ProMedica’s finance chief doesn’t blame people for being skeptical when the not-for-profit health system took on more than $1 billion in debt to buy a massive, bankrupt senior living provider.
“So many people were like, ‘What in the world are these guys doing?'” said Steve Cavanaugh, chief financial officer of the Toledo, Ohio-based health system. “They just assumed, ‘It’s going bankrupt. It must be a broken company.'”
ProMedica’s leaders say they knew buying HCR ManorCare meant sacrificing—at least in the short run—their debt ratio and perhaps even their credit ratings. Indeed, all three rating agencies have since downgraded the health system, citing its debt ratio. The tradeoff, they say, was made in service of a larger, multipronged strategy that’s just starting to bear fruit.
A little over two years after ProMedica’s $1.4 billion purchase closed and in the midst of a global pandemic, HCR appears to be a stable component of the health system’s operations. In the first half of 2020, HCR—which now makes up almost half of ProMedica’s revenue—posted a 7.7% operating margin, boosted by $156 million in federal stimulus grants, compared with a -1.9% margin in ProMedica’s provider division, which drew $84 million in federal grants.
Even in 2019, before the pandemic and resulting federal grants, ProMedica’s senior care division posted a 2.4% margin, compared with 0.4% in its provider division and -3.9% in its insurance division.
“I just think they had a strategy, they went in and executed it and ManorCare has been that piece of the strategy that’s been very consistent,” said Kevin Holloran, senior director with Fitch Ratings. Holloran admits he was one of the deal’s initial skeptics.
Like many senior living companies, HCR had struggled beneath rising rent payments before the deal. ProMedica was able to work out an agreement with HCR’s landlord, Welltower, that cut its rent from $450 million a year to about $150 million a year. Even though their contract still includes a 2.75% annual escalator, Cavanaugh said the lower rent means HCR will generate cash for the system despite the rent increases. ProMedica now owns 20% of HCR’s real estate, while Welltower owns the other 80%.
“What has really damaged some of the leased skilled nursing facilities over past couple years has been annual increase in lease levels,” said Steve Kennedy, executive managing director with VIUM Capital. “You’ve got ProMedica to some extent on both sides of that coin. … I think it makes a lot of sense.”
S&P Global Ratings, by contrast, views that 2.75% lease escalator as a potential problem if senior care reimbursement doesn’t keep up, said Anne Cosgrove, a director with S&P. The agency issued a multi-notch downgrade of ProMedica the month after it bought HCR, citing its issuance of $1.15 billion in debt and $524 million in cash to fund the deal.
“We have written about it as a potential risk factor because if you don’t have cash flow growth that exceeds that, you’re going to start seeing more compression,” she said.
The broader strategy
The biggest misunderstanding about the deal initially was the perception that HCR was an operating and financial mess because it was going through bankruptcy, which was not the case, said Cavanaugh, who was HCR’s CEO when the deal closed. Even when it was on the brink of bankruptcy, HCR was performing well operationally and financially, he said. The floor fell out when its main revenue source, Medicare, shrunk its reimbursement.
“We had a lot of leverage like a lot of private equity-held companies do,” Cavanaugh said, “and when the reimbursement changed, it just sank the company. It wasn’t really about the operations.”
The vision behind bringing HCR and ProMedica together was bigger than just lower rent payments. The deal transformed HCR into a not-for-profit subsidiary of ProMedica, which allows it to bring the same quality initiatives used in ProMedica’s hospitals into its senior living facilities, Cavanaugh said. ProMedica’s senior care division is also in partnership talks with a handful of other health systems around the country.
“HCR as a standalone company would not have been able to have those kinds of conversations and get to the finish line on them,” Cavanaugh said.
Mark Shaver, Welltower’s senior vice president of business strategy and health systems initiatives, said that in addition to serving as a strategic capital partner, ProMedica used Welltower’s business insights and data analytics capabilities to expand and identify key divestitures, which ProMedica used to sell three facilities in Maryland.
Being not-for-profit also opens up HCR to access tax-exempt as well as taxable markets for capital, Kennedy said. HCR can now take advantage of government options for low-interest loans especially for skilled nursing and senior housing operators, he said.
“Given their scale, if you can reduce your cost-to-capital on the real estate by a significant number of basis points, that can translate into large dollars,” Kennedy said.
Then there’s the fact that ProMedica now controls a system of acute-care, senior living and insurance operations, which creates somewhat of a closed referral system in areas where it operates all three divisions.