By Jim Melloan
Worth Magazine , December 2001. Used with permission.

Get rent—the simple, effective strategy employed to keep Ventas alive while Washington undid its damage

On April 28, 2000, we received a note from Debra A. Cafaro, the president and chief executive officer of Ventas, a real estate investment trust based in Louisville, Kentucky. “We are delighted that you included Ventas in your Equity Index,” she wrote. “I enjoyed the coverage of all of the women CEOs profiled and am honored to have such esteemed company. We at Ventas intend to do our part to enhance the performance of the Equity Index.”

We appreciated Cafaro’s sentiments but privately thought, Good luck, Debbie—you’ll need it. At that time, Ventas’s stock was in the pits, trading at $3.24 a share. Cafaro had been at Ventas for just over a year, and she had walked into a mess.

The company had been a nursing-home owner and operator called Vencor that, in 1998, split into two separate companies. The spin-off kept the name and operations of Vencor, and the parent company dubbed itself Ventas. Ventas would own the properties and facilities that Vencor operated and become a real estate investment trust, paying out at least 95 percent of taxable income to shareholders each year.

That same year, Vencor was blindsided by Congress. New Medicare reimbursement rules slashed payments to it and companies like it more than anyone had expected—even more than the government had intended. This spelled disaster for Ventas. Despite the corporate divorce, it still counted on Vencor to provide virtually all of its rental income. It also owned a large number of near-worthless Vencor shares.

Cafaro had no experience in the health care industry, but she had been involved in bankruptcy workouts. Before becoming president of Ambassador Apartments, a Chicago REIT, she had worked as a partner in a small real estate and finance law firm. Cafaro joined Ventas in March l999. Not long after, Vencor defaulted on its rent and filed for bankruptcy, the first of five major nursing-home operators to do so. In response, Ventas hired Merrill Lynch to help with Vencor’s restructuring.

In a recent interview at the office of Ventas’s New York City law firm, Willkie Farr & Gallagher, where some of Vencor’s restructuring negotiations took place, Cafaro reviewed the strategies she had employed on behalf of Ventas shareholders during two tension-filled years. “You have to know what you want very clearly,” she began. “Our business plan was to get rent.”

During her first week on the job, Cafaro says, she maxed out Ventas’s line of credit, giving her a cash trove of $100 million. “That was hugely important, because the threat [from Vencor and its creditors] was always, ‘that a reorganized Vencor would be in a position to do well, so she held out for an agreement that stipulated annual rent escalators of 3.5 percent; Vencor and its creditors wanted increases of only 2 percent.

The negotiations, Cafaro says, had “some characteristics of a street fight. It was about who was gonna get what in a pie that shrunk. It is really not for the faint of heart. People yell. People posture.” A Pittsburgh native, she calls her background We’re gonna stop paying rent, and then you’ll be dead.’ And I could say, ‘Do it! Because I have a hundred million dollars in cash that will allow me to litigate with you, and I know that within months I can get a judge to turn that rent spigot on, because that’s what the rules are.’ And so, checkmate.”

Cafaro had confidence that Congress would restore enough Medicare reimbursement to keep the nursing-home industry from going belly-up. She also knew “solidly working class.” “I did get into fights. It was a tough neighborhood. You don’t go from being the mailman’s daughter to corporate executive without having a certain core toughness,” she says.

In the end, Cafaro, Ventas, and Vencor all came up winners. (Vencor shareholders lost out, however, getting nothing in the bankruptcy reorganization.) Vencor, first among its five brethren to emerge from bankruptcy, has been rechristened Kindred Healthcare. Shares started trading over the counter last April at around $30; they’ve already doubled, though on spotty volume.

And Ventas? With a return of 144 percent, it is the No. 4 performer among all REITs for the 12 months ended September 30 and the No. 1 performer in the Equity Index, with a 339 percent return since March 3, 2000. It ranks third in size among health care REITs, with 268 facilities.

Now Cafaro’s task is to refinance Ventas’s $850 million of debt and bring its interest payments down from 10 percent to about 9 percent—more in line with those of her competitors. She also has to decide what to do with Ventas’s shares in Kindred. For now, she says, she’s hanging on (Ventas’s 9.99 percent stake is the maximum allowable under REIT rules). Long-term, however, she may need to sell shares to acquire properties that will broaden Ventas’s tenant base. She may also decide to distribute them to Ventas shareholders as part of the company’s dividend.

With its debt refinancing and the disposition of its Kindred stake still to come, Ventas is in a position to benefit in the near term, says Banc of America Securities analyst Gary Taylor. Both he and Merrill Lynch analysts Doug Simpson and A.J. Rice recently put a 12-month price target of $13 on the stock, but shortly thereafter the shares hit a new high of $12.85. The stock has since pulled back, but the analysts say they may revise their targets upward. Rice says that Cafaro is well regarded in the industry and could emerge as a major consolidator; Taylor believes that Ventas will have to put together a team that specializes in acquisitions. Until Ventas’s tenant base is diversified, reliance on Kindred has to be considered a major risk.

But betting on Ventas—or some other REIT—is a good idea. According to research from Ibbotson Associates, in recent years REIT performance has not correlated with that of either regular equities or bonds. REITs returned a total of 12.6 percent in the 12 months ended September 30, versus a loss of 26.6 percent for the S&P 500 and a gain of 14.1 percent for 20-year government bonds. Furthermore, health care REITs are in a position to outperform as nursing homes and hospitals remain in recovery mode. The reinstatement of adequate reimbursement lets them make money, and declining interest rates mean they’ll be able to expand through acquisitions.

Cafaro says that she welcomes Ventas’s next stage, likely to be less acrimonious. She says, “I’m a lover now, not a fighter.”

Staff writer Jim Melloan wrote the previous feature on the Equity Index, published in spring 2000.