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
Doucet Asset Management Recent Letter To AdCare
Updated on