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An Activist Position in AdCare Could Cause the Stock to More Than Double by TMFDeeJ aka Jason Knapp

AdCare $ADK is an interesting special situation that I have been writing about and have owned for nearly a year now. There was a new development at the company today that I am about to discuss, but first here’s some background on the company for people who are not familiar with it. The following is an excerpt from my August 1, 2014 article on the company: From 0.0% to 8.5%, the World’s Greatest Secret Dividend Growth Story.

 AdCare
AdCare

“The other day I came across possibly the best dividend growth story in the market today. Better yet, it’s a secret. OK, it’s not really a secret, but it’s a small cap stock that is completely transforming itself that not many people are talking about.

Adcare Health Systems is in the business of acquiring and managing senior living facilities, i.e. assisted living facilities, independent living facilities retirement communities, etc… Historically, the company has not done a good job at managing its facilities, so the it has decided to change its business model. After the transition later this year, Adcare will no longer managed these facilities, but instead it will own them and lease them out to operators who might be more competent. These assets have value, that is not being fully reflected in the company’s stock. The move will allow it to begin paying a dividend to current investors and potentially eventually be sold to a healthcare REIT.

According to the company’s press release, it will begin paying a quarterly dividend of $0.05 starting in Q4 2014. At today’s share price, that is equivalent to an annual yield of 4.25%. Yawn. Wait, it gets better…the company will increase this dividend by $0.01 every quarter after that for “the forseeable future.” If Adcare successfully executes this plan, that would put its dividend at a much more attractive 7.7% annualized in Q4 2015 and 11.6% in Q4 2016 (assuming that it can keep increasing it at that pace).

After reviewing the presentation, the company states that it will have an annualized dividend of $0.40/share in Q1 2016. That’s equivalent to a yield of around 8.5% based upon today’s share price. Let’s look at how this yield stacks up against similar companies:

CareTrust REIT, Inc. (CTRE): 4.9%

Sabra Health Care REIT, Inc. (SBRA): 5.3%

Health Care REIT, Inc. (HCN): 5.0%

Omega Healthcare Investors Inc. (OHI): 5.5%

Aviv REIT, Inc. (AVIV) 5.0%

This implies that there’s 50%+ upside in the stock once the dividend hits this attractive level a year and a half from now plus you will be able to collect the dividend along the way while you wait once it starts later this year. Plus additional potential gains if the company was to be bought out by a bigger healthcare REIT, which there’s no shortage of today and it has expressed being open to.

With NewCastle (NCT), Extendicare (EXETF), Ensign Group (ENSG) and CareTrust REIT (CTRE) already in my portfolio I wasn’t exactly looking for another senior living play, but you take what Mr. Market gives you. At least the sector has tremendous demographic tailwinds. I definitely do find this one very interesting. Of course, there’s always execution risk associated with this sort of transaction. Also, one has to question of a management team that was so terrible at managing these facilities can successfully complete this transition.

Here’s the company’s official announcement: AdCare Announces Strategic Plan to Transition to a Facilities Holding Company; New Business Model Designed To Optimize Cash Flow and Unlock Shareholder Value and my favorite, an investor presentation.

Here’s a link to an excellent Value Walk article that first brought this situation to my attention: AdCare Health Systems: NOLs, REIT Conversion, Cash Allocation.

Since I wrote this post, despite a significant improvement in the company’s operations its share price has dropped 28% versus a gain of 6% in the S&P 500.

Companies this small, a market cap of only $69.1 million, don’t often attract the attention of activist investors. So I was pleasantly surprised when I saw this afternoon that someone had filed a Schedule 13D on AdCare. For those of you who are not familiar with 13Ds, any individual or firm that purchases more than 5% of a company’s stock must file a 13D with the Securities and Exchange Commission. 13Ds can be an important tool for individual investors to find out what savvy investors or activist investors are buying.

A 13D was filed on AdCare today, causing the stock to rise by more than 4%. The filing was made by a firm called Doucet Asset Management, LLC. I am not personally familiar with Doucet, but I have reached out to the firm’s founder Chris Doucet to see if he is willing to discuss the new position in AdCare. In the meantime, here’s the text from a letter that Mr. Doucet sent to AdCare’s Board of Directors with emphasis and comments added by myself:

“Dear Board, 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 Company’s 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 Company’s 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 Company’s 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 Company’s $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

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