ProMedica deal finances a big nursing home play

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Toledo, Ohio-based ProMedica is coming to market next week with a $1.46 billion offering that includes $1.21 billion of taxable bonds to repay a bridge loan used to help finance its large-scale play into the skilled nursing space earlier this year.

ProMedica plans $246 million of tax-exempt hospital revenue bonds, according to a preliminary official statement. Tax-exempt proceeds, issued through Lucas County, Ohio, will finance the system’s Generations of Care Tower at ProMedica Toledo Hospital and other building and equipment projects.

The taxable tranche, officially issued by The Toledo Hospital for the ProMedica Healthcare Obligated Group, will permanently finance ProMedica's July 26 acquisition of HCR Manorcare’s operations. ProMedica initially used $524 million of cash and a $1.15 billion bridge loan from Barclays to finance the transaction. ProMedica also entered into a new joint venture with Welltower Inc., a healthcare-focused real estate investment trust, to own 20% of the real estate associated with the organization.

The acquisition adds a 27-state system with 168 skilled nursing facilities focused on high acuity patients, another 54 assisted living facilities, and more than 100 hospice and home health offices. HCR ManorCare converted to a not-for-profit entity that operates as a division of ProMedica.

Barclays is senior manager on both the taxable and tax-exempt pieces of the sale.

Fitch Ratings provided a first-time rating on ProMedica, assigning a BBB-plus rating. The outlook is stable.

Moody’s Investors Service and Standard & Poor’s Global Ratings had not yet issued reports about the upcoming deal at publication time but had downgraded ProMedica in August following the HCR ManorCare acquisition. Moody's rates the enterprise Baa1 and S&P assigns a BBB rating.

ProMedica’s total long-term debt is set to jump to $2.3 billion from $972 million with the transaction and debt service will rise to north of $100 million from about $50 million a year depending on the interest rates that ProMedica is able to fetch.

“No matter how you add those things up that is approaching a $2 billion dollar transaction and that has certainly had an impact on its leverage,” said Fitch senior director Kevin Holloran.

Holloran said Fitch’s BBB-plus rating reflects the fact that HCR ManorCare is a cash-flowing asset.

“We are looking five years out into the future and if it continues to cash flow these guys can quickly add to their balance sheet strength as they pay that debt and it changes that field position rather quickly and so we like it in the BBB range and at the higher end of the BBB range,” he said.

George Huang, senior municipal research analyst on the not-for-profit healthcare sector at Wells Fargo, says the ManorCare acquisition was surprising both because of its scale and because it moves ProMedica away from its more traditional focus of acute care. Still, he said, it makes sense because there has been a lot of thought in the sector regarding vertical integration as new payment models force hospitals to assume more and more risk related to a patient’s total episode of care.

"The amount of leverage that they have had to take on to close the transaction is significant," Huang said. "This is the acquisition of a big national operator and it's also the acquisition of a business line that has not been a core to [ProMedica's] operations."

Huang added that partnering with a REIT was another surprising aspect of the transaction and could explain why ProMedica opted to issue taxable debt.

"Taxable debt provides more flexibility and this is helpful when you are not sure what your strategy is," Huang said. "A tax-exempt structure would have been much more restrictive."

A tax-exempt offering would bar the venture from being for-profit and Huang said that the fact that the system entered into a joint venture with a REIT operator could bring up questions regarding taxability for certain operations. Also, if ProMedica has thoughts of partnering with someone else when it comes to operations, issuing taxable debt gives some flexibility to do so.

The acquisition more than doubles ProMedica's $3 billion revenue base and expands post-acute and long-term care operations, while adding to the system’s leverage and significantly diluting balance sheet and liquidity metrics.

Holloran said that ProMedica effectively bought the operations of a company that cash-flows nicely.

“ProMedica bought a company that is now in their portfolio of assets,” Holloran said. “It’s an investment with deploying capital investing in this company and it’s related to what they do in the healthcare space which over the long term should benefit ProMedica.”

The system’s financial flexibility is further enhanced by its ability to both monetize assets from the HCR ManorCare acquisition and to potentially sell off part or the whole of the HCR ManorCare operations should a stress situation arise.

According to Fitch the move is already paying off for ProMedica. ProMedica negotiated much better leases for the buildings than ManorCare did before the merger.

The transaction also includes a lease payment guaranteed by ProMedica to the landlord, HCP Properties, of which ProMedica is 20% owner and Welltower is 80% owner. The lease term is initially 15 years, with two five-year renewals, and one four-year-and-eleven-month renewal. The terms of the lease are such that year one is $179 million, with built-in inflators of 1.375% the first year, and then 2.75% for subsequent years.

“This lease payment level is significantly less than HCR ManorCare was paying in its pre-bankruptcy state, where the lease payments were approaching $400 million annually,” Fitch said.

HCR ManorCare had filed for bankruptcy in March as it struggled to keep up with rent payments amid declining Medicare reimbursements.

In the immediate wake of the ManorCare acquisition, S&P lowered ProMedica's rating to BBB from A-plus. The outlook is stable. Moody’s downgraded the system to Baa1 from A1. The outlook is negative.

Both rating agencies cited the significant long-term weakening of ProMedica’s balance sheet, which doubled the system’s debt, as well as the 20% investment in the real estate joint venture with Welltower.

HCR has more than 50,000 employees providing services in 450 assisted living facilities, skilled nursing and rehabilitation centers, memory care communities, outpatient rehabilitation clinics, and hospice and home health agencies operating under the names of Heartland, ManorCare Health Services, and Arden Courts.

ProMedica, which operated in six states, said the acquisition expanded its business into 30 more states. After the acquisition the system employs approximately 70,000 people with annual revenues of about $7 billion.

A ProMedica spokesperson said that the health-care company anticipates to pay an interest rate of about 5% on the tax-exempt debt it offers.

“For the taxable issue, we will not know what our rates are until we go to the market and determine the specific amounts and maturities,” the spokesperson said.

While the Federal Reserve has been gradually raising benchmark interest rates this year, the spread in interest rates paid for top-rated hospital debt and lower-rated issues has been minimal. ProMedica’s debt is still rated investment grade, keeping interest rates relatively attractive, said Huang.

"This gives [ProMedica] the ability to get a somewhat favorable cost of capital since money is still somewhat cheap," said Huang.

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