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Regional Health Properties (formerly AdCare Health Systems Inc.): Valuation insight from 13D filers

Jan 20, 2016

List of 13D filers:

  • Ephraim Fields, March 2016
  • Doucet Asset Management, January 2016
  • Doucet Asset Management, June 2015
  • Doucet Asset Management, June 2014
  • Park City, August 2013

Ephraim Fields, March 2016


We believe that a not widely read 8k filed on February 9, 2016 highlights the underlying value of ADK’s assets and the value that could be created through a sale of the entire company. In this filing, ADK disclosed that it granted a party an option to buy ADK’s Arkansas facilities for $55 million or what we believe equates to a 10% cap rate. We believe the Arkansas facilities are ADK’s weakest, so if a party is considering paying a 10% cap rate for these facilities, we believe ADK can obtain even more favorable multiples for its more attractive remaining facilities.

Page 14 of the Company’s latest investor presentation (http://www.sec.gov/Archives/edgar/data/1004724/000100472416000166/adcareinvestorpresentati.htm) provides an interesting illustrative valuation for the Company which we summarize below for your reference:

Assumed Cap Rate 8.0% 8.5% 9.0% 9.5% 10.0%
   
Implied Equity Value Per Share $5.46 $4.62 $3.86 $3.20 $2.59
   
Premium to Stock Price (2/5/16) 163% 122% 86% 54% 25%

 


Doucet Asset Management, January 2016


Based on our research, there are two ways potential buyers might value ADK: A Cap Rate Basis and a multiple of AFFO. Both would translate into a price significantly higher than the stock currently trades today.

Cap Rate Basis

On the Omega Healthcare (NYSE: OHI) most recent quarterly conference call, the CEO stated the following: Turning to the deal environment. We have seen a handful of large transactions priced in the 7% yield range. While we have a couple of mid-sized pipeline transactions that were priced in the mid 8% yield range, our deal pricing for new transactions is likely to be higher. Smaller skilled nursing facility transactions will likely price in the 9s with mid-sized deals in the high 8s. So if we assume the cap rates in the market have weakened since November in skilled nursing facilities, we might want to use a 7.5 to 9 cap range instead of a 7 to mid 8 range. Management has given guidance to the Street suggesting the Company revenue is expected to be in the range of between $31-31.8 million and lease expenses of $8 million implying net operating income of $23.4 million assuming you use the mid-point in revenues of $31.4 million. My assumption is you would have to include and additional $500k in lease expenses for the Ohio properties to be conservative giving you an adjusted NOI of $22.9 million. Based on cap rates ranging from 7.5 to 9.0 and assuming 20 million shares outstanding, we come up with the following values after paying off the debt and the preferred securities at par:      

Cap Rate    Gross Value    Net Debt          Net              Px Per Share

7.5                  $305.33mm      $163mm         $162.33mm            $7.11

8.0                  $286.25mm      $163mm         $123.25mm           $6.16

8.5                  $269.41mm      $163mm         $100.41mm             $5.32

9.0                 $254.44mm      $163mm         $91.44mm                $4.57

FFO Multiple

Based on the past operating history by the Company, I think investors would all agree the Company made the right move by outsourcing the management of the facilities to good operators and becoming a property and lease holding Company. While it is my firm belief we received discounted lease rates reflective of our poor past operating history, it was the right thing to do. This is just one more reason why I believe the stock is undervalued. Management reiterated its guidance of $.25 to $.30 in AFFO post transition. It is remarkable the Company will be able to produce this much AFFO given the high blended cost of capital of (7.33% based on our estimates which is hundreds of basis points over the market) and G&A as a percentage of revenue around 15% (versus a market average of around 5%). AFFO would be increased by about 33 cents a share just by lowering borrowing costs by 200 basis points and lowering G&A to the market average of 5% of revenues. This would represent an increase of over 100% in AFFO. According to Bloomberg, the market currently values for Skilled Nursing Facilities at around 15 x AFFO. If the Company were able to lower its cost of capital and rid itself of layers of G&A, it could easily trade in the $7s or even $8s. However, even if an acquirer does not pay a market premium for the Company and does not give ADK any of the benefits from cost savings an acquirer would realize in interest costs and lower G&A,the stock would still trade around $4.12 (assuming the mid-point in AFFO of $.275).

Conclusion

Based on these two valuation methods, investors would expect to see a price of between $4.12 on the low side and the $8s on the high side in the ordinary course of business.  


Doucet Asset Management, June 2015


According to Bloomberg Analytics, the average cap rate for the healthcare REIT universe is 6.3, while the average FFO multiple in the space is 13.8. So what does this mean for ADK valuations? If one sifts through the press releases, 8Ks, 10Qs and 10K since July, 2014, investors can make several relevant projections, apply multiples to those projections and make certain value assumptions.

Revenues   $28.834 million   (assumes conservative assumptions on three remaining properties)

Convert Debt             $7.7 million                  (assumes $7.5 million note is not converted by 7/31 and is paid off)

Mortgage Debt          $111.086 million (assumes the Company pays down four mortgages in the amount of about $18 million and brings $1 million in proceeds in excess of the mortgage amounts and $2 million in restricted cash onto the balance sheet)

Preferred Debt          $53.830 million

Bank Debt                    0

Cash                               $17 million                   (assumes $7.5 million note is not converted by 7/31 and is paid off)

Estimated Annualized FFO $.34                  (beginning annualized FFO in Q415 assumes no acquisitions and G&A and lease expenses projected on July, 2014 have not changed)

Based on the above assumptions and corresponding multiples, ADK would be worth $4.65 on an FFO basis and about $9.00 on a fully diluted basis. The latter would only be realized if the company was sold to a strategic buyer who liked the properties, leases and the operators.  However, a price of $4.65 and an FFO of $.34 annualized by Q415 assume interest costs remain at the very high current cost of capital of about 7.29% and the Company is not successful in adding accretive acquisitions which would of course add to the FFO. For every 1 million shares the Company is successful in purchasing at current levels, the Company would add over $340,000 to FFO or about $.017 per share. This increase in FFO would give the Company the ability to increase the dividend by $.0136 per annum or about 40 basis points to investors (assuming the Company continues their dividend policy of paying out only 80% of FFO in the form of earnings). 


Doucet Asset Management, June 9, 2014


What is AdCare Worth?

We believe if AdCare were to sell its assets, stockholders would realize a value of between $6.44 and $8.22 per share and a mid-point of about $7.30 per share.  While we hope that the willingness by Mr. Brogdon to purchase a majority stake in the Company at $8.00 per share and Park City Capitals suggestion that the stock could be worth $13.00 per share are more accurate than our calculations, the consistent theme among all of our filings and letters is the stock is worth a lot more than $4 and the Company has done little to bridge this gap.While we have attempted to internally value AdCare based on severaldifferent valuation metrics, we have determined the cleanest and most accurate way to value the Company is through a sum of the parts analysis.

This belief is reinforced by the fact that we are convinced there would be two different natural buyers for the two different parts of AdCare Health Systems business.

Sum of the Parts Analysis

Our internal sum of the parts analysis places a value on the owned real estate and a separate value on the leased and managed only properties.

Owned Properties:

AdCare currently owns 25 properties with approximately 2700 owned beds. In evaluating the real estate, Park City Capital stated, in its July 15, 2013 13D filing, that the average skilled nursing home sold for $89,300 per bed to REITs in 2012, according to a 2013 REIT industry report. However, since that report was published, there have also been several high profile mergers in the industry including the NorthStar acquisition of Formation Capital and Safanad for $1.05 billion and Ventas $2.6 billion purchase of ARC Healthcare so far in 2014. We have also noted dozens of smaller transactions, public and private,in the southeastern portion of the U.S. where most of AdCare properties are located. Bed prices ranged between $88,000 to $180,000. To be on the conservative side, and since we have been told the $88,000 per bed transaction was for a combination of unprofitable beds and older properties, internally we use a valuation of between $90,000 and $110,000 per bed which would equate to approximately $243 million and $297 million in gross value for the owned real estate. A mid-point price would equate to approximately $6.00 per share, subsequent to the execution of all stock options, warrants and conversion of the convertible bonds outstanding to common stock.

Leased and Managed Only Properties:

AdCare currently has 13 properties which are leased or are managed-only properties. While we do not ever remember seeing the Company breakdown revenue as far as owned properties and leased properties in their 10Q and 10K filings, ex-CEO Boyd Gentry did suggest to shareholders on several occasions that the revenue from the leased side of the business accounted for about $75 million of AdCares roughly $225 million in revenues in 2013. Assuming this information is correct, one could also make the assumption the Company would realize a market range of margins on the leased revenue.

With the aforementioned stated caveats, the values range between $.90 and $1.70 per share for the leased and managed-only portfolio. We found the publicly-traded healthcare companies with the highest percentage of leased properties in their portfolio as a percentage of the total portfolio and did a simple Trailing Twelve Months Revenue to. Enterprise Value Calculation (Rev/EV). We then applied those ratios to AdCare.

The lowest and highest multiple comparables we found with a high concentration of leased properties were Diversicare (DVCR) and Kindred Healthcare (KND) respectively. Their Rev/EV multiples ranged from .60% to .32% for the trailing twelve months giving this division of AdCare an imputed value of $24 to $45 million or $.90 to $1.70 per share, assuming a fully fully dilute share count of 26.4 million shares. The mid-point valuation number came out to $34.5 million or about $1.30 per share.

Sum of the Parts:

So if one were to add up our mid-point valuation for the owned real estate of $6 per share plus our mid-point valuation for the leased and managed only properties of $1.30, he would get a total mid-point valuation of approximately $7.30 per share.

Brogdon and Park City Valuations Much Higher Than $7.30 Per Share

Both Brogdon and Park City suggested valuations much higher than $7.30 a year ago when the overall skilled nursing/nursing home market was weaker than it is today and before merger mania began in earnest in the healthcare industry.  As a result, we can only assume a $7.30 price tag for the entire

Company would be very conservative and perhaps even on the low side of reality.  At the very least, what we concluded from our internal analysis of AdCare is there is a strong argument to be made that the shares of AdCare are tremendously undervalued at the current stock price. Additionally, at the very least, since we understand that there are no debt covenants that restrict the buyback of the common stock or repayment of high coupon debt, there should have been some plan of action announced by or on the May 31st press release which stated a plan to do one or both was put in place by the Board.

 


Park city capital, August 2013


Our analysis, which is outlined below illustrates that in the REIT conversion scenario, the REIT would be worth $5.28 per share and pay an annual dividend of $0.28 per share (5.4% dividend yield).  We estimate the operating company would be worth $6.43 per share, resulting in a combined value of the REIT and the operating company of $11.71 per share.

We also continue to believe the Company’s owned real estate could be sold to a REIT and the Company could pay off its debt and have approximately $4.03 per share in cash to distribute to shareholders.  In addition, we believe that the remaining operating company would be debt free and worth $6.43 per share, representing a total value of $10.46 per share.

We believe the operating company would be worth $6.43 per share.  We continue to believe that management, or perhaps another management team, should easily achieve double digit EBITDAR margins by the fourth quarter of 2013, and should achieve double-digit EBITDA margins over time.  Table 1 shows that the Company’s peers earned trailing twelve month EBITDAR margins of 12.7%.  In addition, Table 1 shows that the Company’s peers trade at a mean EV/EBITDAR multiple of 7.5x.

Table 1:  Company Peers Trade at 7.5x EBITDAR

Company   TTM EBITDAR Margin EV/EBITDAR   TTM EBITDA Margin EV/EBITDA
Ensign Group   13.9% 8.6x   12.4% 9.7x
Skilled Healthcare   11.4% 6.4x     9.2% 7.9x
Average   12.7% 7.5x   10.8% 8.8x

Source:  Company filings and Park City Capital estimates.

Table 2 illustrates at 7.5x EV/EBITDAR, the operating company would be worth $6.43 per share assuming a revenue run rate of $230 million and a 12.7% EBITDAR margin.

Table 2:  Operating Company Should Trade at $6.43 per Share

Sales   $ 230,000,000  
EBITDAR Margin     12.7 %
EBITDAR   $ 29,210,000  
EV/EBITDAR     7.5 x
Enterprise Value     219,075,000  
Cash     10,928,000  
Capitalized Rent     69,300,000  
Market Value     160,703,000  
Shares     25,000,000  
Price   $ 6.43  

Source:  Company filings and Park City Capital estimates.

Note:  This analysis assumes conversion of convertible notes.

In a sale-lease back scenario, we continue to believe the Company’s real estate portfolio is worth $4.03 per share.  According to Levin Associates, in 2012 REITs paid an average of $89,300 per bed for skilled nursing facilities.  Table 3 shows that if the Company’s owned facilities were sold for $90,000 per bed, these assets would generate approximately $242 million.  At June 30, 2013, the Company had total debt (excluding the convertible notes) of approximately $141 million.  If the Company were to use the proceeds to pay back all of its debt (excluding the convertible notes), it would have approximately $101 million ($4.03 per share) to distribute to shareholders in a special one-time dividend.

Table 3:  Real Estate Asset Sale Should Generate Net Cash of $4.03 per Share

Owned Beds     2,691  
Sales Price Per Bed   $ 90,000  
Proceeds     242,190,000  
Debt     141,374,000  
Net Cash     100,816,000  
Shares     25,000,000  
Net Cash Per Share   $ 4.03  

Source:  Company filings and Park City Capital estimates.

Note:  This analysis assumes conversion of convertible notes.

In a REIT conversion scenario, we estimate the REIT would be worth $5.28 per share and would pay a $0.28 per share annual dividend, representing a 5.4% annual dividend yield.  In this scenario, the combined value of the REIT and the operating company would be $11.71 per share. As mentioned above, this plan may be the most favorable outcome because it would result in an even higher value for the real estate, could be more beneficial to shareholders from a tax perspective, and shareholders that remain shareholders in the REIT would receive a sizable dividend.

Table 4 illustrates how the REIT would be able to pay a $0.28 annual dividend per share assuming a 9% capitalization rate and the aforementioned $90,000 value per bed.  We annualized the Company’s second quarter of 2013 interest expense and applied a 6.0% of rental income G&A expense, which is in-line with peers.  In an effort to triangulate rental income from multiple calculations, in Table 5, we calculated the rental income for the REIT using a coverage ratio of 1.3x.

Table 4: AdCare REIT Should Trade at $5.28 per Share     Table 5: Rental Income Check  
Owned Beds     2,691     Sales   $ 230,000,000  
Value Per Bed   $ 90,000     EBITDAR Margin     12.5 %
Carrying Value     242,190,000     EBITDAR     28,750,000  
Cap Rate     9.0 %   Coverage Ratio     1.3 x
Rental Income     21,797,100     Rental Income   $ 22,115,385  
Interest Expense     13,412,000              
G&A Expense     1,307,826              
Spread     7,077,274              
Shares     25,000,000              
Dividend per Share     0.28              
Yield     5.4 %            
Price per Share   $ 5.28              

Source:  Company filings and Park City Capital estimates.

Note:  This analysis assumes conversion of convertible notes and a 100% dividend payout ratio.

Table 6 shows the current dividend yield on AdCare’s senior housing REIT peer group of 5.4%, based on stock prices as of August 23, 2013.

Table 6:  Senior Housing REITs Trade at a 5.4% Dividend Yield

Company Dividend Yield
Health Care REIT 4.9%
AVIV REIT 5.5%
Sabra Health Care REIT 5.9%
HCP 5.1%
Omega Healthcare Investors 6.3%
National Health Investors 4.8%
LTC Properties 5.1%
Average 5.4%

Source:  Company filings and Park City Capital estimates.

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