Tuesday, June 1, 2021

Regional Health Properties: Inadequate Pref Exchange Offer

Reader "ADL" mentioned this one in my ill-fated Medley post the other week and I took a small position but the write-up hung out in my draft folder, this afternoon the company announced an exchange offer that appears inadequate to me.  Regional Health Properties is offering 0.5 shares of common stock for each preferred share, on a headline basis its a healthy 20+% premium on today's closing prices (RHE closed at $12.04, RHE-A closed at $4.90), if fully exchanged the preferred stock would only receive 45% of the proforma shares when it should be 90+% (similar situation would be the AHT preferred exchange last year). The exchange offer requires an amendment to revise the terms of the preferred stock (liquidation value to $5/share, eliminate the accumulated dividends) that would require 2/3rds preferred shareholders voting for the amendment (non-votes are the same as no votes).   Below is the original write-up, but now that things are in motion, seems like an even better opportunity as the company attempts to recapitalize.

Original Write-up

Regional Health Properties (RHE) (fka AdCare Health Systems)  is a real estate investment company (but technically not a REIT) focused on senior housing in the southeast United States.  It's another small and illiquid idea, the common stock is probably uninvestable and the preferred stock has a market value of $12.4MM. The company has a rough history, some previous fraud accusations, multiple CEOs in a short time frame, etc., but if you look past the mess to the underlying assets and the recent announcement of a possible recapitalization of the balance sheet, there might be an interesting personal account type opportunity here.

High level summary, the company's primary business is owning or leasing 24 senior housing properties and then leasing or subleasing those properties on a triple-net lease basis to operators.  A few of these properties the company now either manages or operates on a temporary basis due to operators failing.  Of the 24, 12 are owned and leased out under traditional triple-net leases, meaning the tenants pays for all expenses, the rent is virtually the same as net operating income to calculate a cap rate.  I don't quite understand the leased model where they then turn around and sublease the properties, seems like a dangerous spread trade to me where you have to reach for risky tenants to make it work.  It appears that's how its played out with most of the distress in their tenant base happening in the subleased book, so we'll ignore that for the purposes of the pref thesis.  Below is the rent-roll for the owned properties:

This portfolio is financed with an assortment of government guaranteed debt (generally a negative, means the borrower couldn't get reasonably commercial terms without the government guarantee), total debt is approximately $55MM.  

Add in the $12MM as the market value of the preferred and through the preferred stock you're buying the owned triple-net portfolio for $67MM or an ~11.5% cap rate, as usual with me, pretty back of the envelope math.  The preferred stock trades for $4.50, has a standard liquidation preference of $25, but hasn't paid a dividend in several years. The total liquidation preference is over $35, but it almost doesn't matter, the preferred stock is unlikely to be made whole so any incremental value above the senior debt accrues to the preferred stock, it is the fulcrum security despite the common having a current market cap above $20MM.

In their recent earnings release, RHE added this line:

In early 2020, the Company began on-going efforts to investigate alternatives to retire or refinance our outstanding debt of Series A Preferred Stock through privately negotiated transactions, open market repurchases, redemptions, exchange offers, tender offers, or otherwise. Costs associated with these efforts have been expensed as incurred in Other expense, net and were approximately $394,000 and approximately $144,000 for the three months ended March 31, 2021 and March 31, 2020, respectively.

Apparently they initially started down this path just before covid, now that things are opening up and rent collections are largely back to normal, the time is right to address the capital structure as it clearly doesn't work anymore.  My guess is RHE will attempt to exchange the preferred shares for common stock, maybe something similar to what happened over at Ashford Hospitality Trust (AHT).  Just for a quick example, if you valued the triple-net lease portfolio at a 9.5% cap rate (a higher quality but smallish triple-net like CareTrust REIT (CTRE) trades at 6-7% cap and has been buying properties this year in the 8-10% range) then the preferred might be worth $25MM, or a double.  But that's just a guess, the upside seems highly variably in mind but the downside is fairly well protected.

Other thoughts:

  • Senior housing obviously suffered during covid, but with vaccinations now widely completed for the elderly and front line workers, new residents can begin to move into facilities.  There might be a temporary ramp up as move-ins were delayed the last year, but there's certainly an open question at least in my mind if covid permanently impaired senior housing and whether alternatives might become more popular than housing the most at-risk all together in close quarters.
  • Whatever the common stock is doing is a mystery to me, it might be caught up in meme stock trading or other pump and dumps, ignore it, its almost certainly going to get completely diluted.  The unpaid preferred is $30.1MM, so the total due to prefs is ~$100MM, you have to be pretty optimistic on their leased/operated properties to see any value to the equity, and if you are optimistic, the preferred is still the better risk/reward.
  • I don't know who owns the preferred stock, it's hard to parse out with publicly available data sources, and surprisingly/concerning that despite having the right to nominate board members to represent the preferred stock, no one has to-date.
  • RHE should probably just sell themselves, but in their press release and 10-Q they hint their strategy is in the opposite direction, they want to go in growth mode, difficult to fully understand how they could do that but certainly couldn't without first resolving the preferred share overhang somehow.

Disclosure: I own shares of PHE-A

33 comments:

  1. "if fully exchanged the preferred stock would only receive 45% of the proforma shares when it should be 90+%" Sorry, could you explain?

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    1. Preferred stockholders are due ~$100MM, since preferred stock is senior to common stock and the company isn't worth $155MM (they have $55MM in debt), any value above the debt should be allocated to preferred stockholders. This proposal is only giving the preferred 45% of the recapped company, when it should be 90+%. In a bankruptcy scenario, sometimes you see old common stock get a couple percentage points of the post-reorg company to move things along, could argue that should be the same scenario here.

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    2. So you plan to reject the offer? Sorry, I'm new to these things. If the exchange goes through and the stock price stays the same that implies a ~$92m EV for the pro forma equity, is that right? Are you at all worried about the common price falling if the exchange happens? Also when do you think the prefs could possibly yield again? Anyways the price is up, so congrats. I guess the market agrees with you (not sure if it's a really tempting r/r now)

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    3. Yes, I don't plan to participate in the exchange offer. I'm not sure if looking at the current common stock price is useful, seems like its disconnected from reality, but yes, about a $92MM EV if the exchange offer were fully subscribed and completed.

      It's sort of a circular/reflexive thing, maybe the prefs can take advantage of the meme stock nature of the common, get the ratio bumped up a little, but not too much that it throws a wet blanket on the day traders in this thing. But the prefs should get nearly all the value, the above is just some game theory/trader talk.

      To your yield question, the prefs will never get paid a dividend again.

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  3. Thank you for the write-up. Two questions.

    "Through the preferred stock you're buying the owned triple-net portfolio for $67MM."

    1. Was market rate for these twelve properties manually calculated or can that be found in some filing?

    2. In situations like this, do the owned outright properties always go to the preferred stock? Or, where can I find what the preferred stock give shareholders rights to?

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    1. $67MM was just the debt plus the preferred stock market value at the time I wrote it, it's not the market value of the properties. Since the common should effectively be worthless, if you own the preferred stock you are the equity here, so $67MM can be thought of as the enterprise value if you own the preferred stock. The preferred stock is unsecured, so the properties don't go to them technically, but the preferred stock is senior to the common. I just used the owned properties as a proxy for the value of the company, the rest of it could be worth something but probably not a meaningful amount to the thesis.

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    2. Ahhh, so now that would be $77M or a 9.4% cap. Which would imply maybe $1 ish move left to be made to get to fair value?

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    3. The current EV through the prefs is approximately $70MM (there are 2.8 million pref shares) or an 11% cap rate on the owned properties. Again, this is just my simple math, should probably do more work on it, they have G&A, doesn't sound like they're selling, so its more of a quick and dirty exercise than true deep valuation work.

      The math gets a bit circular/reflexive when you use the common stock as a proxy for the exchange offer, but I think the prefs should get at least $8-$10 of value. A 9.5% cap rate on the owned properties would be ~$9.75 of value to prefs, subtract some to throw the common equity a bone. Maybe that's too idealistic, but somewhere between current prices and there probably makes sense.

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  4. My thoughts exactly. I dropped a line to IR and the CFO that I consider this a nice opening offer and look forward to the real deal. I hold in the neighborhood of 1% of the prefs so they probably don't care that much what I think, but it never hurts to express your opinion politely (have also been communicating with SVVC, slightly less politely, of late).

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    1. Good luck with SVVC, been watching that one from the sidelines

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    2. Yeah, that one I can't recommend; it's a pure greater-fool trade, and the starting point of me is a pretty big fool.

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  5. why would anyone in their right mind - let alone 2/3 of the pref owners - consent to a giving anything close to this to the equity? why wouldn't they push for equity to get zero/near-zero?

    as you said, in bankruptcy the precedent is for equity to get some token option value - but much less than 5% proforma in distressed situations where the equity is hopelessly underwater with basically no prospect for recovery (eg here). there is no chance equity would get an equity committee, etc, in this case. why wouldn't the prefs just call the bluff, all the way up to 95% conversion ratio, or something like that?

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    1. I agree. Only thing that's swishing around in my head is if there's a way for the prefs to take advantage of where the common is at, not fully squash the meme stock nature of it, but yeah prefs should get almost all the value.

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  6. Just dropped a line to IR. On another note, any new thoughts on APVO now that the board has vested some options prior to the annual meeting in a few weeks?

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    1. No real new thoughts on APVO, still holding in small original size (1-2%), I assume Tang gets elected to the board, from there I'm not really smart enough to know but still seems like an interesting situation to me.

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  7. MDC, Any new thoughts on SDTTU. Why isn't it trading higher?

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    1. No new thoughts here either. It's not trading higher because there is uncertainty around the amount and timing of the final distribution due to the outstanding litigation, I don't have any particular insights on the timing, but I continue to hold it.

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  8. The part the preferred investors are missing is the common investors have to vote on the deal also.

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    1. As proposed, yes, but as proposed the common investors should all vote yes. I don't know if this could be structured a different way to avoid the common stock needing to approve, seems like that shouldn't hold it up.

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    2. So to take the other side, if the company offered 90% to the preferred why would the common vote yes? Perfect example is AHT.

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  9. https://www.sec.gov/Archives/edgar/data/0001004724/000119380521000787/e620674_ex99-2.htm

    Letter from the largest preferred holder.

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    1. Ah, there we go! Thanks for finding/posting.

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  10. Hey MDC, another great write-up on a really interesting situation - I've been wondering what happens in such a scenario for years and now I can finally watch.

    Some things which strike me:
    You're right to say the pref is the fulcrum security, but it's only that in Ch. 11. It looks like they generate enough cash to stay current on interest and the maturity on the debt is very little over the next 5 years. So I can't see what would make this go into Ch.11 at least in the short to medium term.

    If it’s not going to Ch. 11, then it’s a classic prisoners dilemma between common and prefs. If it stays as is, commons can never get any divs. And the prefs are accruing liabilities at a faster rate than the company is generating value so the common will never be worth something. But then the prefs aren’t collecting any divs either. The only way they can improve their situation outside of Ch. 11 is if they both agree to an exchange. The prefs will of course claim it’s preference plus all accrued interest and not a penny less (see the letter). But that’s a complete wipeout for equity and so why would they ever agree to that?

    The reality is that the common does have value and that value is what the prefs would need to give them in order to get them to agree to an exchange outside of Ch. 11 – and that depends on the makeup and mindset of the common owners. Against that background, it doesn’t strike me that the initial offer is wholly unreasonable. And of course the value of the common would be greatly reduced if it looked like the company might go into Ch. 11 – because there the settlement would move more along the lines you suggest. But I would be wary as a pref holder in Ch. 11. My understanding of bankruptcy law is that the concept of impairment covers both value and form of claim – and in Ch. 11 it’s possible that the debt successfully argues it is impaired and therefore manages to cram down a plan which takes the value you’ve calculated away from the prefs.

    If I had to bet, this feels quite hard to resolve and so I think it will spend quite a bit of time batting exchange offers back and forth before something is agreed in a year or two. But as to where it ends up it’s really hard to tell. I suspect they’ve been advised by people who understand this better than me and so the initial offer probably isn’t as irrational as it looks on first look. I’ll be grabbing my popcorn and good luck!

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    1. Thanks for the great/thoughtful comment. I was thinking about this dynamic yesterday too, the benefit of preferred stock to a company is its not debt, and not paying doesn't force them into bankruptcy where the prefs can enforce their seniority. Do have to play somewhat nice with the common, but as someone else suggested earlier, you can see how the AHT common has benefited from the pref exchanges and its a similar reopening/meme type trading sardine. I'll calm my expectations, maybe we get a little better offer, but points all well taken. Thanks again.

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    2. Delighted to be able to give something back after enjoying your thoughtful blog over the years. And BTW, if you want to watch what happens to prefs which have stopped paying divs and have accrued lots of unpaid interest in Ch. 11, be sure to watch the Navios Maritime (NM) Ch. 11 docket which should start screening near you sometime this fall (I'd be amazed if it doesn't!). It's a bit different there as it's almost certain the debt is impaired, but the prefs are at $9-10 today with maybe $8-10 of unpaid interest on top of the $25 par Cheers!

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    3. I agree w/you about the setup, s445, and would add that Ch11 is unlikely, both because they have the cash and mgmt almost always sees that as a last resort (unless they are highly strategic and doing a prepack). Plus it'd be very risky. For a small enterprise like RHE, even a consensual tactical bankruptcy has the opportunity to convert to wipe them out because of fees (the Altman/Wang bankruptcy book mentions this, if I recall; I was surprised but shouldn't have been).

      I disagree, somewhat, about the timing. It's definitely a fiesta of game theory, but the market's given RHE a gift in the form of its current stock price. There is no telling how long that gift will last, and management wants to strike while they can. Too bad they don't have an active shelf (as far as I know), though there's no telling whether that would kill the rally (like what happened with GOED recently--not quite the same, but essentially a recap). So while it's true prefs don't have all the power or value, the clock is ticking, management has no idea when it stops, and I'm sure they'd prefer a cleaner capital structure when it does.

      Also, since the stock price (up 10x in the last 6 months with not much change in the biz!) seems driven primarily by technical and sentiment weirdness (my guess, anyway, as good/bad as any), I think management might be thinking that a pref takeout and "bold new growth strategy"-type thing as hinted at might even drive the price up yet further (my guess of their guess).

      So their incentive is to get this done ASAP and keep pressing on the gains. My further guess is that the initial offer might be in part a signal to common holders of the stock's high value: look at how much .5 share of RHE is worth! If so, that boxes them in a little bit in terms of next moves; they can't, say, quadruple the offer without probably dinging the common. As MDC says, it's reflexive. And guessing intents and signaling is def of a sucker's game, since you can ascribe any motive to anyone.

      If I were management I'd be working very hard to get this done quickly, anyway. Current common price is a gift horse. I'd maybe bump the common and add either a low-face pref, some warrants, or both, do a shelf and an ATM as soon as humanly possible. Then again, I am not running a public company so there are probably all sorts of flaws in my analysis.

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    4. ADL - there's a lot of sense in what you say on the timing I hadn't considered. I guess we'll see...

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    5. Some good points. While in principle the common should own basically zero percent of the pro forma entity it seems unlikely that that is going to happen here, given insider ownership and the idiotic trading price of the common.

      It's basically a battle between the common holders and the pref holders. However, I think one important aspect to keep in mind is that insiders wanted to get rid of the prefs in the first place! They think they can grow the company, for that it's probably a good idea to get rid of the overhang. Now, insiders own ~10% of the common, they probably are not going to give that away for nothing.


      But the current deal is never going to pass. I think there probably is room to meet in the middle. I.e. common holders end up with 10% - 25% of the company, i.e. 1 for 1 or something like that. Shitty deal for the pref holders, but the flip side is that, if you do it quickly, the pref holders get $25 in common for $10 in prefs or something like that (at market prices) and given the madness in the common they might be able to sell their shares to the meme traders.

      I agree that Chapter 11 would be a disaster for everyone ..

      The above is not a strongly held opinion, just some random thoughts.

      Thanks for posting, very interesting situation. What I like is that you have the tail upside of the meme stock while the downside is protected by the seniority of the prefs. What if the common goes to $50? Probably very unlikely, but can't rule it out .. Where would the prefs trade in that scenario?

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  11. Not a fan of the company having large portions of "lease sandwiches" (basically the WeWork of healthcare) where they lease a property long and re-lease the property to operators... in a distressed situation.

    If not for that aspect I would be more involved.

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    1. I agree, I believe it’s sort of a legacy of the old business model where they operated the facilities as well, they moved to get out of that business and be a landlord, so they turned around and subleased their leased portfolio.

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  12. Can I redeem this for common shares at any time or only once there is an offer that everyone agrees on?

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    1. It is just a proposed offer at this stage, once they move forward with it, you'll have an opportunity to participate or not. But its not a continuously ongoing offer that you can exchange at anytime. There might be several, see AHT for a possible example of how things might play out.

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