Ventas-NHP: Stellar Healthcare REIT?

|
 |  Includes: NHP, VTR
by: Zacks Investment Research

In concurrence with the ongoing consolidation in the REIT (real estate investment trust) industry that redefined the market dynamics, the healthcare sector witnessed a significant development when Ventas Inc. (NYSE:VTR) announced the acquisition of its rival Nationwide Health Properties Inc. (NYSE:NHP) in an all-stock deal.

The transaction, worth $7.4 billion, would create one of the largest publicly traded REITs in the U.S. and arguably the leading healthcare REIT as per value.

Since late 2010, publicly-traded REITs' easy access to the open market for funds has provided an impetus for increased accquisitions and mergers. Healthcare REITs had announced $11.25 billion worth of acquisitions in 2010, led by the $6.1 billion purchase by HCP Inc. (NYSE:HCP), the largest medical REIT in the U.S.

HCP acquired ownership interests in 338 post-acute, skilled nursing and assisted living facilities from HCR ManorCare Inc., a leading privately owned provider of skilled nursing facilities.

The latest acquisition by Ventas reinforces the buzz in the healthcare REIT industry, spurred by the aging Baby Boomer generation’s increased demand for assisted and independent living facilities. The combined entity would have a pro-forma equity market capitalization of approximately $17 billion and a pro forma enterprise value of approximately $23 billion.

According to the terms of the agreement, each Nationwide Health share will be traded for 0.7866 of Ventas' share. Based on the closing pre-bid stock price of Ventas on February 25, 2011, this would equate to $44.99 of Ventas stock for each Nationwide Health’s share, representing a premium of approximately 15% to the shareholders of the latter.

The transaction is expected to complete during the third quarter of 2011, when Ventas' shareholders are expected to own approximately 65% of the combined company and Nationwide Health shareholders are expected to own the balance 35%. The transaction is expected to be accretive to Ventas' recurring Funds from Operations (FFO) with immediate effect and Funds Available for Distribution (FAD) after the closing.

The merged entity brings two of the most complementary customer franchises together in the healthcare real estate market and gives way to a much diversified body with better scope. The merged company will have over 1,300 total assets in 47 states, the District of Columbia and two Canadian provinces at its disposal.

The combined portfolio would generate about 70% of the total net operating income (NOI) from private-pay sources, minimizing its dependence on government reimbursement rates.

Post-merger, senior housing segment would account for approximately 55% of the combined company's NOI, with skilled nursing facilities and MOBs (Medical Office Buildings) accounting for approximately 22% and 11%, respectively. The merger would strengthen Ventas' position as the largest owner of seniors housing assets in the U.S. and extend its national MOB footprint by 14 million square feet of owned and managed MOB space.

Furthermore, the transaction would result in a reduced leverage for Ventas, and the combined company is expected to have the lowest leverage in the industry, with a debt to enterprise value ratio below 30% and net debt to EBITDA ratio of 5x at closing.

The strong balance sheet of the merged entity is expected to improve its long-term cost of capital and credit profile, as both the participating companies have a track record of prudent balance sheet management.

In addition, the combined company's shareholders are expected to benefit from stable and secure dividend payouts from both companies. While Ventas has increased its dividend by 8% annually on an average since 2004, Nationwide Health also has established a reputaition of conservative capital management and cash returns to shareholders in the form of steady dividend.

According to data complied by Bloomberg, healthcare REITs are anticipated to produce the highest dividend payout in the REIT industry in first quarter 2011 buoyed by better-than-expected year-over-year revenue growth with accretive results from over $11 billion acquisitions announced in 2010.

Solid dividend payouts are arguably the biggest enticement for REIT investors, as U.S. law requires REITs to distribute 90% of their annual taxable income in the form of dividends to shareholders.

Healthcare REITs usually lease their facilities under "triple-net" master lease agreements, based on which the tenant pays all taxes, insurance, and maintenance charges for the properties, in addition to rent. This insulates the companies from short-term market swings that may adversely affect the operations of a particular facility, and creates a steady revenue stream.

Healthcare is relatively immune to the economic turmoil faced by office, retail and apartment companies. Consequently, healthcare REITs are well poised to retain their growth curves and simultaneously please the shareholders with a steady pick-up in dividends.

The CEO and chairman of Ventas will serve as the CEO and chairman of the combined company. Post-merger, Ventas will retain its corporate headquarters in Chicago, Illinois. The merger would arguably create a leading provider of healthcare facilities, with one of the most diversified portfolios in the healthcare sector and exposure to nearly all types of facilities. The transaction, therefore, is a win-win deal for both the participating companies.

We presently have a Neutral rating on both Ventas and Nationwide Health, which currently enjoy a Zacks #3 Rank that translate into a short-term "Hold" recommendation indicating that the stocks are expected to perform in line with the overall U.S. equity market for the next one to three months.