A common term associated with net-net investing is liquidation value. In theory a company's current assets minus their liabilities approximates liquidation value, what the company might receive if it were to decide to close down and distribute the proceeds to shareholders. Often a company's accounting liquidation value is not accurate except in cases where a company's assets are mostly cash, they have no liabilities, and management is determined to return the proceeds with as little friction as possible (read: lawyer/advisor fees). A liquidation is where accounting value meets real world value, and a company's balance sheet gets a gut check. Are the values on the balance sheet accurate?
In the public markets companies don't liquidate often, principally due to an incentive mis-alignment. In many public companies management does not own a majority stake, and the company's ownership interest is divided among many diverse parties, that have never had, or will ever have contact. A company's management is incented to keep their job, after all that's usually their only source of income. The company's owners usually don't have enough power individually to force a liquidation, and when they do have enough power management can often work against them eroding value.
Sunlink Health Systems (SSY) is in a unique position not unlike many companies on the brink of failure. The company's management needs to work hard to liquidate balance sheet assets to stave off potential failure. As management fights to keep their jobs shareholders are rewarded as potentially undervalued assets are sold for market value.
I was first introduced to Sunklink Health Systems through Whopper Investments, he wrote them up as a potential odd-lot tender opportunity. I received their annual report in the mail, and even though I only own a tiny position for a tender I was compelled to browse their financials. Browsing their financials led me to read most of the report as I became hooked on their story.
Sunlink Health Systems purchased five hospitals in 2001 with leasehold rights to a sixth hospital. The company subsequently purchased another two hospitals and three home health businesses. The company also operates nursing homes and a pharmacy business. The company currently operates 232 hospital beds and 166 nursing home beds throughout their facilities. The company's hospitals are primarily in rural locations.
The health care industry landscape has changed dramatically since the company acquired their facilities in 2001. They went from earning operating profits from their hospitals to sustained losses most recently. Compounding their losses is the fact that the company took on debt to finance their acquisitions, and it's coming due quickly. The company doesn't have the means to raise capital, and with their operating subsidiaries generating losses management has been placed in a tough spot. As a result the company has started to sell off hospitals.
Most recently the company sold two hospitals. The first was a 50 bed facility in Southeast Missouri for net proceeds of $7.4m. The company used $5.2m of the sale proceeds to pay down their debt. The company also sold the Memorial Hospital of Adel, located in Georgia for $8.35m last year. They used the net proceeds of $7.5m to pay down debt further.
In 2011 the company sold the lease to the Chilton Medical Center to Carraway Medical Systems for a monthly rent of $37,000, and the option to purchase the facility for $3.7m. Carraway Medical Systems operating license for the hospital was revoked by the Alabama Department of Public Health due to their inability to meet financial obligations. Carraway defaulted on their lease to Sunlink. Sunlink tried to re-lease the facility but failed, their lease reverted to the original owner. This property will be a total loss for Sunlink.
In 2004 the company sold a medical center in Georgia for $40m in consideration.
As of the most recent annual report, the company owned and operated three hospitals, one nursing home, and one joint hospital/nursing home, as well as their pharmacy business.
As mentioned above the company is facing two issues forcing them to monetize their assets, they are losing incentive payments for electronic health record conversion, and they are facing a debt maturity date in the next year. As such the company expects to sell three of their hospitals within the next year if possible, and apply those funds to their debt, and use the remainder as working capital. In theory the facilities they are keeping are expected to be profitable in the near future.
It's significant that I haven't mentioned anything related to the company's valuation yet, understanding the background is important to Sunlink. The company trades with a market cap of $7.5m, but a better measure of value would be enterprise value, which is $23.3m. The company's book value is $33m, of which $30m is their physical plant, which has an original cost of $64m. The company has $9.5m of debt due in the next year, with $8.7m due shortly thereafter.
An investment thesis for Sunlink is fairly simple to construct after building out this story. Are the three hospitals the company plans on selling worth more than $18m? The two hospitals sold in the past few years sold for about $7.5m apiece (net). If that figure holds true for the three latest hospitals the company would be able to pay back their debt and have cash left over to finance working capital. The company is attempting to hold onto their best assets, the profitable pharmacy operations, nursing homes with profit potential, and land that is being redeveloped into a multi-use office park.
A simple scenario for what might happen is as follows: the company sells the three hospitals for $7.5m each net of taxes and fees for a total of $22.5m. They pay back $18m in debt and then have $6m available as cash and a greatly reduced liability structure. The company retains their pharmacy segment which is currently profitable, although barely, and the nursing home/hospital that they believe has the best profit potential.
An investment in Sunlink works out if the company is able to sell their hospitals for $7.5m or more each. If they can do that then this is a much slimmer company, with no interest payments, and a remaining collection of assets that are profitable, or will be soon. If the company can't sell their hospitals for $7.5m it's possible they will enter receivership. A bankruptcy receiver might sell the company's hospitals, but it's likely shareholder recovery would be much smaller.
Investors seem to love lottery ticket investments, and Sunlink qualifies as such. Investors have an additional factor on their side, the company's management is highly incentivized to sell the three hospitals, if they don't they will likely lose their jobs. If they do they will keep their jobs, but also reap the benefits as the share price rises, and their stock options vest.
Disclosure: Long an odd-lot.