Southern Cross care homes: Landlords offer last hope
Southern Cross is teetering on the brink of financial collapse due to an almost unique confluence of factors that has forced the company into desperate measures.
Only time will tell if the care home operator's unilateral decision to cut its rental payments by a third will prove foolhardy, but it had little choice - high rents lie at the very heart of the company's problems.
The root of Southern Cross's current troubles lies in its decision, in 2007, to list itself on the London Stock Exchange.
In the process, it sold most of its property freeholds and then leased them back - "a unique business model borne out of credit euphoria", according to Henry Dixon, fund manager at Matterley.
Rents were inflation-linked - and could only rise. "This looked OK at the time," says William Laing at healthcare analysts Laing & Buisson, but with inflation rising sharply in the past two years, Southern Cross has felt the pinch.
The result is an unsustainable £180m going out each year in rent, which has undermined the company's ability to invest in its homes.
The very nature of the business model itself has also impacted on investment, some observers suggest.
"Southern Cross was set up as a [property investment vehicle]; there was no real focus on management and quality," says Mr Laing.
The resulting under-investment affected occupancy levels as its homes suffered by comparison with those run by competitors, he says.
This disparity was highlighted when the Care Quality Commission introduced star ratings of care homes - poor, adequate, good and excellent.
"Southern Cross runs a higher number of poor and adequate-rated homes," says Mr Laing.
However, the commission says this simply reflects the large number of homes that Southern operates.
The company itself simply says that it has made "significant progress in the operational turnaround of the business", including investing in new services - such those dealing with dementia.
Either way, the business model laid the foundations for the huge rental payments the company now faces.
Not only was there less cash left for investment, but Southern Cross was forced to charge higher fees to compensate, again hitting occupancy rates.
While Southern was contending with the double whammy of paying out more in rent each year and taking less in fees, another problem, quite beyond its control, struck hard.
Arguing that it needed to dramatically cut the UK's budget deficit, the government announced it would introduce swingeing spending cuts.
As a result, local authorities were forced to cut the fees they were willing to pay for care home residents.
The cuts hit Southern Cross harder than most. Across the sector as a whole, privately-paying residents make up about 42% of all those being cared for, Mr Laing explains. But at Southern, the figure is about 20%.
Fee income, therefore, took yet another hit.
All these factors have pushed Southern Cross to the brink, but the key to its short-term future remains renegotiating its onerous rental payments.
Only the 80 or so landlords themselves know whether a deal can be struck, although those with their own loans to service will not be in a position to accede.
If a deal can be reached, there is a "reasonable chance [Southern] can turn it around", says Mr Laing.
If they don't, then Southern will be in clear breach of its lease covenants, and the most likely outcome will be that the operator will be forced out.
This does not mean, however, that the residents will follow suit. "The principal factor that all stakeholders agree on is the delivery of care," says Jeremy Tasker, head of healthcare at Colliers International, a company that helps care home operators and landlords negotiate leases.
He says there is no way residents will be forcibly moved, but rather a new operator will simply take over the lease.
Nor should residents at other care homes be concerned about a similar fate befalling them.
The vast majority of homes, local authority cuts aside, have not had to contend with high rents, because they own the freeholds of their properties.
In fact, some care operators such as Care UK and Primary Health Properties have prospered.
With the benefit of hindsight, Southern's "unique" business model does not seem like such a smart move.
As Mr Dixon says: "You have to own the bricks and mortar when times are tough."
The decision to sell them off could yet be Southern's undoing.