From the Wall Street Journal
February 4, 1999
Assisted Living Companies Become the Stocks from Hell
By Lawrence Strauss
About a year ago, companies that ran assisted living facilities, like
Alternative Living Services and Assisted Living Concepts, were hot growth
stocks, commanding multiples above 30x earnings.
Not any more.
On Monday, Assisted Living Concepts announced it would restate earnings for
all of 1997 and for most of 1998 because of accounting issues related to
joint real estate ventures. The stock lost more than half its value that
day, closing at 6.
The other shoe dropped on Thursday when BancBoston Robertson Stephens
analyst Sheryl Skolnick said the firm had actually suspended coverage of the
industry amid concerns about a General Accounting Office report to be
released later this year.
Her stunning announcement caused many stocks in the group -- including
premier names like Sunrise Assisted Living Corporation -- to plummet.
Sunrise closed Thursday at 38 1/4, down 8% for the day and off more than 25%
from its 52-week high of 53 1/8 set in late December. CareMatrix closed at
18 5/8, down 5 3/8 for the day and nearly half its 52-week high set last
March. And Alternative Living Services closed at 21 13/16, down about 15%
for the day and about 40% below its high of 35 ¼ set last April.
Amazingly, Skolnick still calls the industry fundamentally sound. But she
worries about the stocks' volatility as investors wait for the GAO report to
be published. The biggest fear: more government regulation of the industry.
Although Skolnick doesn't expect the report to bring about major changes,
"between now and then, the stocks won't trade on fundamental values," she
says.
Bloodbaths usually bring out bottom fishers, and this time is no exception.
"I believe it's a buying opportunity, and I [don't] think. . . extensive
regulation is coming to the industry any time soon," says Kirsten H. Jensen,
who tracks the sector for Legg Mason Wood Walker.
Assisted living facilities provide housing in a setting similar to an
apartment complex. Ideal candidates don't require the level of care offered
in a nursing home, but perhaps need assistance with daily chores such as
bathing or taking medication. Most tenants pay the fees directly out of
pocket, with no third-party reimbursement.
No doubt, the group looks cheap -- on paper. As of Thursday's close,
Sunrise, the most expensive stock in the group, traded at 26x the $1.47
analysts expect it to earn in 1999, according to First Call. Alternative
Living was changing hands at 15x projected 1999 earnings, and CareMatrix was
at 13.7 x projected earnings, according to First Call.
But even before today's selloff, the industry had been dogged by worries
about the companies' liberal use of "off- balance-sheet financing." By
linking up with developers in separate joint ventures, these companies avoid
paying many of the huge start-up costs of building assisted living
facilities. Borrowing the money directly would force them to take
depreciation expenses and pay interest on the debt, depressing net earnings
and making it harder for them to raise capital.
That has raised some red flags. In early January, Wheat First Union analyst
Craig Dauer downgraded Alternative Living Services to a Hold, based on
quality-of-earnings concerns. Dauer noted that the company has become more
reliant on joint venture financing "to off-load losses from startup
facilities." In the third quarter of 1998, 76% of Alternative Living's
startup facilities were in joint ventures, up from 59% in the fourth quarter
of 1997, he notes.
The industry's liberal use of off-balance-sheet financing also troubles
accounting maven Howard M. Schilit, president of the Center for Financial
Research and Analysis in Rockville, Md.
"They are forming joint ventures with the apparent intent of shifting some
losses off of their books and onto the books of their partner," he says,
adding it's not unique to this sector. "It's clearly done with the intent,
at least temporarily, of shifting the operating performances off their books
during the early years when there will be losses."
Chris Teeters, an analyst for Schilit's group who wrote a report on
Alternative Living's accounting, sums up the problem this way: "Losses are
disproportionately allocated to the joint venture partner."
That was the problem with Assisted Living. Before the market opened Monday,
it put out a press release saying a joint venture partner had reimbursed it
for 90% of the startup losses from that venture, and Assisted Living had
actually recognized those reimbursements as income. Other companies in the
industry, like CareMatrix and Alternative Living, maintain they do not
follow that practice, and the analysts we spoke with say Sunrise uses little
off-balance-sheet financing.
Tom Komula, chief financial officer of Alternative Living, acknowledges that
joint real estate ventures are widespread in the industry and that his own
company uses them. But these ventures, he tells Barron's Online, are
"instrumental in mitigating the risk of growth in this industry to the
public." He argues that industry fundamentals -- notably occupancy rates --
are strong. In other words, a rising tide lifts all boats.
Fans of the assisted living sector maintain that this week will turn out to
be an aberration and that the GAO report won't lead to major upheaval. The
bulls still like the group's rising profit margins and long-term growth
rates in the 30% range, the potential for industry consolidation and a
perfect demographic wave -- the graying of America.
"I love the macro environment for the sector - the fact that a lot more
people are getting older and a lot of them don't need to be in a nursing
home," says Carlene Murphy Ziegler, portfolio manager of the Artisan Small
Cap Fund. Earlier this week, Ziegler says, she added to the fund's stake in
Alternative Living, raising it to about 200,000 shares.
Ziegler and other contrarians may ultimately be right, but accounting issues
have a way of coming back and biting companies and their shareholders.
As long as that cloud hangs over assisted-living companies, don't expect
these stocks to shine on Wall Street any time soon.
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