Five Star Quality Care (FVE) – Tender Offer Competing Bids – 25% upside

Current Price –$2.76

Offer price - $3.45

Upside – 25%

Expiration date – TBD (likely sometime in Nov, 2016)

SEC filling

 

Background:

On Oct 3, 2016 ABP Acquisition (controlled by Portnoy family, owner of 8.6% FVE shares through Senior Housing Properties Trust) ) commenced tender offer for 10m shares at $3 per share. This represented 20% of the shares outstanding. Right after the announcement the price jumped to $2.7, leaving only minimal spread to the offer price. I expected this offer to be heavily oversubscribed and therefore only part of the shares (my guess was around 40%) to be accepted at $3. I also expected that after the tender expiration the share price would drop back to $2-$2.2, which would overall result in losses for those who acquired shares in order to participate in the tender. So eventually I decided to skip this one.

However, all of that changed yesterday when Senior Star (owner of 6.8% of FVE shares) announced a competing tender offer for $3.45 per share for the same 10m of shares. Despite material increase in the offer price, the share price jumped only 9% to $2.77 leaving a large spread. There is also a further potential upside if Portnoy’s react to this with a more aggressive offer. Worth noting that Senior Star acts as an activist investor and offered a number of ways to improve share shareholder value. They also openly oppose corporate governance structure that protects only the interests of Portnoy’s family (Barry Portnoy is managing director of FVE and all directors come from Portnoy related entities).

After Senior Star announcement, the downside is much more protected and I no longer believe the shares will drop back to $2-$2.2 levels after the tenders expire. The company is clearly in play and two strategic investors / current shareholders indicate that FVE is undervalued at current prices (most probably they even consider it undervalued at $3-$3.45). Even if Portnoy’s do not issue another competing bid, their thoughts on FVE valuation have been made public and share price is unlikely to return to pre-announcement levels.

 

FVE valuation:

I have no particular insights into FVE business, so your opinion is as good as mine. I suggest to read through Senior Star’s 13Ds (here, here and here), which outline the case for undervaluation and mismanagement of FVE by Portnoys. Below are just my back of the envelope thoughts on how to think about FVE’s valuation.

It is one of the largest operators (and owners) of senior living communities and skilled nursing facilities. The company aims to be the high-end player. The industry is ripe for consolidation (maybe this is what both strategic investors are playing for) and clearly benefits from demographic tailwind. Company’s presentation provides a good overview. Only 20% of FVE revenue comes from Medicare/Medicaid so it is far less exposed to potential government funding changes relative to other senior living facility operators.

From valuation perspective, the company trades at 0.7xBV, majority of which is comprised of owned buildings and land. Clearly investors do not attribute much value to the operating business and maybe rightly so – the company has not grown over the last few years (stable EBITDAR 2011-2015, occupancy rates are declining) and all of the positive operating cash-flow has been consumed by capex. So this is a relatively stable no-growth business that operated at cashflow break-even for the last few years.

 

FVE

Source: FVE investor presentation

Splitting valuation in different parts:

1. Assets on the balance sheet, i.e. equity book value – $3.5/share. Senior Star in their 13D filling offered to acquire all 33 properties at $325m vs current BV of $351m, so balance sheet valuation of properties seems to be legit.
2. Current operating business – $0 – as it operates at cash breakeven;
3. Value of future operational improvements and growth – no idea where to pin this exactly, but with occupancy at 84.3% and shown potential to increase prices, the company could potentially earn materially more with the same asset base. So this part is clear >$0

The bottom line is that the downside seems to be well protected by the BV of owned properties ($3.5/share). And this is probably the reason why the two strategic investors are taking advantage of the depressed share prices.

 

Other considerations:

FVE will announce Q3 earnings on the 4th of November and this might materially affect the share price.

Portnoy might find some other way to deal this situation. While do not know what it might be Portnoy historical track record of doing everything to extract dollar from minority shareholders is quite extraordinary.

It is possible to hedge the downside risk with Jan 2017 put options (Nov options will probably end too soon) with $5 exercise price. Currently I am shown the bid-ask spread on these at $1.85-$2.6. However, to hedge successfully one needs to guess the proration factor correctly. Also hedging would limit any further upside from the potential bidding war.

Senior Star have so far announced only the intention of the tender offer and have not commenced the actual tender yet.

FVE with $135m market cap is a tiny part in Portnoy REIT empire, so a full take-over might be in the cards as well.

 

 

41 COMMENTS

  1. William Silver

    Portnoy carries a nasty reputation. This probably works out unless Portnoy comes out on top since he has a history of fleecing his controlled entities thru big fees, etc

    1. dt

      You are absolutely right that Portnoy tend to squeeze out their managed REITs through high fees that end up in the top entity – RMR Group. Btw. RMR Group is performing like star so far this year.

      Now when it comes to this situation specifically, RMR Group is getting management fees of c. $9m per annum from FVE vs. overall Portnoy stake in the company of only $12m. So clearly Portnoy want to secure this management fee and therefore I doubt they will allow another entity to consolidate almost 30% stake and risk loosing control of FVE.

      A big question is whether Portnoy have any other way of blocking Senior Star tender, cause if not, then the only way to secure the control of the company is by even higher tender or full acquisition of the company. Otherwise, after Senior Star tender is completed, a proxy fight to remove Portnoy affiliated directors from the board is very likely. And if the proxy is successful, then the current ‘Portnoy discount’ would likely disappear and FVE would trade at least at book value, i.e. $3.5/share.

      In the tender communication Senior Star noted “We are encouraged by the precedent set by Five Star’s independent Board members in waiving certain ownership restrictions and granting certain approvals in order to clear the way for the Portnoy’s tender offer.” So, it seems that any restrictions that could block the tender have already been waived. This gives confidence that Senior Star tender should go through as announced unless a higher offer emerges.

      In my view this is a win win situation for FVE shareholders. If no other offer emerges, then Senior Star gets control and pushes out Portnoy and this in turn lifts the share price towards book value. And if another offer from Portnoy emerges, then share price will get a boost upon announcement.

      Would love to hear different opinions on how this might play out.

      For those unaware of Portnoy or RMR, I recommend reading through VIC write-up and comments: https://www.valueinvestorsclub.com/idea/RMR_GROUP_INC/137988#description

  2. aloke roy

    thanks for the idea. wondering how big you’ve sized the position?

    1. dt

      It is quite big compared to other special situation plays, as I believe downside is quite well protected here. Having said that these arbitrage trades together comprise only certain part of overall portfolio.

  3. dt

    One more thought re Portnoy interests – Senior Housing Properties Trust (Portnoy entity) gets $200m in annual rent from FVE (almost all of EBITDAR). I would not be surprised if these rents are above market prices and Portnoy are funneling cash from FVE’s shareholders. This might be an even higher incentive to secure control of FVE.

  4. d s

    is this an odd lot, are there limits on shares to be tendered?

    1. dt

      This is not an odd-lot tender and all shares will be prorated equally. If one of the tenders does take place, I would expect proration to be c. 40%.

    1. dt

      Hi Michael, I count it at 40% by assuming that some of outside shareholders do not participate in the tender (30%) and then that neither of the bidding parties participate (another 15%). So you have 22.5m of tendered share and 10m of shares to be accepted, thus proration works out at c. 40%.

      The big question here is how many of outside shareholders will not participate and 30% is just my educated guess based on historical observations and the fact that half of FVE shares are held by retail investors and at least some of them might simply not be aware of the tender or not know how to participate in one.

  5. sharpei

    are you suggesting to tender all the shares that one buys? Then sell the shares not bought in the offer in the open market?

    1. dt

      I am not suggesting anything, but I can share my views and my own intentions. Currently I am waiting for two events:
      1) Senior Star to commence the tender officially – so far it is intention only.
      2) Portnoy response

      So at the moment I am holding on to the shares until one of these happen (or shares spike higher up) and then will decide whether to tender or not.

  6. d s

    did it gap up from 1.99 following Portnoy offer? I feel like I missed the meat of the move at this point..

    1. dt

      Indeed before the Portnoy offer the share price was below $2. Of course would have been better to buy before Portnoy announced the offer like with any other trade which looks great in hindsight.
      Having said that, Senior Star offer is a game changer and I believe there is plenty of upside left.

    1. dt

      My guess the case will go to court. I am not legal expert, but seems like allowing one party to launch tender offer and restricting another party should be illegal. Response from Senior Star should come shortly.

    1. dt

      For now yes, as I believe the company is significantly undervalued relative to assets on the balance sheet. But I no longer think that this value gap will be closed in the short term. Will revisit again after Senior Star’s response, now the ball is in their court.

  7. dt

    Portnoy increased the amount of shares they are willing to buy from 10m to 18m, so if the tender takes place, the proration is likely to be quite low, meaning that most of the shares tendered will be accepted at $3/share.

  8. Michael

    Are you planning to tender shares at $3? It seems like if a large block of shares are handed over to the Portnoy’s, that could weigh heavily on the price of whatever shares are not taken in the tender.

    What do you think the proration might be like for the Portnoy offer?

    Thanks.

    1. dt

      If there is no further response from Senior Star, then I will tender my shares in Portnoy offer. If there is, I will reconsider.

      As for proration, per my comment above, I expect most or all of the tendered shares to be accepted.
      Excluding existing Portnoy and Senior Star stakes, there are 42m shares and Portnoy are willing to buy almost half of it. Also some other shareholders will not tender due to undervaluation relative to assets on the balance sheet.

    1. dt

      Seems like Thomas and Friends are willing to start proxy fight and Portnoy are blocking them in every way they can.

  9. Michael

    Sounds reasonable. Thanks.

    Let’s hope Senior Star comes back with something that will goose the price. The Board sure doesn’t seem to be interested in helping them.

  10. sharpei

    seems like Thomas and Friends pretty quiet, do you think they’ll make a move soon?
    If they don’t do anything do you think this falls after tender done?

    1. dt

      I have really no idea if and what will they do. However, as they hold large financial interest in the company and its undervalued assets, they should do something to preserve that value. I assume Senior Star are smart investors who care about valuations of their holdings.
      As to whether the price falls after the tender, your guess is as good as mine – however IMHO this play will not end with the tender and as long as proxy fight will continue the share price is likely to stay around current levels. But that is pure speculation on my side.

  11. exponential

    hi dt-

    the last day to tender for the portnoy $3.00 appears to be november 10 (i could be wrong). wondering when you are going to decide whether to submit the shares for tender? some brokerage houses seem to say they need a few days before the expiration date and after that tendering is on “best efforts” basis it seems. also, has anything to date from senior star caused you to change the decision to tender into the $3.00 offer? thanks in advance for your perspectives as always.

    1. dt

      When it comes to timing of tender, you should check with you own broker by what time the shares need to be submitted. For IB, one can tender on the date of expiration, usually before noon.
      So far Senior Star has not really made any further moves besides the higher tender offer, so if the same continues I will tender my shares in Portnoy offer.

  12. dt

    ‘Very informative’ talk during the conference call:
    “We will not be discussing, taking any questions or making any comments on today’s call regarding third-party tender offers for Five Star’s common stock or potential board nominations.”

  13. sharpei

    Thomas Brother letter out urging shareholders to not tender

    1. dt

      Sadly there is nothing new in their letter and they do not mention anything about potentially challenging Portnoy behavior in court.

  14. exponential

    hi dt-

    is it just me or does the current price of $2.60 seem like a no brainer to add if you can tender into portnoy offer at $3.00. what are the main risks you think? the ones i can think of are that portnoy withdraws the offer or that the price after proration drops to the $1.50 level on the remainder of shares given bad earnings report. also, wondering what you think is the current worst case proration scenario if the tender goes through? (guessing lower price may cause more folks to tender). thanks again in advance.

    1. dt

      The worst case scenario is that all unaffiliated shareholders tender their shares which would mean that only 43% of the shares get accepted in the tender. After the tender share price drops to $2/share at which the remaining 57% of my holding would be sold. This scenario results in 12% loss from where I bought, or 7% loss if purchased now at $2.6/share.

      If the proration and post-tender share price end up only slightly more favorably (e.g. 60% of the shares are accepted and post-tender price is $2.2), then one gains 3% by buying currently, so in that sense it is as you suggest a ‘no brainer’.

      There is no way Portnoys will withdraw the offer unless forced to do so. I expect that majority of shares tendered will be accepted (at least >70%).

        1. dt

          I was advised that those buying today will not be able to tender as by the expiration date they will not be record holders (3 day settlement period as there is no ‘guaranteed delivery’ option for this tender). So only those who bought the shares yesterday or earlier will be able to participate in the tender.

  15. dt

    Shares trading far higher than expected. I have sold short 25% of my tendered holdings in pre-market at $2.5/share – did not expect shares to trade so high today.

  16. dt

    Tender offer results are out (apparently these were out already yesterday, but still no SEC filling).
    http://www.businesswire.com/news/home/20161111005306/en/ABP-Acquisition-LLC-Announces-Tender-Offer-Results

    Proration is 79%, i.e. only 21% of the tendered shares will be returned to shareholders, the rest will be accepted at $3/share. So even though the full thesis of this special situation (Senior Star tender or higher tender by Portnoys) did not work out, this trade still produced a decent return.

    79% at $3/share + 21% at $2.65/share = average selling price of $2.92/share. Compared to initial price at $2.76, this results in 6% return in a month (my personal return was slightly smaller at 4.5% as I sold short prematurely at $2.5).

    1. Rachel

      Thanks for idea. I managed to load up last week at $2.6/share, so the return I am looking at is closer to 13% in one week.

      Keep up the good work!

    2. Jonathan K.

      Clearly not the best possible outcome, but as you say the return is still pretty good. Thanks.

  17. Jamie Schmidt

    Any input on the longer-term attractiveness of the activist campaign?

    1. dt

      Assets are clearly significantly undervalued. However, Portnoys’ now have close to full control of the company and will likely use it to their advantage. I doubt one board member from activist will make a huge difference. Unless there are some more decisive actions come from activist side (e.g. challenging Portnoys in court), I do not see a clear path how the asset value and share price could converge.

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