Deal of the Year – Heritage shows skills with healthcare deal

What is remarkable about the Skilled Healthcare story is that Heritage tripled its investment in the company despite the business falling into bankruptcy in 2001. And while bankruptcy typically means a write-off for equity investors, it didn’t for Heritage. Instead, the firm strengthened the management team, repaid all creditors and managed to retain 95% of its equity. In 2005, Boston-based Heritage sold the provider of skilled nursing and contract therapy to SHG Holdings Solutions Inc., a holding company formed by Onex Partners LP, for $640 million, including the assumption of debt.

“It took a lot of focus to repair the business and full-time negotiations with other stakeholders in the business,” said Mark Jrolf, a partner with Heritage. “Bankruptcy creates adversarial parties, but we worked through it and left all the of the creditors paid in full, but the process was all consuming for two years.”

In 1997, Heritage made its initial investment in Skilled Healthcare, which was then called Fountain View Inc., a family-owned business with $68 million in revenue and $8 million in EBITDA. At the time, the company had nearly 1,300 beds in nine facilities. Heritage believed the high acuity model for long-term care would be a winning strategy because it offered a lower cost alternative to traditional hospitals and kept the company away from competing with the growing stock of Assisted Living units.

In 1998, Heritage completed a sizable add-on acquisition of Summit Care, delisting the company from the Nasdaq for about $144 million plus the assumption of about $130 million in debt. The deal brought Skilled Healthcare’s number of beds to 6,600 and total revenues and EBITDA to $290 million and $30 million, respectively.

However, the leverage that Skilled Healthcare accumulated proved to be sizable. In addition to its assumed debt load, the company issued $120 million in senior subordinated notes with an 11.25% interest rate, a term loan facility of up to $85 million and a $30 million revolving credit facility to facilitate the Summit merger and future growth. By May 2001, due to a $6.1 million judgment that stemmed from the death of an elderly female resident at one of Skilled Healthcare’s health centers, the outstanding debt and a market that was being besieged by reimbursement challenges, the company began failing to meet millions of dollars worth of debt-related payments.

Skilled Healthcare filed for Chapter 11 bankruptcy in October 2001. Believing in the company’s underlying cash flows and strong real estate value, Heritage stood firm during the bankruptcy period, focusing its resources on improving earnings, attracting an industry-leading management team and finding successful exit financing that would allow all creditors to be paid in full. During its time under protection, the company hired new management, including Boyd Hendrickson, who replaced Robert Snukal as Skilled Healthcare’s CEO, and Jose Lynch, who was brought aboard as president (a newly created position).

“We had to convince as many of the creditors as possible to give us time and a chance to work out the turnaround. We had to attract a management team that would be capable of carrying changes,” said Jrolf. “Boyd Hendrickson and Jose Lynch came, and they saw the opportunity for value. Bankruptcy offered them a company with market positions and assets and time to implement their plan to run the most efficient skilled nursing model in the industry.”

Paid in Full

In July 2003, the company emerged from Chapter 11 with strong EBITDA and an improved capital structure. All creditors were paid or restructured in full and Heritage and the shareholders were able to retain 95% of the equity, which was made possible by a series of debt recaps.

“The refinancing they did allowed them to go back to the institutional market so they could provide liquidity to shareholders. The company raised one financing in 2004 and another in 2005, allowing shareholders to receive a dividend and be structured so the buyer assumed the debt,” says a banker familiar with deal. “This is very unique.”

Led by Hendrickson, Skilled Healthcare experienced tremendous growth since 2002. In all, Heritage made approximately four post-bankruptcy add-on acquisitions for the company, the largest of which, Kansas-based Vintage Park Group, closed late last year. Since 2002, Skilled Healthcare has seen a 21%, three-year compound annual growth rate in profits and has increased its facilities base from 50 to 70. Based on the strong financial performance, the company completed a number of debt refinancings, returning $140 million in equity to its shareholders in 2004 and 2005.

Additional reporting by Dan Primack and Ari Nathanson.

Heritage Restructures Itself

While the Skilled Healthcare deal proved to be a winner for Heritage, other investments that did not work out so well have prompted the Boston-based private equity firm to shake things up a bit. Peter Hermann, a co-founder with Heritage, and Mark Jrolf are spinning out to create a successor firm and plan to start fundraising at the beginning of next year. Heritage raised $150 million for its inaugural fund in 1995, around $380 million for its second fund in 1997 and nearly $850 million for its third fund in 1999, which positioned Heritage as a large-market firm—a change that caused the firm to stray from its knitting.

The plan now is for Heritage to spend the remainder of 2006 working with its portfolio companies and trying to generate liquidity events. It then will go back to the fund-raising market in early 2007 looking to raise between $300 million and $400 million. The new fund will be recommitted to family-owned middle-market deals, with a relaxation of its requirement that prospective targets have at least $75 million in annual EBITDA. The fund also will not include firm co-founder Michael Gilligan as a general partner, although he plans to stick around for most of 2006.