Assisted Living Concepts is a recent spin-off that has fallen short of its promises to investors and been punished by the market. The company trades at a reasonable multiple of trailing earnings and has a clean balance sheet, good earnings growth prospects and some downside protection in real estate value. The company is also shrinking its share base through opportunistic share repurchases.
ALC is the Milwaukee based spin-off of assisted living centers previously owned by Extendicare, a Canadian company whose remaining business has converted to a REIT. The majority of ALC’s facilities were purchased from Old ALC (a Nevada company with the same name) in January 2005. New ALC operates 208 residences with 8,535 units in 17 states.
Brief Company Description:
Assisted living is designed for seniors who seek supportive care and services in addition to housing. The average ALC resident needs help with 2.5 ADL (activities of daily living) a day. In this way, assisted living facilities are sort of midway between nursing homes and retirement communities. ALC management likes to say that there are two models for assisted living, “social” and “wellness/medical”. The company focuses on the wellness model, which means to me that their facilities are closer to nursing homes than they are to senior apartments.
ALC focuses on small suburban communities with populations between 10,000 and 40,000. Individuals in these targeted communities have a net worth between $100,000 and $500,000. The company thinks this smaller market approach shields it from some of the competitive pressures in the industry and gives it access to more stable and cheaper labor. It is also worth noting that many of ALC’s regions have been less affected by housing market declines than the country as a whole, though as we discuss below, we do not think housing market issues will weigh heavily on the company’s earnings.
The old ALC facilities were constructed with a cookie-cutter design mostly between 1995 and 2000. They are geographically diverse, intentionally focusing on the country’s least litigious states. In 9 of the 17 states in which ALC operates, the company has Medicaid funded residents. Thus, company-wide Medicaid numbers (14% of revenues) are not really representative of a typical ALC facility. In states like Washington and Oregon that percentage will be much higher. In other states, such as Wisconsin and Michigan, that percentage will be 0. ALC’s goal is to be private-pay only, which will significantly increase its average daily rates.
How did the company let down investors?
ALC was a great story coming out of the spin-off. The transaction was taxable, thus there was a large incentive for EHSI (who’s largest shareholder, the Jodrey family, also populated ALC’s board) to keep the stock price low. Additionally, the old ALC had not been run with a profit-maximizing mandate – the original founder focused on lower-income residents - so earnings were depressed by a large percentage of lower-profit Medicaid residents. Because Medicaid residents pay only 2/3 as much as private-pay residents, and because they tend to be higher cost residents from a maintenance standpoint, there was (and still is) a tremendous amount of upside to ALC’s earnings power as they transition to private-pay only. The average stay in an ALC facility is between 18 and 24 months, so the transition to private pay was expected to be smooth as Medicaid move-outs were to be gradually replaced by private-pay move-ins. At the time of the spin-off, EBIT had been rapidly improving as management was having success reducing its Medicaid census, and yet ALC was still only 70% private pay (by unit). There was a lot of low-hanging fruit for ALC and the market expected results fast. By the end of Q4 2006, overall occupancy was rising, EBIT was up sharply, private pay census was quickly growing and there seemed to be much room to go and thus more sharp EBIT growth expected.
I believe there are three significant reasons the hedge-fund populated shareholder base abandoned ALC in 2007.
1) Mass Medicaid evictions lead to occupancy and EBIT declines
On the Q4 2006 conference call, CEO Laurie Bebo repeated previous assertions that they expected overall occupancy to continue to “go north” and “achieve industry averages” in the 90%-95% range, despite increased Medicaid evictions. Heading into Q1 2007, ALC had been increasing its private-pay average daily census about 1.6% a quarter while decreasing its Medicaid census by about 1% a quarter. This steady rate of occupancy improvement ended in Q1 when ALC decided to exit Medicaid contracts in Texas at an accelerated pace.
During the first quarter of 2007, Texas changed its Medicaid program to a managed care model, which the company expected to result in lower Medicaid rates in several of its Texas markets. Texas gave the company the option to continue contracting through third-party managed care companies, but ALC declined. As a result, ALC was unexpectedly forced to terminate contracts and thus evict large numbers of Medicaid residents. The company took a hit to occupancy and earnings that took the market by surprise. EBIT fell 8% sequentially and occupancy fell from 84% to 81%. This was ALC’s first major let-down; it would not be its last.
Over the first two quarters of 2007, average daily census of Medicaid residents fell 27% while private-pay average daily census grew only 1.8% on a same-store basis. The company’s stock price had fallen from $10 at January 1 to $8.50 during the mid-August market sell-off. The company repurchased 260k shares (at an average price of $10.70) over the second quarter and guided for private-pay census growth of around 70-100 units in the third quarter.
ALC’s third quarter proved to be the last straw for many investors as the company reported that private-pay occupancy, rather than growing by 70-100 units, was flat. Management reported record private-pay move-ins, but these were countered by record move-outs, most of which were residents who expected at some point to have to roll over to Medicaid coverage, and were making a proactive move to a home that could accommodate Medicaid residents. This dynamic was not anticipated by management at all, and Bebo noted on the conference call that they were seeing this trend continuing into the fourth quarter. While earnings had leveled off (and even improved some from the second quarter), occupancy had fallen to 78% from 86.4% at the end of Q4 2006.
2) Housing market implodes and leads to fear it will affect move-ins
While Assisted Living Concepts was failing to live up to its occupancy guidance because of its rapidly declining Medicaid census, the entire senior living space traded down sharply with the housing market. We believe fears that declining home prices will force potential customers to forego or delay moving into ALC’s homes are overblown. Our industry research has confirmed our view that the housing market has yet to affect move-ins, and that for most residents this is really a need-based decision, made quickly over a 2-3 week period. Often the children are left with the task of selling the house, or the house is not sold because the move to a home is viewed as temporary. ALC’s own home operators continue to report that they aren’t seeing any effects from the housing market and daily rates have continued to rise as 2007 has progressed.
Additionally, ALC’s sites are located in smaller communities that have been less affected by the housing bubble. As we will discuss below, 76% of the company’s sites are located in towns with fewer than 40,000 in population.
3) Management credibility called into question and capital allocation worries
ALC has continued to make acquisitions and has embarked on an ambitious plan to expand capacity at some of its 100% occupied sites. This has frustrated investors who view stock buy-backs as the best use of funds, since the company could be buying back its own shares at a mere $64k a unit. CEO Laurie Bebo faced many questions about capital allocation on the most recent conference call, and she defended the expansion plan and acquisitions as high return investments.
This management team, headed by a 36 year-old CEO, is young and can come across as a little strong-headed on conference calls and in conversation. They have bought shares each time the stock has tanked, and they continue to buy at today’s levels. Undoubtedly they have a firm conviction that the stock is grossly undervalued at today’s prices, but sometimes they leave us with the impression they are trying to please everyone too quickly. Most importantly they misjudged some of the second-order effects of hastily exiting Medicaid contracts. It would be interesting to have a full picture of the economics of continuing those contracts, because we wonder if management ended up making a poor decision. In the end, this decision was not disastrous because 1) they can always backtrack and take Medicaid residents again and 2) profitability has held up well and actually grew sequentially in the last quarter.
What is the market missing?
After the third quarter report, ALC’s stock price fell under $7.00. With a management team that has failed to live up to expectations twice in a row and is now hesitant to give any guidance whatsoever, there is a general perception that an investment in ALC is “dead money for a while.” The fast money is currently bailing out of this stock, and I think this is a great opportunity to buy a decent company at fire-sale prices.
Despite 2007’s decline in occupancy and EBIT growth, I think the long-term earnings power of ALC is unchanged. At the beginning of the year, the stock was attractive because it traded at a low multiple of a reasonable estimate of earnings once occupancy improved to industry levels. As we will discuss below, that multiple is now much smaller and the margin of safety is much much larger. Investors, including ourselves, were expecting this EBIT ramp-up to happen immediately and thus the stock was punished by short-term oriented investors who wanted to ride another spin-off to a quick home-run.
The company’s long-term goal is to replace its Medicaid residents with higher revenue and higher margin private-pay residents. It has additional growth opportunities at its 100% private-pay occupied company-owned sites that feature enough excess land to support expansions. The decisions that led to 40% of ALC’s Medicaid patients moving out this year were consistent with the company’s long term plans and have paved the way for future earnings growth.
Our due diligence in this name has led us to believe that private-pay move-ins will continue to grow and that the company’s sites in Texas are recovering nicely after the Medicaid evictions. We believe private-pay move outs from residents who like the option of going to Medicaid, while a surprise to investors and management, will ebb as new residents move in with the knowledge that Medicaid will not be accepted.
We also maintain our confidence in CEO Laurie Bebo and the rest of ALC management. The expansions of 100% occupied sites are a good use of funds and should exhibit good returns. The company continues to buy back shares at great prices, which should meaningfully reduce share count. We continue to like management’s fiscal discipline; for example, whenever they do site visits, they stay and eat at company homes rather than staying in more expensive hotels or eating out on the company dime. I think they were overzealous and tried too hard to please Wall Street by giving guidance on occupancy, but we are confident they will learn from this mistake and move on. While ALC may have let down shareholders who wanted a quick return on their investment, the long term prospects of the business remain solid.
Management’s options are struck at $11.80 and do not vest unless certain performance targets are met. The board members are very focused on creating value for shareholders and have said they have no qualms about replacing management if they do not live up to the board’s expectations.
Valuation: Downside Protections and Upside Confections
At $6.75, the company’s TEV is about $545mm. This is about 16x LTM EBIT and around 12.5x LTM EBITDA minus maintenance capex of about $8mm (conservative 100k per unit). A simple way to think about earnings power is to assume occupancy remains the same but the Medicaid census (currently 19%, down from 30% in 2006) is replaced by private-pay residents. Each private-pay resident earns $30 more per day, so we would see a $13.4mm increase in revenues (1.2k residents x $30 bucks per day) without having to assume any increase in costs and capital requirements. This would bring our EBITDA minus capex multiple to around 9.5x. From that point, there is considerably more upside, as occupancy is only 78%. If occupancy rose to 90%, revenues would rise another $45mm or so. Assuming operating margins are a conservative 60%, this would add another $27mm to our EBITDA minus capex figure and bring our multiple to around 6.5x. These figures do not factor in organic earnings growth through price raises, which have been healthy at over 6% year to date. ALC’s earnings will also see upside when the company expands capacity at some of its company-owned fully occupied sites.
The company also owns 151 properties, 122 of which were owned by the Old ALC. Replacement cost for these sites is considerably higher than the $64k units the company currently trades at.
This is a high-fixed cost business in what many people perceive as a real growth-industry. This being the case, there is always the risk that competition will be irrational with its capital allocation. If one big player decides to invest in building many ultra-fancy facilities, it’s going to hurt everyone. Capex wars have felled many industries (theme parks, movie theaters) which otherwise should have decent economics.
ALC protects itself from these risks by being located in smaller suburban communities. 76% of sites are in towns with fewer than 40,000 in population. 34% of the sites are in sites with declining populations, with 30% of the overall sites in towns with declining populations under 40,000. 22% of the sites are in towns with declining populations under 20,000. The company also benefits from owning its properties; this gives management much more flexibility in exiting unprofitable sites.
So far the macro picture continues to be good for senior living providers, as the population continues to age and industry participants are not adding much capacity right now. Time will tell, but the credit crunch might also prevent overbuilding in coming years. ALC continues to be protected from such pressures because of its owned real-estate and its locations. While some ALC sites face local competition, many of the sites are the only game in town.
At today’s prices, ALC is a low-risk investment, protected by the replacement value of its assets, which trades at a very low multiple of earnings power. The company’s lumpy performance has let down investors, but ALC is moving in the right direction by accelerating the eviction of Medicaid residents. While sharp declines in Medicaid census this year have curbed earnings growth, this has paved the way for future gains as vacancies are filled with higher margin and higher revenue residents. In today’s market, the hedge fund herd can give up on a company quickly when they lose faith in the business and management. We think management is continuing to operate the business well and that recent weakness in the stock presents a great opportunity to buy into ALC at bargain prices.
- 54% of voting power held by Jodrey family. Board members have expressed willingness to replace management if they see fit, but it would be hard to shake things up if you wanted to.
- Young management. Much of the long thesis depends on management executing the plan to increase occupancy with private-pay residents
- Severe recession might pressure pricing and make it harder to find private-pay residents
- This is a relatively unregulated industry which might receive more government oversight in the future. This might not necessarily be a bad thing, as government regulation can often benefit the regulated industry.
|Subject||re: quality of homes|
|Entry||11/16/2007 10:12 AM|
|1) Do you have any opinion about the attractiveness of ALC's homes vs. peers at their |
Not in every market. We had been focusing on Texas because we viewed that as the sorta epicenter of the Medicaid capacity decline (it turns out, Washington, Oregon and Arizona are being more troublesome). In Texas, the interesting dynamic was that many competing private-pay homes were close to full or already had waiting lists. There are a handful of sites in areas with tons of competition (where the home was literally situated in a neighborhood of assisted living, nursing and retirement homes), and in some of those locations the homes had promotions and competed on price (and from what we can tell, their pricing was similar to comparable competitive sites). But in most of the locations, this was not the case. There were many cases where competing sites did not even know about the existence of a nearby ALC facility and vice versa.
How does mgmt plan to increase utilization to 90% with
private pay customers? How long would it take to get from 78% utilization to 90%
Yeah, this is the big question for ALC. I tried to address it in my last post but i'll elaborate. . . The company recently installed a larger sales-force in Texas to try to drive occupancy there, and it is working very well so they will no doubt look to other regions to beef up sales staff. Texas sites were expecting to fill up soon, so if we saw that rate of private-pay growth company-wide, we’ll start seeing sharp increases in occupancy in the near term.
Still, bottom-line, private-pay census growth over the 6 quarters before Q3 2007 was only about 66 per quarter. This includes 2006, when the company had a smaller sales force and was still a part of Extendicare, but that is only 265 residents per year, which is a depressingly slow rate. Company-wide, we think recent private-pay growth, backing out medicaid-related private-pay moveouts, is closer to 100 a quarter and growing – but this is still only 400 a year. We think this rate ramps up in 2008, but I don’t have anything better than rough guesses at how quickly they can get to 90%. Because of this uncertainty, capital allocation decisions are much much more important. If the company uses its free cash flow each year to buy back shares while it ramps up occupancy at a slower pace than we anticipate, this will still work out very well. If it makes a lot of dumb acquisitions, our return will be much lower.
|Entry||11/16/2007 12:29 PM|
|Thanks for posting!! It's worth a lot to hear such insights from people who have looked at sites, etc.|
I think your friend was correct about structural reasons it would have a hard time matching industry occupancy levels and margins quickly, and obviously he was wise to not invest in the stock. But I have to say, I sort of disagree with him about high rates/subpar offering to the extent that he believes ALC's rates are above-market. Their sites are a little depressing and cramped, but in the competitive markets we’ve studied they don’t differ much from the competition. Maybe we looked at different regions though. I do think that all these facilities are pretty bleak and depressing and not cheap. But I don’t think ALC overcharges or offers poorer services than similarly priced peers at this point. It's interesting to hear from opposing views though. . .
|Subject||private pay numbers in July|
|Entry||08/07/2008 12:21 PM|
were you on the call this morning and do you think that the fact that July private pay numbers are up marks a turning point here or is it still too early to call?
|Subject||RE: private pay numbers in Jul|
|Entry||08/07/2008 01:23 PM|
glad to hear someone cares. . .i hope july marks a turning point but i am not sure. management has implied before that pirvate pay was turning a corner (like jan 08), but this is the first time they've reported an actual up month. still, these guys have let us down before.
nevertheless, this stock is a screaming buy. they have about 1000 move ins per quarter, so a slight reduction in these move-outs (many of which are still results of the medicaid extraction) could see a sharp uptick in private pay. at some point it will happen.
the macro-headwinds are tough for them, but they have an even stronger demographic tailwind. . . i continue to believe they have great, small homes and they will be full in the near future. i've visited a lot of them in the last year.
i'm happy to field any questions. the ALC story hasn't really changed, so i wont update this writeup for now.
|Subject||RE: A few questions|
|Entry||08/28/2008 01:25 PM|
|Hi Skimmer! Thanks for asking some questions. I still think this will work out very very well from current levels. Regarding your questions:|
1)One aspect of the typical bear case argument against ALC is the idea that there is a structural impediment preventing them from getting to industry occupancy levels. I definitely believe this is not the case and I think ALC will eventually get to 90% occupancy. We have to remember that most of these ALC homes are very small, with about 40 units. So while getting from 68% to 90% occupancy sounds like a monumental feat that must depend on a huge demand surge in weak markets, what we’re really talking about is adding a handful of residents to each home.
I also think it’s important to reiterate the point that getting out of medicaid is a huge change for homes in medicaid states. This was bound to be a hard transition and I think the company is finally getting over this in some of its regions. Just 3 years ago, in an average 40 resident home in Texas you had 13 medicaid residents. That number was over 20 for such homes in Idaho and Arizona and a whopping 31 in Washington. I think this data point also helps us understand how the company has been able to reduce expenses so successfully. Aside from just reducing staffing with occupancy, they were able to reduce staff hours because private-pay residents are much cheaper than medicaid residents.
I’m not exactly sure how long it will take to fill these homes and obviously this is a crux issue as we discussed previously in the thread. In recent quarters, ALC has been averaging over 1k move-ins per quarter. Just a small decline in move-outs due to the medicaid rollover situation and the economy, and we could see meaningful spikes in occupancy. I’m hoping private pay occupancy starts turning this quarter and really ramps up to near 90% next year. A tailwind from the economy might help that happen faster.
While I don't think rationalization is necessary, I wouldn't mind seeing ALC sell a few homes in some place like Washington to medicaid operators. . . just to show the market that this is always an option for them.
2) We do a fair bit of regular due diligence work and have happened upon a few of the sites that are expanding. Consistent with management’s statements, those sites continue to be full and on-site staff thinks it will not be hard to fill the new units. Still, we have not talked to *every* site that is expanding, so to a certain extent, we’re still taking management’s word on this one. All in all, I'm not so thrilled about the expansions.
3) We’ve been following the facilities in Texas very closely and we do a pretty big due diligence project for the rest of them every few months. We’re still hearing that things are going very well for the company. . and certainly we didn’t see performance fall off a cliff in June like a saw in many other companies I’ve been researching. It’s interesting to see how volatile occupancy can be at the site level. . . you’ll have homes that are generally pretty full that have dips in occupancy due to a couple deaths or moveouts and then you’ll have sites that ramp up occupancy very quickly with little warning. But my bottom line answer to your question is: No, by looking at our research I cannot confirm that July was indeed a turning point. We've been seeing that things had been going well in May and June and continue to go well. . . but we can't definitively say that we're at some massive turning point.
4) I think this one is hard to nail down. It’s not like every site is exactly 68% occupied and I know exactly how many people have to be hired with each 5% notch up. I think if we see a company wide 5% improvement in private pay occupancy, we will see benefits all the way to the bottom line. I am not concerned about understaffing. The first people who would complain in such an instance would be the remaining staffers, and we haven’t heard any of that yet.
5) I dunno. . .to me, the acquisition sucked. It’s interesting to talk to the board about this issue. They believe that one thing ALC is very good at is managing operations. So they clearly think they can improve operations and earnings at Caravita. At the same time, they seem to know that buying back shares was a better value . . . yet they think growing the company modestly is a way of rewarding management a little and getting them excited about their jobs. Obviously this argument was a little lost on me. The fundamental issue to me is that we can really drive returns by just operating the current footprint as best we can. . . The acquisitions environment should only get better, so we can expect to see more little ones like Caravita that ALC can fold into its footprint. But we (and from what I can tell, the board) still understand how to best generate outsized returns here: run the current sites well, use excess cash flows to buy back shares and reap huge rewards when occupancy ramps up.
6) I looked at SRZ and passed last year because it just seemed too priced for growth for me. Everything has come down a lot, so I need to revisit these guys. SRZ has some great assets but obviously some hair on it.
|Subject||RE: follow up|
|Entry||09/02/2008 05:49 PM|
yes, it's a little odd, but you have to remember the regional differences here. the recently transformed homes are mostly in texas, oregon and washington, which haven't seen as bad of a housing bust and as much of an economic slowdown as we've seen in other regions. texas alone counts for 30% of those homes.
i guess the point she was trying to make is that the roll-over related move-outs are ebbing but the reason you aren't seeing that in the numbers is because of the economy related move-outs.