EXETF - Extendicare

[Olmsted]

I recently started a position is Extendicare.  The stock has sold off on a dividend reduction.  The gist of the valuation story is that the sum-of-the-parts of its U.S. business and Canadian business is much less than its value based on standalone comparable companies in the U.S. and Canada.  The company has hired Citigroup to explore strategic alternatives.

 

I'll leave it at that for now since the note I am attaching treats the situation much more thoroughly than I would, though my math concurs with the analysis.

 

There's also a short mention here:

 

http://reminiscencesofastockblogger.com/2013/05/27/week-99-patience/

 

EDIT: Thanks to Phil Etienne for bringing this one to my attention.

Extendicare_Analysis_-_Hawk_Ridge_Partners.pdf

[Myth465]

This is a very good idea thanks. I was around when the US reference company did there spin off and saw it work wonders.

This idea capitalizes on the insane reit valuations. I like the cap structure, like the fact that you get paid to wait, and like the options available to Management.

 

I would prefer a spinoff vs, a sale.

Any thoughts on Management. I will be buying this later in the week

 

[no_free_lunch]

I am not very familiar with valuing companies based on EBITDA.  Some of the comparison companies have different debt amounts, how do you factor that in when you are using EBITDA?  Is it just EV / EBITDA to standardize?

 

TIA

[Myth465]

Yes EV / EBITDA.

 

The key to the investment is looking where reits trade, then looking at the amount of property they have in that space.

REITs trade at noise blend valuations.

[luck]

excellent idea olmsted.  just listened to the conference call.  hawk ridge writeup lays it out in amazing detail. 

[fareastwarriors]

very interesting, listening to the call now.

[mcliu]

This basis seems to be predicated on a huge multiple for the Canadian business. I can't get to the same numbers.. Did anyone try to replicate the #s?

[no_free_lunch]

mcliu,

 

I was able to get to the numbers.  I basically just confirmed what was on the reminisces link at the top of the post.  I am not quite sure what you are saying though, the internet being what it is, are you questioning whether the comparables are appropriate or you don't agree with the basic math?

 

For Canada I have $65-$70M EBITDA, 490M debt for Canadian operations and $570M total market cap.  To justify the statement that the canadian operations alone are worth the whole market cap we add the market cap to the debt which gives $1.06B.  Divide that by $65M EBITDA and you have a 16 ratio.  I came up with 21x for leisureworld and about 17x for Chartwell.  It doesn't seem unreasonable from that perspective.

 

There is also the dividend perspective.  To get the 7% yield of leisureworld and justify the full market cap the canadian ops would have to pay out about $40M or ~60% of EBITDA.  Leisureworld is paying out about 65% of EBITDA (assuming 40M EBITDA which is actually on the high side) so it is somewhat comparable.  Chartwell's dividend is only 5.5% so a 7% dividend sounds reasonable.  The Canadian ops would also have lower debt to EBITDA than their competitors.  About 7x versus 8-10x I think.  As such, the dividend coverage ratio seems appropriate.

 

Now that is the easy part.  Now I am trying to figure out how comparable these other companies really are.  The one difference might be that extendicare only owns about 60% of their canadian operations, I think their competitors are closer to 100% owned.  It seems that should already be factored in with EV/EBITDA analysis but I am not sure it is apples to apples.

[ap1234]

Interesting analysis. At first glance, I agree with mcliu. If you accept that the valuations for Extendicare's Canadian peers are 'reasonable', then it appears to be quite an attractive situation (especially if you actually think mgmt. will monetize the US assets). The problem I have is with the valuations of the Canadian peers. My issue is not whether Leisureworld is a good comp but rather is the valuation of Leisureworld remotely reasonable.

 

In my opinion, virtually all REITs in Canada (with a few notable exceptions) are trading at lofty valuations which only make sense if int. rates stay low for a very long time. While this is possible, I wouldn't want to make that bet (I just don't know the direction of rates one way or another). I understand the 'annuity' like cash flow streams of the Canadian nursing home operators. But I can't get my head around the incredibly high valuations for Leisureworld and Chartwell.

 

In the short-term, if the US assets gets monetized I imagine the idea will work out. But I don't know how to get comfortable with the downside scenario (i.e. assuming nothing changes and the US monetization never happens). In this scenario, you have to get comfortable with the valuation of the current parts which you will be left to own.

 

I'd be curious to hear whether other people who follow the space closer feel that the Leisureworld and Chartwell are trading at reasonable valuations? If not, what is a more appropriate valuation to pay for these businesses if you don't think int. rates have to stay low forever? I'd get more comfort if I thought the Canadian peers were undervalued or at least reasonablly valued today as opposed to potentially overvalued. 

 

[mcliu]

Thanks no_free_lunch and ap1234.

 

I guess the play is for the Canadian stub to quickly trade up to its comps before there's a revaluation of the entire REIT sector.

 

The absolute returns over the long-term seems small given the high multiples.

[no_free_lunch]

Below is a link to a repost of a TD REIT valuation article.

 

http://www.investorvillage.com/mbthread.asp?mb=6781&tid=11208473&showall=1

 

LW Leisureworld

 

Senior Care Corp.

 

$12.00 Our $12.00 target price is based on an 11.75x-12.25x multiple to our 2013 AFFO estimate. It is a discount to the 13.5x-14.0x multiple

 

that we use to generate Chartwell’s target, due to our expectation of lower nearterm AFFO/share growth potential versus Chartwell. It is

 

a premium to the ~8.4x implied by Extendicare’s price target, as we believe it has a much less risky/volatile earnings stream, given the

 

focus in Ontario only and not the U.S. Our price target implies a 14% premium to our pre-tax NAV estimate of $10.50, which is higher

than both the 6% premium implied for Chartwell and 11% discount for Extendicare.

 

EXE-UN Extendicare REIT $8.00 Our $8.00 target price utilizes a ~7.0x EV/EBITDA multiple on 2013E versus the current 7.6x 2012E average for the U.S. Skilled

 

Nursing peer group, and equates to a ~8.4x multiple on our 2013 AFFO/unit estimate. The lack of tax shield and still relatively high

 

leverage versus its peers are key negative factors, in our view, partially offset by a relatively high distribution yield and partial exposure

 

to historically more stable Canadian government funding.

 

They are valuing leisureworld based on AFFO, so perhaps we should try the same for extendicare.  The company has $85M  AFFO in 2012, with only $34M from Canada.  Apply an 11.75x to that and you get about $400M, admittedly below current market cap of $570M.  However, the US operation has $110M EBITDA or $51M AFFO.  You would be valuing the US ops at about 3.5x AFFO which seems really cheap. 

[mcliu]

You should probably look at this one on an unlevered basis given the differences in the capital structure.

[Myth465]

I really like the idea.

It looks like the Canadian operations and dividends support the valuation. At 48 cents per year based on the Canadian operations I think we cover the valuation on the stock.

The dividend, stock price, and capital structure can be supported by the Canadian business. Growth can be funded by the government and debt via initiatives like the current facilities they are building / modernizing.

 

So inmo the US business is free.

 

The question is whats it worth. I dont know but I know if a stable operator leased those properties outside of our current political environment, and could turn a profit then the company that leases those properties would be worth a mint. Especially considering the low debt, low rates on debt, and unencumbered properties. Very interesting idea, I look forward to learning more over the next few weeks. We do have a mid 2014 deadline though imposed by the Fed. Rates may begin to rise around then which pushes down the value of REITS...

 

Not sure what the upside is. But the downside is limited, and I get paid 7% while I figure out the upside / wait for it to happen.

[no_free_lunch]

Not sure what the upside is. But the downside is limited, and I get paid 7% while I figure out the upside / wait for it to happen.

 

I think that is a good way to look at it.  My best guess is that the upside is $0 - $4 / share but it is really just a guess. 

[no_free_lunch]

It is also worth noting that this would not be the companies first spinoff (they haven't actually said they will spin-off the US ops, sale still on the table).

 

May 31, 2006:

 

Nursing-home operator Extendicare Inc. said Wednesday that it plans to convert into an real estate investment trust after it spins off a U.S.-based subsidiary.

 

http://www.cbc.ca/news/business/story/2006/05/31/extendicare.html

 

[Myth465]

INMO you need to separate the Realty from the Business to get maximum value.

 

The multiple on the US business will be fairly low due to the political environment. One would want to hold onto that until it stabilizes.

I would keep the US business, and spin off the realty. I think they want to get rid of the US Operating business though to ease reporting and comps.

 

Its interesting because there are 3 distinct assets. The Canadian business justifies the market cap, and is underlevered. Pays you a nice yield to wait.

The US Operating Business isnt worth much due to the political environment, but should earn a decent ROIC to stay viable unless the Gov wants to run these.

 

The Realty business would trade at 20x earnings or a yield of 5% right now if sold today, but putting market rents on the US Operating Business is probably not feasible.

 

Very interesting, but few ways to lose, my kind of investment. Thanks for the link, will have to look at what feel through in 2006.

[ItsAValueTrap]

But I can't get my head around the incredibly high valuations for Leisureworld and Chartwell.

When I looked at Chartwell's accounting, it struck me as questionable.  They may be overcapitalizing expenses (e.g. maintenance/repairs).  The payment-in-kind deals also seem designed to hide/defer losses.

 

Chartwell is constantly issuing stock so it might be a darling of investment bankers who don't want the music to end. 

[Uccmal]

Olmstead, I really like this idea. 

 

I took a small position immediately upon reading the thesis.  The Canadian operations are sound.  I am familiar with the operations of Leisureworld, Revera, and Extendicare, and a number of tinier facilities through another keyhole.  I have never seen an empty bed.  Operating costs that are mandated by regulators get passed on to their respective Ministries of Long Term Care ( the taxpayer) in Canada. 

 

In my opinion they are being punished for reducing he dividend, which was previously bolstered by the income trust structure.  I haven't dug deep into the financials yet, but on a cursory glance it looks as though they can meet debt payments in Canada, and the dividend. 

 

As Myth has suggested the US operations are a little stickier, and harder to value.  We get paid to wait for a stabilization or a spinoff. 

 

I dont think the upside is huge.  An absolute maximum may be 75% but that's okay.  I am looking for solid dividend payers to finance my impending exit from paid work.

[Uccmal]

I picked up about a 5 % position on Exe so far.  Lost money on it so far :-)

 

The analysis Olmstead attached is good, if somewhat overoptimistic, IMHO.

 

Now, they may be correct if the potential breakup unearths value, and allows EXe to raise the dividend.  But,  Unless there is an increase in the dividend there will be little to push the stock higher. 

 

That being said, if the American Unit were IPOed via the Canadian shares as "gifts" there may be something there.  Its enough for me to get paid to wait and see what happens. 

 

This could become a very long term hold, perhaps until I am a resident....

[Gamecock-YT]

I hope they manage expenses better than the $19.14 it took to mail annual reports to me today.

[Myth465]

I hope they manage expenses better than the $19.14 it took to mail annual reports to me today.

 

LOL spoken like a true value investor.

[no_free_lunch]

Earnings are out:

 

http://www.extendicare.com/uploads/private/EXE%20Q2-13%20Release-Final_7598.pdf

[Olmsted]

Just listened to the conference call.  It was kind of a "status quo" call.  Numbers were essentially the same year-over-year excluding their exit from Kentucky. 

 

There was a bit of talk about seeing increased lawsuits, and they had to strengthen their reserves for those.  They are also making some operational changes to combat that trend, including some stepped-up customer service to mitigate, and enhancing documentation and therefore their ability to defend.  The language they used made it sound like more ambulance-chasing attorneys than serious malpractice.  Also noted that they were seeing many fewer problems in states with tort reform.

 

Management said nothing about the strategic review until prompted.  An analyst asked whether the chairman stepping down had anything to do with the strategic review.  He was told it was for "personal reasons" and that we should not read anything more into it.  Although, he did see fit to point out that the new chairman also happened to chair the strategic committee, for whatever that is worth.  Regarding the review, no comment but that it is ongoing, the committee is meeting with advisers to go over options, and that they hope to wrap it up by year end.

 

 

[Shane]

Thanks for the summary olmsted!

[Uccmal]

Thanks for the update Olmstead.  I was most interested in any commentary on the "split".  Save me listening to the call. 

 

I am wondering why they self insure.  In Canada that is probably okay where filing a facetious lawsuit requires the plaintiff to pay the bills.  In the US it seems dangerous.  That being said I am sure there is language in their residency contracts that protects them from being sued for Norwalk virus,or some such, spreading in a facility from resident to resident.  Any medical practitioners that enter their facilities are likely required to be self insured as well.  So maybe its not a big issue.