TWST: John, first of all, have all the nursing homes been affected by the implementation of the prospective pay system?

Mr. Hindelong: All the nursing homes have been hurt, either badly or devastatingly. But I think those companies with a high exposure to the contract therapy business are the ones that seem to have fared the least well, or most poorly. And those that are more oriented to the bricks- and-mortar and patient care business have been hurt badly but not quite as badly.

TWST: Are there any strategies that the companies who have fared the worst can employ to improve their positions?

Mr. Hindelong: There is no quick-fix solution to the problem. The reimbursement provided for a certain kind of care is just inadequate. The simple solution, if there were one, would be to convince the government officials that there needs to be a change, a massive change in reimbursement levels, and that's just not going to happen anytime soon. But there almost has to be some relief.

TWST: Isn't there a bill before Congress the Access to Quality Nursing Home Care Bill? Will it help?

Mr. Hindelong: There have been a number of proposals in Congress to moderate some of the devastating cuts of the Balanced Budget Act of 1997 and to moderate some of the cuts that are implicit in the change from cost-based reimbursement to prospective payment. Whatever moderation the industry might get will help, but probably not dramatically so.

TWST: John, how has all this been reflected in the stock prices over the past year?

Mr. Hindelong: The stocks have performed poorly. And frankly, earnings estimates generally seem to continue to go down. And as that happens, stock prices tend to follow. This has been an extremely difficult year for investors in the nursing home industry. The problem, of course, is that there doesn't appear to be a light at the end of the tunnel. There's nothing that I'm aware of on the horizon that's going to significantly improve the fundamentals of this business anytime soon.

TWST: Would you say that the companies have been unfairly treated by the market?

Mr. Hindelong: I'd rather say that they've been treated unfairly by the government. But I think that the market has responded fairly because the earnings have evaporated.

TWST: May we talk about the four companies that you follow in this sector? Give us your views on each of these companies and tell us what you're suggesting investors do with the stocks. Let's start with Beverly.

Mr. Hindelong: For the record, I have not been recommending any nursing home stocks for quite sometime. I continue to remain open to upgrading when there are signs of bottoming out, but I just don't think that we're there. Currently, I cover four nursing home companies. I've dropped coverage of four over the last 18 months for precisely the issues that we're talking about. Regarding Beverly (BEV), I think they are probably going to do somewhat better than most of the companies in the industry. That's because they are less dependent on the contract therapy business than most. But they have one unique issue to deal with that the others do not at this point; they're working through the final resolution of a major investigation that was undertaken by the government which will extract from them roughly $200 million and that's painful. It's going to adversely affect their interest expense, for sure. In addition, there are a number of nursing homes that the government, wants removed from the Medicare program, and that's another problem unto itself. So it's a workout, and it will take sometime. I think the management has done as good a job as it could under the circumstances, but despite the fact that the stock is down sharply, I still think it's premature to turn positive on the stock.

TWST: You say that the government wants some of the nursing homes to be removed from the Medicare program. What are the implications of this? Is there a stipulated time period with respect to how long the Medicare ban lasts?

Mr. Hindelong: I'm not sure if there's a time period or not. But obviously, once the government has made that decision, the value of these nursing homes in the marketplace goes down. So one couldn't expect Beverly to get attractive prices for these facilities.

TWST: Tell me about Centennial. Is this a new name for an old company or a new company?

Mr. Hindelong: Centennial (CTEN) is a company that came public a couple of years ago. Within the last year, with the stock down, Welsh, Carson had agreed to take them private because, like all nursing home stocks, their share price had deteriorated. However, just before that LBO was consummated, it was announced that there was a government investigation under way at four of their facilities. To make a long story short, the LBO never happened and the stock plummeted. And the company has had to scramble in recent months to remake itself as a publicly owned company. Frankly, it has done a reasonably good job. Now, the investigation of the company continues and here again, it's premature to signal the all- clear. But the fundamentals of the company have held up reasonably well actually, very well under the circumstances that the industry faces. So among the nursing home companies, it's probably more attractive than most, but you still have this issue of a government investigation under way, and I think earnings are still suspect across the spectrum of the entire industry. But I think they have done a better job than most. And on a price basis, it's probably more attractive than most.

TWST: What's the mix of Medicare, Medicaid and private-pay for Centennial?

Mr. Hindelong: It's not that different from most: about 53% Medicaid, 23% Medicare, and 24% private-pay. They have an exposure to the therapy business, and that's where the problems have been the greatest.

TWST: What about Genesis Health Ventures?

Mr. Hindelong: Genesis (GHV) is a company that has been struggling as have so many. Genesis has significant exposure to contract therapy and likewise, now the profitability in the pharmacy business is declining. So their census has held up, but they're just not getting paid adequately for their Medicare patients, and that's a problem for them and for everybody. So here again, even though this stock is down sharply, I just think it's premature to get excited and turn positive on the stock.

TWST: HCR Manor Care, I believe, has the highest proportion of private pay in its mix.

Mr. Hindelong: That's correct.

TWST: Is this reflected in your opinion of the stock?

Mr. Hindelong: No small coincidence, HCR has the highest private-pay patient mix and the highest earnings level and it has performed the best or the least badly. So all those things go hand in hand. I think their problems are, to some extent, reflected in the stock price. But even on the private pay side, the nursing home industry is facing a significant issue. That issue, of course, is the emergence of assisted living. For a significant percentage of patients in nursing homes, the assisted living provider does a better job of matching the needs of the patient with the services available at the institution. So assisted living, in many cases, can provide a better quality of care at a lower cost, vis-a-vis the nursing home. And assisted living, as one might expect, is targeting the private-pay nursing home. That's a new competitive pressure that is affecting HCR as well as the other nursing homes with respect to their private-pay patients. So here again, I think the stock has held up well. The company is doing better than most fundamentally. But there are still issues to be dealt with that would keep me from getting too optimistic on the stock in the near term.

TWST: Let's turn to the assisted living sector. John, do most of the companies in this sector provide a continuum of care from almost- independent living through assisted living to specialized care for patients with Alzheimer's?

Mr. Hindelong: Some do. And I guess it's debatable as to whether or not assisted living should operate as an entity unto itself or whether it should be a part of a continuum of care. I don't think it's an either/or situation. I think that with respect to assisted living, if you target your market, and market your service well, you can be successful; to the extent that you become a continuum, you create issues. For instance, over the years, companies like Integrated Health Services (HIS) and Vencor (VCRI) have had assisted-living divisions, and they've divested of those assisted-living divisions, I think, among other reasons, because it became a situation where you were competing with yourself and that's never a good strategy. So I think it's a separate business line unto itself. But that's not to say that it can't exist within a continuum of care. Certain companies have pursued that strategy and will pursue it, so it's not as though it can't work that way.

TWST: How do the fundamentals for this segment look, going into 2000 and longer term?

Mr. Hindelong: I think the assisted-living segment has a tailwind. That is to say, we all know that it's a very powerful demographic story. And as I've said, for a significant percent of the elderly population, this is the more cost-effective alternative vis-a-vis the nursing home. The issue that assisted-living providers need to deal with, day-in/day-out, is that of competition; the barriers to entry are not particularly great. Unlike the nursing home industry, there's no requirement for a certificate of need to get into the business, so like bees to honey, this attractive market has attracted aggressive local entrepreneurs and/or healthcare companies. But at the end of the day, I think there will be a handful of companies that provide good quality care. But it's not as though there won't be bumps and bruises along the way. So I think it's an attractive segment, but competition clearly is an issue and will continue to be an issue.

TWST: Do you have a preferred business model in this segment?

Mr. Hindelong: Sunrise Assisted Living (SNRZ), I believe, is the premier play in this group because it focuses on upscale markets and because of its conservative financing and accounting. But even it will have occasional problems.

TWST: Do you still have a buy on the stock?

Mr. Hindelong: No, but longer term, I believe that Sun-rise will do very well.

TWST: What would it take for you to raise your market perform to a Buy status?

Mr. Hindelong: Time and performance.

TWST: What kind of time horizon should an investor have if he or she were to buy Sunrise today?

Mr. Hindelong: Maybe 12 to 18 months.

TWST: Given this level of investor sentiment, how difficult will it be for these companies to access capital in order to expand and grow?

Mr. Hindelong: On the nursing home side, they're not growing, and they're not likely to access capital at reasonable rates anytime soon. As opposed to growing, I think you'll see some consolidation, that kind of thing, but I think access to capital at attractive rates is not likely to be available anytime soon.

TWST: Not to the assisted-living companies, either.

Mr. Hindelong: Yes, I think that statement holds true for the assisted living industry also. But here again, I think if the companies perform, eventually markets recognize that, and the capital access issue takes care of itself.

TWST: Are there other companies in the sector that investors should know about?

Mr. Hindelong: I think the largest company, Alterra Healthcare (ALI), is an interesting play. They've had an earnings mishap. And I think they kind of got religion with respect to some of the less-than-very- conservative accounting and financing practices that they've used, and they're starting to make changes there. These changes have resulted in a significant reduction in earnings expectations. From current levels, and with the stocks having stabilized here, I think it will be an interesting stock, but it may take a while for confidence to return to the group. Things need to be sorted out with respect to some of the issues that have been raised in the last couple of quarters there, but I think they are a survivor and, over time, will prosper.

TWST: It is too early to put money into the stock?

Mr. Hindelong: I think it is, because when you go through the kind of transition they're going through, you often find that there are unforeseen glitches, so I think it's premature. But I do think it's a company that has the managerial skills and the financial wherewithal to, over time, correct its problems.

TWST: Are there any others that you'd highlight?

Mr. Hindelong: No, I think those would be the ones to focus on right now.

TWST: John, what is the outlook for healthcare services in general and long-term care in particular?

Mr. Hindelong: Healthcare services in general has to be broken down, I think, by segments. I think the hospital industry is on the verge of stabilizing, and I think there are some attractive values in that group. I think the nursing home industry is going to continue to struggle, not only because of the Medicare cuts, but they continue to be targeted for investigations. And given the fact that Beverly has agreed to pay off $200 million, it makes one wonder who's next. I don't think Beverly handled these issues much differently from the other players, so a negative precedent has been set. And of course, you also have, as I mentioned before, continued competition from the assisted living industry. So I think this group will remain under pressure for a while. On assisted living, I think the industry, generally speaking, is attractive, but it's a question of building investor credibility over time. Among other niche groups, I think the renal care segment is attractive and has good growth and stable reimbursement. And I think home health has been hit hard and it's a question of selectivity. And I think Lincare (LNCR) is probably the most attractive stock in that group.

TWST: Thank you.

JOHN F. HINDELONG Donaldson, Lufkin & Jenrette 277 Park Avenue New York, New York 10172 (212) 892-3583 (212) 892-5153-FAX

Copyright 1999 The Wall Street Transcript Corporation All Rights Reserved