Description

Summary

Buy Medical Properties Trust – MPW. $11.78

MPW is a hospital focused healthcare REIT.   It trades VERY cheap on an absolute and relative basis (8.7x FFO, 8.9% dividend yield, and 8.75% implied cap rate).  Its assets and properties are good/fine. 

I think there’s 45% total return upside over 1 year to get to my $16 price target.  Plus you're paid to wait. 

Plus, I believe it is a very attractive takeout target for the big healthcare REITs (VTR, HCN, and HCP), who have become increasingly interested in the hospital real estate.

Ventas - VTR - recently bought hospital assets (Ardent transaction property and opco with a 7% cap rate and 2.5% annual rent escalators). And all 3 have been looking at buying more hospital real estate (partly thanks to the Obamacare tailwinds reducing bad debt, and increasing volumes and lives covered).  So obviously hospitals have been doing better (take a look at HCA, UHS, LPNT, THC, and CYH – although THC and CYH generally don’t execute well)

MPW is down recently from a combination of

-          A secondary offering that they did on 8/6/2015 to fund a recent $900mm acquisition (of Capella’s hospital real estate and opco).  The offering was downsized and priced quite cheap amid general negativity around long duration real estate, healthcare REITs, triple net lease, etc.

-          Not surprisingly, REITs are generally disliked at the moment.  Those who are raising equity are being further punished. 

-          MPW hasn’t been the greatest at investor relations or communicating with the street.  They’re great allocators and operators,  but they could use help in IR

-          Also, I think people had been a little miffed about their foray into European hospital real estate (mostly in Germany, but also did some small acquisitions in Spain and Italy of only $122mm in purchase price – so only 2% of total assets in Italy and Spain, but they did say that they want to do more in Europe)

o   However, I think European real estate presents a great opportunity given the high cap rates and very cheap cost of debt financing.  The spreads there should narrow as ECB QE continues.  MPW raised EUR 500mm 7 year unsecured debt on 8/12 for 4% to fund the recent German acquisition.  Their comparable USD denominated debt trades at 4.5% yield

Valuation: Cheap cheap cheap

8.7x normalized FFO (pro forma for recent acquisitions), and  8.9% dividend yield (with a 75-80% dividend payout ratio) and 8.75% cap rate.  This is very cheap on a relative and absolute basis 

-          Other healthcare REITs trade at 15.3x 2015 FFO, and 14.3x 2016 FFO, and 5.5-6% dividend yields. 

o   around 6-7% cap rates

Admittedly, hospitals deserve have higher cap rates since they’re not considered as interchangeable and are more specialized (compared to, say, class A office building perhaps). 

But MPW has had a great track record of operations and has very few defaults and even fewer losses ( <1% loss rate over the last 10 years).

The appropriate cap rate is around 7-8%,  call it 7.5%, which would value NPW at $14.50

Most REITs also trade at a premium to NAV (10-20%), meanwhile MPW trades at a discount to NAV now. You could get to a $16 price target using a 10% premium

-          That would equate to a 6.6% dividend yield and 11.75x FFO,  still pretty cheap vs. peers and perfectly reasonable

That’s 36% upside from price appreciation,  +9% dividend,  for  45% total upside. 

Catalysts

- Management gets on the road again and tries to explain their story (like last time when the market didn't like the Median German acquisition, they went on an extensive roadshow and explained everything.  This set them up for a strongly oversubscribed equity offering and the stock moved higher)

- MPW sells some of their better assets and either recycles the capital or pays down debt – they seem to be willing to do so

- Investors understand that MPW doesn't want to (and doesn’t have to) raise more equity

- Management clarifies the confusion post the recent equity offering

- They continue to pay the 9% pro forma dividend (which is very safe)

- VTR, HCP, or HCN buys them

Capital Structure

233mm shares pro form at $11.78.  $2.74bn market cap

$3.25bn debt

$46mm cash

2016 pro forma financials

$1.36 FFO/share

$575mm NOI

Sentiment

In general, sentiment is pretty negative on long duration REITs at the moment.  Generalists don’t want to own them ahead of a rate hike (despite 10 year yields actually generally trending flat to down as of late).  I’m also of the view that the long end rates will stay low thanks to global QE and the relative attractiveness of U.S. Treasuries versus other government bonds.    REIT investors have been hiding in apartment REIT, secular growing REITs (like towers and EQIX), and had been hiding in hotels, but those got slammed on weaker RevPAR from a strong dollar, and supply concerns (Airbnb and new hotel growth).

For MPW, most the concerns are just around the macro headwinds (rising rates, and hence triple net lease ones not as well positioned).  Some of the discount that MPW has is just around investor communications.  They’re not the best at communicating or getting the word out.

They have tried to change that in the past though.  For example, when they bought a bunch of German hospital assets last year, they did a poor job explaining the deal at first.  They went on an extensive roadshow and drummed up more than enough demand for the eventual offering to fund that deal.  MPW stock was actually up around 1% on the offering announcement, and then rallied a few more percent after the deal was done.

Recent Secondary Equity Offering

There’s been a lot of confusion after the recent equity offering that they did to fund the Capella transaction.  They priced it at $12.25, the stock was trading at $13.50 the day before.

The transaction would have still been accretive for them below $12.  Of course the weak reception for the equity offering makes it tougher for MPW to do future FFO accretive deals (MPW has had a track record of increasing FFO in the teens from a combination of accretive acquisitions and organic rent growth).  Some investors are worried about the need for future equity issuance, what the rating agencies think, and what MPW’s strategy is.

Here is some clarification

-          They do not need to raise more money.  There’s no immediate need and they’re comfortable with their capital structure now.  They had previously wanted 50% debt/assets,  but now are at 55%, which they can live with

-          Their normalized FFO run rate is now ~$1.36,  up from the $1.28-$1.32 that they guided to pre deal (just 2 days before the equity offering), given more accretion from using more debt

-          The ratings agencies are fine with this and there won’t be rating changes

-          They’re done with new deals for now and equity raises.  Until the market is more agreeable

Normalized FFO – 4.6% more accretive with more debt

-          Their normalized FFO / quarter is about 2 cents higher.  They had previously said 32 cents / quarter run rate in the previous prospectus (or $1.28) with the previous equity raise assumptions.  Now it’s more like 33.5 cents/quarter

-          The original prospectus had assumed 45mm shares, issued at the prevailing market price. 

o   At the time, they ran pro forma adjustments through Jun 30.  The #s came to be 32 cents in normalized FFO.  i.e. the $1-28-1.32 guidance on the earnings

-          Now with more debt, less equity, taking that to 33.5 cents a share x 4 = $1.36.   

-          So closer to $1.36,  6 cents higher FFO than before

-          That doesn’t include the extra accretion of 2 cents / share from the operating company portfolio of the recent Capella hospital real estate acquisition

o   They didn’t include the Capella opco accretion since it’s not contractual, but they are confident that they’ll get it

More equity needed? No

-          They don’t need to raise more equity.   They’re also done with the debt that they need to raise 

-          They previously wanted to hit 50% net debt / total gross assets < that’s where they thought they would have been at the total equity offering at the originally anticipated amount

o   And 6x net debt / adjusted EBITDA

-          Now pro forma ended up at 54%  net debt/total assets,  a little over 6x net debt/EBITDA

o   They are fine with this level of leverage.  The rating agencies are fine with it as well  (MPW is rated at Ba1 / BB+ from Moody’s and S&P).  They were on the path to be investment grade.  But that may take a while.  The rating agencies want more scale, more tenant diversification, and for net debt/total assets to get back down to 45-50%

-          No unfunded commitments.  No plans at this time to come to market

-          They just termed out the rest of the debt for the recent German acquisition

Rating agencies?  They’re fine with it

-          Credit rating agencies are fine and comfortable.  It’s a bit higher than the 45-50% that they’d rather be (their target area).  But they have more diversification and size now

-          This pushes out a potential upgrade to IG. Although an upgrade wasn’t in the short / medium term anyway

-          To get to IG, they need

o   gross assets >$5bn – currently at $5.6bn

o   Tenant concentration of the top 2 < 30% - currently at 35%

o   Fixed charge coverage >3.5x – currently at 3.5x

o   improvement in leverage (debt/EBITDA <4.5x) – currently at 6x

o   debt capital <40% - currently at 55%

Future deals / capital?  - they’re done, can’t do anything

-          The market’s receptiveness throws a monkey wrench in future acquisitions. 

-          And leaves people with bad taste in their mouths for another equity offering

-          They could do potential co-investment 

-          Could sell assets and recycle capital.   E.g. Has freestanding ERs with Adeptus;  developed those at low teens cap rates

o   A number of those freestanding ERs developers have sold those at lower cap rates.  They could maybe sell some of those 6-7% cap rates.  

§  Could harvest some and gain there and recycle that capital.   

-          Has other hospital properties with good double digit cap rates / returns right now.  Perhaps could sell them for 7-8% cap rates

-          So for now, they’re just sitting on the sidelines.  Not paying down debt,  just waiting for the market to clear up

Technicals

Historically, this ~$12 level has been a strong support level over the last 5 years.  It’s bounced up off that level in 2013 and 2014

While $16 has been resistance. 

It’s pretty oversold by any measure

MPW has been down around 13% over the last week,  while other healthcare REITs have been flattish over the same time frame

Recent Acquisitions

MPW has generally made smart and accretive acquisitions and deals over its history

In August 2015, they bought Capella for $900mm - LTM EBITDA multiple of 7.8x ($600mm allocated to real estate, $300mm allocated to the operations)

-          9.1% yield

-          CPI based escalators from a 2% min, 4% max.  15 year term, with 4 five year renewals

In December 2014 they bought Median.  The largest acute care and rehabilitation hospital system in Germany.  They bought it for EUR 705mm or $900mm USD,  9.3% lease rate.

-          27 year master lease

-          Lease payment increase by 70% of German CPI, or 1% floor

They also have some organic new construction, but it doesn’t move the needle much

Management

I think management is very good at what they do (underwriting and operating hospital real estate and operations).

It’s a pretty small sleepy company.  Not the best at IR

I think they should sell themselves.  They’re not against it at least.    This makes so much sense for VTR or HCP or HCN

Properties

62% general acute care

26% inpatient rehab

8% Long term acute care

80% US

19% Germany

1% UK

They also have a small portion of RIDEA / opco investments in hospitals, which include profit interests, equity investments, and equity like loans

Those have been doing well thanks to the favorable hospital environment, which I think will continue as the economy improves (which drives more commercial coverage which has higher reimbursement), and further benefits from Medicaid expansion and public exchange volume increases

- RIDEA stands for REIT Investment Diversification and Empowerment Act

Tenant / Credit quality

They’ve had <1% of credit losses over the last 10 years. 

They currently have 2 facilities (out of 174 – pro forma) which have been in bankruptcy for about 1-2 years, but both facilities have continued to pay rent during the entire time, and MPW expects to get new tenants into both facilities. 

They’ve generally done a great job of working out any troubled properties, while continuing to collect rent

98% of their properties have EBITDAR/rent coverage of over 1.5x.  ~96% of their properties have EBITDAR/rent coverage over 2%

 Triple net leases

- The majority of their hospitals are effectively under triple net leases

Rent escalator distribution:

- 89% based on CPI

   - 41% full CPI (with floors or 1-2.65%)

   - 48% are CPI based with collars from 1-5%

- 9% based are fixed, at around 2.5% increase annually

- 2%  flat

Risks  

 - Regulatory / reimbursement:   However, Obamacare and CMS have been favorable for hospitals. Yes hospitals are urged to contain costs, but the government isn't out to get them.  A lot of hospitals (e.g. the non-profit ones) don't make much money, so it's hard to cut reimbursement further or else you put a lot of them out of business

 - Equity raises:  these guys raise equity (and debt) to make new investments / purchases.  Generally they've been able to buy hospitals around 8-11% initial yields (while MPW trades richer, so its accretive).  Historically, they’ve been able to accretive buy assets, raise rents, and grow FFO/share at low teens CAGRs

 - Interest rates: a rise in rates could pressure valuation and financing costs.  Although their 9% dividend yield and 8.75% implied cap rate is relatively cheap and already very wide on an absolute and relative basis.  The spread versus rates is already very wide, and hence MPW should be less sensitive to rising rates

- Tenant defaults:  MPW has plenty of small tenants who can run into random / weird issues.  But generally these tenants reorganize, or MPW can find someone else to take it over.  The have 2 buildings (out of 174 going) through restructuring: both are still paying rent.    MPW has historically been able to keep collecting rents while tenants reorganize, or get someone else into the property.   Hospitals are generally tougher to re-lease though, hence why the returns are higher

Catalyst

Catalysts

- Management gets on the road again and tries to explain their story (like last time when the market didn't like the Median German acquisition, they went on an extensive roadshow and explained everything.  This set them up for a strongly oversubscribed equity offering and the stock moved higher)

- MPW sells some of their better assets and either recycles the capital or pays down debt – they seem to be willing to do so

- Investors understand that MPW doesn't want to (and doesn’t have to) raise more equity

- Management clarifies the confusion post the recent equity offering

- They continue to pay the 9% pro forma dividend (which is very safe)

- VTR, HCP, or HCN buys them