Doucet Asset Management Recent Letter To AdCare

Updated on
June 29, 2015

	AdCare Health Systems
	Board of Directors
	3050 Peachtree Road NW
	Suite 355
	Atlanta, GA30305

	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 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
	acquisitions.

	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).

	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.

	Sincerely,

	Chris L. Doucet
	CEO, Managing Partner
	Doucet Asset Management, LLC
Thumbnail for 751575

Leave a Comment