A Tough Lesson in Due Diligence
Sabra Health Care Proves Poor Research Yields Worse Results
Last Friday, I wrote about some problems they’re having over at Sabra Health Care (NASDAQ: SBRA). There's a link to that article at the end of this one.
Today, I’m going to recap the issue and expand on my analysis of the sticky situation and why that’s going to send Sabra’s stock price plummeting.
Before We Get Started
Sabra is a health care REIT, or real estate investment trust. It invests in skilled nursing facilities, hospitals, senior housing, and other medical-related real estate and then rents those facilities back out to other companies that operate them.
Now, I’m actually a fan of REITs. They provide amazing income and are typically a really profitable investment. In order to be classified as a REIT, a company has to give out at least 90% of its pre-tax income to shareholders. That makes for some pretty sweet dividend payments.
And since they’re typically really solid companies, they get great rates when they borrow money to buy real estate. It’s not like investing in mortgage-backed securities that are based on subprime loans. These are seriously prime loans. So, the companies aren’t paying out a ton of revenues as interest. That means more cash to share with investors.
But, as you'll see after reading this article, not all REITs are great investments.
**Side Note: If you’re interested in learning about some really great REITs (and other great investments) like the ones that have scored my readers profits of 175%, 190%, 210%, and even 300%, click here to check out my premium investing service, The Wealth Advisory.**
Now, after that shameless self-promotion, let’s get back to a REIT you want to stay well away from.
A Bad Decision Gets Even Worse
Back in 2015, Sabra purchased four skilled nursing facilities from a Maryland operator called Neiswanger Management Services (NMS). At the time, I guess it seemed like a great deal for Sabra. The company got the facilities and immediately rented them back out to NMS for an astronomical amount.
Even though Sabra paid $234 million — or about $345,000 per bed — the rent was going to more than cover the cost of the facilities. And it would add around $25 million a year to its revenues.
Now, that $345,000 per bed is about three times higher than what a new facility in Maryland would cost. And it set the record for per-bed cost in the skilled nursing field.
But hey, Sabra was renting those beds right back out, and NMS was now contributing over 12% to Sabra’s top line.
What could possibly be bad about that?
Well, fast-forward a little under two years...
See You in Court
The Maryland state's attorney is suing NMS for mistreating patients and Medicare fraud.
Yeah. That’s pretty big. People at NMS could go to jail over this.
You see, NMS was maxing out patients’ Medicare and then kicking them out — either sending them to unlicensed facilities in Baltimore or just dropping them off at homeless shelters or in families’ driveways.
One woman, for instance, was transferred to an unlicensed facility in the city. There, she was forced to give up her Medicaid debit card and PIN so that the facility could use it as it saw fit. Then, when she cancelled the stolen card and the managers of that facility found out, she was taken to a homeless shelter and abandoned. All the while, she was supposed to be receiving treatment for cancer. But she wasn’t getting any medical care.
In another instance, a patient was dropped off in her family’s driveway on a 100-degree day once her Medicare had run out.
Both of those patients were eligible for Medicaid. But that doesn’t pay as much to facilities like those NMS was running. So, instead of taking care of them and taking the lower payments, NMS was cycling them out as quickly as possible to refill the beds with the more “valuable” Medicare patients.
That’s not only unethical and downright sickening, but it’s also illegal.
The longest Medicare will pay for skilled nursing is 100 days. Now, the average Medicare stay is between 27 and 30 days. But somehow, many of NMS’s patients were staying there for the full 100. Then they were getting kicked out. In fact, over the course of the investigation by the state’s attorney, NMS gave at least 1,061 patients the boot. To put that in perspective, there were half as many patients that got involuntarily discharged from the other 225 skilled nursing facilities in Maryland combined during the same period.
So, that’s a dead giveaway something fishy was going on at NMS.
What makes matters worse is that the majority of those patients were eligible to go on Medicaid once their Medicare ran out. But they still got the boot. That’s because Medicare pays about double what Medicaid pays for skilled nursing services. It’s illegal to refuse those patients in this state, though. And what NMS was doing by kicking them out instead of allowing them to transition to Medicaid was against the law, too.
So how is Sabra to blame?
A Little Research Goes a Long Way
Well, a little due diligence would have told them that the money coming in from the NMS facilities was way too high. I mean, why were they making so much more money than any other operator in the state? Were they just that good?
I don’t know about you, but when I hear something that sounds too good to be true, I do some research. I certainly don’t go shelling out three times the highest price something similar has ever sold for.
But I’m not working at Sabra. If I were, maybe they wouldn’t be in such a terrible situation right now.
You see, with NMS contributing 12.5% of Sabra’s revenues, the REIT stands to be the biggest loser in this lawsuit. Well, after Sabra's shareholders, that is.
Chances are that NMS will fold if the charges stick. And they likely will. In Maryland, they rarely bring charges on a company unless they’re sure the case is watertight.
So, when NMS folds, Sabra loses the single tenant responsible for 12.5% of its revenues. Sure, they’ll be able to rent out those facilities to someone else. But nobody's going to pay as much as NMS did. At least nobody doing anything legal.
It’s like I said last week, Sabra is in trouble. Sabra bought a townhouse that was worth $250k, but paid $1 million for it because there was a renter paying $10k a month. Never mind that there’s no way anyone else would pay that much to rent it.
So, let’s say Sabra can make up some of that rental income from a new tenant. We’re still talking about a 10% drop in rental income... at the bare minimum.
Plus, there’s the $234 million investment. Management will have to write that down to fair market value. We’re talking about a $75–$100 million write-off. That’s a material loss. And that’s going to hit their financials hard.
When the market realizes what’s going on — or when Sabra finally reports the reduced revenue and huge write-down — shares are going to tank.
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A Little Bit of History Repeating
Don’t believe me?
Well, believe history then. Because this isn’t the first time Sabra has gotten hurt by investing in health care facilities without doing its homework.
Back in 2015, around the time Sabra was buying the NMS facilities, it had another tenant go bankrupt. Sabra had bought one hospital and provided loans to two others run by the same group.
The facility cost $120 million. The loans were for $110 million and $66.8 million. All told, Sabra invested around $284 million in the hospitals. The one facility was eventually sold for $96 million. Sabra took a $24 million loss on that. And the loans were written down substantially.
And Sabra stock tanked once investors figured out the magnitude of the loss. It dropped over 20% in just a few weeks once word got out.
That facility was contributing 6% of Sabra’s $210 million in rental income back then. And the loss on the loans and facility were around $100 million (give or take). The loss cost shareholders 20%.
Now, Sabra brings in around $167 million. It’s about to lose around 10% of that (or more) and write down potentially as much as another $100 million.
So, Sabra stock fell 25% after losing 6% of its revenue stream and writing down around $100 million when it was making about $34 million a year more than it is now. Just imagine how bad a 10% revenue cut and a $100 million write-off is going to hurt the stock today.
I mean, 20% is just the beginning. It’s the most conservative estimate... the best possible scenario. In fact, the share price could fall as far as 50% when the market catches on.
But Sabra’s price continues to march upwards. Probably because nobody else is talking about this. My article last week was the first linking the NMS lawsuit and Sabra. There was another released last weekend, but I really can’t find anything else.
Everyone is just talking about how great Sabra stock is. It even made a Forbes list of the top six safest 6% yielding investments! Somebody's going to look pretty dumb for that when the stuff hits the fan.
Think that +6% yield is going to protect you from a 50% loss when this news really starts catching attention? I sure don’t.
Sabra’s Loss, Your Gain
So, how can you play this?
Well, if you own Sabra stock, sell it now. Before the market catches wind of this story.
But if you don’t, you can always bet that it’s going to crash by short-selling the stock.
“Borrow” some shares from your broker and sell them at the current market level. Then, when the stock tanks, buy it at those cheap prices and repay the loan from your broker.
You’ll have to have what’s known as a margin account to do this, though. It’s like collateral on the shares your broker will loan you to sell.
But if you’re not interested in a short trade, there’s an option (literally) for you. (I know. Bad pun. But I love them. My friends call them my “dad jokes.”)
Anyway, you can buy put options on a stock that you think is headed down. Each one gives you the right to sell 100 shares of that stock at a set price. That’s the strike price. You can either exercise the option — if you own the shares or can buy them below the strike price — or sell the put to another investor, presumably someone who does own the shares and is trying to cut losses.
The put options on Sabra only go out to July expirations right now. I’d be looking at those since they give the most time for the news to hit and the shares to head south. You know what they say: "The market can remain irrational longer than you can remain solvent." So, give the market some time to come to its senses and go with the expiration farthest out.
Any way you play it, Sabra shares are headed for a severe downturn. And lots of investors are going to get caught flat-footed when they take a turn for the worse.
Don’t be one of them. Sell your shares now if you have them. Short the stock or buy puts if you want to profit from Sabra’s loss.
And always pay attention to the companies that do business with your investments. You never know when some extra due diligence will save your shirt.
To investing with integrity (and betting against ignorance),
Follow me on Twitter @AllBeingsEqual
To access my first article on the subject, click here.