The Death of a Health Care REIT
Back in June of 2015, Sabra Health Care (NASDAQ: SBRA) bought five long-term care facilities in my home state of Maryland. The seller was Neiswanger Management Services LLC (NMS). And the homes sold for a ridiculously high price of $234 million. That’s around $345,000 per bed — about three times higher than what a NEW facility would cost in Maryland.
The deal sort of made sense at the time, though. NMS was making a ton of money from these facilities. And NMS agreed to enter into a 15-year lease of the facilities they’d sold to Sabra. Great, right?
If This Doesn’t Make You Mad…
You see, in December of last year, the Maryland attorney general filed a lawsuit against NMS for taking advantage of the MD Medicare system. NMS was collecting as much as possible and then giving patients the boot once their Medicare money had dried up. Not just despicable treatment, but also illegal. Very illegal when those patients were eligible for Medicaid.
In fact, over the course of the investigation, NMS issued at least 1,061 involuntary discharge notices to patients. That’s twice as many as all of the other 225 care facilities in Maryland combined.
And it gets worse. The average Medicare stay is between 27 and 37 days. But NMS’s Medicare patients were staying for over 100 days. Then, even if the patients were eligible to get Medicaid, NMS was kicking them to the curb and sending them to unlicensed facilities throughout the state or just dropping them off at family members’ houses.
You see, Medicare pays a boatload of money for long-term care in skilled nursing facilities like these. But Medicaid pays a pittance in comparison. So, NMS was basically maxing out the amount of Medicare cash they could get from each patient and then kicking them out once the less profitable Medicaid payments would be due to take over.
And from an ethical standpoint, it gets even worse. Some of the people used as examples in the case were abandoned in the driveways of family members’ houses and left to sit in near 100-degree heat.
So, NMS is in some serious trouble here. Someone might even go to jail over it. And the company is likely going to have to sell off any valuable assets it has and then just fold.
Nobody knew about this back when Sabra bought the facilities. And that’s why the company was willing to pay so much. They were cash cows. Money was rolling in faster than at any others in Maryland.
And now, after selling a bunch of facilities to Genesis, about 15% of Sabra’s revenue comes from the leases on those five. That’s going to be a big cut when those leases are terminated and the losses have to be written down.
Even worse is that Sabra now owns four facilities that cost a pretty penny but aren’t really worth a dime. So, the next tenant isn’t going to pay nearly as much as NMS was. Double whammy!
Think of it like this: You buy a house that’s really worth $250,000 but you pay $1 million. But you did it because that house was being rented out by a really successful drug dealer for $10,000 a month. You didn’t know the guy was selling smack. You just knew the money was rolling in month after month.
Now the dealer got arrested and isn’t going to be coming back next year. And you’ve got to fill the place with someone else. But the thing is, nobody but someone who’s going to do something illegal in that place is going to pay you $10,000 a month. So, you have to rent it out at the market rate — say $2,400 a month.
Now you’ve got a house that cost a million dollars and a mortgage payment between $4,000 and $5,000 a month. But you can only rent the house for $2,400. You’re losing a lot of cash on that deal. Plus, you’ve got to pay for the upkeep of the property.
That’s pretty much the situation Sabra’s in right now. Or will be once the lawsuit is over and NMS is a distant memory.
Sabra might be able to recoup some of those lost revenues with a new lease on the properties. But there’s no way it’s getting what NMS was paying. So, we’re talking about at least a 10% drop in rental income once NMS is kaput.
That’s really going to hurt Sabra’s stock price once the market realizes what’s going on. A lot.
But the thing is, only a few people seem to have noticed the connection between NMS and Sabra. And if anyone else has, they definitely haven’t realized how much of Sabra’s revenues come from the NMS leases.
The short ratio — that’s the number of days at average trading volume it would take to cover all of the short positions on SBRA — is sitting at a pretty high 10.23. That means it would take more than two weeks at average volume to cover all the short trades against Sabra.
Typically, that’s indicative of a short squeeze in the making. That’s when there are a ton of shorts and the stock moves up forcing short positions to be covered. It drives up volume and also share price. But in this case, there’s good reason for all those shorts. This stock is destined for some devastation.
Different Story, Same Ending
Sabra had a tenant go bankrupt before. Back in 2015, a tenant leasing one of its properties in Texas went bankrupt, and Sabra was forced to sell the facility... at a steep loss. Really steep. The hospital sold for around $96 million. But Sabra had recently paid over $120 million for it. That’s a 20% loss on the hospital. But Sabra had also made loans to two others, and the bankruptcy meant it was not getting that money back.
And that crushed the stock price. It dropped over 25% once the market took notice of the situation. There’s no reason to think it will be any different this time around. In fact, the loss might be even more drastic.
Back when the bankruptcy happened, Sabra was bringing in rental income of $209.8 million a year. And the single tenant made up about 6% of that total. Now it has rental income of $167.4 million. And NMS makes up over $25 million of that. 15% of the revenue comes from a tenant that’s probably going bankrupt!
If losing those unsecured loans and 6% of its rental income dropped the share price by 25%, just imagine how much a 15% loss of income will cost investors.
And while this is bad news for current shareholders, you can profit from it with a short position on Sabra’s common stock. It’s trading around $26 right now. That’s practically its all-time high. I wouldn’t be at all surprised to see it drop by way more than 25% once it becomes clear to investors that Sabra’s going to lose 15% of its revenues.
Another way to play the downside is to buy puts on Sabra’s stock. Right now, they’re only going out to July of this year. So, if the market doesn’t realize what’s about to happen to Sabra’s revenues, those might have to be rolled into a new position with a later expiration.
But mark my words: these shares are going to drop precipitously, and those puts are going to become very valuable. It’s not a matter of if, but when.
To investing with integrity (and shorting deceit),
Follow me on Twitter @AllBeingsEqual