott Estes, "In the past, the threshold was as low as 2,000 to 3,000." Centennial, was announced last October and is expected to close in April.

Instead, there is much speculation as to which public companies may go private. Mariner. Genesis, and Vencor have all been mentioned as candidates, and Integrated Health Services recently surprised Wall Street by confirming that it was having discussions with financial organizations interested in a leveraged buyout. Harborside Healthcare was taken private last year by Iovestcorp, and Centennial Healthcare Corporation is on the verge of being taken private by Welsh Carson Anderson and Stowe. The deal, which will allow Centennial to grow 'without the pressure of being microanalyzed," according to Alan Cosby, vice president of marketing for the Atlanta-based Centennial, was announced last October and is expected to close in April.

The same phenomenon has been going on in assisted living. Lazard Frere's Real Estate Investors took Kapson Senior Quarters and Atria Communities private early last year.

The poor performance of many stocks may fuel consolidation among assisted living chains. At last falls National Investment Center for the Seniors Housing and Care Industries' conference, panelists agreed that, of the then publicly traded assisted living companies, roughly half would be gone by the end of 1999.

Market saturation continues to be a problem for the assisted living companies, especially in markets with appealing demographics. "Bumping up in the same market will be inevitable," says Kumpel. "CareMatrix and Atria Senior Quarters do. Sunrise and Marriott run into each other a fair amount; Brookdale and Hyatt Classic Residence run into each other. ARV and almost everyone in California do. I think the urban-focused providers are going after a big enough pie that they can peacefully coexist. The ones going after the smaller markets are most at risk, such as [Alterra's] Sterling and Assisted Living Concepts, both of whom are targe ting the suburban or exurban moderate customer."

To differentiate themselves from competitors, assisted living companies are building specialized products. "You can only build so many Ritz Carltons. You need Holiday Inns and Motel Sixes, too," says Andrew McPherson, an analyst with Volpe Brown Whelan. Industry leader Alterra (formerly Alternative Living Services), for instance, offers five different brands. including one that is upscale and metropolitan and another that targets moderate-income suburbanites.

Another niche: combining assisted with independent living, as Grand Court Lifestyles has done. There is an increase in congregate housing of this sort. usually with about 90 units devoted to independent living and 20 to assisted living.

More chain operators are integrating assisted living communities into networks of hospitals and nursing homes, as CareMatrix and American Retirement Corporation are doing. GerAssist, a Brentwood, Tennessee-based assisted living company, is providing home care, adult day, and health and wellness for seniors rather than concentrating on filling up buildings. Besides offering additional income, the services "act as a feeder to the community, a unique marketing approach that also allows us to create brand name recognition," says President Raj Kaushal, MD.

Targeting residents with Alzheimer's or other types of dementia is a "major, major trend," observes Wedbush Morgan Securities analyst Roxanne Cheng. "Incontinence management is the other big thing among the elderly, but nobody's using it as a marketing handle," she notes.

However, assisted living companies are becoming more medically oriented in general. "Everybody's going to end up getting a lot more health care focused," Cheng says. "ARV has arrangements with Omnicare and NovaCare. You're going to see more and more of that."

The cost of capital is putting a crimp in the smaller assisted living chains' growth plans. REITs have not been able to finance as many facilities as before, private equity lenders can't fill the void, and secondary offerings are out of the question because of volatility in the sector.

The bigger chains have not been affected as much, partly because they can often generate their own funding. Sunrise and Marriott raised needed capital by cashing out on some of their facilities, entering into sale/manageback arrangements. "They build for $8 mill, sell for $14 mill, then manage for a healthy management fee," Cheng says. "They get the income in cash from selling and--at no or minimal risk--a management fee, no depreciation on the books, and no leverage."

Emeritus made a similar move with some of its leased facilities when good lease rates became harder to come by as REITs pushed up the rates to make the business more profitable. By restructuring leases into management agreements, Emeritus improved its cash flow by $800,000 per month.

With continued huge demand for the product, Estes says 1999 looks to be another good year for assisted living chains--but it will be best for companies that are least dependent on the capital market to fund growth. "Self-funding is very important," he says.

                               TOP 5 EARNERS
                 These chains had 1998's highest revenues
                               (in millions)

Integrated Health Services $3,000
Sun Healthcare Group       $3,000 [*]
Beverly Enterprises        $2,812
HCR Manor Care             $2,209
Mariner Post-Acute Network $2,036


(*.)ESTIMATE

                            MANAGING TO GET BY
            Pure-play management companies and owner/operators
         reap rewards from managing others. Here are the leaders.

CHAIN                            FACILITIES MANAGED
Complete Care Services                          192
Genesis Health Ventures                         170
ServiceMaster Diversified Health                128
Integrated Health Services                       56
National HealthCare Corporation                  50


                               MOVIN' ON UP
          Thanks to mergers, acquisitions, and construction, these
           assisted living companies gained the most units in 1998

                             UNITS        UNITS  UNITS
CHAIN                     12/31/98     12/31/97 GAINED
Alterra Healthcare Corp.    15,003        9,467  5,536
Atria Seniors Quarters       7,600 [*]    4,170  3,430
CareMatrix Corporation       5,096        1,756  3,340
Marriott Senior Living
 Services                    9,675        6,573  3,102
Assisted Living Concepts     6,648        4,888  1,760
Regent Assisted Living       2,774        1,101  1,673
ARV Assisted Living          7,944        6,300  1,644
Advocat                      4,755        3,114  1,641
EdenCare Senior
 Living Services             2,544          982  1,562
Emeritus Assisted Living    11,258        9,740  1,548


(*.)ESTIMATE

                               REIT ROUNDUP
              Of the REITs investing in senior housing, these
                 boasted the highest market capitalization
                     rates as of 12/31/98 (in millions)

* Meditrust            $2,285
* HRPT Properties      $1,842
* Nationwide Health
   Properties            $996
* Health Care Property
   Investors             $953
* Healthcare Realty      $880
* Health Care REIT       $726
* Omega Healthcare
   Investors             $610
* National Health
   Investors             $604
* American Health
   Properties            $515
* LTC Properties         $463


Source: Irving Levin Associates

METHODOLOGY

The CLTC 50-plus ranks chains based on the number of beds or units owned, managed, or leased. It includes only companies whose primary business is operating long term care facilities, as opposed to real estate companies that own facilities solely as an investment. Rankings are based primarily on data supplied by the companies. All data is as of 12/31/98.

Sniff SNF

For the near term, nursing home chains won't he looking to Wall Street to fuel growth. This became a virtual certainty following fourth-quarter 1998 earnings and expectations. The main culprits: the cost of transitioning to PPS, decline in census as companies change their acuity mix, and a sharp reduction in demand for contract therapy. As a result, at press time in early March, all the major chains except HCR Manor Care were trading at or below $6 a share.

PPS has clearly thrown many chains for a loop. Vencor announced that its earnings for the quarter, excluding one-time charges, would be "substantially lower" than they were in the previous quarter, when it reported a loss of $0.02 per share: "While volume wends in both the hospitals and the nursing centers have improved, operating costs have increased. In addition, Vencare's [contract rehab] revenues are expected to decline."

A reduction in demand for therapy in IHS's contract rehab business also lowered the company's fourth quarter expectations. While IHS announced that its facility and RoTech [home respiratory] divisions were "on plan for the quarter," the company's contract rehab division predicted fourth quarter hilly diluted EPS, before severance and transition costs, of $0.35 to $0.45 a share. Wall Street consensus was $0.75.

IHS was providing less therapy to its own residents as well. Patients in smaller operations "suddenly reduced usage of Symphony rehab services in December," the company reported. Although 11115 had laid off 1,000 therapists, it was not enough to match the revenue fall-off, the company said.

Sun Healthcare Group expected a significant fourth-quarter loss due to a drop in demand for therapy services and transition to PPS. Consequently. Wall street analysts dramatically lowered earnings expectations over the next year. To further compound the bad news, rating agencies downgraded Sun's (as well as Genesis Health Ventures', IHS' and Mariner Post-Acute Network's) debt.

Sun was caught off guard by the "steeper-than-expected reductions in Medicare reimbursement," confessed Andrew Turner, chairman and CEO. "And the decline in demand for therapy services outpaced even our very substantial reduction in our therapy workforce." Adding to the company's woes, Turner said, is "the failure of most Medicaid reimbursement systems to keep pace with the actual cost of care.

Genesis' problems stem in large part from its acquisition of Multicare, which some industry observers say it paid too much for. The debt-laden company's fourth quarter operating EPS before non-cash charges was $0.20, versus consensus of $0.25 and year-ago EPS of $0.36. The company pointed to reduced earnings from its 43.6 percent-owned Multicare affiliate, due to lower-than-anticipated occupancy and quality mix, reduced quality mix at Genesis centers, termination of management agreements covering eight nursing homes, and increased benefit costs. Also affecting earnings were "PPS, increased regulatory initiatives, and continued pressures on operating margins by payors," the company said.

PPS is at the root of Beverly's problems. While its fourth quarter earnings were $0.20--$0.0l better than expectations, the company reduced expectations for 1999. David Banks, CEO of the company, said in a prepared statement "We knew that converting to the dramatically different care protocols demanded by PPS would be a gradual process that inevitably would hamper our efforts to maximize fourth quarter operations."

Mariner Chairman and CEO Keith Pitts attributed his company's sorry showing-a net loss for the quarter of $0.17 cents per share versus a profit of $0.08 per share in the year-ago comparable period--to PPS "combined with lower than expected census, higher than expected operating costs, and external pressures from regulators, litigators, elected officials, and the media."

One exception to the general fourth-quarter bloodshed was HCR Manor Care, which reported earnings of $0.45, up 22 percent against the year-ago comparable period. "Our financial success following this merger is a confirmation of the underlying strength of our operations and management team," said Paul Ormond, president and CEO, adding one ominous note: The patient mix reflected some erosion in the private paying census over the past year.

Says Raymond James analyst Jim Kumpel: "You can look left and right and see nothing but carnage except HCR Manor Care, which actually improved earnings on a year-over-year basis. Their performance stands in stark contrast to their peers, who had loaded up on contract therapy services that benefited them under the old Medicare system.

"HCR stuck to its simple strategy of delivering low-cost services in-house, and that pays off under the new PPS system."