Capitalizing on deal-making conditions in skilled nursing
How can operators take advantage of favorable conditions?
Peter Kane and Mike Monticello
The skilled nursing industry saw deal-making conditions improve dramatically in 2021. How can operators take advantage? Sellers are abundant, and financing is readily available, creating opportunities for small operators to expand. Plentiful capital also means sellers shouldn’t lack for bidders.
But in contemplating a deal, operators should be careful to select the right partner — one with the right competencies. Among other things, these include knowing how to construct deals that will be acceptable to participating investors.
Conditions are ripe
Record amounts of private equity capital — at least $1.5 trillion1 — were left on the sidelines in 2020. But as the pandemic eased, deal-making rebounded, spurred in part by looming potential federal tax increases.
The healthcare sector benefited from the upswing. Deals totaled 426 in the first quarter of 2021, according to data reported by PwC, up 21% from the fourth quarter of 2020 and the highest quarterly figure ever. Valuations are also up, with enterprise value compared to earnings before interest, taxes, depreciation and amortization hitting 16.1x.2
Motivated sellers open the door for opportunistic buyers
In the skilled nursing industry, a challenging operating environment has hurt occupancy rates, squeezing weaker operators and producing a shake-out effect. “Companies that were limping along before COVID-19 will not be able to survive long term,” said Peter Kane, managing director and group head, CIBC US Healthcare Banking.
This is likely to benefit the surviving companies, according to Peter. “Companies that maintained a steady state will probably get stronger. Those that are exceptional will have the capital available to make acquisitions — potentially at a discount.”
Smaller operators may be especially well suited to take advantage of the abundant capital. “Historically, they’ve been able to expand with relative ease by acquiring struggling properties,” Peter said.
New entrants may also be able to capitalize if they have real-world qualifications. In the past, facility managers with sufficient experience have struck out on their own. “A manager can start in year one with three facilities. Over time, based on how well they do, they can go to 10 to 15 relatively quickly,” Peter said.
But even in an environment of motivated sellers, buyers should resist the temptation to expand just for the sake of expanding, according to Mike Monticello, managing director and group head, CIBC US Healthcare Banking. “If you’re already a successful operator, be opportunistic. You want to pick up facilities that are additive.”
Valuations and motivations
Though valuations are up, many times an operator’s circumstances or concerns weigh heavily in their calculations. In fact, with smaller sellers, price may not even be the primary consideration. Typically, these firms are very close to the on-the-ground operations, and their goal may be something other than getting the top price.
“Their trigger could be certainty of close, or how confident they are the new operator will be a good steward of the facilities they’ve been operating for the last 10 or 20 years. They may want to be sure their residents and employees will be properly taken care of, so they know they’ve left the operation in good hands,” said Kane.
Buyer abundance enhances exit opportunities for family-owned operators
On the flipside, this environment may also be attractive to operators looking to downsize. Smaller ones are often family-owned companies, and after many years in a challenging industry, they may be fatigued. “If they can’t persuade the next generation or their management team to take over, now is a logical time to be a seller,” said Monticello.
Today’s favorable conditions may also appeal to large operators. Some may have become regionally stretched and in need of streamlining. Unloading certain far-flung properties can relieve the seller of heightened operational challenges.
For example, an East Coast company may have picked up a couple of struggling properties out West. Now that they’re profitable, they’re more attractive to local operators. In today’s environment, those operators may be more motivated and better financed.
Ready capital can reduce operating risk, fuel expansion
The current environment may facilitate a variety of creative transactions. A recent deal by CIBC involved a high-quality, California-based family operator of 16 facilities. The company is managed by a second-generation operator whose father has owned skilled nursing facilities for 25 years, expanding from one facility to 25 over that period.
Several years ago, the son purchased 3 facilities of his own, which were in the process of being delicensed. Because of this, the acquisition was financed with hard money at a rate of 11%.
In a refinancing, CIBC provided $60 million at a more attractive rate, as well as a $16 million revolving loan. “The three facilities were stabilized over time, and we were able to refinance the debt at a lower rate. We also provided some additional capital to invest in the properties,” said Kane.
In the past, the father had never owned the underlying real estate, leaving the operation vulnerable to rent increases. With this refinancing, both the father and the son are now interested in making real estate ownership part of their business model, potentially reducing their operating risk. This deal could also enable them to capitalize on the attractive returns long enjoyed by real estate investors in this sector. Real estate ownership can also improve margins for operators that would otherwise be paying an annual escalator as part of a traditional sale-leaseback transaction.
Down the road, this deal may also facilitate further expansion. “The bottom line is: we’re taking a high-quality operator that has some consolidation plans and making several loans to assist them with that and with future growth,” said Kane.
Finding a partner: competence to close
With so much capital ready on the sidelines, healthy operators are in a position to shop around for the best terms. But the best price is not always the best deal. “Some banks are more aggressive on terms, and it’s great to see competition, because it indicates the desirability of the sector,” said Monticello.
But in looking for a financial partner, operators should also consider longevity. Lenders with experience know their credit partners well. They know what sorts of deals will fly — or how to tweak them to make sure they will.
“A good partner will also be proactive, helping to keep the operator on track with their strategy, and will anticipate deals. With regular dialog, they’ll even be able to bring deals to your attention,” said Kane.
While acquisition-financing terms became more creative during the pandemic, CIBC’s process for vetting loan applicants remains the same. “What we always look for is: who’s the operator, and what’s their track record?” said Kane. “Sometimes the bright, shiny, beautiful facility looks awesome, but it just doesn’t perform.”
“Our clients know that we’re not just putting numbers into a processing system,” Monticello added. “What also matters is character. They could have great financial numbers but have regulatory problems and be in deep trouble.”
With the right partner and the right deal, high-quality operators can generate a tremendous amount of value for themselves, according to Kane. “But the magic of a good deal is everybody wins. If everybody leaves the negotiation feeling they got the best deal, that was a good deal.”
The deal-making conditions in today’s skilled nursing industry are favorable for both buyers and sellers. Abundant capital means financing is readily available for buyers, while the industry shakeout resulting from the pandemic means sellers are also plentiful. High-quality operators are likely to benefit from this situation — if they select the right financial partners.