Animals spirits

When operating at a loss, purchasing a competitor may not be the best course of action

July 21, 2016

About the author

Noam Ganel, CFA is the founder of Pen&Paper, a value-oriented, contrary-minded journal of the financial markets. Between 2010 and 2020, Ganel worked for Silvergate as Vice President in Capital Markets. He provides advisory services to family offices,  private companies, and financial advisors.

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Brookdale senior living solutions (BKD) operates 130 retirement centers, 915 assisted living communities and 78 continuing care retirement centers (CCRCs), serving about 108,000 residents. Not only is BKD the largest senior living operator in U.S., the company doubled its revenue in the past five years, from $2.4 billion in 2011 to $4.9 billion in 2015. But neither the size nor the revenue growth increase has translated to earnings. The medical care REIT has not distributed any dividends since 2008.

Management has not retained earnings either. In each of the past five years, for every dollar of revenue, 95 cents were used to pay for operating expenses. And non-operating expenses added 50 cents, which was paid by equity and debt issuance. Your correspondent often wonders when companies choose to classify debt and financing obligations as non-operating expenses. If debt, classified as non-operating expense, is not used for the operations of the business, what is it for? 

Perhaps, to build an empire. At the promise of future synergy benefits, economies of scale and increased operational efficiency, BKD purchased, in 2014, Emertitus Corporation, a senior living service provider operating residential style communities. Valued at $3 billion, BKD assumed $1.4 billion of Emertitus debt and exchanged $1.6 billion of its shares, notes Jason Oliva of SHN, a senior housing industry publication.

But impartial to the dissonance between the classification of expenses, capital markets eventually penalize management that does not show a reasonable return on equity. $100 invested in 2008 BKD would be worth at $487 in 2013. Compare that to $100 invested in the company in December 2010, which, post the Emertitus acquisition, at the end of 2015, would be worth $86.

Overlooking the balance sheet and income statement, management continues to boast about its size. “As I look to 2016 and 2017, I am excited about Brookdale’s clear leadership in senior living,” notes T. Andrew Smith, boss of Brookdale. “We have started capturing the significant cost synergies available to us, leveraging our size and scale. And we expect that we will show strong cash flow growth.”  

A promising mission statement does not always translate into business results. “To enrich the lives of those we serve with compassion, respect, excellence and integrity” is a noble goal. And yet it is unsustainable without earnings.