Description

Description

A long position in VTR should provide 20 - 30% upside with minimal risk.  The stock is mispriced due to macro factors and negative issues that are temporary in nature.  For hedged investors, market risk can be hedged by going long VTR and short HCN and OHI in ratio.

Company Overview

Ventas (VTR) is a large-cap healthcare REIT that is in the S&P 500.  It is in the process of spinning off the skilled nursing portfolio into a company called Care Capital Properties Inc (CCP).  The spinoff is expected to be completed in 2H15.

Background

VTR was founded in 1983.  The current CEO, Debra Cafaro, joined the company in March 1999 when it was close to bankruptcy and successfully turned it around.  She is highly regarded as a shrewd capital allocator/dealmaker and rightly so.  Annualized return from the start of her tenure till now is 22.3% vs 11.4% for the Dow Jones US REIT index.

VTR generates consistent cash flow by owning a diversified portfolio of healthcare real estate.  It invests in senior housing communities (SHC), skilled nursing facilities (SNF), medical office buildings (MOB), and hospitals.  Dividend per share has grown at 8.6% CAGR in the last 10 years.  During the Great Recession, the dividend stayed constant at $2.05 and grew again in 2010.  This is a testament to the remarkable resilience of VTR’s portfolio.

The total market value of healthcare real estate is estimated to be $1 trillion and less than 15% is owned by public REITs.  VTR has ample opportunities to grow.

Data cited below are as of 1Q15.

SHC

·         VTR owns 69,617 units of seniors housing.  31,572 units are under the operating model (SH-OP) where VTR takes operating risk and hire an operator to manage the property.  The rest are under triple-net lease (SH –NNN) structure with annual rent escalators but less upside.

·         Quality mix = revenue from private pay and Medicare and a higher number is preferable.  Qmix is 100% and 95% for SH-OP and SH-NNN respectively.

SNF

·         The SNF portfolio will be spun-off as CCP.  VTR is keeping the properties that are leased to Kindred and Genesis

·         Triple-net structure lease; Qmix = 51% and 1.8x cash flow coverage

MOB

·         Hospitals generate demand for service which in turn creates strong tenant demand.

·         On-campus = MOBs which are physically located on hospitals sites.  Affiliated off-campus = MOBs that are not on site but are affiliated with hospital systems.

·         On-campus > affiliated off-campus > unaffiliated off-campus.  On-campus MOBs have better economics and higher barrier to entry than their off-campus cousins. 

·         71% and 25% of NOI are from on-campus and affiliated off-campus MOBs respectively.

Ardent and CCP Transaction

Ardent

Ardent is a private for-profit hospital company.  VTR will purchase Ardent for $1.75B and sell the operating company to Sam Zell for $475mm.  On a net basis, VTR invested $1.4B and will receive an initial cash yield of 7.5%, 2.5% annual escalators with 3x rent coverage.

CCP

Ray Lewis, an experienced Ventas executive, will become the CEO of the new company.  Pro forma 2014 NOI is about $295mm and $22mm for G&A.  The balance sheet will have $1.3B of debt.

Post Transaction

Both transactions are expected to close in 2H15.  Post-closing NOI concentration will be SH-OP 29% vs 26% pre-closing, SH-NNN 26% vs 24%, MOB 20% vs 18%, hospitals 13% vs 7%  and SNF 4% vs 18%.

Same store NOI growth profile will be stronger as higher growth business will represent higher share of NOI than before.  Pro-forma 2014 SS-NOI growth will improve from 3.9% to 4.3%.

Valuation

2014 NOI = $1.86B.  Unlevered FCF = $1.58B.  FCF = $1.1B. 

Base Case

The best comparable for CCP is OHI which is trading at a 6% dividend yield.  Both will be pure-plays on SNF with small and regional operator focus.  CCP will have lower debt/EBITDA ratio.  Assuming cost of debt = 4%, G&A at $23mm, and a 6.4% dividend yield, CCP is worth $12/share (# of VTR shares outstanding).

I assume VTR post transaction unlevered FCF to be $1.47B, and FCF/share of $2.95.  Assuming SS-NOI growth of 3%, with modest DOL and DFL, FCF/share growth should be in the 6 - 7% range.  Past 5 and 10 year CAGR of dividend/share growth was 7.7% and 8.6% respectively.  Using a discount rate of 8.5%, and a growth rate of 4.5%, VTR is worth $73.75.  Sum of the parts is worth $85.75.  The stock is trading at $64.5, representing 33% upside.

Bear Case

Cost of debt = 4.5% and 7.5% dividend yield; CCP is worth $10/share.  Assume FCF growth rate of 2.5% VTR is worth $49 and sum of the parts yields $59/share.

Recent Weakness

VTR is a great business run by a strong management team and supported by a demographic tailwind.  Nielsen forecasts 2015 - 2020 population growth in the US is to be 3.5% while the 75 years or older cohort is expected to grow 10.7%.  In VTR’s submarket weighted by NOI, 75+ population growth is expected to be 12.6%.

Mr Market had rewarded VTR and the stock is often priced at 20 – 30% above NAV.  Since the start of the year, the stock has declined from $80 to $64 due to issues that, in my opinion, are temporary.

First, the long end of the curve has steepened as the market expects the Fed to increase rate this year.  About 50% of NOI are from triple-net lease which investors view as similar to bonds.  Secondly, the strong returns from SHC have attracted new construction.  Recent data from NIC indicates that new supply is growing faster than demand.

Lastly, since 2010, management had taken advantage of the expensive stock price by issuing equity for acquisitions.  Its gross real estate book value grew from $6.7B in 2010 to $23B in 2014.  With the stock losing its premium to NAV, acquisitions become less accretive and thus hurt its external growth prospects.

Opportunity

From time to time, the market provides opportunities to investors with the stomach to ride out volatility and time horizon greater than the next 12 months.  VTR is such opportunity.

Triple-net lease is similar to bonds, but they are not the same.  The key difference is that VTR’s leases have fixed or CPI - linked escalators with caps and floors built into the leases.  Additionally, post transaction triple-net will only represent 40% of NOI.  Investors have over-reacted, in my opinion.  During the taper tantrum of 2013, VTR sold off from $83 to $55 and went back up to $80 in 13 months.

New supply in SHC could become an issue and it is difficult to quantify the impact at this point.  SHC represents 55% of NOI post transaction.  With the demographic tailwind and in the context of a 5 year time horizon, I am comfortable with the risk.

As to the last issue of bleak external growth as VTR cannot use its stock as cheap currency, my view is this: Debra the CEO has been through two recessions, periods of rising and declining interest rate, periods when the stock trade at discount to NAV, the last over-supply cycle in SHC during 1998 – 2001 and she has proven to be capable.  She is only 57 years old.  I am not worried about growth.

Market risk can be hedged by shorting HCN and OHI in ratio.  Please note that HCN is trading at 9 – 10% above NAV and OHI is trading at 26 – 30% above NAV while VTR is trading at NAV.

Risk

·         New supply can negatively impact the performance of SHC.

·         DOL is high at the tenant level.  While rent coverage ratios are strong today, they can deteriorate quickly.  HCP’s HCR Manor Care investment is an unfortunate example.

·         Materially higher interest rate would push up cap rates and discount rate.  My valuation numbers may turn out to be too high.

Catalyst

·         Closing of Ardent and CCP spin off.

·         25bps rate hike is priced in.  Stability in the treasury market should follow after the Fed hike rates.

If the Fed surprises the market by not hiking rates in 2H15, the 10 yr treasury yield should go down and this would work wonders for VTR