Investor Skepticism of Skilled Nursing Helped Prompt Ensign’s Home Health Spin-Off

Despite multiple quarters of record earnings and a stock price that dwarfs that of other publicly traded skilled nursing companies, executives at The Ensign Group (Nasdaq: ENSG) said that investor skittishness over SNF assets played a major role in their decision to spin off its home health and senior housing business lines into a new company.

The proposal to separate skilled nursing from Ensign’s other segments will create an opportunity for investors who may like the company’s approach to post-acute care in spite of their personal aversion to skilled nursing, CEO Christopher Christensen said during a Tuesday call with shareholders and analysts.

“There are people that don’t really like our profession, that don’t like our industry, and they like our model and they like the results we achieve,” Christensen said. “This gives them a chance to invest in Ensign and what we believe in and how we operate and the fundamentals and the way we acquire — the contrarian acquisition model we tend to follow. It gives them a chance to do that without necessarily coming into an industry that they’re uncomfortable with.”

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The Mission Viejo, Calif.-based skilled nursing leader on Monday followed through with a long-floated plan to separate its home health, hospice, and senior housing business lines into a new publicly traded company, The Pennant Group. Set to close by the end of 2019, the transaction will help those individual businesses more easily navigate the changing post-acute landscape, executives said — while also divorcing home health and hospice from the baggage that SNFs can occasionally carry among the Wall Street set.

“Following the spin-off, we will be able to raise capital in ways and at times that Ensign may not,” the company wrote in an investor presentation pitching the deal to shareholders. “Relatedly, the public market appetite for investments — both debt and equity — in the skilled nursing space stands in contrast to the appetite for similar investments in home health, hospice, and senior living businesses, which may attract better equity valuations and more favorable debt financing via certain offerings.”

Daniel Walker, the current Ensign executive who will take the Pennant CEO reins once the spin-off is complete, doubled down on that perspective in a letter to shareholders.

“More education about and visibility into these uniquely situated operations will create a better understanding of the value we believe remains somewhat hidden and overshadowed by the market’s perception of the skilled nursing industry at large, despite Ensign’s successful history of outperforming industry peers in many key metrics,” Walker wrote.

It’s no secret that skilled nursing facilities generally rank near the bottom of most investors’ wish lists in the greater seniors housing and care space. The asset class finished dead last in a Lancaster Pollard outlook survey for 2019, with just 8% of respondents predicting that SNFs would see the most growth in the year. Home health boasted 40% support among the surveyed leaders, with memory care and affordable senior housing nearly cracking 50%.

Source: Lancaster Pollard

Going back a year, only 14% of respondents to a March 2018 survey of investors from real estate services firm CBRE said SNFs met their acquisition requirements, compared to 98% for medical office buildings and 72% for ambulatory surgical centers.

But Ensign maintains a unique advantage in the marketplace, frequently outpacing its publicly traded counterparts and turning in quarter after quarter of impressive results. In the first quarter of 2019, the company reported a 27.2% increase in skilled nursing income over the same time in 2018, with a same-store occupancy boost of 163 basis points — and a transitioning occupancy gain of 349 basis points.

Ensign on Tuesday also reported overall net income of $27.4 million for the quarter, up 18.3% from the same time in 2018, and record earnings per share of $0.49 — breaking the mark set last quarter. The company’s shares closed Tuesday’s trading at $50.91 per share, a drop of $1.12 or 2.2% — a figure that dwarfs the closing marks of fellow publicly traded SNF providers Genesis HealthCare (NYSE: GEN) at $1.29 per share, or Diversicare (Nasdaq: DVCR) at $3.90 per share.

Dana Hambly, an analyst with the investment firm Stephens who covers Ensign, told SNN that despite the company’s success, home health and skilled nursing companies don’t necessarily pull from the same pool of investors.

“There are definitely investors that just do not want to have anything to do with SNFs,” Hambly said via e-mail. “Many of them include investors in home health companies like AMED [Amedisys], LHCG [LHC Group], and EHC [Encompass Health]. Those companies generally talk about how much business they are taking from the SNF.”

In addition, high-profile skilled nursing restructuring efforts at the real estate investment trusts (REITs) have grabbed headlines in recent years, perhaps scaring off those with less experience in the skilled space.

“ENSG is miles away from some of the other publicly traded SNF operators.  GEN has strung together some better quarters more recently, but they have been dealing with a lot of distractions and a strained capital structure,” Hambly said. “It doesn’t help industry sentiment, either, when many of the health care REITs with SNF exposure have had to restructure or terminate leases with tenants.”

Still, Hambly noted that blind SNF phobia could have proved costly for investors in Ensign’s specific case.

“Anyway, those that stayed away missed a nice run in the ENSG stock over the last 18 months,” he said.

The decision to spin off wasn’t confined to perceived investor disdain for skilled nursing assets, however. Even though Ensign had built its home health business line to operate more or less autonomously from the skilled assets, the leadership team had run into barriers when attempting to branch out into partnerships with other SNF operators, Walker said.

“Part of the opportunities that exist there is to continue to work with other providers in the whole post-acute continuum that, in some cases, are hesitant to do business because of the channel conflict issues that exist,” he said.

In addition, management identified a closer link between home health and senior housing — particularly the assisted living setting — than between home health and skilled nursing.

“Home health happens a lot more in an AL setting than it does in a skilled nursing setting,” Christensen said. “There is a lot more overlap between these two particular industries than our industry with these. It is pretty natural even outside of our organization.”

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