Current Price –$2.76
Offer price – $3.45
Upside – 25%
Expiration date – TBD (likely sometime in Nov, 2016)
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.
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.
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.
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.