Five Star Quality Care Inc. (NYSE: FVE) is not a company that many investors know very much about.  After the move we have seen over the last year, and then the sharp reversal over the last week, investors might want to start looking at this one.  Some new recent developments have the company under focus and there may be something for small-cap investors that look for value and for growth.  The focus of the company is on senior living communities, from independent living all the way to nursing care facilities.

In this weekend’s version of The Unusual Suspects, we noted that Five Star is expected to have a secondary offering of up to 10 million shares this week and also noted that all of the shares are being sold by the company.  This stock has found its shares selling significantly because of dilution with a drop from $7.20 before the share sale was announced, down to $6.27 on the day of the news, and then to close out the week at $6.10.  Now we have almost another 5% drop so far on Monday.

Five Star is now worth about $210 million in market capitalization and at $5.83 it has a 52-week trading range of $2.72 to $8.95.  This one peaked at an intermediate term closing price of $8.78 on April 5th.  In the ensuing nine weeks the selling has been relentless.  The stock price has witnessed roughly half of this decline after the company announced plans for a secondary offering of 10 million shares.  What a reaction!

As a backdrop to this decline, the company has enjoyed remarkable stock performance year-over-year, very attractive fundamentals and positive operating numbers.  It might make some ask if the stock was overbought during its run higher in the first place.

In spite of the recent declines, Five Star is still up more than 70% for the year.  The company boasts a gross margin exceeding 86% and a profit margin of 2%.  Its quarter-over-quarter earnings are up 20.5%.  The company is number three in its industry with a return on equity (ROE) exceeding 16%.  Its PE is a modest 8.71, nearly the lowest of public companies in the industry.  Its forward PE is less than 7.  Remarkably positive, its Price to Free Cash Flow (P/FCF) is narrowly greater than $4.

The company also noted that the proceeds from the secondary offering will be for general business purposes, which includes repaying an outstanding bridge loan and for funding in part the cash purchase price of pending acquisitions and other possible future acquisitions.  This gives at least some growth capital to the company even if it is dilutive to existing holders from before the offering.  The current gross proceeds would come to close to $55 million after fees.  Our only concern in comparing this one to peers in senior care is that the company may not have a dividend for some time or that when it does declare a dividend that it may lag peer payouts.

With an average volume narrowly exceeding 200,000 shares per day, Five Star would not fit all portfolios.  Analysts consensus is a mediocre 3.0 on a 5 point scale, but we only saw one official price target at $7.00 per share.  That will change after the secondary offering as the company is effectively raising capital and simultaneously increasing its presence with Wall Street analysts.  The joint book-running managers for this offering are Jefferies & Company, Citi, and UBS Investment Bank.

It was back in February that a firm called Davenport & Co. raised its rating to “Buy” and the company’s investor site lists that Stifel Nicolaus also covers the company.  After the offering is completed, Jefferies, Citi, and UBS will all likely cover the senior living operator with formal analyst coverage.

It is very rare that a secondary offering alone creates a 20% drop in the price of stock without other news.  This is one offering which investors and traders alike will want to watch as it comes to fruition.  Investors who bought shares before today may feel like they were bitten by the company.  They should consider that the bite was only by someone with dentures.

JON C. OGG

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