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DALLAS-In a close-out of due diligence, Capital Senior Living Corp. has dropped a $35-million buy-out plan for Hearthstone Senior Living Corp. In turn, the proposed buyer has revised its business plan to focus on expansions and conversions in its portfolio and continue the acquisition hunt for a home-care agency in Texas.

“Our due diligence was thorough and our financial analysis extensive,” James Stroud, chairman of Dallas-based Capital Senior Living, says in this morning’s press release. The company and Hearthstone, headquartered in the Woodlands near Houston, began discussing merger prospects in early 2007, about six months after Hearthstone sold its real estate for $431 million to Nationwide Health Properties Inc. of Newport Beach, CA. It was reported in late December 2007 that due diligence had begun, with the Hearthstone acquisition slated to close in the second quarter.

Had Capital Senior Living proceeded to buy Hearthstone, it would have gained 32 leases of assisted-living facilities, totaling 2,192 units with a resident capacity of about 3,800. The 89%-occupied, 10-state portfolio would have added four new markets for the buyer. Prior to due diligence, the acquisition was projected to increase revenue by 54% to $289.1 million and boost EBITDAR by 75% to $94.4 million. It also promised a blended EBITDAR margin of 32.7% and incremental rent expense of $35.3 million.

Capital Senior Living’s revised business plan is heavily focused on conversions of independent living units to assisted living and dementia care and expansions at its existing properties. In the release, company leaders are estimating $27 million will be spent to expand three properties, relying on supplemental mortgage financing and cash to cover the cost to produce another 180 assisted living units, 60 dementia care units and 30 independent units. Work is slated to begin after midyear.

In addition, Capital Senior Living will spend about $2 million to convert another 176 independent living units at eight properties to assisted living and dementia care during the next two reporting quarters. The company converted 80 units last year.

Capital Senior Living’s team predicts the conversions will boost revenue by $4.3 million with a 60% incremental margin. The expansions are projected to push revenues by $9.1 million, also resulting in a 60% incremental margin. Historically, conversions and expansions have generated a 28% return on investment.

“The successful execution of this plan is expected to result in higher occupancies, increased revenues and operating margins and improved cash flow,” says Lawrence A. Cohen, Capital Senior Living’s CEO.

According to Capital Senior Living, independent living units account for 70% of the portfolio, totaling 64 assets in 23 states. Assisted living units make up 23% of the portfolio and the balance is dementia care. Economically, independent living units are 100% private play, with a $2,200 average monthly rate and 34-month average stay. In contrast, assisted living units are 96% private play, with $3,100 average monthly rates and 26-month average stay.

In today’s release, Capital Senior Living also reported a joint venture with Parsippany, NJ-based Prudential Real Estate Investors to build 101 independent living apartments and 45 assisted living units in Perrysburg, OH. Completion is slated for Q1 2009. PREI is funding 90% of the project, which will be 65% leveraged.

In Keller, TX, Capital Senior Living picked up a leasing contract for a 47-unit assisted living development, Whitley Place. The 10-year lease has two five-year renewal options. It resulted from the asset’s $5-million purchase by a publicly traded healthcare REIT. The management contract will add $1.4 million annually to Capital Senior Living’s till.

Capital Senior Living also has JVs with Blackstone Real Estate Advisors of New York City and Stamford, CT-based GE Healthcare Financial Services. The business plan does include additional development with co-investment ranging from 5% to 15% on Capital Senior Living’s behalf. In turn, it will receive management and development fees.

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