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From 0.0% to 8.5%, the World's Greatest Secret Dividend Growth Story

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August 01, 2014 – Comments (4) | RELATED TICKERS: ADK , SBRA , HCN

The other day I came across possibly the best dividend growth story in the market today.  Better yet, it's a secret.  OK, it's not really a secret, but it's a small cap stock that is completely transforming itself that not many people are talking about. 

Adcare Health Systems (ADK) is in the business of acquiring and managing senior living facilities, i.e. assisted living facilities, independent living facilities retirement communities, etc...  Historically, the company has not done a good job at managing its facilities, so the it has decided to change its business model.  After the transition later this year, Adcare will no longer managed these facilities, but instead it will own them and lease them out to operators who might be more competent. These assets have value, that is not being fully reflected in the company's stock. The move will allow it to begin paying a dividend to current investors and potentially eventually be sold to a healthcare REIT.

According to the company's press release, it will begin paying a quarterly dividend of $0.05 starting in Q4 2014. At today's share price, that is equivalent to an annual yield of 4.25%. Yawn. Wait, it gets better...the company will increase this dividend by $0.01 every quarter after that for "the forseeable future." If Adcare successfully executes this plan, that would put its dividend at a much more attractive 7.7% annualized in Q4 2015 and 11.6% in Q4 2016 (assuming that it can keep increasing it at that pace).

After reviewing the presentation, the company states that it will have an annualized dividend of $0.40/share in Q1 2016. That's equivalent to a yield of around 8.5% based upon today's share price. Let's look at how this yield stacks up against similar companies:

CareTrust REIT, Inc. (CTRE): 4.9%
Sabra Health Care REIT, Inc. (SBRA): 5.3%
Health Care REIT, Inc. (HCN): 5.0%
Omega Healthcare Investors Inc. (OHI): 5.5%
Aviv REIT, Inc. (AVIV) 5.0%

This implies that there's 50%+ upside in the stock once the dividend hits this attractive level a year and a half from now plus you will be able to collect the dividend along the way while you wait once it starts later this year.  Plus additional potential gains if the company was to be bought out by a bigger healthcare REIT, which there's no shortage of today and it has expressed being open to.

With NewCastle (NCT), Extendicare (EXETF), Ensign Group (ENSG) and CareTrust REIT (CTRE) already in my portfolio I wasn't exactly looking for another senior living play, but you take what Mr. Market gives you.  At least the sector has tremendous demographic tailwinds.  I definitely do find this one very interesting. Of course, there's always execution risk associated with this sort of transaction.  Also, one has to question of a management team that was so terrible at managing these facilities can successfully complete this transition.

Here's the company's official announcement:

AdCare Announces Strategic Plan to Transition to a Facilities Holding Company

New Business Model Designed To Optimize Cash Flow and Unlock Shareholder
Value


http://finance.yahoo.com/news/adcare-announces-strategic-plan-transition-200100257.html

and my favorite, an investor presentation...

http://investor.adcarehealth.com/phoenix.zhtml?c=196757&p=irol-IRhome

Here's a link to an excellent Value Walk article that first brought this situation to my attention:

AdCare Health Systems: NOLs, REIT Conversion, Cash Allocation

http://www.valuewalk.com/2014/07/adcare-health-systems-inc-adk/

I'd love to hear others' thoughts on this idea or any other special situation investment ideas that they have.

Thanks for reading.  Have a great weekend!

Jason

4 Comments – Post Your Own

#1) On August 01, 2014 at 11:09 AM, TMFHelical (98.81) wrote:

Jason,

I find this curious.  As a long time holder of HCN, I'm quite familiar with the sale-leaseback trend going on in the senior living, skilled nursing, etc. space.  It makes sense from a tax standpoint, and cuts in reimbursement rates has created a 'need for cash' for many operators.  But .. the story is often an operator decides to focus on 'operating the facilities' and sells or spins out the RE.  Owning and leasing the real estate has certainly been the better business the past few years, but it still strikes me a uncommon for management to keep the RE and look for an operator.  Maybe not, and that is just the side I've seen most.

Anyway, this sounds interesting, but I wouldn't touch it until I know 'who the operator' of the facilities will be.  The REIT will be hugely dependant on the facilities they own being well run. If they engage a large established player, great.  If they have a patchwork of small and independant management groups, I would expect problems.

Ralph

Helical Investor 

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#2) On August 02, 2014 at 12:54 PM, JeffryClarke (47.18) wrote:

So I'm looking at the numbers here...to a potential REIT acquiror this looks like $10.4M per year in operating cash flow, which is $8.5M + $2M for lower debt rates + $2.5M in avoided G&A less $2.6M for the preferred stock dividend.  (I'm excluding the $1.7M in convertible interest because I can't seem to find how many shares the convertibles would convert to and so don't want to deal with the hassle yet.)  At a 6% yield, that would make ADK worth $173M to a REIT acquiror.  I don't know REITs that well though - does the distributable cash flow at a health care REIT roughy equate to the $10.4M above?  Or do they exclude maintenance capex or other things from the distribution?

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#3) On August 02, 2014 at 5:04 PM, JeffryClarke (47.18) wrote:

OK, so it looks like about 25M shares fully diluted if the convertibles convert and all of the options and warrants are exercised.  So we have $12.1M in potential FFO (a REIT term I learned today).  Assuming they could sell for 14x-15x FFO based on the comps, you've got $6.80 - $7.30 per share in a sale.  That's pretty good.  I'm very seriously tempted to buy...

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#4) On August 06, 2014 at 1:09 PM, mfoster (< 20) wrote:

This is an interesting investment to look into. Besides crunching the numbers though, has there been a quality check on the facilities themselves? While some do not care, a fair portion of children looking into these homes for their parents want to make sure they are going to be living in a quality establishment.

Michael Foster   http://comforcare.com/ohio/dayton

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