CAMP HILL, Pa. - Where others might see a nursing home industry in trouble, Trans Healthcare Inc. sees an opportunity.

That's what lured THI to the bankrupt Sparks-based Integrated Health Services Inc., which it has agreed to buy in a deal valued at $327.5 million. Assuming that the sale wins approval in U.S. Bankruptcy Court, THI will move its headquarters to IHS' Sparks campus, retaining the 675-person work force there.

The acquisition would roughly triple Trans Healthcare's size, making it a significant player in the industry and a major presence in the Baltimore area.

Navigating troubled waters is nothing new for Camp Hill, Pa.-based THI. The company was started in 1998 to capitalize on industry upheaval after Medicare sharply cut payments to nursing homes, plunging several large long-term care chains into bankruptcy.

"It was a contrarian investment," said Anthony Misitano, THI's chief executive officer. "We thought there were going to be buying opportunities."

THI began buying small groups of nursing homes, building up to its current 94, including nine in Maryland.

In the interim, the industry began to recover after Congress adopted a temporary increase in rates, and all of the companies except IHS emerged from bankruptcy. But the temporary increase expired in October, and payments again fell. One major chain recently declared bankruptcy.

Again THI made a contrarian move, signing the deal to buy IHS' leases and management contracts for $97.5 million in cash and the assumption of $230 million in liabilities. With IHS, Trans Healthcare would have 274 nursing homes in 26 states.

"Going national for nursing homes is not the trend," said Stephen Monroe, editor of the trade publication SeniorCare Investor. "It's a bad market. Why would you want to more than double your size?"

Most nursing homes deals now, Monroe continued, are "onesies-twosies," mom-and-pop operators selling single or small groups of homes to medium-size, regional companies.

For example, Eldersburg-based Nexion Health Inc., which is buying nursing homes, is pursuing a strategy of moderate growth and geographic focus. Currently it has 44 nursing homes and wants to be in the 50-to-70 range, concentrated in Texas and Louisiana.

"There are selective opportunities for expansion," said Francis P. Kirley, Nexion CEO and a former IHS executive. "Economies happen when you have regionalization."

To Misitano, however, the chance to go big and national with the Integrated deal is coming about because of "a match made in heaven."

IHS offers the company the infrastructure - THI needed a new computer system, for example - staff and space to operate a national company, which THI has wanted to do from the beginning.

"That's one of the really compelling aspects of the IHS transaction," Misitano said. "The work force is in place. We'll be able to continue to grow the company. What we're inheriting will be enough to service what we acquire."

IHS' Sparks location is another plus. Misitano said he plans to move to Maryland eventually. But for now, with a 9-year-old daughter who's happy in school, it's a manageable 50-minute commute from THI's current location near Harrisburg, Pa.

Familiar facilities

The deal would bring Misitano and other THI executives a set of facilities they've run before.

More than one-third of Integrated's 180 nursing homes were once owned by Continental Medical Systems Inc., where Misitano previously worked. Misitano stayed on after CMS was sold in 1995, but left after the successor, Horizon/CMS, was sold two years later. The company that bought Horizon/CMS immediately sold large chunks of the business, including many former CMS properties, to Integrated. Misitano left to start his own company, taking a half-dozen or so others with him.

Rocco A. Ortenzio, a CMS co-founder, also started another company then.

For funding, both turned to Chicago venture capital firm GTCR Golder Rauner LLC.

"We had made a lot of money with Rocky and Tony [on CMS]," said Ned Jannotta Jr., a principal at GTCR. So GTCR put up money to launch Ortenzio's new company - Select Medical Corp., which went public in 2001 - and THI, in which it continues to hold a stake.

THI's launch to acquire nursing homes appealed to GTCR "because a new prospective payment system for Medicare was just being implemented," Jannotta said.

"We thought it would create a lot of distress, and there would be a decline in multiples for assets and a decline in buyers for those assets."

Enthusiasm for deal

And Jannotta is confident that the IHS deal will be a winner.

"The biggest attraction is that our management team at THI has been exceedingly successful in improving the operating margins and the care level," he said.

Since THI is privately held, its financial reports are not public. (It does say its revenue is more than $500 million.) Misitano said it has improved earnings at nursing homes it has taken over.

"We have seen an uptick in operating margins between 5 and 7 percent," he said.

Misitano said THI improves performance both by improving occupancy - the percentage of beds filled on an average day - and by adding specialized programs to boost revenue per bed.

In part, he said, the positive results stem from deliberate decisions about what nursing homes to take over. "We probably evaluated between 600 and 1,000 buying opportunities apart from IHS," he said. "We are disciplined; we're not buying for the sake of buying. Our capital partner has patience and foresight."

THI tends to look for concentration in a market. It works with local physicians - some eventually practice in the nursing homes or on their campuses - to develop specialized programs in areas such as dementia and wound care.

Relationships with physicians lead to referrals that help keep the beds filled. Currently, Misitano said, THI homes are around 90 percent occupied, while IHS homes have occupancy of 86 percent to 87 percent.

While that sounds like a small difference, he said, 4 percent more beds filled each day, over 180 homes, adds up to a lot more revenue.

There's a good possibility that THI can improve occupancy at the IHS facilities, said Marcy Chong, a research analyst for the Service Employees International Union, which represents nursing home workers, including at some of the IHS and THI facilities.

"Due to the long and drawn-out bankruptcy process, the [IHS] homes were left to drift, and operations may have suffered."

Adding specialized programs not only builds occupancy, but also allows THI to handle more Medicare patients, who bring higher reimbursements and higher margins.

Traditional nursing home clients are frail elderly who stay for extended periods. THI calls them "residents." They are, on average for THI homes, 80 years old and stay for more than two years, according to THI. State Medicaid programs pay for most. About one-fourth of THI's clients, however, are "post-acute," or "sub-acute," recovering from an illness or operation, generally after a hospital stay. THI calls them "patients." They get more care than do the "residents," with services from professionals such as physical therapists. Their stays are generally 12 to 18 days and most are paid for by Medicare, and some by private insurance.

Misitano said Medicaid programs pay, on average, about $135 a day. Medicare pays about $300. The Medicare patients are more expensive to take care of and stay for much shorter periods but, Misitano said, bring a higher daily profit margin.

By adding staff and programs, THI plans to convert some Medicaid beds to Medicare. Misitano is also interested in a model, in use at some of the old CMS homes now owned by IHS, where one wing has an even higher level of clinical services, and is designated as a "specialty hospital." It gets a higher level of reimbursement, and can operate more efficiently by sharing nonclinical services, such as food and housekeeping, with the nursing home. Misitano also plans to provide outpatient therapy at some centers, using staff and facilities already on the premises.

In addition to adding the nursing homes, the IHS deal also brings a therapy division; Misitano said THI had been planning to develop one anyway. In general, he said, THI envisions running IHS at something very much like its current shape and size.

"We may want to do some pruning," he said, "but at the moment, our view is that everything fits and makes sense. At the end of the day, the group of homes that remain are strategic to the business model we have at THI."

Regarding staff, he said some IHS executives may choose to take severance packages but nearly all employees will remain.

Difficult environment

As THI moves ahead - the deal could close in the second quarter if there are no hitches - the environment for the industry remains cloudy, perhaps even stormy.

"The Medicare [reimbursement] add-on that expired Oct. 1 remains expired, and whether the industry will be able to get that back is doubtful," said Joshua M. Wiener, a long-term-care researcher at the Urban Institute. "On the Medicaid side, states are under enormous financial pressure. With the cuts that will be needed in '03 and '04, states can't take Medicaid off the table."

Nursing homes also face competition from assisted-living facilities and home nursing services for clients, Wiener added.

But Jannotta, THI's venture capital partner, sees sufficient prospects in the industry to think that THI could go public relatively soon.

"THI would be well-positioned to access the public markets any time in the next year and half," Jannotta said. "It will have the size and profile to look at public markets, assuming we get stability in reimbursement."

Misitano, accustomed to operating in difficult environments, sees more gains for the industry over the medium term, as the population ages. While he said the projections for IHS assume no change in current reimbursement levels, he added, "I think the best scenario is that the reimbursement will be corrected, and the demographics suggest the nursing home will continue to be a significant player with a lot of opportunity."