The SeniorCare Investor: Assisted Living Concepts Public

 

AdCare Health Systems Also Completes Its Small IPO

Although there were questions about whether to proceed with the proposed restructuring of Extendicare Inc., including the spin-off of Assisted Living Concepts (NYSE: ALC) into a separate publicly traded company, as a result of proposed changes in the tax treatment of Canadian income trusts, it all went according to plan, more or less, with just a 10-day delay. ALC began trading on the New York Stock Exchange on November 10.

Prior to the official spin-off, ALC was trading on a "when issued" basis in the $8.25 to $8.75 range. But once it was officially trading, it dropped to a low of $7.44 per share, which is not as bad as many companies or divisions that are spun out. Oftentimes, shareholders who receive the new shares in the smaller company sell them in the first few weeks, significantly depressing the market price while buyers are waiting for the shares to hit bottom. ALC seems to have avoided this problem, so far, and closed the month at $8.74 per share.

A week after the spin-out, ALC released its third quarter earnings as a public company for the first time since its predecessor company was sold to Extendicare back in January 2005. In its last reported quarter before the sale, annualized EBITDAR was $42.3 million, compared with $65.2 million for the third quarter 2006 annualized EBTDAR. Not bad for two years, but some of Extendicare’s ALFs have been added to the new ALC. For the nine months ended September 30, 2006, ALC reported net income of $4.4 million, but that was after transaction costs (the spin-off) of $3.7 million, a loss on impairment of long-lived assets of $3.1 million and net loss from discontinued operations of $1.5 million. EBITDA for the nine months was $38.8 million, or about $0.56 per share.

For the third quarter, the company posted a very modest net income because of $4.5 million of one-time charges. EBITDA was $12.7 million, or a small decline from the $13.4 million in the year-ago quarter. The EBITDA margin, however, dropped more dramatically to 21.7% in this year’s third quarter from 23.9% a year ago. Management stated that the current quarter was negatively impacted by higher G&A expenses associated with the spin-off, but census was lower than the year-ago quarter as the company tries to lower its Medicaid population and supplant it with higher private-pay residents. The strategy is working, with the Medicaid census decreasing by 5.2% from a year ago.

Equity analyst Frank Morgan of Jefferies & Company had a Hold rating and a $7.25 price target for ALC before the third quarter earnings release, but changed his rating to Buy and a price target of $9.25 per share after the earnings release. He likes the fact that average daily revenue per unit increased by 7.5% to $88.00 per day compared with a year ago and that the overall census is beginning to rise again.

At 84.8%, the company’s occupancy is well below the 91.6% average of its publicly traded peers and below the overall industry average, but Mr. Morgan believes that represents an opportunity for the company in a market where there is limited new development but increasing demand. And with less than $90.0 million of debt and a new $100 million line of credit that has not been drawn upon, the company’s capital structure can support solid growth by acquisition. What remains to be seen is how the company’s relatively young CEO performs while out from under her former parent’s watchful eye.

As for Extendicare, its shares are no longer traded on the New York Stock Exchange, and the company, now known as Extendicare REIT (TSX: EXE.UN), has become a Canadian REIT listed on the Toronto Stock Exchange amid all the proposed changes in income trust tax laws in Canada. Some people were surprised that they went ahead with the restructuring despite the uncertainty, and there was the usual sniping that the family that controls the company did what was best for them and their heirs.

Canadian competitor Chartwell Seniors Housing REIT (TSX: CSH.UN), which has been expanding rapidly in the U.S. seniors housing market, believes that based on the REIT qualification rules as proposed, as it is currently structured and based on the location of its assets and the source of its income, it may not qualify as a REIT and may be subject to the proposed income trust tax rules as drafted. Chartwell believes, however, that the government’s proposal does not intend to change the manner in which distributions that are classified as "return of capital" are taxed.

In Chartwell’s case, since its inception approximately 85% of its distributions have been characterized as return of capital, something that it believes will be likely in the future as well. It is important to note, however, that the proposed rules are just that, proposed, and until they become law anything can happen. And as it now stands, there would be a four-year transition period until 2011. Given that Extendicare is a newly formed REIT with its restructuring, and with no history of distributions as a REIT, we are not sure how they will fare under the proposed changes.

Assisted Living Concepts is not the only newcomer to the publicly traded club. AdCare Health Systems (AMEX: ADK.U) finally got its IPO priced, three months after it was originally expected. On November 10 the company sold 703,000 units for $9.50 per unit in an offering managed by Newbridge Securities Corporation and Joseph Gunnar & Co., two regional firms. Each unit consists of two shares of common stock and two five-year warrants each to purchase one share of common stock at a price of $4.50 per share.

For now, only the units will be available for trading on the American Stock Exchange. Within 90 days of the IPO, or sooner if determined by the underwriters, the units will be divided into their separate components of two common shares and two warrants, the units will cease to exist and the shares will start trading. At that time we will include the share price information in the provider stock table on page 3. But with just 2.3 million shares to be outstanding, there will be limited trading activity.

AdCare currently manages 15 facilities, comprising six skilled nursing centers, seven assisted living facilities and two independent living communities with a total of more than 800 beds/units. In addition, the company operates a recently acquired home health agency.

Based in Springfield, Ohio, all of the company’s properties are located in Ohio, but it is unknown if their acquisition plans include expanding to other states. Annualized revenues are just over $22.0 million with a net loss this year that could be over $2.0 million. In 2005 revenues were $21.9 million with a net loss of nearly $1.2 million. Obviously, management has its work cut out to generate future interest in its shares. A few acquisitions wouldn’t hurt, and we assume the $6.1 million of net proceeds from the IPO will be used for expanding their business.

We were not able to find a current price for the units, other than the issue price of $9.50, and it is difficult to value the component pieces of the units until the company gets bigger with some profit. The overall market for senior care stocks, however, was not too pretty in November with all but three of them posting price declines.