Shareholders challenge nursing home company

Despite 135-fold share price increase since 2002, investors -- who offered to buy the company last month -- say it is undervalued

Email | Print By E. Thomas Wood

If you had been brave enough to spend $120 on 1,000 shares of Brentwood-based nursing home operator Advocat Inc. as it hemorrhaged cash in May 2002, your investment would be worth $16,200 as of 11:50 this morning. Stock performance like that is just not good enough, say two current shareholders.

In a filing with the Securities and Exchange Commission, Los Angeles-based investment funds Bristol Capital Advisors and Oakdale Capital Management have revealed that they are pressuring Advocat's management to do something about the fact that the stock, even after a run-up of more than 250 percent in the past year, is still trading at only about 6.5 times earnings.

In passing, Bristol and Oakdale also disclosed that they made an offer to buy Advocat outright last month. The company, whose board rejected the offer, has not previously divulged the fact that it was made.

Paul Kessler and David Cheng, principals of the two funds which share office space, met with Advocat President and Chief Executive Officer Bill Council on August 15 to discuss their concerns, and they followed up with an August 18 letter that is reprinted in today's filing. Praising the company for a job "well done" in improving operations recently, the investors told Council: "We feel there is tremendous cash flow growth opportunity for Advocat above and beyond that which can be found at other similar nursing home companies."

But they went on to express concern that there is "a misunderstanding in the public equity market with respect to a perceived overhang associated with the potential litigation liability." The letter does not spell out the nature of any litigation threat looming over Advocat.

In its most recent 10-K annual report filed with the SEC, the company mentions expenses totalling about $1 million that it incurred in settling a regulatory action with Arkansas authorities in 2004, as well as another $1 million that an insolvent insurer was unable to pay toward a claim the company made after losing a professional liability case, also in Arkansas. The umbrella carrier on the policy says Advocat should pay that amount itself, but the company disputes that assertion.

The report also says Advocat is facing 16 other professional liability lawsuits. An "unfavorable outcome" in any of these cases "could have a material adverse impact" on the company, it states. In its most recent quarterly report, the company said it maintains a self-insurance reserve of $27 million to cover potential professional liabilities.

"We invite you to talk with us and some of our more trusted debt lenders about the possibility of providing financing should this ever become an issue that is beyond of the scope of the current free cash flow of the Company," Kessler and Cheng wrote. The invitation would appear to be a veiled suggestion that the company consider going private in an HCA-style leveraged transaction.

The investors go on to express concern over "potential premature acquisitions" that they seem to believe Advocat's management is considering. "An improperly valued stock currently prevents you from using your stock as currency for any acquisitions that may present themselves," they write.

The letter closes by expressing disappointment at Council's "verbal representation of the Board's rejection of our offer letter dated July 18, 2006 to acquire the Company for $16.80 per share." The investors told Council: "We will leave the door open to discuss a potential acquisition when you and your board of directors feel the time is appropriate."

Advocat's stock is up 3.85 percent at midday, to $16.20, on moderate-to-heavy trading volume.