A concerning report about retirement living company Aveo Group (ASX: AOG) was released over the weekend. Written by Adele Ferguson and Sarah Danckert, the article has some highly concerning accusations and I expect Aveo shares could be hit hard at the market open this morning.
The concerns are significant and wide-ranging but appear to focus on 4 main areas:
- Aveo is focused on churning customers for profit (given that it is entitled to large exit fees of up to 35%-40% of the property value when residents leave)
- Despite units being freehold, Aveo imposes draconian clauses and restrictions on residents with overly legalistic and imposing contracts
- The company is effectively converting its freehold properties to leasehold 'by stealth' and is confusing customers about what they are actually purchasing
- The company is engaged in 'asset stripping' via charging very high fees including real estate agent fees (the company is its own agent) and exit fees when a resident leaves
Churning residents
The thing that struck me the most was that Aveo has a target 'portfolio turnover' for its residents of 10% to 12% per annum. This means that ~10% of residents leave Aveo villages each year at which point the company levies the major exit fees of up to 40% of the property value. The average transaction price point was $287,000 in 2016.
Taking a quick look at Aveo's books this morning, it's obvious that resident turnover is a significant contributor to earnings, although it is difficult to tell how much is due to exit fees alone as revenue is lumped together.
Aveo is also a major beneficiary of Deferred Management Fees ('DMF') which accrue to the resident and are payable as a lump sum upon exit. Media reports asserted that the company's fees were egregious but without a like-for-like comparison to other providers this is difficult to ascertain.
Is Aveo strapped for cash?
Even so, looking back through the company's reports, it's become obvious that portfolio turnover has been an important focus over the past five years, dating back to 2012 (when the company was known as FKP):
"In addition, a key strategy for the Group is to generate cash flow from the Retirement division through a number of initiatives including increasing the turnover of units."
It looks as though deferred management fees and resident loans have been a major contributor to the company's reported cash flows in recent years. If I had to take a guess I would say that Aveo charges such high fees in order to dissuade residents from leaving and/or to reduce its liability to them when they do leave.
If I understand correctly, looking at the books alone, it is difficult to make the case that Aveo is specifically aiming to churn residents for profit, because if too many residents became unhappy and left, the company would be under serious pressure in having to repay all those residential loans. That said, it does appear that the company is very dependent on finding new residents to replace old ones, which could be why it makes residents sign non-disclosure agreements in order to protect its brand image.
Are media claims accurate?
However, there are a few concerning things that tend to support media assertions that the company is basically harvesting retiree funds. First is management's recent announcements that the high level of occupancy would be used to lift prices. If we assume that the exit contracts are truly as onerous as claimed, it's very difficult for residents to move out (the average age of residents is 82.8 years; they are not young) and thus they may have no choice but to wear the higher fees.
Second, another giveaway, is the fact that the Retirement Villages Group (RVG) acquisition resulted in lower earnings margins, according to the recent half-year report:
"DMF margins (were) impacted by legacy RVG resident contracts which have inferior terms relative to the average Aveo contract."
This suggests indeed that the Aveo contract is something of a 'market leader' – but not in the good way. In a nutshell, I found the media article very concerning, and in my opinion Aveo is dependent on incoming residents and its very high fees in order to maintain its financial position and current levels of earnings. In this way it is reminiscent of Estia Health Ltd (ASX: EHE) which recently hit turbulence and had to raise capital in a very similar situation.
Surprisingly only ~0.15% of Aveo shares were held for short-sale in recent times. I wouldn't be surprised to see this figure jump sharply upwards in the near term. Were I a shareholder in other retirement companies like Lifestyle Communities Limited (ASX: LIC) I would also consider these media reports a polite warning, and a signal to evaluate what a company's sources of revenue are, whether they're ethical, and likely to be sustainable.
