March 01, 2012 - 4:03pm EST by
2012 2013
Price: 100.00 EPS $0.00 $0.00
Shares Out. (in M): 130 P/E 0.0x 0.0x
Market Cap (in $M): 250 P/FCF 0.0x 0.0x
Net Debt (in $M): 460 EBIT 0 0
TEV ($): 710 TEV/EBIT 0.0x 0.0x

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  • Undervalued Bond


Skilled Healthcare 11% Senior Subordinated Notes (Caa1, CCC+), trading at par, offer in our opinion a very-safe opportunity to clip nearly 1% per month until the bonds are called.  The bonds are currently callable at par with 30 days notice, and the Senior Secured Credit Facility carries a springing lien if notes remain outstanding come October 14, 2013, given temporal seniority of the notes vs the 2015/2016 credit facility.  We expect the notes to be called prior to that date.  Could happen tomorrow, could happen a year and a half from now, although that latter is admittedly more unlikely – notes become dreaded “current debt” Jan 2013 so our guess is this is max a 6-7 month allocation of capital.  Maybe not the most attractive idea from a total return perspective, but the notes do provide a relatively safe ~1% monthly return, with permanent loss of capital unlikely and even price volatility unlikely given currently callable at par.  A limitation is that the notes are somewhat illiquid  for larger money given issue size is  only $130mm, and that the likelihood of company refinancing (discussed in more detail further below) over next year is high so not a long-term home for capital.

These notes represent $130mm of SKH’s $476mm of total debt.  Most of the remaining debt is through the 2016 term loan with a $342mm balance at yearend 2011.

Cap structure and leverage:

  2011a 2012e  
Cash           16.0            17.0  
Revolver due 2015 (max $100mm)                -                   -    
Term Loan due 2016         341.8          321.8  
11% Senior Sub Notes due 2014         130.0          130.0  
other debts             4.0              4.0  
Total Debt         475.8          455.8  
Total Debt / 2011 EBITDA 3.6x   5x covenant
Total Debt / 2012 EBITDA estimate 4.2x    
3-yr Avg Adj FCF to Total Debt 11%    
2011 FCF to Total Debt 17%    
2012e FCF to 2011 yearend Total Debt 8%    

Overview of Business

Skilled Healthcare Group (equity ticker SKH) is an owner/operator primarily of Skilled Nursing Facilities (SNFs) but also Assisted Living Facilities (ALFs), hospice, and contract rehab.  SNFs are generally a mediocre business, with heavy exposure to government reimbursements through Medicare and Medicaid (~70% combined).  Unlike most peers, SKH has significant ownership of its SNF and ALF properties.  From an operating perspective, about 30% of the companies 10,500 beds are located in cash-strapped California, and another 30% in Texas.  Kansas, Missouri, New Mexico make up about 10-15% each of the company’s beds as well, and the company’s operations span 8 states in total.  76% of the company’s revenues are from SNF operations and the remaining is attributable to ALFs, contract rehab, and hospice.  2/3rds of its revenues are from Medicare and Medicaid, at 38% and 29% respectively.  Private Pay is 23% and Managed Care is 10%.  California as a geography makes of 40% of company revenues, and we estimate exposure to Medi-Cal (California’s Medicaid program) to be 12% on a consolidated basis California Medicaid

The company has been and will continue to be occasionally acquisitive, historically acquiring tuck-in locations within the SNF/ALF space and more recently in allocating capital to complimentary businesses such as hospice to diversify SNF exposure.  In terms of capital allocation in the future, according to mgmt on their Q4 2011 call, FCF will first address leverage and then opportunistically be allocated toward acquisitions.

From a credit perspective the company is fundamentally sound in our opinion.  Cash generation allows for continued debt prepayments, although we recognize margins will remain under pressure in the future relative to prior years.  In 2011, the company paid down $45mm of its beginning year total debt of $520mm, by fully paying off a partially drawn revolver and prepaying some of its term loan balance. Adjusted FCF generation, if we back out a $53.5mm payment in Q3 2010 due to Humboldt county settlement, has averaged $50mm/year over the past 3 years and $36mm/year inclusive of the settlement, representing 11% and 7% of total yearend 2011 total debt, respectively.  Debt to 2011 Adj EBITDA leverage is 3.6x and 4.2x based on 2012 guidance.  Continued debt prepayments will likely reduce the latter figure over the next 4 quarters.  Going forward, the company expects revenues about flat year over year and margins down ~200 bps reflecting largely the RUG IV correction effective October 2011.  Guidance implies $30-35mm in FCF before WC use if any.


Summary Financials:

  2011a   2012e   notes        
Revenues            870                   875   2012 guidance at 865-880    
Adj EBITDAR            150                   133   132 to 135      
  margin 17%                
rent               18                      19            
Adj EBITDA            131                   114   2012 guidance at 112 to 116    
  margin 15%   13%            
2012 estimated FCF walk-through                  
EBITDA                     114            
  Interest                     (37)   8% cost of avg debt, assume $20mm add'l paid down by yearend
  Tax                     (20)   at 39% of EBT      
  Working Capital                         -     WC has historically been 0 to 20mm use of cash  
Cash from Ops                        57            
  CapEx                     (20)   per guidance      
FCF                        37            

Note: term loan amortization at 1% per annum is $3.3mm, and is excluded from above figures.

Significant Real Estate ownership offers some downside protection

Additionally, relative to most of its peers, SKH owns a significant portion of its real estate.  

Indeed, a skilled nursing facility is relatively non-fungible in the very near-term, but an industry-wide insolvency issue notwithstanding, it’s reasonable to believe that SKH could engage in sale –leasebacks for liquidity if needed.  For the notes, other than the senior secured credit facility no other material debts including mortgages have a claim on these tangible assets.

As a very rough approximation we estimate SKH’s SNF and ALF real estate value to be worth around $500mm (vs $476mm of total book debt at year end 2011).  To arrive at this figure we use the annualized (based on mrq) rent they pay on their leased beds and assume their owned beds would be able to yield similar rents.  Also, as SKH receives rent payments on 5 facilities leased to 3rd party operators totaling $2.2mm (approx $4,900/bed), these are also added to the $50mm rent figure and then we apply conservative market cap rates to estimate the selling price those facilities might yield, arriving at roughly $500mm.  Walk-through is illustrated below.

Estimate of Real Estate Value

  owned leased total % Owned
SNFs (incl. 5 leased to 3rd party) 57 22 79 72%
ALFs 21 2 23 91%
Totals 78 24 102 76%
SNFs - beds (excludes those leased out)                 6,491              2,692            9,183 71%
ALFs - beds                 1,030                 282            1,312 79%
                  7,521              2,974          10,456 72%
Q4 Rent 4.9      
Annualized rent 19.6      
Beds leased                 2,974      
Rent paid per bed 6,600      
implied total rent on owned beds                    49.6      
add: rent from 5 facilities leased to 3 party                      2.2      
total implied mkt rent                    51.8      
Cap Rate assumptions est. value in $ millions    
12%                     432      
10%                     518      
8%                     648      

Key Risks

  • Notes are currently callable with 30 days notice.  On their call mid-Feb, CFO Dev Ghose cited opportunity to potentially save $1.3mm (an implied 1% relative to current coupon) if they were to refi the ’14 notes, but quoted the markets as “still pretty choppy”.
  • This is a refinancing story dependent upon health of debt markets so some extent – with total leverage at about 4x EBITDA and the company likely to stay cash flow positive, the bonds are covered and SKH can service its debts and then some, but nonetheless, this is a refinancing story given the springing lien of the credit facility in late 2013.
  • Unexpected lawsuit is always a possibility in the industry – something to the tune of Humboldt county is unlikely in the near-term in our opinion.  Humboldt County was a litigation issue disclosed for several years in prior 10-Ks, ultimately growing into a class action suit with a $677mm verdict against SKH.  SKH ultimately settled for $53mm, drawing the revolver and paying that balance off within a few quarters.  Nonetheless, any headline of similar tone may affect company’s ability to refinance.
  • 40% of the company’s revenues are generated in California and 30% of the company’s revenues are from Medicaid, implying roughly about 12% of total revenues from State of California Medicaid program.  Moreover, California plans to withhold 10% of net Medicare reimbursement (will be retroactive for the period June 2011 through August 2012), but will ultimately release those funds by Dec 31, 2012.
  • Company is ~5 months into digesting at 12% cut via RUG IV correction through Medicare Part A.  Guidance does reflect this but nonetheless, Medicare represents 40% of revenues and some Managed Care contracts are benchmarked using RUG IV.
  • General competitive pressures exist from other care settings such as Home Health, the company and others report.


  • No significant catalysts – bonds trade at their call price and are currently callable with 30 days notice.
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