HCN’s Sunrise Acquisition: Not a Bargain, But Has Long-Term Strategic Value

When Toledo, Ohio-based Health Care REIT (NYSE:HCN) announced on Wednesday that it was acquiring all of the approximately 58.3 million outstanding shares of national senior living provider Sunrise Senior Living (NYSE:SRZ) for $14.50 a share, it didn’t exactly get a bargain—but it did make a smart long-term investment, analysts agree.

Despite the steep price tag, there was a strategy attached to the transaction, says Philip Martin, the director of REIT research and strategy at analyst firm MorningStar.

“It was by no means a bargain price—it was a premium price,” he says. “But longer-term, there’s strategic value.”

The $14.50 per share represented a 62% premium above the stock’s closing price the night before, and the deal’s 2013 cap rate is an estimated 6%. However, the price Health Care REIT paid for Sunrise wasn’t exactly startling.

“People may say they overpaid, but it’s also not surprising,” notes Daniel Bernstein, an analyst with Stifel Nicolaus’ Research Team. Both HCN and fellow healthcare REIT, Ventas, Inc. (NYSE:VTR) had indicated there would be a 20 to 30 basis point drop for cap rates on large portfolios, he says, adding that his firm wasn’t surprised by the cap rate. “It’s a very valuable portfolio, despite the high price point.”

Overall, the deal has positive implications. The portfolio has locations in very durable, sustainable markets, Martin says, especially in terms of population growth and other key demographics.

Although Sunrise has garnered some less-than-favorable headlines in the past couple years after a bankruptcy scare in early 2009, concern over the premium being paid for the senior living provider’s stock wasn’t necessarily related to the operational performance within the company’s portfolio—it was more over the company’s financials, says Martin.

“Sunrise has historically proven to be a pretty adept owner, developer, and operator of higher-acuity senior living properties,” he says, adding that the provider is widely considered one of the pioneers of assisted living. “Operationally, they still have what it takes.”

Now that Sunrise has Health Care REIT in its corner as its financial partner, the senior living provider will have the ability to invest more in its properties, monetize the real estate value it has created, recapitalize its balance sheet, and focus on its core expertise: operating, says Martin.

While Bernstein suspects the acquisition won’t be immediately accretive to the REIT’s earnings, upside does exist.

“There are some levers they can pull, with restructuring management fees and refinancing debt with Health Care REIT’s lower cost of capital,” he noted.

As a result of the deal, relative to some of its peers in the healthcare REIT arena, such as Ventas, Inc. (NYSE:VTR) and HCP Inc. (NYSE:HCP), HCN is a “bit more levered” and more dependent on the capital market, Martin says, adding that he wouldn’t be surprised to see them be comparatively more active in terms of raising equity in the next six months.

Following the transaction announcement, a few analyst firms downgraded HCN, including UBS and Goldman Sachs. However, the day after news of the deal was made public, Standard & Poor’s Ratings Service released comments on Health Care REIT, stating that its BBB- rating and positive outlook on the company had not been affected by the agreement to acquire Sunrise.

“In our view, the acquisition will enhance the quality of Health Care REIT’s portfolio through the addition of well-branded, high-quality, private-pay assisted living facilities that are primarily located in high-barrier and high-cost housing markets,” says S&P. “We acknowledge that Health Care REIT is reliant on the capital markets to fund its voracious appetite for growth. We could also revise the outlook to stable if the company faces challenges digesting its acquisitions or terms of the Sunrise transaction change such that Health Care REIT pays a higher price or is unable to sell the management business.”

Written by Alyssa Gerace