While some investors focused on large-cap healthcare stocks during the fourth quarter of 2013, such as the purchase of HCA Holdings Inc (NYSE:HCA) by Larry Robbins‘ Glenview Capital and Sean Cullinan‘s Point State Capital, we believe the following stock, which is a smaller company operating in the same industry, could be a more compelling idea.
Activist investor Michael Novogratz of Fortress Investment Group is the largest shareholder of Brookdale Senior Living, Inc. (NYSE:BKD), a stake he has maintained for several years. Other hedge fund managers joined him during the fourth quarter by purchasing additional shares of the healthcare facilities provider, including James Dinan of York Capital Management, Jacob Gottlieb of Visium Asset Management and Thomas Ellis / Todd Hammer of North Run Capital.
Brookdale Senior Living, Inc. (NYSE:BKD) is a $4.2 billion market capitalization company that is the largest provider of senior housing in the United States, operating 649 communities (47% of which it owns) across 36 states (of which Florida and Texas are the two largest) with capacity to serve approximately 67,000 residents. The company generates annual revenue of $2.5 billion, 80% of which is from private pay sources (as opposed to relying on Medicare, Medicaid or insurance).
Similar to other senior housing providers, Brookdale Senior Living, Inc. (NYSE:BKD) enjoys favorable secular trends, including growth in the senior population (which is three times faster than the base population) and a favorable supply-demand fundamentals (only 1.9 million units serving 12.0 million seniors, or a 15% low penetration rate, while new construction remains low). In addition, BKD’s value proposition is its status as the only provider with scale across the continuum of senior living (from at home service to active housing) with a fully integrated platform to provide ancillary services (such as home health, therapy and hospice) to its residents. The company has an ongoing development-growth plan called Program Max that will reposition / expand its community portfolio, adding higher levels of care / services and generating 12-15% unlevered returns.
In February 2014, BKD agreed to acquire smaller peer Emeritus Corporation (NYSE:ESC) for $2.8 billion (including the assumption of $1.4 billion in ESC’s debt), further entrenching its status as the largest owner-operator of senior housing in the nation, with $4.9 billion of annual revenues (over 80% of which is from private pay sources). BKD expects to generate up to $100 million of revenue synergies annually from expanding its existing products / services and reduce operating expenses by up to $45 million annually. Offering new products / services to the combined company’s 100,000 residents should provide further synergies.
Following a strong rally in the stock after the fourth quarter earnings release and deal announcement, the shares are not cheap, trading at a forward EV/EBITDA multiple of 14.0X versus 8.3X for its peer group of healthcare facilities. This premium likely reflects positive investor sentiment regarding the ESC deal. However, since the merger announcement on February 20, 2014, the combined market capitalizations of the two companies increased by roughly $900 million, which is lower than the $1.45 billion present value of the known revenue and cost synergies management announced ($145 million annually discounted at a 10% rate). With additional synergies from new offerings as well as a higher value for the combined company’s real estate portfolio (to which Brookdale Senior Living, Inc. (NYSE:BKD) will apply its Program Max), there seems to be more upside to the shares, even if management is not fully able to realize its revenue and cost synergy targets in the near-term.