|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|
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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:
|Revolver due 2015 (max $100mm)||-||-|
|Term Loan due 2016||341.8||321.8|
|11% Senior Sub Notes due 2014||130.0||130.0|
|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.
|Revenues||870||875||2012 guidance at 865-880|
|Adj EBITDAR||150||133||132 to 135|
|Adj EBITDA||131||114||2012 guidance at 112 to 116|
|2012 estimated FCF walk-through|
|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|
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
|SNFs (incl. 5 leased to 3rd party)||57||22||79||72%|
|SNFs - beds (excludes those leased out)||6,491||2,692||9,183||71%|
|ALFs - beds||1,030||282||1,312||79%|
|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|
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