June 29, 2015
AdCare Health Systems
Board of Directors
3050 Peachtree Road NW
First, I want to commend the Board on hiring Bill McBride as AdCares
CEO last fall. He had the difficult challenge and task of navigating
the Company through its transition to a property holding company.
Based on conversations with several reputable REIT experts, they have
all confirmed what I already suspected-Bill has done an exemplary job
executing on the initiatives set forth by the Board. He has virtually
completed the Companys transition in leasing or divesting its portfolio
of 40 properties to new operators while negotiating favorable triple-net
leases with long terms and standard annual escalators. In addition,
Bill is making strides in addressing the Companys capital structure.
This has significantly improved the optics of the Company to prospective
acquirers as AdCare is simply a plug and play target at this point. Most
impressively,Bill has done this with little disruption to the Companys
operations and little to no deterioration in patient care.The long
awaited benefits of Bills efforts should be imminent.
I am convinced the Board made the right decision to hire Bill and convert
AdCare into a real estate holding company. Nonetheless, the successful
transition from an operating company to a real estate holding company has
not been reflected in the price of AdCares common stock. I believe the
combination of successive capital raises with little clarity on the use of
proceeds coupled with the rising short interest in the stock have relegated
ADK to ridiculously low levels.
Bill has made it clear on recent conference calls that his main desire
is to use part of the Companys $35 million in recent raises to make
accretive acquisitions of nursing home properties. The market has shown
its disappointment in the lack of success in accomplishing this goal by
selling the common stock off by nearly 25% over the past 90 days. However,
during the same timeframe, fundamentals of the Company have clearly
improved suggesting there has been a marked disconnect between the operational
performance of the Company and the stock price.
So what can the Company do in the near term to take advantage of this short
term dilemma and help restore investor confidence in Bill, the Board, and
the stock? One answer is to use some of the cash on the Companys balance
sheet to initiate a buyback of the Companys stock and augment the Companys
current strategy of growing the value of the enterprise by making accretive
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
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).
Most REIT investors understand and appreciate the Companys strategy. Simply
put, convert the existing portfolio to a holding company, reduce G&A
to a nominal level, use the cash to make accretive acquisitions, and
ultimately sell the portfolio to a larger REIT at a synergistic multiple
for both parties. However, while the broader market fully appreciates
the power of the model the Company is creating, the stock has been
relegated to orphan status due to the aforementioned successive raises
combined with the inability of the Company to close on a single
acquisition. As such, you should ameliorate your current
strategy. Take this as an opportunity to buy ADK stock on the open market at
significant multiples discount to its peers, exploit the current dislocation
in the market and any others that may occur in the future. The Company can in
essence invest in properties it knows very well at a 10 cap and ultimately
sell the company at a much lower cap rate at some point in the future. This
would be appear to be a good way to augment your current strategy in the
short term, regain investor confidence and build long term value.
Buying back stock would also be a low risk method of building value as
the Company is more familiar with each of these properties than its
competitors. The Company would also avoid transaction costs and associated
transition risks typically associated with the purchase of a new property.
I am happy to discuss my analysis in more detail at your convenience.
Chris L. Doucet
CEO, Managing Partner
Doucet Asset Management, LLC