The proposals come only days after the care home firm - which has 750 homes and 31,000 residents and is the UK’s largest - announced 3,000 job cuts, and only a week or so after it unilaterally decided to slash its rent bill by 30% in order to stave off financial ruin.
That move unsurprisingly made its 80 landlords very (Southern) Cross indeed, hence today’s alternative suggestion: by effectively making them a gift of nearly 20% of the firm’s home portfolio, its is presumably hoping to assuage landlords ire whilst simultaneously cutting its own cost base down to more manageable proportions. Its goal is to slash its annual rent bill from £202.3m to £137.5m.
Will it work? Well, the homes certainly ought to be worth a lot more as going concerns than as empty buildings, so if the landlords can find alternative operators for them it could all turn out to have a (relatively) happy ending. And there should certainly be interest from rival outfits such as Four Seasons and Bondcare, especially as these firms are already landlords of some 85 Southern Cross homes. But as the homes it will want to offload will naturally tend not be the best performers in its stable, a good number of them will likely not find new operators, and will have to close. Even Southern Cross admits that the number of homes facing closure is in double figures, with all the consequent distress and disruption of being re-homed for an estimated 5,500 elderly and blameless residents.
So how, given that the ‘eldercare’ market is expanding briskly and enjoys a degree of revenue stability that would be the envy of many other sectors, did Southern Cross get into such a hole in the first place? And why is it apparently facing bankruptcy when it still has hefty income and only around £50m of debt? The trouble dates back to its ownership by private equity giant Blackstone, which bought the firm for £162m in 2004 and rapidly tripled its size by acquiring two rivals, financing the deal by a sale and leaseback of its entire property portfolio. To many investors this looked like a safer bet than the usual leveraged buy out, but in reality it didn’t make much difference - rent, like interest, still has to be paid every month.
Interesting to note also that both Blackstone and the then-management team did pretty well on the deal, extracting big bucks while the getting was good. Southern Cross floated on the FTSE250 in 2006, and its market cap peaked at over £1bn a year later. Then chairman William Colvin and three other directors sold their entire stakes in 2007, netting themselves an estimated windfall of £35m. As pension fund watchdog PIRC told the FT recently, this is hardly best practice ‘Shareholders like to see directors maintain a meaningful stake in the business in order to achieve an alignment of interests. To sell an entire holding, however financially advantageous, doesn’t send the best signal.’
The size of the rent bill bequeathed to the current management, plus automatic increases annually for the 30 year terms of the leases, meant that it took only a modest drop in referrals from local authorities as a result of spending cuts to put the entire business in jeopardy. Hardly a ringing endorsement of private sector involvement in the healthcare sector, a business where the consequences of failure far exceed the purely financial…
So, will its landlords accept the deal? On the face of it, it seems to be their best chance going, the alternative being bankruptcy, which would send reputational and financial shock waves throughout the sector. Not to mention the human and political consequences of re-homing all those residents. But here’s the rub - the landlords may not be able to afford to say 'yes', having themselves borrowed heavily to buy the homes in the first place. So the outcome will probably depend on the willingness of their banks to extend the terms of their loans. What a mess.