Covington Issues Open Letter to Advocat (AVCA) Shareholders Following Rejection of $8.50/Share Bid

May 16, 2012 8:16 AM EDT
Covington Investments, LLC today issued the following open letter to the shareholders of Advocat Inc. (NASDAQ: AVCA) in response to the rejection by the Company's Board of Directors of Covington's proposal to purchase all common shares of Advocat for $8.50 per share in cash in a negotiated transaction:

Dear Fellow Shareholder:

We are extremely disappointed by the response of Advocat Inc.'s Board of Directors on May 14, 2012, rejecting our proposal to acquire all common stock of Advocat for $8.50 a share in cash. Just two business days after our letter and press release on May 11, 2012, the Advocat Board released a letter that says it has thoroughly evaluated Covington's proposal and rejects it in favor of pursuing its own strategic plan. Advocat's letter states that the Board takes its fiduciary responsibility seriously and has thoroughly reviewed our proposal, but it appears to us that the evaluation of Covington's high premium offer was done without obtaining outside advice from an independent financial advisor.

Our proposed price of $8.50 a share represents almost a 100% premium to the unaffected share price and values Advocat at premium multiples compared to other publicly traded skilled nursing facility companies. We believe it is a compelling proposal. Advocat's Board indicates our offer is inadequate, but does not articulate how its strategic plan (which, as indicated in the Attachment to this letter, has not significantly evolved in years) will achieve more value in the foreseeable future. As shareholders, you have a right to understand the clear basis for the Board's determination of the inadequacy of our offer.

Advocat also indicates its stock is undervalued. We believe that the unaffected stock price reflects the uncertainty of Advocat's strategic plan and that, in the absence of our offer, it will stay at or around the unaffected price based on the Company's performance. We are offering a near 100% premium to the unaffected price to finally allow shareholders to achieve a return at a full and fair price. One need only look at a stock chart to recognize the shares have not appreciated in value and have traded in a fairly tight range for the last several years in spite of the strategic plan referenced by the Company. Our offer also eliminates the substantial industry and strategic execution risks facing the Company.

Advocat in its letter states that its strategic initiatives and investments will generate value that "will be realized over the next several years." We disagree. These strategic initiatives have been discussed by the Company in its quarterly earnings calls and SEC filings for the past several years. However, recent quarterly earnings do not show any track record of significant improvement. Moreover, the Company's own proxy statement filed on April 30, 2012, points to declining financial goals in terms of setting the bar for executive compensation. Specifically, the proxy states that 40% of the bonus for executive officers is based on operating income performance. It then states that the budgeted operating income, as adjusted, for 2012 is $9,299,000. This compares to the budgeted operating income in the 2011 proxy for determining executive bonuses of $11,556,000, a 20% decrease. Actual operating income, as adjusted, for 2011 was $6,127,000. How long must shareholders wait for things to improve such that value in excess of $8.50 a share is created for shareholders? And why should shareholders accept operating income levels for determining bonuses that actually decrease? The Company appears to be aiming lower not higher.

Rather than seeking independent shareholder input on our proposal, Advocat put forward that the opinions of its Chairman and Vice Chairman of the Board "serve as useful proxies for the views of many of [Advocat's] shareholders." We think it is important that the Board consider what is in the interests of all shareholders, not just "two of [its] significant shareholders" who have financial interests as directors that are not the same as the other shareholders. Moreover, contrary to the Company's assertion, the objection of these shareholders is not determinative of the successful conclusion of a negotiated merger transaction, and should not be a legitimate reason to support a decision not to engage with us. We do not understand how the Board can put a "not for sale" sign on the Company, especially in the face of an offer with such a significant premium relative to the Company's strategic plan which simply has not materialized.

In its letter, Advocat implies that it has engaged with Covington by referring to a meeting with two directors solely "in their capacity as significant shareholders" of the Company. However, they did not say anything or ask questions at this meeting. In our view, a one-sided conversation does not amount to engaging with us, and we remain perplexed at the Company's continuing refusal to do so.

Please join us in expressing your dissatisfaction with the Advocat Board's decision. Specifically, we encourage you to call or write the directors and management urging them to engage in meaningful discussions with Covington regarding our proposal. As stated previously, we remain interested in a mutually agreeable and negotiated transaction. The contact details are:

Advocat Inc.1621 Galleria BoulevardBrentwood, TN 37027-2926Ph: (615) 771-7575Fax: (615) 771-7409

It is clearly in the interests of all shareholders for the Board to take prompt action to allow shareholders to realize compelling value for their shares now.



John E. McMullanPresident Covington Investments, LLC

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