Southern Cross: Solved

At a meeting on Wednesday, Southern Cross, its lenders and the landlords’ committee reached an agreement that “the continuity and quality of care to all 31,000 residents will be maintained and that every resident will continue to be well looked after”.

In a joint statement, the company, its lenders and its landlords said: “The company and the landlords will work towards a consensual solution to the company’s current financial problems, which will be delivered over the next four months.”

The basic problem is simple enough to outline. Southern Cross was an operating company of old folks’ homes. Income was largely from local authorities who have a duty to pay for such care for local residents. Outgoings were largely labour and rent. Labour is pretty much a fixed amount as there are staffing standards and regulations which must be met. Rent was a rising amount as the company had sold off the freeholds of the homes and then leased them back on rising rent only leases.

The solution is similarly obviously simple. If income is declining, which it is both because vacancy rates are rising and also because local councils are cutting the amounts they are willing to pay for care, labour is a fixed cost, then obviously rent needs to be reduced to avoid bankruptcy.

On the other side of the ledger, landlords are similarly stuck. They’ve got care homes: they can’t turf out the elderly and stick students in or anything like that. So they can’t change the use of the buildings. If Southern Cross does go bankrupt then they’ll need to find a new operator of the homes, that operator almost certainly insisting upon lower rents as a condition of taking on the work.

So, whatever happens, the landlords are going to get less rent.

Thus the obvious solution. The landlords reduce the rent, perhaps gain a piece of the Southern Cross equity as compensation and the company survives. Only one point left, what happens to the management?

It is understood Landlords want some of Southern Cross’s top management – including chief executive Jamie Buchan – to step down from the reworked company, but this is being opposed by the care home group.

A source close to the discussions said the dispute is the “main sticking point” and stressed that landlords, who have been highly critical of present management, “will not concede” over the issue.

An objective observer might say that a management that has erred should indeed go. One that refuses to do so might almost be seen as protecting the rights of said management rather than the shareholders they actually have a duty to.

Originally published in Forbes.