Wednesday, January 8, 2020

Five Star Senior Living: Reorg with Spin Dynamics

*This one ran away from me a little bit today but still likely cheap, wrote most of this last night after @valuewacatalyst (probably my favorite follow) tweeted on the idea and reminded me that the distribution had just happened, but below is the thesis -- interesting situation that's worth keeping an eye on or looking for something similar in the future*

Five Star Senior Living (FVE) is an RMR Group (RMR) controlled operator of primarily independent and assisted living communities for Diversified Healthcare Trust (DHC), which is RMR Group's externally managed senior housing and medical office REIT that was formerly known as Senior Housing Properties Trust (old ticker: SNH).  RMR manages a series of REITs and doesn't have the best reputation with investors, there's an obvious conflict of interest present in most external REITs, we last ran into RMR when they purchased the net-lease retail assets of SMTA for RMR's hotel REIT, Hospitality Properties Trust (HPT), their incentive is growth regardless of price or fit.  Their agreement with FVE is similarly structured, RMR gets a 0.6% cut of revenues without paying attention to profit.  Everyone knows the demographic tailwinds that should support the senior housing sector, the population of those 75 or older is growing at 2-3x the rate of the overall population in the United States.  Developers got excited, overbuilt in recent years into this well telegraphed demographic trend and senior housing operators have struggled due to the oversupply of rooms.  However the trend might be improving, construction is a little more rationale now and each year we move forward the demographic wave of seniors gets closer to being realized.

Five Star has been on the brink of collapse a few times (it was originally a spin of DHC 15+ years ago), they've been hampered with a poor business model of both high operating leverage (labor is expensive and often semi-fixed regardless of occupancy levels, insurance premiums, private vs public pay, etc) and high financial leverage via leasing their properties on a triple net basis from big brother Diversified Healthcare Trust.  They couldn't survive the oversupplied market and their troubles have bled into DHC's share price as well.  Through a restructuring with their largest creditor DHC, which is akin to a pre-packaged bankruptcy reorganization, Five Star will now be primarily an asset-lite operator of senior housing and the capital requirements will be DHC's responsibility.  The new structure is very similar to what is used in the hotel REIT industry where the REIT owns the property but in order to qualify as a REIT, the REIT needs to hire a third party management company, that's going to be Five Star going forward, switching from being DHC's tenant to their hired hand.  The primary difference, in the hotel industry the best revenue stream is the brand/franchise royalty, the Five Star brand isn't Marriott, so its just the less attractive but still a decent enough business of managing the property component in this situation.  In return, DHC received about 85% of FVE equity and distributed about 51% of the proforma shares outstanding to DHC's shareholders via a taxable special dividend, keeping the rest on DHC's balance sheet.

Five Star's new management agreement is for 5% of gross revenues plus the opportunity to earn another 1.5% of revenues in incentive payments if certain property level EBITDA targets are met.  FVE management is guiding to $20-30MM in EBITDA this year, even putting a 4-5x multiple on that and the stock could be a double from here.  The company has essentially no significant conventional debt following the restructuring, they will have a few remaining owned properties that carry mortgages but its pretty minor, a few non-DHC leases and a self insurance liability that is backed by their marketable securities portfolio.  Following the share issuance and sale of fixed assets to DHC, Five Star has approximately $100MM in proforma cash (this will likely not be all cash but a receivable from DHC for working capital liabilities, but eventually will be cash **EDIT: apparently this is wrong, being told that cash will be ~$35-40MM**), not far off from the proforma market cap of $112MM (31.1 million shares using a $3.60 share price).  Even at a 4x multiple of $25MM in the mid-point EBITDA range, the business is worth $100MM plus the $100MM in cash, FVE could be a $6+ stock without a demanding valuation.

Why does this exist?  DHC's shareholders are primarily retail investors who are hungry for yield or REIT index funds, few fundamental institutions would continually want to suffer the abuse of owning an RMR externally managed REIT.  The distribution of FVE shares was especially small, on 1/2/20 for each share of DHC, DHC shareholders received 0.07 shares of FVE, meaning it's likely an automatic sell due to its insignificant size and its 0% dividend yield (or if it's a REIT index fund holder, it would no longer be in the index).  Five Star has plenty of red flags, but the combination of a reorg to a better business model and the spin like dynamics of placing the new shares in disinterested holders makes it an interesting near-to-medium term opportunity.

Disclosure: I own shares of FVE


  1. MDC thank you for the very interesting post.
    I have a few questions:
    1) If the company is that profitable, why did they spin it with so much cash?
    2) Are there any comps that you can point to for valuation comparison?

    Thanks you again!

    1. The cash is essentially from the sale of the leasehold improvements at the properties, in order to restructure and change the business model DHC had to buy those from FVE. Since these were previously triple-net leases, FVE had the responsibility for upkeeping the properties and any capex, but now that shifts to DHC. It's not a spin in the traditional sense where these days spins are usually loaded with debt to pay a dividend to the parent, it's more a "spin like" situation where the shares were distributed to the parent's shareholders but it was really a reorg and DHC shareholders are the creditors receiving their recovery. BKD and CSU are the other two primarily operators of senior housing versus owners, but this situation is so unique and the presence of RMR in there, didn't think a straight comp made sense but those would be the ones to look at as well.

    2. Sorry - the purchase of the fixed assets already happened, the cash is "cash" in that DHC will be assuming FVE's negative working capital.

    3. If the negative working capital position doesn't revert, then the proforma cash is really $35-40MM. At $4 share price, that's somewhere around 3-4x the projected EBITDA, cheap but maybe not that screaming bargain it appeared initially? Strange situation.

  2. Also - would you expect RMR to sell in the market the shares they haven't distributed? If so, it would be negative for the share price...

    1. There could be an overhang for a bit, but unlike DHC shareholders, RMR via DHC is more likely to have a sense of the value and not be an indiscriminate seller.

  3. Who do you comp the business against?

    1. BKD and CSU are two operators, different business mixes, but I kind of intentionally didn't comp them to anyone because of the external management situation and other hairy aspects.

  4. Can you link us to @valuewithacatalyst? Can't find it on Twitter...

    1. Oh sorry, its @valuewacatalyst. I can't link Twitter unfortunately, blocked on my work desktop, one reason I'm not active on Twitter.

    2. Nevermind, now showing up. If there are other Twitter accounts you like please share! Thanks.

    3. Actual handle is @ValuewaCatalyst

  5. Thanks very much for this idea. I bought a small position, hoping the price would back down. But it's rocketed ahead today and I can't resist taking profits.

  6. Thanks for sharing this idea.

    I would like to point out another couple items of potential incremental value.

    1) FVE shows net PPE of 165MM. Accumulated depreciation amounts to 103MM. Gross PPE is therefore ~268MM.

    Given the restructuring, it would be logical to assume that FVE is strategically moving away from leasing/owning units and toward only managing units. A sale of the owned units (2,108 units, or 7% of the portfolio per management's November 2019 presentation) could potentially result in gross proceeds of up to 268MM (with the units being sold at cost and assuming all of the PPE relates to the owned units and not to, for example, corporate offices). The balance sheet shows a "mortgage note payable" of 7MM, resulting in net proceeds of 261MM (268MM - 7MM). With 31.1 million shares, the 261MM results in an incremental value per share of $8.39.

    Regardless of whether management does or does not take such action, the economic reality is that the owned units (relatively safer realty assets) should not be valued at the comparatively low EBITDA multiple which is being applied to the unit-management business (i.e., 4X-5X EBITDA in your write-up). Ultimately, the owned units represent a source of hidden value. If the market fails to recognize this, management can always dispose of the owned units in order to unlock the value.

    2) While I understand that FVE should perhaps carry some sort of discount given RMR's relationship with DHC, I consider that it is worthwhile to make a comparison to other publicly traded companies in order to show that a 4X-5X EBITDA multiple is likely excessively low. Yahoo Finance shows BKD (Brookdale Senior Living Inc.) with an EV/EBITDA multiple of 17X and CSU (Capital Senior Living Corporation) with an EV/EBITDA multiple of 27.73. Just using the lower of these two comparables (17X) and applying a 50% discount results in an EV/EBITDA multiple of 8.5X.

    Furthermore, even such a discount in the EV/EBITDA multiple seems excessive to me. If RMR/DHC were to run into financial difficulties, does this automatically entail that FVE would not continue to operate the properties? Not necessarily. While margins may be impacted, I doubt that RMR/DHC would look for another operator, especially given their ownership interest in FVE. If RMR/DHC were to become financially distressed and dispose of the units that FVE is currently managing, does this automatically entail that FVE would not continue to operate the properties? Again, not necessarily. Any acquirer of the units may decide to continue to work with FVE as the unit operator, especially given FVE's experience in managing the units historically.

    3) Additional value should also result from the disposition of the 1,264 units of free standing skilled nursing that are planned for disposition based on management's November 2019 presentation). The balance sheet shows "assets held for sale" of $13.4MM and "liabilities held for sale" of $16MM. As such, just giving away these assets for free would result in a boost to book value of ~$2.6MM. Any cash proceeds resulting from the sale would further increase book value.

    1. Great comment - I agree my 4-5x multiple is excessive, but just sort of showing how disconnected the price appears to be and given all the moving parts, builds in a discount for being wrong (for example, regarding the cash vs negative working capital). To the DHC running into financial difficulty and selling assets point, reading through DHC's plans, they intend to sell some senior housing assets, presumably currently managed by FVE, so we'll see if they keep those contracts and if that's incorporated into management's guidance (they say it is). Thanks again, really appreciate the additional thoughts.

  7. While everyone here acknowledges that RMR companies are hated, there is little discussion for why the discount might or might not make sense.

    This looks scarily similar to another RMR spinoff, Travelcenters of America. It manages truck stocks, but just as FVE, it was the operator of the real estate owned by an RMR REIT, Hospitality Properties Trust. In 2007 spinoff investors pushed the price of TA up to $47 per share, it collapsed 95% by Q2 2008. I pasted a write up from 2007 below that sounded just as logical as this write up on FVE. The similarity that I find most striking is that both companies had a large net cash balance which made them look cheap on EV/EBITDA. However TA used up all its cash very quickly to increase revenues, rent to its REIT affiliate and fees to RMR with no observable benefit to its bottom line. It has never paid a dividend.

    I think the chance that FVE will sell its owned real estate and use the proceeds for dividends or buybacks is close to 0 as that would decrease revenues and thereby reduce fees and value at RMR. I do agree however that there is a price for everything but I think it makes more sense to look at this on a Price-to-EBITDA basis as cash wont be paid out to shareholders. On that basis, it trades at 5.0x to 7.5x EBITDA, maybe still cheap but a little less obvious than before.

    TA write up
    Key sentence: In the LTM period ended 9/30/06, TA generated $4.8 billion of revenues, $179.1 million of EBITDAR and $25.6 million of EBITDA and is currently valued at only $90.7 million on an enterprise value basis.

    1. Certainly similar in some ways. But there is a key difference in that the contract between Travelcenters of America and HPT required TA to make lease payments to HPT. The VIC post states: "The balance of power in the relationship between HPT and TA clearly rests with HPT. The leases are triple net and year 1 annual rent is $153.5 million vs. LTM 9/30/06 EBITDAR of $179.1 million. Clearly, the Company is leveraged aggressively out of the gates. The rent level bumps to $157mm in 2008, $161mm in 2009 and so on."

      On the other hand, FVE will not be having to make lease payments to DHC.

      Given no meaningful debt (only a small mortgage) and no meaningful lease obligations (no lease payments have to be made to DHC as a result of the restructuring and only 1% of portfolio properties will remain leased), FVE's financial leverage profile is starkly different from that of TA. That's a key point. TA underperformed over the long-term partially due to its significant financial leverage. There is no such financial leverage in FVE.

      In terms of operating leverage risk, it also appears this risk is mitigated by the nature of the contract between DHC and FVE.

      The relevant 8-K indicates:
      "Pursuant to the New Management Agreements, we will receive a management fee equal to 5% of the gross revenues realized at the applicable senior living communities plus reimbursement for our direct costs and expenses related to such communities, as well as an annual incentive fee equal to 15% of the amount by which the annual earnings before interest, taxes, depreciation and amortization, or EBITDA, of all communities on a combined basis exceeds the target EBITDA for all communities on a combined basis for such calendar year, provided that in no event shall the incentive fee be greater than 1.5% of the gross revenues realized at all communities on a combined basis for such calendar year."

      FVE will therefore be reimbursed for the direct costs and expenses related to communities it is operating for DHC. On top of that, it will receive an additional 5% of gross revenues as well as potentially an additional 1.5% of gross revenues. Given the fact that DHC is essentially covering the costs associated with operating the communities (including fixed/quasi-fixed costs), it follows that FVE's operating leverage risk is for the most part transferred to DHC.

      Lastly... a key issue that we are all aware of is the relatively bad reputation of RMR. As you indicate in your post, RMR is mainly interested in increasing the revenues of the companies it manages. In a way, and given the nature of the contract between FVE and DHC, this could benefit FVE in some circumstances.

      If RMR decides to increase the units owned by DHC (i.e., through acquisitions/purchases) and expand the agreement between FVE and DHC to include such units, this would represent incremental value for FVE. RMR would benefit as it would see revenues increase at DHC (and also FVE). FVE would also benefit as it would have more units to operate, with costs being reimbursed by DHC and keeping 5% of gross revenues as profit. Therefore, the fact that RMR may seek to increase units and revenues at the companies it manages (i.e., DHC specifically) "at any cost" (without considering, in this instance, the profitability to DHC) could ultimately benefit FVE. FVE would not see its financial or operating risk increase while its own revenues and profits would increase. I think this is a possibility, though not one I would ascribe any current value to. That being said, I think the main point to consider is that the relationship with RMR is nowhere near as "toxic" as the one that was structured between TA and HPT.

      Incentives between TA and HPT were not quite aligned, whereas the incentives between FVE and DHC appear more aligned. If anything, it is DHC that is getting the short end of the stick, since FVE does not necessarily have to keep a hyper-vigilant eye on community costs as these will be reimbursed by DHC.

    2. Ultimately, the risk profile of TA and FVE is materially different. I think the long-term performance of TA should not be used to discount the value of FVE.

      The VIC post states how the contract between TA and HPT was essentially structured to extract value from TA: "I will point out from the start that this is a risky investment due to the lease deal that was negotiated between HPT and TA. The lease agreement clearly appears to have been structured to funnel as much cash flow as possible from TA to HPT in the form of rent payments."

      The arrangement between FVE and DHC does not appear to have such characteristics. FVE does not have to make fixed lease payments to DHC. DHC will be reimbursing FVE's costs. DHC will additionally be paying FVE 5% of gross revenues.

      FVE has practically no financial leverage (negligible debt obligations and negligible lease obligations). FVE has significantly reduced operating leverage as DHC is reimbursing costs. Like all investments, this is not a risk-free situation, but I do think it is a highly asymmetric situation with substantial upside remaining at prices below $6. I think more clarity will emerge (and the market will re-price this stock) the next time financial statements are released.

    3. Thanks for the thoughtful comment - I agree, feels similar, but TA is structured more like the old FVE with a big net lease obligation back to HPT, here that's been changed to a 5% revenue cut off the top, different business profile. However, your posture is correct RMR will look out for themselves and I don't expect the economics of the business to accrue to minority shareholders over the long run, more of a short-to-medium trade opportunity.

    4. 100% agree that this management structure is way more attractive than a leasing agreement. However that might be missing the forest for the trees. The point is that within a year TA was trading at 10% of its original net cash balance, not because they owned leases but because they would use all cash to acquire assets at full value and then split that value with RMR. Even if the current assets are great and generate lots of cash for shareholders, what do you guys think they will do with that cash?

  8. Does anyone have a link to the currently-existing arrangement between RMR and FVE?

    Not the arrangement between FVE and DHC (since it appears that one does not have any conflicts of interest). But the one wherein RMR manages FVE. What are the specific terms of that agreement?

    1. I would be interested in that as well. Also, does anyone have any insight on where the communities are compared to "target EBITDA" since SNH has the right to right to terminate 20% of management agreements per year if they underperform?

    2. This is from RMR's last 10-K:
      "Each Managed Operator pays RMR LLC a fee under its business management agreement in an amount equal to 0.6% of: (i) for Five Star, Five Star’s revenues from all sources reportable under GAAP, other than revenues reportable by Five Star with respect to properties for which Five Star provides management services, plus the gross revenues of properties managed by Five Star determined in accordance with GAAP"

      Anyone have anything else?

    3. Keep in mind that there is some alignment of interests between RMR and FVE in that Adam D. Portnoy has a very substantial stake in both entities through ABP LLC and ABP Trust.

      It wouldn't make much sense for RMR to extract value from FVE since it would be tantamount to moving money over from one pocket to the other. He could certainly "arb" the ownership difference (i.e., have profits accrue to the entity where he has a greater stake), but this seems like a highly inadvisable strategy for anyone to pursue from a legal perspective. I feel RMR already has enough of a reputation to engage in such behavior going forward.

  9. I believe that the discount being applied to FVE for the RMR management is for the most part unwarranted. As a previous post mentions, there is an alignment of interests between RMR and FVE given the presence of a mutual shareholder with a substantial economic interest in both companies. It is worthwhile to go through a hypothetical example to see how the incentives are lined up for this shareholder.

    RMR only takes 0.6% of revenues from FVE. And Adam Portnoy owns about ~50% of RMR's economic interest. This means that for a $1,000 increase in revenues in FVE, RMR will take $6 as a management fee, of which you can think that Adam Portnoy "owns" half given his ~50% ownership in RMR, or $3.

    How much value can be "destroyed" in FVE through these $1,000 incremental revenues for the new-revenue decision to be "net-neutral" for Adam Portnoy? Let's be conservative and ignore his indirect ownership in FVE through DHC, and instead only consider the 12% ownership in FVE through ABP LLC and ABP Trust. So Adam Portnoy would only "experience" 12% of the loss which FVE experiences.

    Given the aforementioned hypothetical $3 gain through the RMR stake, Adam Portnoy would only be willing to suffer losses through FVE up to $3. Any personal losses beyond this would be a net-negative for him. The $3 in personal losses, given his 12% stake in FVE, are equivalent to $25 in losses for FVE. In other words, if FVE loses $25, this entails a $3 loss for Adam Portnoy given his 12% ownership.

    So it appears that a rational agent in such a position would be willing to lose $25 for every $1,000 in incremental revenue through FVE, as the $3 in personal losses through FVE (from a 12% stake) would be effectively recovered through the $3 in personal gains through RMR (from a 50% stake). Any FVE loss beyond $25 for every $1,000 in incremental revenues (negative 2.5% margin) would be considered a "net-negative" in this hypothetical example.

    Is such a massive discount in FVE relative to peers really warranted given this illustrated alignment of interests? The management of FVE does not appear to have an economic incentive to be reckless and to "burn cash." They would really have to be very prudent/careful in deciding to "burn any cash" as any amount beyond a negative 2.5% margin would actually erode their own economic position. It appears to me that any rational actor in such a situation would be better-served figuring out how to generate positive-margin revenue for FVE, instead of trying to meticulously arbitrage (as a previous post said) any value/ownership differential. Engaging in such arbitrage would not only be legally questionable (to say the least), but it also appears to be economically questionable, as this example illustrates.

    1. Furthermore, there is a limit to how much "cash can be burned" at FVE. You can determine whether that is just the current cash on balance or the current cash on balance plus whatever cash they generate in the future. Regardless, I am quite confident that there is a comparatively larger size of positive-margin investments for FVE to take on. In other words, why would FVE management choose to burn through (let's say) $50MM of cash through negative-margin investments? Firstly, such investments would have to be carefully designed to not be more negative than a 2.5% margin, as previously shown. Additionally, why invest in negative-margin investments when there are likely to be some positive-margin ones out there? I would potentially understand the logic of negative-margin investments if one were talking about a sizable amount (i.e., billions) of capital to be deployed. But that is not the case which FVE finds itself in. The amount of capital it currently has to deploy, and any additional cash it may generate in the future which would thus be available for future investment, are sufficiently small that any capital allocator should be able to generate a positive return, regardless of how small this return is. It would be senseless to invest in negative-margin investments with positive-margin investments being available.

      I therefore don't see why FVE should be valued as a firm that "destroys value." The contractual arrangement with DHC appears sound, as a previous post detailed. And there appears to be an alignment of economic interests between FVE and RMR given the mutual ownership.

      Due to all this, I do not think that FVE necessarily deserves a discount to peers on an EV/EBITDA basis. The business operations are worth more than currently being valued.

      Even if one altogether ignores the business operations, the company is worth more on a book value basis (after adjusting for the restructuring elements) than the current market cap. The last 10-Q showed book value of 104MM. Following what another post mentioned before, this amount should be increased by at least 103MM to account for the full value of the units it owns and which are carried on the balance sheet at a depreciated non-market-value amount. The book value should also be increased by 75MM in order to account for the liabilities which DHC will be paying for as part of the terms of the restructuring.

      This results in book value of 104MM + 103MM + 75MM = 282MM. With 31.1 million shares outstanding, that's a per share adjusted book value of $9.07.

      I don't think that book value is the ideal way to value FVE, however, especially in light of the fact that the company's business model revolves around providing services and since there is no longer any risk of financial distress post-restructuring. That being said, the book value does provide a reference point and some idea of a margin of safety existing in the stock. I would consider the on-going business operations to be more valuable than this considering management's EBITDA expectations, applying an appropriate multiple, and accounting for any excess assets.

      With the stock at around $5, does the market really expect that FVE management will burn through ~$4 in value? And would such expectation of "cash-burn" actually be justifiable given the calculations presented before regarding the "logic" behind value destruction? I am inclined to think more favorably of the market, and think this is instead a temporary dislocation due to DHC shareholders not knowing what they own.

  10. London Special SituationJanuary 15, 2020 at 11:31 AM

    Hi Everyone,
    Interesting idea - for your information, we did some DD on the company and followed up with the company on some items we considered crucial for a first take on the possible valuation of this asset. Two key points for this group to understand:
    (i) The net cash is $35m and not higher as the $75m was always intended to remove the Working Capital overhang created through the transaction period
    (ii) The implied valuation of the remaining OpCo is less attractive as one might have thought initially. While 4-5x EBITDA makes little sense for an an asset light manager of this kind, the true FCF will be materially lower going foward driven by: 1) $12m EBITDA reduction expected through DHC asset disposal program, 2) $5m Capex needs driven by the owned properties, and 3) Lack of NOLs so effective cash tax will be at 26%

    Hence, even at a more appropriate EBIT / FCFF multiple of 12.0x of $15m + $25m Excess Free Cash the upside is limited from here for a fair EV of $205m. There is some upside to G&A costs going forward, but we are talking about $2-3m max.

    Regardless, great idea and certainly timely call at the time of the post @ $3.6/share. If I were long from there I would take some chips off the table.

    1. Thanks for sharing these points. Couple of questions/comments:

      i) Per last 10-Q cash and equivalents was 39MM. And there's also about 11MM of excess/unrestricted investments on the balance sheet, resulting in a total of 50MM.
      ii) Agree that 4x-5x EBITDA does not make sense for a typical asset-light manager. Regarding the $12M EBITDA reduction, does management's 2020 guidance for 20MM-30MM EBITDA already take this into account?
      The $5MM capex serves to show the underlying value of the owned properties. What possibilities are there to unlock this value? While RMR would be opposed given a likely reduction in revenue fees, it feels that the value in the real estate is sufficiently large to warrant paying the RMR agreement termination fee.

    2. Doesn't applying a 12x multiple to consolidated cash flows ignore/hide the real estate value?

      I understand a 12x multiple on only the cash flows pertaining to FVE's business as an operator. However, the cash flows pertaining to FVE's owned assets (including the -$5MM capex) should be valued differently as the business profile is much different from that of a senior living operator.

    3. London,

      Where are you getting this "$12m EBITDA reduction expected through DHC asset disposal program" from?

      The $900MM DHC disposition has been known for a while, and the DHC Jan. 2020 presentation shows that almost $700MM of units had already been "sold or under agreement to sell" as of 12/31/2019.

      Wouldn't FVE's EBITDA guidance have accounted for this? It must have. FVE and DHC are both managed by RMR. And even the DHC Jan. 2020 presentation reiterates FVE's 20MM-30MM EBITDA guidance on slide 14.

    4. London Special SituationJanuary 16, 2020 at 3:21 AM

      To be clear, we do not have history with this company, so there is an information asymmetry here between us and RMR, hence, we are inclined to believe the company/RMR when they mention specific numbers unless we can verify independently.

      (i) We walked through the following math with them with current EBITDA of $8m annualised gives $32m, subtract -$12m from DHC disposals gets you to the bottom of that range once the assets exit - our reading of the $30-20m range is that it depends largely on WHEN the DHC assets are disposed, but the end-point and therefore Opco valuation is the same.

      (ii) Regarding the owned asset value - obviously this is already accounted for in the current EBITDA and EBITDA-Capex, so the "hidden value" only exists to the extent another operator is will to own them at a much higher multiple (or really lower cap rate) - we have no reason to assume this is the case, but it is possible. If you were the split the opco and remaining real estate, naturally your EBITDA would be lower, so the actually value created/destroyed simply depends on the actual EBITDA impact (vs. your 12x) and the achievable cap rate (vs. 1/12) on the assets (book value is probably the wrong starting point) - we have zero quality information on either EBITDA impact or cap rates for so those assets, so prefer not to guess blindly.

      Lastly, just because you have to spend capex on a real estate asset does not mean is has value (excess or even any), in fact, it can mean the opposite, for example if there is a significant capex backlog, or if your agreement with the operator is weak because the assets are not well located/operated.

  11. Understood that there is some mutual ownership across RMR and FVE, providing SOME alignment of interests. Beyond that, however, what are the odds that FVE cancels the management agreement with RMR?

    Per the last 10-K:
    "RMR LLC provides business management services to us pursuant to our business management agreement. These business management services may include, but are not limited to, services related to compliance with various laws and rules applicable to our status as a publicly owned company, maintenance of our senior living communities, evaluation of business opportunities, accounting and financial reporting, capital markets and financing activities, investor relations and general oversight of our daily business activities, including legal matters, human resources, insurance programs and the like.

    Fees. We pay RMR LLC an annual business management fee equal to 0.6% of our revenues. Revenues are defined as our total revenues from all sources reportable under U.S. generally accepted accounting principles, or GAAP, less any revenues reportable by us with respect to communities for which we provide management services plus the gross revenues at those communities determined in accordance with GAAP. Pursuant to our business management agreement with RMR LLC, we recognized business management fees of $9,059 and $9,316 for the years ended December 31, 2018 and 2017, respectively.

    Term and Termination. The current term of our business management agreement ends on December 31, 2019 and automatically renews for successive one year terms unless we or RMR LLC gives notice of nonrenewal before the end of an applicable term. RMR LLC may terminate our business management agreement upon 120 days’ written notice, and we may terminate upon 60 days’ written notice, subject to approval by a majority vote of our Independent Directors. If we terminate or elect not to renew our business management agreement other than for cause, as defined, we are obligated to pay RMR LLC a termination fee equal to 2.875 times the sum of the annual base management fee and the annual internal audit services expense, which amounts are based on averages during the 24 consecutive calendar months prior to the date of notice of nonrenewal or termination."

    So let's say FVE has to pay approximately ~3 times ~$9MM = ~$30MM to be conservative.

    If the price to exit the relationship with RMR is only $30MM, what would be a reasonable discount for FVE to trade at on an EV/EBITDA basis relative to comps? Isn't there a point at which an activist would get involved and try to push for a termination (or at least a modification) of the agreement with RMR?

    Clearly the possibility that an activist succeeds in such endeavor decreases the greater the stake Portnoy continues to maintain in FVE. At the same time, the incentives for RMR to recklessly extract value from FVE are lower the greater the stake Portnoy continues to maintain in FVE.

    It seems that if Portnoy maintains the current stake in FVE, the incentives aren't fully there for RMR to destroy value at FVE. If, however, Portnoy decreases his stake in FVE (making future value-destruction at FVE therefore more probable), it follows that an investment in FVE would be much more attractive for any potential activist (with FVE valued at a discount to comps, with Portnoy's decreased stake reducing the obstacles to terminating the RMR agreement, and with the costs to terminating the RMR agreement being relatively small).

  12. Does anyone buy this $8-$10M in cost savings they think they can get fro "strategic sourcing?" That's a large amount of money for them in they can do it. Is it credible?

    1. Not sure. Regardless, I believe that isn't in the given guidance for 2020, since those cost saving initiatives appear to be more of a 1-2 year process.

      I personally wouldn't ascribe value to the initiatives for the meanwhile or base a long thesis on them. If management does deliver, however, then you get some nice additional upside in 2021 numbers.

    2. Turns out those savings are the community level, so will have minimal impact on FVE's income statement. Jeez, these guys are shady.

  13. Anyone have any updated views on the company/stock?

  14. As of March 31, 2020:

    36MM in unrestricted cash and cash equivalents
    41MM in accounts receivable due from related party
    19MM in unrestricted debt and equity investment
    Total of $96MM

    Adjusted EBITDA (with reasonable adjustments) at $12MM per quarter

    So for a market cap (as of 05/07) of only $105MM... you get the $96MM + a business with substantial hedged variable costs (DHC reimburses FVE the community-level costs of the managed properties) that is generating $12MM per quarter

    Little analyst coverage. No questions asked on the call

    1. Thanks - you also have all the owned real estate. I don't quite understand the price, I have added a little bit in the last couple months.

    2. Indeed. I also added

      Management broke down the gross and net carrying value of the real estate in the last press release which is quite useful/informative. They also specify the revenues from this owned real estate, which can further help toward assessing the market value of the owned real estate (i.e., apply a margin % to the revenue and capitalize that)

  15. FVE ramping up the investor relations....I just received the following email:


    Stonegate works with Five Star Senior Living Inc. (FVE) as an Investor Relations advisor and we are currently scheduling update / introduction conference calls with management. I noticed you were on their Q120 earnings call and wasn’t sure if you’ve had a chance to speak with management recently

    I included a summary of the Company below. Please let me know if you have any interest in scheduling a call with management."

    1. Apparently they saw my name and moved onto the next person, I didn't get that email. If you do talk to management, please post anything you found interesting, thanks!

  16. Interesting write up.

    Is this thing really trading at ~2x pre-COVID EBITDA? In 1Q20, FVE generated $12.4mm of EBITDA (add-backs seem legitimate). That annualizes to close to $50mm on an enterprise value of ~$95mm. DHC sold 599 senior housing units in Apr. 2020, but that shouldn't be that material vs. all of the units that FVE manages for them currently.

    What are we missing here? With what seems to be ~$5-10mm of recurring costs below EBITDA, $94mm of liquidity and "downside protection" in the earnings because of the DHC management fee, there should be ample room to get to the other side of this where earnings should retrace higher.

    Why then is someone selling stock here?

    1. I assume your question is mostly rhetorical, but I'll take a stab at it as somehow who owns quite a bit of it (for me at least):

      - Covid is particularly hurting senior housing, not just for the obvious death rates and costs, but the turnover in senior housing is pretty high and right now who in their right mind would put a family member in senior housing unless it was the only option? Occupancy is surely going down, not as bad for FVE as DHC, but still a significant headwind.

      - The RMR revenue share agreement is just strange for a non-REIT, I've really only seen these in operating companies with Fortress, and its semi-abusive, really skews incentives and the termination fee would be a significant portion of the EV. Almost might make sense to capitalize the termination fee when thinking about the EV because any acquirer would need to pay RMR to get control of FVE.

      But yes, I agree with your general sentiment, I've been a buyer here and there through the covid-crisis, pretty good business model and they've got some downside protection with cash and their owned real estate.

  17. Another one that worked out well. Any thoughts now that FVE is trading above $8?

    1. It has had quite the run, I believe its now my largest position, I'll re-evaluate next month once I hit long-term capital gains treatment, might sell or trim then, but still probably relatively cheap depending how you treat the RMR implied liability.