The Post-Acute Care Market is Ailing. Is There a Prescription for Investors?
Ron Greenspan, Leader of FTI Consulting’s Real Estate Restructuring practice, and Scott Bingham, Co-leader of US Transaction Services, look at the issues bedeviling post-acute care providers and possible paths forward for concerned stakeholders.
What is happening: Driven by the continued aging of the vast baby boomer generation and other forces, the post-acute care market was projected to grow between 2017 and 2021. However, severe headwinds are impacting the industry and adversely affecting many participants’ cash flow.
Who is affected: The post-acute care industry consists of facilities that provide a range of services for patients following a stay in an acute care hospital but who are no longer in need of such care. Treatment facilities include home and hospice centers, skilled nursing facilities, inpatient rehabilitation and long-term acute care hospitals. The affected industry stakeholders are private equity lenders and investors, debt holders and leaseholders (landlords).
Why it’s happening: A myriad of headwinds occurring at the same time: 1) industry consolidation through acquisitions has levered up balance sheets where growth had been assumed; 2) lower Medicare reimbursement rates have eroded margins; 3) a continued decline in acute care patient census (people who may subsequently need post-acute care) has dropped the volume of “customers”; this may be compounded by a focus by insurance companies pushing for shorter stays in the facilities as well.
Where it’s happening: Compounding the industry’s operational challenges is the frequent use of sale-leaseback transactions for the facilities used; many of these leases have rents (one of an operator’s biggest expenditures after patient care) scheduled to increase irrespective of declining revenues. When an industry is under this type of financial pressure, the threat of bankruptcy and cramdown (reduction in principal balance and interest rates) can sometimes induce renegotiation. But this is not available for leasehold liabilities. Hence, the possibility of reorganizing often turns on a joint legal/financial issue — it depends on whether the leases are true operating leases or are subject to being re-characterized by the court as a financing transaction that can be modified in a plan of reorganization.
When it might settle: Changes to GAAP accounting for leases that take effect January 2019 will add additional “mud” to the waters. While the GAAP changes will not affect the cash flows of the operators, the changes will cause many traditional operating leases to be reflected instead as balance sheet liabilities. That will affect perceived creditworthiness and potentially endanger loan covenant compliance.
A Path Forward
While management teams at the facilities can cut operating costs to try to maintain profitability, they may also look to landlords to renegotiate leases (rent reduction). However, many facilities are leased from publicly held REITs which are disincentivized to participate in such negotiations since any material changes cannot be kept confidential and could precipitate adverse changes elsewhere in their extensive portfolios.
Moreover, the traditional landlord response to a defaulting tenant — terminating the lease and eviction — is often not a viable option in the post-acute care industry. A landlord must evaluate the assets it controls, and potentially some assets used in connection with the operations which it does not control, and decide whether it can repossess the premises and effectively operate the business. In this scenario, finding a competent operator will be paramount for a reasonable recovery as a going concern. The other choice is to shut down a facility completely or repurpose it.
The long-term winners will be those who husband their cash, weather the shakeout that’s bound to come, and position themselves to benefit from the likely reduction in beds available and further industry consolidation.
About the Author: Ronald Greenspan is a Senior Managing Director at FTI Consulting and is based in Los Angeles. Mr. Greenspan is the West Region Leader of the Corporate Finance & Restructuring segment and the National Leader of the Real Estate and Structured Finance group. With more than 33 years of diverse international experience, he applies his broad background to a wide variety of very high-profile advisory, bankruptcy and litigation engagements. He is experienced in representing all stakeholders, including debtors, creditors and equity interests.
About the Author: Scott Bingham is a Senior Managing Director at FTI Consulting and is based in Atlanta. He is the Co-leader of the Transaction Services (“TS”) practice within the Corporate Finance & Restructuring practice. Mr. Bingham has more than 20 years of experience providing clients with acquisition advice on engagements, ranging from $30 billion leveraged buyouts (“LBOs”) and multi-billion-dollar “white knight” defenses of hostile takeover targets to million-dollar private equity placements and strategic “add-on” acquisitions.
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