A corporation's primary obligation is to its owners, the shareholders. In privately held businesses, any free cash flows are available to the owners in a very real, tangible way. However, passive minority investors must rely on management to realize investment value through one of the methods listed above.
Five Star Quality Care (FVE) is in the sweet spot of the senior living communities industry, with approximately 69% of its 2009 revenues coming from private payment resources and the balance from Medicare and Medicaid. It should benefit from favorable demographic trends, but without being substantially dependent upon politically-sensitive government programs that put constant pressure on margins.
It is important to understand the history of FVE. FVE was spun-off from Senior Housing Properties Trust (SNH) in 2000. SNH is managed by REIT Management & Research, or RMR, which is majority-owned by Barry Portnoy. Portnoy has significant ownership and involvement in a web of real estate entities. Portnoy and RMR have ownership and/or management in FVE, SNH, Hospitality Properties Trust (HPT), HRPT Properties Trust (HRP), Government Properties Income Trust (GOV), TravelCenters of America (TA) and numerous real estate investment funds.
FVE leases a majority of its properties from former parent, SNH, which was founded by Portnoy. According to recent ownership data and share prices, Portnoy owned stakes of approximately $500,000 in FVE, $3.9 million in SNH, $6.6 million in HPT and $5.8 million in HRP. Additionally, SNH owns 9% of FVE shares; HRP owns 32% of GOV shares; and HPT owns 9% of TA shares. Clearly, Portnoy has much greater financial interest in his non-FVE investments.
Simple reviews of SEC filings revealed that many of the value realization methods applied on behalf of passive minority investors simply aren't available with FVE. For example, FVE has five directors, including two managing directors and three "independent" directors who serve staggered three-year terms. The "independent" directors have significant ties to Portnoy and his other entities. The situation is similar on the boards of Portnoy's other investments. This reduces the possibility of a value catalyst through a change in control.
Additionally, FVE's CEO and CFO are employees of RMR and two of its managing directors (one of whom is Portnoy) are also directors for RMR. And under their management agreement, RMR may act in SNH's best interests in the event of a conflict between FVE and SNH.
FVE's charter places restrictions on ownership positions over 9.8% of any class of equity shares as long as SNH remains a REIT. There are also restrictions on acquiring any new positions that would result in an ownership stake of 5% or more. SNH and RMR have the ability to cancel lease rights upon an ownership acquisition of 9.8% or greater. Lease rights are also cancelable upon the adoption of any shareholder proposal that is not approved by a majority of the board.
Other tools that deter a change in control include the board of directors' power to create new share classes and issue new shares without existing shareholder approval; specific requirements to serve as a director; limited shareholder ability to nominate directors; and the board of directors' authority (not shareholders) to adopt, amend, or repeal bylaws.
What about relying on management to deliver value to shareholders? FVE has never and does not plan to pay dividends; it has dramatically increased the number of shares outstanding since the spin-off, and it had increased debt each year until 2009.
Yet another negative for shareholders is that as long as FVE has a management agreement with RMR, FVE cannot acquire or finance any real estate without giving SNH or other RMR-managed entities the first opportunity.
The only capital decisions that could be seen as potentially adding value for shareholders are acquisitions and growth expenditures. But even these are suspect. SNH reimburses FVE for a majority of its expenditures and then FVE pays SNH a higher annual rent in return. This arrangement appears to be in the long-term interest of SNH, which is essentially using FVE to help finance expenditures.
Taking all of these factors into consideration, it's difficult to see how passive minority investors can expect to realize any value creation in shares of Five Star Quality Care. Unfortunately, it might be a situation in which Five Star exists only to serve its landlord, Senior Housing Properties Trust, and Barry Portnoy's REIT Management & Research.
Five Star was spun-off on December 31, 2001 at $7.26 per share, has been as low as $1.04, and is currently around $3.04 per share. Over half of shareholder's value has been wiped out since the spin-off. Considering the circumstances, this is not surprising and investors should not expect this to change in the near future.
Disclosure: No positions in any of the securities mentioned.
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