Gordian Group Surveys the Senior Living Landscape Amid COVID-19 Fallout

Morgan Ribeiro: Welcome to PointByPoint. This is Morgan Ribeiro, Waller's Chief Business Development Officer and the host of the podcast. Today, we are joined by Tyler Layne, a partner and member of Waller's healthcare restructuring group, along with Jesse Neil, a partner in Waller's healthcare regulatory practice group, Peter Kaufman, president and head of restructuring and distressed M&A for Gordian Group and Henry Owsley, the CEO of Gordian Group.

Today, we're going to discuss senior care facilities and what they are facing during these tough times for the industry.

So to get started, You all work with senior living facilities across the country of all shapes and sizes and I recently noticed a headline of a Gordian Group article that declared senior living as “a tale of two outcomes: distress or opportunities”. How you would assess where we are right now?

And if so, perhaps we can talk about each bucket in turn and, Peter, I'll start with you. Maybe you could share your thoughts on distress overall in the senior living space and what you're currently seeing with your clients.

 Peter Kaufman: Absolutely. As investment bankers in the overall area of distress, we're certainly seeing a lot in this space. There's stress on various fronts for senior living facilities - COVID occupancy rates are issues, increased costs are issues, and others. We think that more than half of senior living facilities operate at a loss and now they're facing, I think, a 9% cut in therapy reimbursement under Medicare.

So we think that this sector is definitely under siege, which presents problems for those who are in it and opportunities for those who either want to get in it, or want to be opportunistic and acquire some of these financial trouble situations to go on a platform they might already have.

 Morgan: Tyler, what are you seeing and hearing from your senior living clients at this time as it relates to distress in this space?

 Tyler Layne: I agree with Peter on the general outlines of the distress that we're seeing. Over the life of COVID, you've seen so many of the facilities that we deal with propped up by an increase in government funds.

As Peter noted, census is obviously still down. Senior living has always been an area with high fixed costs. That just continues to be the case as costs continue to rise.

Historically a lot of clients have tried to manage their payer mix so that they can get the higher Medicare payments from rehab stays to bridge the gap and the funds that they receive. But many folks who are recovering from surgeries and the like are looking for alternatives to a stay in the nursing home, if at all possible.

On the CCRC front - to a certain extent in assisted living- you're seeing a lot of excess capacity, just because of the way that the boomer population is aging. I think there was a expectation that boomers would enter senior living facilities around the same time their parents did. And that's just not the case. And, on the expense front, you're seeing difficulties in achieving scale and if you do achieve scale, difficulties in integrating the operational efficiencies on that scale. And that's really the only way to make money given the reimbursement rate issues that face the industry. And finally, with the expenses being so high, the easiest way to borrow from Peter to pay Paul is to defer cap ex on the facilities. When you do that's going to catch up to you eventually and really be an issue.

 Morgan: Before we move away from the stress to a more hopeful topic, Jesse, I want to turn to you. Can you help us understand the reimbursement and regulation arena for senior living? We'd love to hear more specifically about reimbursement and the regulatory headwinds. And what do you feel like your clients really need to be aware of?

 Jesse Neil: Sure, Morgan. Even in the broader healthcare space, senior living, in particular, is a highly regulated sub-sector. For obvious reasons, it's a vulnerable population, complex comorbidity issues and so there is a lot of state and federal oversight and investigations. And you missed by an inch on some of these regulations, you - in effect - miss by a mile. You'll have a public notice. You'll have a survey. You'll have an investigation, public reports, you have enforcement actions to manage.

Just having the infrastructure to manage a compliance function that tracks the government's expectation takes a lot of capital and probably substantial scale. So that's the macro regulatory environment that they're trying to operate in and it's difficult. And especially when you look at how they get paid for their services, where you get paid differently by different payers, which by itself is its own issue.

Fairly recently, Medicare adopted what's called a patient-driven payment model, and it's based on six different components. Most of which are based on the presentation and acuity of the patient. You can't just turn on and turn off reimbursement models. You need to have the ability to have trained personnel who can monitor the process, who understand how the billing and coding works and be able to manage that fairly closely. That's just not something that's easy to do. From a high level, I think those are the headwinds on the reimbursement front. We're going to get into this in a little bit, but outcomes and patient satisfaction are increasingly going to be important to maintaining a viable facility.

And that again, takes infrastructure. It takes knowledge, it takes training, it takes oversight. Those are all things that are going to have to be in place for them to succeed. They could be distressed today and not know it.

 Morgan: As a follow up to that, there are some variables because not all facilities are alike. Would you touch on those nuances for our listeners?

 Jesse: Sure. I would say that one of the factors that I think is going to impact the demand for the service is that there are a growing number of services and patients and locations and payers who believe that the services can be provided at home for patients and that's going to be a growing sector. I'm not seeing a lot of the senior living companies really invest in the new models that are coming up in the home care models. So I think that is something to watch. If you've got a company or a group of facilities that are planning for and preparing for that type of extended service, then I think that's probably a good sign. I think probably the best factor to look for is a facility or group of facilities, are they participating successfully in accountable care organizations or Medicare Advantage plans. And, are they in a high-performing network?

A lot of this data is available publicly, but you can obviously get it through the diligence process too. With Medicare Advantage plans and the coordinated care initiatives, they want winners. They want folks who have focused on delivering good quality and also patient service and making sure that the patient satisfaction is at the forefront.

And so I think if you can find facilities that have the right focus and have the ability to deploy the resources needed to execute in a highly regulated and changing environment, then I think those could be really good opportunities.

 Morgan: Yeah, I think that's helpful context, right? That is so important to this whole discussion about distress and how they get reimbursed. I want to get back to the topic of distress out there. Tyler, do you have advice for senior living facilities around assessing their true fiscal health? And what restructuring or turnaround opportunities are available to those in need?

 Tyler: Sure. So I think that in the senior living industry, one thing that we see is there's a tendency to kick the can down the road maybe more than in other industries. Senior living restructurings in the best of circumstances are difficult, but senior living restructuring - when you're talking about mixing in elder care with financial issues - just become even more difficult.

I think it's important for all the players in the industry - whether it's operators, REITs, lenders - to identify the issues quickly and as soon as possible, and find a solution. Waiting will only make the ultimate restructuring more difficult. We're still seeing lots of purchasers and lenders with dry powder looking to buy in the sector, particularly if there's a real estate play or if that purchaser already has scale or can achieve scale by adding a smaller senior living chain to its portfolio. Really assessing the true financial health of what this industry is gonna look like post-COVID is going to be really important. Money's fungible and the lack of usage stipulations on the government funds that have been deployed have really masked those financial problems.

So really coming to grips with the fact that you need to assess this industry as a different industry than what it was pre-COVID is important. And, as Jesse mentioned, deploying those innovative solutions regarding operations and reimbursement and collections, it’s not really enough anymore to rely on your historic EBITDA.

Finally, we've had a lot, particularly in larger senior living restructurings, of just having all the players come to the table and negotiate an acceptable out of court solution. Typically you'll see some combination of lenders giving some relief to the senior living facilities along with the REITs, if there are REITs putting in debt or equity and someone's going to put their capital to work. They're all in this together.

I think it's an area that's facing significant headwinds, but also an area where there's lots of opportunity and lots of ability to come together to find an acceptable solution.

 Morgan: I feel like a related industry in the post acute care sector is home health. And I know that there's a lot of distress in that area. Can you provide some more information on and background on what's happening to grow to home health space?

 Tyler: I think the distress in the home health space is a little bit under the radar because you're seeing increased demand in that area as a result of the lower census and skilled nursing and assisted living as people want to be cared for at home more than they want to enter in a facility. And there's also lots of opportunity in that space for that very reason, but home health providers are facing their own issues.

It's a very turbulent area in terms of reimbursement rates. And you're seeing a lot of divestitures and acquisitions. Some of the larger diversified operations are actually selling off their home help assets. And there's a lot of buyers in their area as well. And so I would say that, it's an area typically we see some distress in but where there's a lot of opportunity right now for the right buyer and a lot of opportunity because of the COVID situation.

 Morgan: I think that's a good segue into my next question, which is for Henry. There's always a silver lining and I'm curious who the winners are here and what you're seeing in the space and who's in a position to acquire these facilities.

 Henry Owsley: There are a number of private equity firms that have concentrated in this area. I think that they are some of the logical players to facilitate a roll-up, which is significantly needed.

Ensign Group to date has done probably one of the best jobs of doing that and their success has been mirrored in their stock price, which has zoomed up in comparison to the poor performance of most of the rest of the public universe here. As folks have already alluded to, the industry is facing a number of problems. And whether you're a consolidator or you are a target, you need to focus on a lot of solutions here. Number one is you need to manage a census versus your facilities. That probably is going to require attention to real estate and one of the things we know right now is forecasting the post-COVID real estate environment is really iffy.

And what those consolidations or managed down in terms of size are going to do, it's hard to tell. You're also going to have significant expense increases, primarily on things like nursing care. And so there may be further demand for labor saving, CapEx, whatever that may be versus some of your skilled personnel, particularly on the admin side, I would think. And it's going to be tricky, maneuvering your way through this. There are always going to be opportunities for vultures in this area for companies that don't manage their balance sheet but I think liability management and census management and understanding cost of capital and how that impacts the desirability or attractiveness of investment opportunities. All those need to go in the mix and companies that are at all unsure of their environment should probably reach out and talk to people who have experience in having seen this movie before.

 Morgan: I'm going to throw a curve ball out there, and I'd love to hear from all of you all and really spark some discussion here. You all touched on this, but I'd love to know the crystal ball. We've been anticipating a lot of activity in this space - and I think to some of the earlier points made, that the government stimulus funds have certainly put a Band-Aid on this - what we anticipate will be more distressed activity. Any thoughts on timing or what we're going to see here over the next six to 12 months?

 Peter: It's tough to have a crystal ball. If you're going to use a crystal ball, I think it's safe to say that the government's going to keep trying to reallocate wealth and keep providing easy money out there as long as it possibly can. And I think it also depends on where are we going with COVID. Is Delta going to wane? Is Mu going to replace it? Are we going to be in a perpetual cycle of the latest variance that might get by the vaccines. I think there's just so much unknown in this particular area that it's very hard to have a crisp view.

 Jesse: One thing that I would note that is central to my practice, but may not be on everyone's mind, is that to the extent that you are a healthcare provider, whether it's senior living, whether it's skilled nursing facilities, to the extent that you received those funds related to the CARES Act or under the different COVID initiatives, there is going to be a wave of audit and enforcement activity that has probably not been met before.

There's so much money, so many organizations. There are going to be a lot of bad actors that rise to the top and that get given an enforcement action pretty quickly out of the gate, but there's just going to be a lot of people that have to respond to government inquiries. They have to prepare audits. It's going to be a variable, it’s going to be a factor, I think over the next, probably six to 12 months. It may be delayed a bit, but once it stabilizes, I do think there's going to be a huge enforcement activity that goes underway.

 Peter: I would just add to that, that if you had asked me a year ago, whether we'd be in the position we are now, I would have said that you're crazy. Here we are and the government money continues to flow. Maybe not the way it did six months ago, but it continues to flow. As long as money's virtually free, there's always going to be somebody willing to refinance debt in this space. And so absent a wave of audit fraud allegations, like Jesse just mentioned, there's always going to be funds available in the depressed interest rate environment.

Until those interest rates get raised, I don't know that you're going to see immediate distress, but I think that it's always bubbling under the surface and the problem with the industry right now is it's really skating on the edge.

 Morgan: I'd be curious just since we've got investment bankers on the line. I know in a lot of the other spaces where Waller is seeing a lot of M&A activity, we're seeing some really interesting structures and interesting partnerships. As you all are working with clients right now, is there anything interesting or new that you're seeing as firms are acquiring these senior living facilities.

 Henry: I think many of the acquisitions that have been done have been what I will call at the asset level. I think as we go forward and people seek to not dismember their organizations one group at a time, but seek a more permanent solution for a recovery for all of their constituents and not just the senior lenders, we will see larger transactions.

As part of that, I would expect senior living distress buyouts to start to mirror those of other industries in which the boards do indeed say, we just don't want to hand over the keys to the senior lenders. We want junior creditor and equity recovery. And that's going to eventually create a different dynamic than perhaps we've seen to date in this space.

 Morgan: So I want to get a counterpoint to one of the things that Henry just mentioned, and that is, the capital that's flowing in from private equity firms. And there's certainly a lot of opportunity there, there's another side to that point. I know Tyler, we've been tracking more the political arena and the increased scrutiny on private equity investments in healthcare. Can you speak specifically to some of that and in any particular implications for this?

Tyler: Obviously, as Henry said, there's a lot of opportunity for private equity firms in this space. Private equity firms are a logical buyer. They have a ton of capital to deploy and are looking for sensible areas to deploy it. And this is certainly an area where we've historically seen private equity be inquisitive. But by the same token, I think they're seeing a political environment that is increasingly skeptical of private equity ownership of healthcare assets generally, and in particular, residential healthcare assets.

One example of that is the House Ways and Means Committee holding a hearing back in March on the effect - both financial and operational - of private equity ownership of healthcare assets and whether private equity ownership precipitates distress or bankruptcies. It is an area where there's a lot of opportunity for private equity firms, but those same clients would be well served to continue to watch the political environment as I know many of them are doing and continue to prepare for increased scrutiny.

 Morgan: I appreciate everyone joining us today.

 Tyler: Always glad to have our friends from Gordian. And thank you, Morgan.

 Peter: Thank you very much. All of you.