Call Start: 11:05
Call End: 11:41
Medical Properties Trust, Inc. (MPW)
Deutsche Bank 20th Annual Leveraged Finance Conference Call
October 11, 2012 11:05 AM ET
R. Steven Hamner - EVP and CFO
Henry Reukauf - Deutsche Bank
Henry Reukauf - Deutsche Bank
Good morning. My name is Henry Reukauf. I do healthcare research here for Deutsche Bank. And this morning we have Medical Properties Trust. They’re going to be presenting and Steve Hamner is the CFO of the company and he is here this morning. So Steve, take it on.
R. Steven Hamner
Thank you, Henry. Thank you all and those are listening on the webcast, I do want to thank Deutsche Bank for having us here. We appreciate it. This morning I’m just going to give a little bit of history because most of you probably have some familiarity with this. But I will give you a little bit of history about the Company and then little bit more detail recent history with the idea of bringing us to where we’re today and what our expectations are in the near and foreseeable future.
We’ve been – we capitalize the Company eight years ago, in 2004. We went public in 2005 on the New York exchange. Today we’re about a $1.5 billion, with almost $2.5 billion in total enterprise value. And that comes from zero. You all know – may remember we started the Company basically as a blunt pool. Myself, Ed Aldag, our CEO; and Emmett McLean, our COO are the three founders. And we’ve been with the Company and continue to manage the Company today.
We are the only healthcare REIT, in fact the only Company that we are aware of that focuses exclusively on financing hospital real estate. We buy hospitals, lease them back to the operators, we don’t do assisted living, we don’t do medical office, we don’t do skilled nursing, its licensed hospitals. General acute care hospitals, long-term acute care hospitals, and inpatient rehabilitation hospitals and we lease to the – to some of the strongest hospital operators in the country.
In fact 80% of our portfolio is with the top 10 operators in their field and by that the three characteristics or the three types of hospitals that I just mentioned. We like the hospital business for two reasons. We get to ask the question frequently why did you chose to do this? Because no one else does that and by the way that’s good and bad, that brings advantages and disadvantages. But why did we do it? Our management team all the way down to the lower levels of the Company came out of hospital operations, hospital finance, hospital financial planning and strategic planning.
So we know what goes on inside the buildings that we own. And we think that’s absolutely critical to be able to invest long-term wisely and profitably in hospital real estate. Because once a hospital goes dark for whatever reason its basically a catastrophe.
Now hospitals – and we will get into our underwriting in just a moment to try to describe how we avoid that happening. But hospitals are just like infrastructure in our view. If you purchase the right hospital, its just like the water works. It’s a community asset that has to be in a particular community. And that’s what we focus on when we underwrite.
There are about 5,000 hospitals in the U.S., not all of those are receptive too or appropriate for our financing, but many many of them are. We think that 5,000 hospitals equates to anywhere between $400 billion and $500 billion in value and very very little of that is owned by REITs or other institutions, less than 1% in fact. You compare that to the other types of real estate office, multi family retail REITs and other institutions own as much as 10% or 15% of the value of those types of real estate.
Hospitals are very stable. They very rarely close. Those that you read about closing are of a particular type. Usually they’re typically government owned. They’re not even built to make a profit because they’re built to serve truly the poorest of the poor. We don’t buy those hospitals.
Just going through some of this to try to speed it up a little bit, but again hospitals are a part of the community that they’re in. They’re very difficult to relocate. Hospitals don’t like to move. So when we underwrite a hospital that we purchase, that’s what we’re looking for. Many hospitals, we have hospitals not portfolio for example, they have parts of them that over a 100 years old. And they’re not going anywhere because there is a huge economy and communities that has built up around that hospital and there is nowhere else to go in those particular cases.
So it’s a very, very good business to be in. Despite what you may read, the hospital business is a good business to be in for those who know how to operate. The top 50 percentile of all hospitals in the country, talking about general acute care hospitals are very profitable. The top 25% are extremely profitable with operating margins in the high teens to high 20s. And those are the hospitals that we focus on.
Since the beginning in 2004 when I mentioned that we capitalize the Company, we grown from zero assets, we had zero contract and zero assets to today almost $2.4 billion. You will note there that during the credit crisis between 2008 and the early part of 2010 we stopped acquisitions. We had no issues, we had no cash flow issues, we had no maturity issues during that time, we were just afraid of what was going on in the world as was everybody else. So we put the breaks on acquisition.
Nonetheless we still have grown from the beginning of the Company by over 25% annually. In 2012, by the end of this year we will – we expect to have done – to have acquired $800 million in properties in 2012. Now if you average this out, that’s about $300 million or $400 million a year on average. And we will do $800 million this year. There is no reason to expect or no reason to think that we cant do that again in 2013. The market is huge, the opportunities are tremendous and we will get into the cost of capital issue in just a moment to show how the model works so very well for us.
These are some of our tenants and these tenants which many of you will recognize, most if not, all of them represent 75% of our income. The top operators in their respective field Prime Healthcare is among the top 10 for profit, acute care operators and I won’t go through each of these. Community Health the second largest and others that again I’m sure most of you’re familiar with. These are the types of tenants that we focus on and continue to do business with both these tenants and new tenants, new relationships every year. We are all over the country.
What this chart shows is our exposure, our concentration to any single property. Now we have two tenant relationships, Prime Healthcare and Ernest Health that represent about 20% each of our total investments. And that’s an important metric and we watch that obviously, but the more important metric than that is the individual exposure to a particular hospital because every single one of these hospitals is a business on to itself. Even though it maybe owned by a common operator, and we underwrite the business as a standalone hospital that can – that does do business on its own and you can see that no single facility represents even 5% of our total portfolio. And of course we expect that will continue to decline as we continue to grow the balance sheet.
This is very, very important to us. This is our EBITDA lease coverage ratio on average across the portfolio. And it shows that in 2006 that metric was 3.2 times. Our tenants generated EBITDA of 3.2 times our lease payments. By the end of this year, actually right now that coverage has grown to 5.5 times. Same portfolio now we’ve added some, but typically when we add then they come in at a lower coverage. So this is a truly phenomenal metric that demonstrates a couple of things. One, we know how to underwrite. We know how to buy hospitals at a high cap rate, 10% with 3.2 times coverage and choose operators that know how to operate hospitals, that operate them profitably, that grow them even through the worst economic conditions that any of us in this room have ever been through, towards a day they’re at a 5.5 times coverage.
Now there maybe questions later about the Affordable Care Act, about the Romney-Ryan Plan, about overall healthcare reform and our view is that it has at best an immaterial effect on hospital operations, but assume that we’re wrong and it has a more meaningful effect. We have a huge shock absorber here in this lease coverage ratio that would allow us to allow our tenants I should say, to absorb meaningful reimbursement losses and we still get paid our rent. Our rent by the way represents less than 5% typically of a hospital’s net revenue. So its not a high dollar amount on the income statement.
Speaking of healthcare reform, whichever form that takes on the one hand a controlled economy by a government with a single payer system versus something more can to the republic plans that goes more to free market, in either takes hospitals will be around. Hospitals aren’t going anywhere. General acute care hospitals are the key point of the healthcare delivery system and under all of the plans, they’re actually expressly named as that, the general acute care hospitals will be the gatekeepers.
This is the scale of acuity, typically that patients go through starting with the general acute care hospital where most patients will go for a few days and then depending on their conditions and their treatments maybe discharged to long-term acute care hospitals inpatient rehabilitation facilities and then on down the acuity scale into skilled nursing and outpatient setting. We focus again on the top three. These are licensed hospitals. You got to have a doctor’s prescription, a doctor’s order to get into these hospitals, that’s what we will continue to focus on. Not skilled nursing or assisted living or the downscale facilities.
Our hospitals, this is very important. We like to brag on this, but it really does mean something. A number of our hospitals are consistently awarded top performer status by the different measuring agencies. And this is quality of care, this is outcomes. What we find in our portfolio, and I think its true across the spectrum of healthcare delivery hospital systems, the better patient treatment, the better a patient comes out of a hospital, the earlier he comes out of a hospital, better treated, the more profitable that hospital is. Patients who need to go to these types of hospitals and thankfully it is these types of hospitals that generate the highest profits, the highest profit per patient, the lowest length of stay and overall the best outcomes.
This simply shows the different way of looking at our portfolio, 34 of our hospitals are general acute care, 27 long-term acute care and 18 inpatient rehab. This is temporarily skewed towards the post acute care facilities. We want this to be roughly 70% plus for the general acute care. In early 2012 we bought a portfolio of 16 post acute care hospitals and so that has skewed this to where today it’s about not by number of facilities, but by income, its about 50% general acute and 50% post acute.
So we expect that to move that up towards relatively more income coming from the general acute care hospitals and again that’s because those are the facilities that will direct a patients care not only while that patient is in the general acute care hospital, but as its discharged to long-term acute care or skilled nursing or whatever, the general acute care hospital under a concept its being tested now that generally called Accountable Care Organizations, general acute care hospitals will be penalized if they discharge patients and then we have to bring those patients back within a certain period of time. So they will have a much more control over the patient flow. Again, that’s why we want to be more focused on those.
Source of pay, how do we get our money? Of course our tenants pay us rent. Where they get the money to pay the rent? 50% comes from Medicare. Medicare is a good program, again not withstanding what you may read that its going bankrupt and clearly it will become insolvent if changes aren’t made. But relatively modest changes to the Medicare program, an extend to solvency of Medicare for many, many years beyond when its currently predicted to basically cross the line to insolvency.
Some of those changes are extending the retirement date, extending the track retirement age from 65 to 67. Over a pretty long period of time by the way Means Testing. Believe me Means Testing is coming from Medicare because one way or the other there is no political will now, but one way or the other when there is no money left these changes will be made. And Medicare will survive and it will be – will continue to be a strong payer.
Our facilities treat patients very profitably in Medicare. Now again, this is a little bit skewed toward Medicare, normally this would be 40%. But because of the 16 post acute care hospitals that we bought earlier this year, it’s skewed now more toward Medicare. Patients that go to those types of hospitals are typically elderly. They’re coming out with strokes, they’re coming out with multiple joint replacements, they’re coming out with – of brain and another dementia type issues. So this would normally be about 40% and the remainder would be private pay and when we say private pay, we are of course talking about employer based commercial health insurance, managed care and other types of indemnity or other insurance policies.
Medicaid makes up really less than 10% of our tenants revenue. And Medicaid is the – obviously the 50 different programs in each state and each one of them being insolvent now. Medicaid is funded through general tax revenues at the state and the federal level and so its subject to the budgeting process, its subject to highly political discussions whereas Medicare which certainly is not a stranger to controversy, but Medicare is funded with our payroll tax deductions, with premiums and to a lesser extend with general tax revenues.
Point being Medicare and private pay makes up virtually all of our tenants revenue that’s profitable revenue and that’s what lead to that 5.5 times coverage that I showed you earlier. Its important to us, we think especially the conference like this to point out, if you’re willing to invest in a hospital operator, equity or bonds MPT gives a much more secure repayment structure than the hospitals themselves, right. Because we have the asset that the hospital absolutely has to have and we have basically a first claim on every dollar that hospital get.
The first thing they need to pay, before salaries, wages and benefits it’s us. And again we’re not a very big component of what all they have to pay. So we have the ability to control that asset in our leases and virtually every single lease, we have the right to take action, to take that hospital back and bringing a new operator and a new tenant long before there is a payment default. And that’s typically triggered by a low EBITDA lease coverage ratio. For example, most of our leases if EBITDA falls below 1.5 times our lease payment, we have the right to begin taking our remedies, which include as I say bringing in a new manager, and actually terminating the lease and bringing in a new operator because the license goes with us. In our leases we have the right to assign their license to a new operator in the event there is a lease default.
I’ll just mention briefly that again that we underwrite every single asset as if we’re acquiring that particular business and it’s not just the real estate, it’s not even primarily the real estate. Obviously, we do all the real estate underwriting that you would expect, but we underwrite the operation. We underwrite the physicians that practice at that hospital, we underwrite the demographics, we underwrite the types of treatments that go on at that hospital and what the alternatives maybe for patients and physicians rather than practicing at that hospital.
Our number one criteria when we invest in a hospital is, does that particular hospital need to be in that community. What would happen to that community if that hospital went away; and if we can answer that question affirmatively that, yes this particular building, this hospital needs to be here otherwise patients won’t be able to be treated then that’s the key criteria. Then we look at the physician involvement and then finally we look at the operator. We underwrite the operators, he’s a good operator; does he have a good track record.
The point in that is that we can make a mistake on the operator in our underwriting. But if we don’t make a mistake on that first question, if that hospital needs to be there then somebody, some operator is going to be able to come in and operate it profitably and pay our rent and that’s the, obviously the bottom line to us. Thankfully, it rarely happens that we have to change an operator.
We have owned over a 100 hospitals since we capitalize the Company in 2004. Today we own 80 something. We’ve had truly less than a handful; I mean I could count them on less than five fingers of one hand when we’ve had to change the operator. When the operator has failed for whatever reason and we had to bring in a new operator. And we have always done that before there’s a payment default because we have the right to do that and we’ve always done that successfully, very successfully. We end up in every case, we have ended up with a better tenant, with better terms for our lease and in certain circumstances we’ve ended up actually an interest in the operator itself. So not only do we get strong lease returns on the real estate, we get the upside of operations for the operator and we’ll go through that in just a few minutes.
I mentioned the size of the market, talking about now our avenues for growth, how do we continue to do what we do, which by the way is simply we buy real estate from hospitals, we lease it back to the hospitals for an average of a 10% going in lease rate. And that 10% lease rate escalates every year typically by inflation. Sometimes it’s a collared inflation, such that the rent escalates at the inflation rate between 2% and 5% for example, but many times almost half the time, it’s an unlimited inflation area adjustment. So if inflation goes up 10%, we get 10% increase in our rent.
Now a lot of young people in this room, I guess, but you may not remember inflation can get to 10%, can get to a whole lot more than that and so we feel very protected by having those facilities. Now there’s a huge market and again we mentioned earlier that, what we would do this year over $800 billion and that market remains available to us in 2013 and beyond.
The second avenue for FFO per share growth is our investment in the hospital operations. So this is known in the REIT business you might have heard it as RIDEA. That’s an acronym for legislation that was passed in 2008 at the end of the Bush administration that allows Healthcare REITs to invest in their tenant, just like any other kind of REIT has always been able to do. Healthcare REIT can now invest in it. We can own 100% of our tenant, it just has to be structured in a taxable subsidiary, and we have done that to a very successful extent so far with minimum investment we’re earning outsized returns. This year we expect to earn $3.5 million to $4 million on these types of investments with a total investment of about $10 million.
So we made very little incremental investment and for logical reasons I can explain. We get upside on the operations. Just for example very briefly, a hospital where we had to replace the tenant in New Orleans, very good hospital, strong operations, strong profitability, never missed a rent payment, but its parent went into bankruptcy. Well that’s a default on our lease. The parent was the guarantor goes into bankruptcy, our lease is in default. We take our hospital back. And remember the license stays with us. So the operations stay with us. So we take the hospital back and now we have not only our real estate back, we’ve got a very profitable hospital operation where the legislation still doesn’t allow us to operate the hospital; it has to be operated by a third-party.
So we bring in that third party to own and operate the operations and yet we take 20% of the upside of those operations from the operator because we're able to deliver to that operator and up and running profitable hospital. So that’s – in that particular case we have a zero basis in this investment in operations and yet we’re earning a very, very nice return based on our 20% interest.
And this is basically what I have just mentioned, we own the real estate, we own part of the operations. It is a passive investment and to the extent that, that operations generate losses we have absolutely no responsibility to fund those losses, it’s only the upside.
We’re all over the country. I think I mentioned that, fairly well concentrated in big urban markets. These slides by the way will be on the website. Now that brings us to a really, what we want to point out very briefly. Again, going back to late 2008, looking into the [abuzz] along with the rest of the world as to what was going to happen in the financial market.
We cut the dividend by 25%, we didn’t need to, didn’t have to again because our tenants continue to pay our rent, continue to grow in fact in profitability during the entire credit crisis. But we cut the dividend, continued to pay it in cash by the way. Cut the dividend by 25%. We stopped all acquisition activities and we – between 2010 when we saw activities or we saw opportunities really beginning to come back into play.
We raised $1 billion in 2010 and early this year we raised over $1 billion in debt and equity capital. And you can see that on the balance sheet slide here on the left hand portion of this slide and we started to put that to work. And we put it work actually faster than we thought, such that now that entire $1 billion that we raised is totally invested. And in the second quarter we got the dividend back down below the FFO per share.
Now this is very important obviously especially to, well to any investor debt or equity investor. You can see during that period when we raise the capital before we put it to work, dividends upside down. Payout ratio approaches 120% in a couple of quarters, but we knew that would happen we could do the arithmetic. But we saw the opportunities, the acquisition opportunities, we saw the cost of capital and so we had – we decided to take the long-term view.
We raised the capital, we put it to work, it got to work faster than we thought. Such that today we sit with the dividend payout ratio now below 90%. We expect it will be at 75% by the end of the year and with no other acquisition activity, no other growth assumed for 2013. The payout ratio would stay at that 75% we have a better $6 per share in FFO per share. Obviously we don’t expect to do nothing. We don’t expect 2013 to be flat. We frankly expect it to be significant growth just like 2012 has been. Again we did 2000 – we did $800 million in 2012. We’re not projecting that. We haven’t given any projections in fact for 2013, but the market is the same in 2013 as it has been in 2012. So we absolutely expect continued growth and very profitable growth.
Again, look at the in-place cash returns right now on the entire portfolio. It ranges from the low 9% for our inpatient rehabilitation facilities to the high 10% range, 10.6% on average for our general acute care hospitals. We can still invest at rates like this. In fact our recent investments had been on the higher end of this scale. So we have got tremendous opportunities to invest at double-digit cash returns and on a GAAP basis if you could add roughly, generally 2% to be. So anywhere between 11% and almost 13% GAAP returns and we like to use cash because that’s what we use to pay the divided.
We had very little debt maturities, almost non in fact. 2016 we’ve got a total of $225 million outstanding that would need to be addressed and then not until after 2018 when we have $650 million two issues or 10 year bonds come due. We still have available today, almost $400 million on our revolver and that’s what we would use, what we are using now to fund in investments.
We have said that by the end of the year we’ll do another $200 million in acquisitions. We haven’t announced those acquisitions yet, but we're highly confident that we will in fact acquire another $200 million in acquisitions by the end of this year and that will come off the revolver, and at that point the revolver needs to be replenished.
This is a bit outdated, we used this chart for a road show a couple of weeks ago, but the point is the thing, these are our bonds trading, and this is called high yield. You guys know this better than I do, but our earlier bonds our bigger issue, its trading at about 4.75%. Unsecured 10 year, I mean for a REIT like – it’s almost free money, right. So you combine this and we’d love to take credit for this and we take some, but it’s mostly the [fit].
You combine this with our ability to buy at 10% plus cash cap rate. And our equity which we’re very protective of but certainly we could use, should we decide and we wouldn’t, but we could use 100% equity and still be investing highly accretively at very wide spreads with our going in cash returns. Now thankfully we don’t have to do that. Thankfully there’s a great debt market right now.
So we think all in, this kind of a debt market, reasonable, calculations on equity cost of capital, our all in cost of capital probably isn’t 7%. You saw how we invest. We invest at, on a GAAP basis, on average call it 12%, that’s a phenomenal spread that no other real estate sector can give you. And so why is that? Why are we the only one? Why do we get such high spreads? And the answer is, in our view it’s the total mispricing. It’s the total lack of knowledge in the market about the risk of investing in hospitals. And we think we have demonstrated over the last eight years that there is a great market for investing in hospitals. There is significantly less risk in our view investing in infrastructure type real estate like hospitals, then the areas in skilled nursing facilities and assisted living facilities, which again are very low return, in our view higher risk assets.
Let me just go through this and then we’ll see if there are any questions. This is how we want to manage the Company. How we had planned for the last several years on key metrics. Leverage which we define as total debt to undepreciated cost balance sheet; we want to be in the low 40s. We think that’s highly appropriate for a model like ours where we have no capital expenditure obligations; all of those capital expenditures are the responsibility of the tenants. We have got very, very long term assets with very long term leases, with very high quality credit tenants. So we think low 40s is a very prudent leverage measure for a REIT like ours.
By the end of this year, using the revolver as I just mentioned, we’ll be above that. We’ll need to bring that down. That’s certainly not a range for any type of alarm and we’ll be able to bring that down in any number of ways to certain property sales, equity issuance in retention of the dividend – of earnings I mean. And then on a cash flow basis debt to EBITDA we like that five times range and again we’re right on that as of the end of the second quarter and we’ll be right on that at the end of the year. And finally I have mentioned the payout ratio. For the same reasons that I just mentioned on the leverage, very, very predictable cash flow. Very limited if any bad debt and strong credit tenants. We think that 75% range payout ratio is where the dividend ought to live. And for equity investors that’s very exciting, because we’re there now.
We took the intentional dilution during 2009 and 2010. We put all of that to work. We knew what we were doing and we’re at the point now where we're at this 75%, it will be, that is by the end of the year and be able in a position if appropriate to begin raising the dividend. And all this does is, show again you would expect this, we’re a young Company.
We’re eight years old. We write 15 year leases typically, so we have very, very little lease maturity coming to. And by the way when leases do expire by their terms almost 90% or more of the time the tenants elect to renew those leases. Again hospitals don’t like to move, it’s very difficult to move a hospital typically speaking and so they have the option at the end of the 15 years to renew typically the lease provides three five year options for the tenant to renew and very typically that’s what happens.
One last comment here, I guess, we are not lease free basically, we have 35 people in the Company that manages almost $2.5 billion of assets and so it’s highly scalable. We could add $500 million in assets tomorrow and probably need two or three additional people. So you can see how the G&A has been coming down and we expect it to continue to come down.
If there are any questions, I would be happy to address them; otherwise I appreciate your attention.
Henry Reukauf - Deutsche Bank
Just a minute for one or two if there are any from the audience, I might – okay, go ahead.
What's your view about the LTACH reimbursement [inaudible]?
R. Steven Hamner
I couldn’t quite hear, but I think the question was, what's just our general view on LTACH and LTACH reimbursement? And we’re – I am not sure we would say bullish, but we’re certainly confident in the place that the LTACH plays in the delivery of care. As it’s really everybody now, the American Hospital Association, CMS itself has actually stated that the LTACHs play a significant cost cutting role in the delivery of care and we believe that the moratorium will be lifted at the end of the year and LTACH will start growing. I am getting a red signal here I think that means I am about to be cut off.
I’d be happy to address any questions later or call us. Thank you very much.
Henry Reukauf - Deutsche Bank