Description
Description
Care Investment Trust (CRE), trading at 0.83x P/BV, offers investors a unique situation with an asymmetrical risk/reward profile due to the company being valued as a mortgage REIT, where comparable companies such as NRF, NCT, and CBF trade on average at 0.72x P/BV, when in fact it is well on the way to becoming a healthcare equity REIT, where comparable companies such as HCP, HR, and VTR trade at 2.0x P/BV. We believe an investment in CRE has significant downside protection and conservatively offers investors 25-50% upside in the next 12 months due to several catalysts that have either just been announced or are on the horizon (change in strategy, recent deal execution, change in analyst coverage). What is most attractive to us about this position is its limited downside due to 1) its low valuation 2) strength of CRE’s underwritten book of loans, 3) its strong management team, which is focused on creating shareholder value and 4) its limited leverage on the balance sheet. We believe an investment in CRE is timely today given the company’s recent deal announcement and the subsequent conference call to discuss this deal on Wednesday, January 9th.
Cause for the Sell-Off
The reason for today’s valuation is based on several factors. First, the company went public in June, at which time the public sentiment towards real estate and REITs began to sour. Against this backdrop, the deal was also cold, evidenced by being down 10% from its $15.00 IPO price following the first day of trading. Second, a difficult borrowing environment due to lenders tightening their credit standards prevented CRE from securing a warehouse line until October. Finally, Street analysts have never covered the company as an equity REIT; instead, they have covered CRE as a mortgage REIT. Given the company’s announced change in strategy and recent deal announcement, we believe CRE will soon have to be covered as an equity REIT.
Investment Case
1) Book value protection From our conversations with management regarding the structure and types of loans on the books, management’s strong underwriting background, and our review of the asset types and states in which they operate, we believe book value is solid, as loan coverage ratios (1.8x debt coverage) are healthy and the assets should continue to perform well. Management believes its loan portfolio has a two-year average life, and in addition, believes that its current borrowers will seek to refinance their current loans with CRE. The results so far have supported management’s claim: $26.1mm of loans (9% of the portfolio) has been prepaid in Q307 with a scheduled $34.6mm payment due in Q407. We welcome the asset turnover as it provides CRE with liquidity to pursue its equity strategy.
2) Recent change in strategy The company, given the limited leverage available for its mortgage strategy, announced on its 3Q conference call that it will be focusing exclusively on becoming an healthcare equity REIT. This was reinforced by their recent deal announcement, which we believe will lead to a change in analyst coverage and investor perception of the name.
3) Equity deal announcement The first evidence of the aforementioned change in strategy was announced this week, as the company closed on a $72.4mm equity investment with a guaranteed 8% preferred return and an option to develop an additional $232mm of property. This deal is positive for the company as it has good structural characteristics and helps fill the equity deal pipeline for the future. (We estimate the $232mm option would require $65-70mm of capital, which would equal one quarter of deployment).
4) Upcoming conference call on Wednesday, January 9th Management is hosting a call on January 9th to discuss this deal and plans for 2008. We believe this will be positive for the stock as management lays out its plans to continue its conversion into an equity REIT.
Valuation Summary
Q407 Q108 Q208 Q308 Q408
AFFO ($mm) 3.5 3.9 4.1 4.6 5.6
AFFO / Share $0.18 $0.19 $0.20 $0.22 $0.26
Dividend / Share $0.17 $0.18 $0.19 $0.21 $0.25
Financial Statistics
Cash ROE 5.2% 5.3% 5.6% 6.2% 7.6%
Debt / Equity 0.1x 0.2x 0.3x 0.5x 0.7x
Target Price
Target Dividend Yield 6.50%
Target Price at Indicated Yield $15.37
Upside from Current Price 31.7%
Implied P/BV 1.1x
Total Return (with dividends through Q408) $16.11
Upside from current price 38.1%
Target Dividend Yield 6.00%
Target Price at Indicated Yield $16.65
Upside from Current Price 42.7%
Implied P/BV 1.2x
Total Return (with dividends through Q408) $17.40
Upside from current price 49.1%
Note: Cash ROE defined as AFFO return on equity
On what we believe are conservative numbers, we see CRE being able to obtain leverage of $200mm (0.7x D/E) by year end 2008, which will allow the company to ramp up its dividend to $0.25 / share (growth of 47% y-o-y). Although CRE would be a compelling growth story within the typically slower growth healthcare equity REIT space, we conservatively value the company in a range of $15.50-16.50 per share by year-end 2008, in line with healthcare REITs that today sport a 6%-6.5% dividend yield. We believe this valuation gives little credit to the company’s growth story.
Lastly, we believe CRE is an attractive takeover target for larger healthcare REITs, such as HCP, NHP and VTR. With large healthcare deals being harder to come by and the larger, public companies seeking avenues of growth to put their cash to work, we think CRE is a prime target.
It is worth mentioning CRE’s management team at this point. We have found the management team to be very shareholder friendly and proactive in seeking to create shareholder value. Our background checks on key management members, Scott Kellman and Flint Besecker, has cemented our positive view of this management team. (We note Kellman’s work at OHI and Besecker’s work at GE Financial and Heller Financial). We give management high marks for managing through a difficult time period post-IPO, during which they were able to obtain a warehouse line while banks were tightening credit, and made the switch to an equity REIT strategy when it became clear the CLO market was not coming back in the near future. At each turn, this team has consistently sought to maximize value for its shareholders.
Should the company’s value not be reflected in its trading price and management were to pursue a sale process, we believe a buyer could comfortably pay $18.00 per share (upside of 55% from today’s price), which implies 1.3x book value, but would be highly accretive to the larger healthcare REITs who have a lower cost of capital, efficiencies of scale and trade at valuations of 2.0x P / BV.
Catalyst
1) Equity deal announcement and subsequent conference call on Wednesday, January 9th
2) Change in analyst coverage from mortgage REIT analysts to healthcare equity REIT analysts
3) Market recognition of the change in strategy to an equity REIT and subsequent revaluation