Description

VIC Writeup February 2019 MPW

Summary: MPW is a hospital REIT trading near their all-time high multiple of AFFO despite a potential problem at their largest tenant, Steward Healthcare (37% of Net Operating Income).  They are on the wrong side of the shift from high cost inpatient to lower cost outpatient care and have grown their Enterprise Value “EV” 10x over the last decade+ through acquisitions while cash flow/share has been roughly flat.  Recent cashflow growth has come from enabling Cerberus (via Steward) to acquire middling hospital assets with little-to-no equity.  Should problems at Steward manifest, we would expect impairment of both cashflows and the multiple.

MPW is a REIT that owns acute care hospitals, urgent care, surgery centers, in-patient rehabilitation facilities and long term acute care hospitals.  They do not operate the assets but act as a financing vehicle for operators of the facilities via sale leaseback transactions, as an alternative to leverage loans and high yield debt.  Much of the assets are secured by corporate guarantees or ring-fenced pools of collateral.  This leads to the perception that it is a safe investment.  I question the validity of the perception that MPW is a “safe investment”.  There is a long history demonstrating REITs with tenant issues see negative asymmetry (both to earnings and multiples).  This is especially true in the REIT healthcare space where changing an operator is a challenging transition that impairs economics.  It is not as simple as swapping tenants as in other real estate asset classes.  For example, one can research the history of SNH, HCP, VTR, WELL, SBRA, OHI, CTRE, LTC, SNR and MPW themselves. 

On the surface and what you’ll read in sellside research is these are well covered hospitals with guarantees with stable and predictable cashflows.  The reality is different.  MPW has been providing FFO guidance starting with their first full year as a public company in 2006.  They have missed the LOW END of FFO guidance in 9 of the past 13 years (assuming 2018 comes in line with street expectations).  I do not believe there is another REIT management team that has been worse at predicting their own earnings than MPW.  In fact only in 2012 did they beat the range.  Several of these have been epic misses by REIT standards.  In 4 of the years the misses have been >10% and the average miss is 9%.  The guidance misses have mostly stemmed from tenant issues (e.g. bankruptcy, restructuring, missed lease payments, forced dilutive asset sales).   In January 2019, MPW helped finance a 7x levered hospital acquisition in Australia for BAM at a rumored 5.0% cap rate well below their guidance of 7.5-8% setting them up for a likely miss of their 1.41-1.46 forward FFO guidance.

The landscape of healthcare in the US is constantly evolving and difficult to predict.  There is one clear trend: inpatient spend is heading lower.  According to American Hospital Association, in 2001 ~2/3^rd of health system revenue was from inpatient spend, today that number is ~50% and trending lower.  The movement towards outpatient will continue as inpatient costs are unsustainably high and payers push patients away from hospitals and towards lower cost facilities such as medical office buildings.  This trend is responsible for many of the tenant issues that have arisen throughout the past 10+ years in MPW’s portfolio, which led to several of the guidance misses.

The tenant quality of MPW is also suspect.  HCA, arguably the top healthcare operator in the country, does not do sale leasebacks on their assets.  They finance themselves with debt and equity.  The hospital operators that choose to do sale leasebacks are ones that cannot efficiently access the debt markets.  MPW’s operators are mostly owned by private equity, i.e. intermediate term holders of the healthcare operating companies looking to maximize proceeds and derisk their equity investment.  As I’ll show later, I believe MPW has not only provided their tenants’ private equity sponsors with a full cash-out of their equity, but has enabled them to lock in high equity multiple returns.

MPW’s valuation is expensive compared to history.  MPW currently trades at 14.9x consensus 2019 AFFO/share of 1.21/sh which includes ~20c of straight line rent and other adjustments matching the company’s guidance.  This compares to MPW’s historical average of 10.9x and historical range of 8.5 to 15.0x.  We have seen 13.5x+ levels only three times: 2010, 2013, and today.  The stock is valued as if the company’s guidance is credible and nothing can go wrong.  History suggests the guidance range is a ceiling.

MPW has significantly grown EV over the past decade, but that has not translated into FFO or AFFO per share growth.  Ten years ago MPW did $1.25 per share in FFO and with a $1 billion EV.  Today the EV is $10 billion and FFO per share is expected to be $1.33 for YE 2018, equating to less than 1% per annum FFO/shr growth for a company that has expanded EV by 10x.  MPW grows for growth’s sake to enrich management and hide past sins.  Their investment strategy is a game of hiding the pea by continuing to expand to mask underlying issues.  I believe that at $10 billion this game becomes far more challenging.  Their most recent 50% growth spurt over the past 3+ years has been related to one single tenant, Steward Healthcare.  While MPW has several tenants that are concerning, I am going to focus on Steward for the purpose of this write-up, which is 37% of their exposure (~33% PF for Australia deal) and their single largest tenant.  I contend that Steward could become an issue and the market is not discounting that potential outcome.  Steward is a portfolio company of Cerberus in year 8 of their investment and I believe Cerberus has already realized at least a ~3x equity multiple on their investment and no longer has skin in the game.  Further I will show that MPW enabled Cerberus to aggressively buy middling assets with little equity risk.   By growing Steward, MPW was able to offset dilution from asset sales and other tenant problems.  MPW thought they could then turn around and sell down their Steward exposure, but they weren’t ultimately able to find any buyers.

Steward Background

Caritas Christi was a struggling non-profit hospital system in the greater Boston area run by the Archdiocese of Boston.  According to local news articles in 2010 the system lost $25m in 2009 and had unfunded pension liabilities of $230m.  The Archdiocese hired a new CEO who was able to convince the Attorney General of Mass. to approve the conversion of the non-profit hospital into a for profit hospital.  The constraint was $400m of capex was required to be invested in the hospitals over 4 years to improve care and the owner of the hospital could not pay themselves a dividend for 5 years. Below is a summary of timeline of events which I pieced together through news reports and public filings in an attempt to “follow the money”:

2010 Cerberus bought the hospital and we see that Cerberus’ equity investment was $246m per Mass Attorney General disclosure and various news articles.

2012 Stewards MOBs were sold for $100m. 

2013 Cerberus sold the rights to work at the hospital to a hospitalist for $45m, sold their testing lab for $35m, and vacant land for $24m.  Total proceeds of $105m.

2014 Cerberus closed Quincy Medical Center (1 of the 11 hospitals) and sold the vacant building to a developer for $12m. 

2015 Cerberus fulfills its obligation to spend $400m of capex and can now start taking money off the table.  Per the Mass AG, Ceberus fulfilled their obligations spending $423m on capex by levering up the company.  The operations were not profitable in any of the years listed from 2012-2014 in the report.  Summarizing the AG report 2012 -$2mm; 2013 -$14m; 2014 -$7m in operating income.

Here is an excerpt from the Mass AG report “Since initially investing $245.9 million in the system, Cerberus has not contributed additional equity to Steward. Similarly, Steward did not distribute significant amounts of cash or other assets to Cerberus. For its cash requirements, Steward principally relied on two forms of bank financing: a revolving credit agreement and a term loan.”  We know Steward levered up and sold off assets worth at least ~$220m which is how they funded the required capex.

2016 - Steward owned 10 hospitals and sold 9 of them to MPW in a $1.25bn sale leaseback.  This closed after the 5 year period which precluded taking a dividend.  According to news articles Steward’s CEO said $400m was used to pay down debt at the company and $100m will be used to fund capex… implying some or all of ~$750m went to Cerberus which gives them a ~triple on their equity investment and removes all of their equity exposure. 

2017- Steward buys 8 hospitals from Community Health Systems (Ticker CYH) for $304m, the deal is financed by MPW who pays $400m for the real estate at 7.5% CR.  MPW paid more for the real estate than Steward paid for the real estate AND the operations.  Note that CYH is a struggling regional hospital company and per the company they are selling their weakest assets to pay off debt.  One of the 8 hospitals closed a year after this deal and another is rumored to be struggling.

2017 – Cerberus sues the State of Mass to no longer file financial statements with them and has not issued statements since 2015 which were the 2014 financials noted above.   The case appears to remain open although I believe Stewards move to Dallas will enable them to keep the financials in secret.  I suspect the reason(s) for the lack of disclosure was the fallout that could happen if it was exposed that Cerberus took out $750m in a dividend, hiding that the hospitals are not profitable or both.

2017 – Steward buys IASIS’ 18 hospital portfolio from TPG for $1.9bn. 11 of the hospitals are sold to MPW for $1.4bn to fund the acquisition.  From an article on Bloomberg (May 19, 2017), TPG bought IASIS in 2004 and got just a 1.5x equity multiple on the takeout… they struggled to make this deal work.  Per the 10Q filed before the takeout (IASIS had public filings due to high yield debt) IASIS had $1.8bn of debt vs. a purchase price of $1.9bn.  The deal looks to have paid off 2019 bonds that were due and put some money into TPG’s pocket.  I don’t think Cerberus put up any equity into this deal.  For IASIS, per Bloomberg there is $848m of Term loans outstanding due in 2021.  FWIW, Moody’s withdrew its rating on IASIS when this deal happened from a Ba3 rating.  Fitch rated IASIS debt B.  All told, I think Steward paid $1.9bn for IASIS funded with ~$800m of debt and $1.4bn of mortgages/sale leaseback proceeds from MPW, implying Cerberus received excess proceeds in the hundreds of millions to do the deal.

2018 – MPW, after completing the three transactions with Steward, now has 37% NOI exposure to the tenant.  They announced on 2017.4 call they will sell down the Steward exposure and it was a “key goal”.  The plan was to make a series of sales to bring exposure down initially <30% and ultimately to <20%.  MPW marketed the assets for six months and found a Chinese buyer who was interested in purchasing ~$600m of assets.  The buyer fell through and there are no additional buyers interested.  MPW stopped shopping the assets in August according to their 2018.2 call.  Reminder the period of January 2018 to August 2018 had a frothy debt market and hundreds of billions of equity capital looking for deals yet nothing was able to be executed. 

As part of the IASIS transaction Cerberus took 10m shares of MPW stock.  They no longer show up as a holder on Bloomberg.  I believe Cerberus is out of the stock.

Catalyst

Catalyst:

MPW is trading at peak multiples based on street numbers that match management guidance.  Management has a history of missing guidance numbers and taking the under has historically been a good bet.  Any slip up with a tenant will cause another miss and I would expect if their numbers come down so will their multiple.  There is enough history and evidence to suggest that their largest tenant, Steward, is not on firm financial footing.  MPW enabled Steward to go on a shopping spree acquiring weak assets with MPW, not Cerberus, shouldering the risk.  Assuming the converse, if Steward is fine then why was MPW unable to sell down their exposure in a frothy debt market when it was a “key goal” for 2018?  Should Steward become a problem tenant, you can easily paint some catastrophic scenarios for the stock.  Recently, Sabra Healthcare (ticker SBRA) saw a deterioration with a known 9% problem tenant, driving the stock down nearly 20% relative to the VNQ (the ETF which tracks the US REIT market). There have been numerous tenant issues across the health care REIT space and a typical impact is 10% to 30% rent cut if the company is a going concern.  When REITs remove the operator and sell the assets we typically have seen mid-teens cap rates for the sale price (based on prior rents) to new operators.  A 20% rent cut for Steward is ~$60m and would be a ~13% cut to AFFO.  I believe under a scenario of a tenant issue the historical average AFFO multiple of ~11x would be a likely near term ceiling for the stock when coupled with a 13% guidance cut represents a 30% decline in the stock.   Finally, you don’t actually need a tenant issue to manifest itself for the MPW short to work as they are currently valued at the high end of their historic equity AFFO multiple.