Description

Assisted Living Concepts (ASLC) was the idea I used six weeks ago as an application to VIC. Shortly thereafter the cat came out of the bag with the company’s announcement of a postponement of the annual meeting and the plan to engage an advisor to explore ways of maximizing shareholder value. However, the stock is up only 20% since then, and I believe it is still attractive at this level.

ASLC, which emerged from bankruptcy in 2002, has undervalued assets on its balance sheet, looks more highly leveraged than it is, and is largely unnoticed by the investment community. There may be as much as $30-50M of unrecognized value which translates to an increase of 45-75% in the share price. In addition, after the largest shareholder proposed an independent slate of directors, the company postponed their annual meeting and engaged Jeffries & Co to advise them on strategic alternatives.

Like the nursing home industry, assisted living has very favorable long term demographics working for it. That rosy future led to overbuilding and overpaying in the last decade with the usual results. Changes and uncertainties in government reimbursement compounded the problems (particularly for nursing homes). Today with lots less debt, ASLC gets about 15% of its revenue directly from state paid Medicaid and another 9% from the resident paid portion of Medicaid. The remaining 76% of revenue is private pay.

The company operates 177 assisted living residences (6838 units) in small, middle-market, rural and suburban communities in 14 states where, it claims, competition is less intense. Of these, 122 properties (4734 units) are owned. I believe there is unrecognized value in the owned assets which could be realized by a sale/leaseback, spinning off a REIT, or simply better understanding by the financial markets.

ASLC reported for Q1 ’04 on 5/11. Fully diluted earnings were 23 cents compared to 16 cents in Q1 ’03. Revenues at $42.6M were up just 3.6%, so the improvement reflected mostly the reduced interest cost ($2.4M vs. $3.4M) of ASLC’s debt, refinanced in December ’03. That refinancing replaced high cost senior and junior notes. A little under half of the company’s debt is variable, including several variable rate state housing bonds. No significant repayments are required until 2008.

There is room to improve these earnings. ASLC has 88% occupancy across its facilities, but in Indiana, for example, it is just 70%. The company is getting its licensing requirements squared away in Indiana and should be able to attract new residents. There remain $12.7M of NOL’s (@12/31/03) for which a 100% valuation allowance has been taken. They will reduce the effective tax rate for a few more years.

How about all that leverage? Debt on 3/31/04 was $142.5M, for a dismal debt to equity ratio of 4.5 to 1, but this reflects the reduction of real estate carrying value in fresh start accounting. Property and equipment is carried on the balance sheet at $182M. The president thinks owned units might be worth $60k/unit. Let’s try $55k/unit, a little less than Ventas paid to acquire 2000 units from Brookdale a few months ago. $55k x 4734 units pencils out to $260M. Add the extra $78M to current shareholder equity of $31.8M, and you get nearly $17/sh (6.5M fully diluted share count). Today, TEV is just $208M. Ventas, for one, continues to look for acquisitions, and has expressed its interest in adding to its assisted living portfolio.

Another way to get a feel for unrealized value is to do the mental exercise of splitting ASLC into an operating company and a REIT (like Five Star and Senior Housing Trust). Assuming the split could be financially engineered to produce breakeven for the operating company, you’d be left with something like annual FFO of $2.25/sh for the REIT (assuming same share count of 6.5m). Discounting the comp’s a little to 7.5xFFO, again produces a share price of nearly $17.

Even without any restructuring, the company is producing free cash flow of $1-1.5m/mo. In the last quarter they paid down net debt by about $5m. An accelerated way of strengthening the balance sheet would be an issue of preferred stock.

There is a dust-up in the boardroom and with a significant outside shareholder. That shareholder, Bruce Toll (of Toll Bros.), has a standstill agreement on more share purchases (Toll has to buy out the Chairman, Andy Adams, if Toll acquires beyond his current 27.6% of the stock.) His son-in-law is on the board and served on the Nominating Committee whose slate was not accepted by other board members. The Nominating Committee was reconstituted and proposed a new slate. Toll filed a 13D listing his own candidates, which led to postponement of the annual meeting.

In addition, Andre Dimitriadis, an ASLC board member and CEO of LTC, took a hostage to fortune when ASLC filed its 10K by raising questions about noncompliance with 37 LTC leases. As described in the SEC filings, these sound mostly technical, and LTC has so far not declared a default. The leases are significant and represent $1m or so per quarter of profit to ASLC. The CFO reports them to be pretty much at market rate, so LTC’s financial incentive to topple the applecart is not compelling. The company is making good progress, it says, and has "meritorious defenses" on all the issues. However, Toll has filed another 13D accusing Dimitriadis and Adams of conflicts of interest. An unexpected and adverse outcome on the LTC leases would be material.

The stock hasn’t traded much. MacKenzie Patterson, one of the funds that acquired shares in the bankruptcy, proved ready to sell above 9 a couple of months ago when it was reported they’d like to reduce their position (700K shares) by half. Since the announcement about investigating strategic alternatives, they have been willing to sell around 10.5. Otherwise the trading has been a couple thousand shares/day. Bruce Toll made his last purchase of 557K shares @ $8 last September.

Catalyst

Recognition of full value of units owned
Conclusion of strategic alternatives review
Restructuring of balance sheet
Potential acquisition