|Shares Out. (in M):||6||P/E||0||0|
|Market Cap (in $M):||67||P/FCF||0||0|
|Net Debt (in $M):||56||EBIT||0||0|
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Diversicare Healthcare Services (DVCR) is an underfollowed story with a blend of growth and value in the nursing home industry.
o Guidance to “double the company within 5 years of Q3 2013” and “focus now on portfolio growth”
o ~50% revenue growth since 2012
o 10% portfolio growth in 2014
o 7 back to back quarters of positive and growing EBITDA
· Value* (current value of the business without considering growth potential)
o Value of owned assets: $16 per share
o Value of leased assets: $6.5 per share
o Net Debt: $9 per share
o Net Value: $14 per share (currently trading at around $10-$11)
· New management with proven turnaround strategy
o Industry leading CMS quality measures (QM) score where 64% of facilities are 4 or 5 stars compared to 13% in 2008
o Deployment of state of the art technology across all facilities as a risk management tool and easy onboarding for acquisitions
·No analyst coverage (no questions on the 2Q 2015 conference call) and will present at Sidoti Emerging Growth Conference on September 2, 2015
· Tremendous operating leverage backed by hard asset value, base case scenario:
· 0.3x EV/Sales and 9x EV/EBITDA, currently at $2/share in EBITDA and predicted to grow ~$1/share in EBITDA every year, which will appreciate the stock by $9 every year, a 50% IRR
*Assumptions and analysis are in the Leased and Owned Asset Valuation Section below
DVCR owns and manages, under long term leases, skilled nursing facilities to provide post-acute care in 9 states in the United States. DVCR was previously known as Advocat until they decided to change their name and brand to Diversicare in 2013. They own approximately 1,200 skilled nursing beds and lease an additional 4,500 in approximately 54 facilities in TX, KS, MO, TN, KY, AL, FL, IN, OH. In late 2011, when Kelly J. Gill took over as CEO from COO (joined DVCR as COO in 2010), after former CEO Will Council’s resignation, DVCR went through portfolio restructuring phase divesting of assets in high risk states, Arkansas and West Virginia, associated with high litigation costs. New leadership came on board following Kelly Gill, with James McKnight as CFO joining in late 2012 and Leslie Campbell joining as COO in 2013. Before coming to DVCR, Kelly Gill was previously the executive Vice President at Skilled Healthcare Group (recently acquired by Genesis Healthcare) and has over 25+ years of experience in the long term care industry.
DVCR is now a growth story after completing its period of transition from 2011-2013: replacing the whole management team with better operators, divesting of high-risk assets in litigious states (WV & AR), renovating into high-quality assets, and implementing scalable technology (EMR) that will enable DVCR to quickly “acquire assets accretive within a quarter”. During the transition, DVCR has accumulated 15M in net operating losses cumulative of the last three years as of 12/31/14 and determined that it was more likely than not that future taxable income would be sufficient to realize all of the DTA for income tax purposes. (“our history of not having carryforwards or credits expire unutilized.”) Subsequently, in the year 2014, DVCR assumed operations at 8 facilities and increased bed count by 939 beds, bringing the total to 52 facilities and 5800 beds. DVCR redeemed all of its outstanding shares of Series C Preferred Stock ($4.9M) from Omega Health investors saving 350K on interest payments annually, and became profitable in 2014 after two years of losses. As a result, management received 100% of their potential bonuses for achieving revenue and earnings targets defined in their annual incentive plans. Kelly Gill has been able to achieve 100% of his targets since he started in 2010 with the exception of 2012 and 2013 and we believe this team will continue to execute. For 2015, 33% of their bonus will be based on achieving target revenue run rate of $500M, 33% will be based on achievement of targeted EBITDA growth, 33% will be based on discretionary compensation of overall performance, and there is a one-time bonus upon the achievement of $20M in EBITDA. The incentives are well-aligned to shareholder’s interest and there have been no activity reported for any open-market sale of the stock. (Transactions exclude grants, awards, exercise of options.) Two directors have been making open market purchases of the stock since 2013:
Furthermore, two competitors own 14% of DVCR shares: Individual Lawrence Pack (aka Central Funding) who manages Stonerise Healthcare personally bought 6.5% of DVCR filed in December 2014. Additionally, competitor Covington owns 8.6% of DVCR and made two attempts to take over the company several years ago when the company was troubled.
Since Kelly Gill came onboard as CEO in 2011...
· Divestiture of WV and AR: DVCR has completed the exit of highly litigious states, West Virginia on July 2014 and Arkansas in late 2013, divesting of its detrimental assets and improving the risk profile of the portfolio.
· Improvement of skilled mix: DVCR is maintaining its occupancy around 80% and DVCR has improved its total skilled mix census (Medicare and Managed Care) to 16.1% on 6/30/15 from 13.6% on 9/30/10. The Medicare average rate per day has increased to $458 on 6/30/15 from $394 on 9/30/10. These improvements in these rates reflect the increase in the higher acuity patients and the focus on increasing the acuity profile of overall patients
· Improvement of Quality: “Our most recent QM composite score is 3.87 compared to our industry peer group of 3.39. Likewise, under this ranking system, 64% of our facilities are either 4 or 5 stars in Quality Measures compared to our peer group of 51%” – Kelly J. Gill [August 2015 Earnings Call]
oWhat do these scores mean?
§ DVCR is an industry leader in CMS’ quality measures which reflects lower health care costs while meeting performance standards on quality of care.
§ Pay for performance - “Instead of only paying for the number of services a hospital provides, Medicare is also paying hospitals for providing high quality services.” – CMS
§ Higher score = higher reimbursement, higher quality, lower cost
§ Low cost + high value = pricing power. This should boost occupancy, making use of the operating leverage apparent in the business model, higher margins on incremental revenues.
· Implementation of Electronic Medical Records (EMR) and scalable operating platform: For the past 3 years, EMR has been implemented in all nursing centers for regulatory compliance and to better capture documentation of patient care to aid in the improvement of patient care and as a risk management tool. These features helps DVCR control professional liability loss rates as well as increase patient acuity, improving DVCR’s accountability and quality of service. DVCR has also implemented a scalable operating platform that runs through a central IT platform which allows for seamless and quick integration (at a rate of 5-6 centers every 2 months for a one-time expense of ~112K.) We believe this technology is a game-changer for the nursing care industry as its processes and compliance with CMS becomes more and more complicated (higher barriers to entry) and is especially helpful for acquisitions.
o “We have such uniformity in how we support each and every facility from a technology standpoint and from a process standpoint that what that has now allowed us to achieve is just incredible ability for facility integration. We literally -- once we have installed our systems, we can literally bring the facility on board within a day and a week within large macro system integration. And then what that does is allow us to focus immediately on supporting our staff to deliver the best possible care and certainly and most importantly, to focus directly on patient care as opposed to protracted implementation process.” –Kelly J. Gill [March 2015 Earnings Call]
· Mix in Accretive Acquisition Pipeline: DVCR has grown their portfolio by more than 60% since 2010 and DVCR has improved to a 26/74 own/lease ratio** from a mix of 20/80 in 2010, leading to a lower lease expense as a % of revenue. This ratio will continue to be lumpy with recent/future acquisitions, but management seeks to maintain around a 25/75 own/lease ratio. Furthermore, acquisitions are accretive to earnings within a quarter of the acquisition date.
o One example of the type of acquisitions they are making... recently, on 2/1/15, DVCR assumed operations at a 85-bed SNF in Hutchinson, Kansas, for an initial lease term of 10 years with an option to purchase at a fixed price of $4.25M, exercisable after the first year of the lease.
§Not only do they have the flexibility to exercise that option and convert to owned beds but also they will be able to pick up the facility at 50,000 per bed*.
*According to Levin & Associates, the skilled nursing market hit a record for the average price per bed for the second year in a row last year, in 2014. In 2014, there were 19 transactions with a price above $100K per bed. Average price per bed in 2014 was $76.5K.
**Own/Lease ratio is based on facilities, not beds
Owned Asset Valuation:
DVCR owns 1,314 SNF beds and 26 AL/IL beds and leases 4,690 SNF beds and 470 AL/IL beds. The average price per SNF bed in 2014 was $76,500** and the average price per AL/IL bed was $208,200**. We value the owned beds in their portfolio at ~105M, or $17/share. We see the value of owned beds less net debt as the downside, which is ~$8/share.
Leased Asset Valuation:
We value the leased assets based on an analysis of the annual EBITDA each leased bed generates. Since DVCR has 26/74 own to lease ratio, we imagine what DVCR would look like with a 100% leased portfolio in order to predict the annual EBITDA a leased bed would generate. We keep revenues and EBITDAR constant and run rate lease expense per bed under a 100% leased scenario. The annual EBITDA per leased bed would be $983. The average cap rate for SNF in 2014 was 12.4%**, ~8x EBITDA. Hence, we value a leased bed using an 8x multiple of EBITDA to get to $8K/leased bed, or 1/10th of an owned bed. Altogether, we think that DVCR’s portfolio is undervalued and should be trading at $14.
**Data obtained through the 2015 Senior Care Acquisition Report by Levin & Associates
Rinse and Repeat Model with Operating Leverage
Being an owner/manager of nursing homes is becoming more and more complicated. Nursing homes have to comply with a number of regulations while tracking all their data to reports to CMS. The industry has been consolidating and with low interest rates, there has been a buying frenzy of nursing facilities, especially last year.
We believe DVCR is well positioned in the M&A space with a rinse and repeat rollup strategy and very efficient execution by management. DVCR has a management team with a clear vision that has executed on its initiatives combined with the best-in-class technology that allows for easy onboarding of acquisitions and management for compliance and quality ratings. They made 8 acquisitions last year and all facilities were up and running within a week and accretive within a quarter. DVCR focus on accretive portfolio growth combined with operating leverage should lead to doubling of current EBITDA margins on incremental revenues.
Why we believe revenues and EBITDA margins will expand:
o DVCR’s goal is to “double the Company within 5 years of Q3 2013” and “focus now on portfolio growth”, with a target of acquiring 5-10 new facilities a year. Currently, they have 6,500 beds and are in 54 facilities, which averages to 120 beds per facility. By 2018, we predict they will reach 80 facilities or 9,500 beds with $600M in revenue and 5-8% in EBITDA margins which is 30-48M in EBITDA.
o Operating Leverage: An increase in occupancy leverages DVCR’s existing infrastructure of high fixed costs (wages, litigation, administration/regional supervision, building maintenance and leases, data reporting) to provide high margins on incremental revenues. The same idea with acquisitions. The increase in occupancy of one bed will add, on average, 83K to the top line. A 1% increase in occupancy (60 beds or ~1 bed per facility) will add ~5M to the top line.
o Revenue grew 30% from 2013 to 2014 and the management has a strong focus to grow through accretive acquisition as they did in 2014 and we believe they will continue this trend.
o Regional concentrations of operations to achieve operating efficiencies and capitalize on marketing opportunities: It is DVCR’s sixth consecutive quarter keeping G&A in the mid 6% range and we believe the EBITDA margin will continue to increase due to stabilization of G&A.
o We predict professional litigation expense should be more stable after exiting AR and WV due to a reduced risk profile.
o Investment in…
o Nursing and clinical care so they can enhance coverage to admit patients with more medically complex conditions, thereby attracting higher acuity patients and improving skilled mix and reimbursement.
o Nursing center-based sales representatives to develop referral and Managed Care relationships to attract higher quality payor source.
o Renovating facilities to improve quality of care and profitability.
o Investigation of opportunities to acquire, lease or develop new facilities.
o Improving payor mix, increasing level of higher acuity care, obtaining reimbursements, pursuing acquisitions, and proving high quality care are already a testament to management’s successful execution. Rinse and repeat.
As DVCR grows and gains market attention, we believe there will be a double barreled effect in the increase in EBITDA and expansion of its EBITDA multiple to 12x, the median of where its peers trade at. Even if DVCR does not receive a higher multiple, if DVCR continues to achieve their strategic operating initiatives as they recently have and double the size of the company, DVCR will be growing EBITDA for about a $1 per share a year. Holding the 9x multiple it has today, the stock should appreciate $9 a year, a ~50%+ IRR.
· Professional Litigation Expenses - The company is engaged in 51 professional liability lawsuits, majority of the professional liability expense coming from Arkansas, but the company understands the litigious nature of the industry and has set a reserve for self-insurance that is estimated by a third party actuarial firm, Merlinos.
· Medicare/Medicaid Reimbursement Rates
· Stock Illiquidity
· Wrongful deaths
· Debt interest load
Disclosure: This does not constitute a recommendation to buy or sell shares of DVCR. We own shares in DVCR and we may buy or sell shares without updating this board.
Significant operating leverage
Solid operating results
Significant asset value in owned beds
Management incentives aligned with shareholder value drivers
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